5 Development of Securities Markets: The Indian Experience

Figure 5.6. Market Loans and Interest Rate of Central Government Borrowing
Rupees (thousand crore)
Weighted average interest rate (percent)
900
800
700
600
500
400
300
200
100
0
20
15
10
5
0
1980–81 1982–83 1984–85 1986–87 1988–89 1990–91 1992–93 1994–95 1996–97 1998–99 2000–01 2002–03 2004–05
Weighted average cost
(right scale)
Inflation (WPI)
(left scale)
Market loans
(left scale)

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©International Monetary Fund. Not for Redistribution
Narendra Jadhav 131
ties was lengthened to 15 years in 2003–04. Availability of ample liquid-
ity enabled the reserve bank to lengthen the maturity of gilt issuances, 
with substantial reduction in weighted average yield from 13.7 percent in 
1996–97 to 5.7 percent in 2003–04. Strikingly, the auctioning system has 
facilitated a market-related softening of the interest cost of government 
borrowing as opposed to artificial lowering of the interest cost in the pre-
reform-administered interest rate regime.
On the demand side, the investor base for government securities has 
widened from commercial banks, financial institutions, and provident 
and pension funds to co-operative banks, regional rural banks, mutual 
funds, and nonbank financial companies in recent years. The reserve 
bank’s share of the total stock of government securities has steadily 
declined, reflecting its sterilization operations as well as its policy of keep-
ing private placements and devolvements on its own account to a mini-
mum. Strikingly, despite SLR reductions, banks have been voluntarily 
maintaining gilt investments much above the stipulated levels, especially 
during phases of slack in credit time, slowdown in the demand for credit 
and market expectations of interest rate softening. Mutual funds dedi-
cated exclusively to investments in government securities or gilt funds 
have been set up to encourage retailing of gilts. Furthermore, a scheme of 
noncompetitive bidding reserving for individuals up to 5 percent of the 
auctions’ notified amounts was introduced in January 2002.
These developments have enabled the evolution of a smooth yield curve 
in the government securities market. The maturity of the yield curve 
has gradually lengthened in recent years. Persistent rallies in govern-
ment securities prices have progressively shifted the yield curve down.
Furthermore, with the prevalence of liquidity overhang and the repur-
chase (repo) rate as an anchor of short-term rates, the yield curve has 
progressively flattened in the past few years (Figure 5.7). Transactions in 
the secondary market in the government securities market have expanded 
at a phenomenal pace, increasing from Rs. 1, 22,942 crore in 1996–97 to 
Rs. 2,723,621 crore in 2004–05. The sharp increase, especially in recent 
years, reflected a sustained rally in the prices of the government securities 
market as well as increased use of the repo market.