1. RBI- A Full Service Central Bank 1.1 Cash and debt manager of Govt.

: national and subnational The Constitution of India gives the Executive Branch the powers to borrow upon the security of the Consolidated Fund of India or that of the respective State within such limits as may from time to time be fixed by Parliament or by the respective State Legislature by law. Under Section 17 (11) of the RBI Act 1934, the RBI is acting as an agent of the Central and State Governments for the management of public debt. Under Section 20 of the RBI Act, it is an obligation of the Bank to transact Government business including the management of public debt of the Union Government. Under Section 21, the Bank has the right to transact Government business in India. Under Section 21 (2), the Central Government has to entrust the Bank with the management of the public debt and with the issue of any new loans, on such conditions as may be agreed upon. Under Section 21 A, the RBI may undertake public debt management of State Governments by entering into an agreement. The Bank has established a Primary Dealer (PD) system for government securities, which are regulated by the Bank under Chapter III B of the RBI Act as applicable to non-banking institutions. The procedural aspects in debt management operations used to be governed by the Public Debt Act, 1944 and the Public Debt Rules framed thereunder. Such procedural aspects including the back office functions of public debt management are now governed by the Government Securities Act, 2006. The Internal Debt Management Department (IDMD)of the RBI conducts auctions for raising market loans, formulates calendar for primary issuance, decides the maturity profile of debt, designs the instruments and methods of raising resources, taking into account government's needs, market conditions, and

preferences of various segments, while ensuring that the entire strategy is consistent with the overall monetary policy objectives. The transactions connected with the public debt are decentralised and carried out in 14 regional Public Debt Offices (PDOs). They manage the registry and depository functions, including repayment and servicing functions, and keeping securities accounts

including the book entry form of ownership. The central accounts are maintained by Department of Government and Bank Accounts. Decisions on the implementation of the borrowing program, based on proposals made by the IDMD and market preference, are periodically taken by the Cash and Debt Management Committee of the Ministry of Finance (MoF) and the RBI. While this represents a formal working relationship between the MoF and the RBI, it is further complemented by regular discussions between the Ministrys Budget and Expenditure Divisions and the RBI. 1.2 Regulator of financial markets / products As per the notification of March 1, 2000 of the Government of India issued under the Securities (Contracts) Regulation Act (SCRA), powers have been delegated to the RBI for regulating government securities, money market securities, gold related securities, securities derived from these securities and repo contracts. As per Section 45W of the RBI Act, 1934, the Bank has the power, in public interest or to regulate the financial system of the country to its advantage, to determine the policy relating to interest rates or interest rate products and give directions in that behalf to all agencies or any of them, dealing in securities, money market instruments, foreign exchange, derivatives, or other instruments of like nature as the Bank may specify from time to time. The trading in Government securities on stock exchanges is regulated by the Securities and Exchange Board of India (SEBI). Under Section 3 (1) of the Payment and Settlement Systems Act, 2007, the RBI is the designated authority for the regulation and supervision of payments system in India barring stock exchanges or the clearing corporations of stock exchanges which are under the regulatory purview of the SEBI. 2. Debt Management during Crisis RBIs unique experience MSS : The Market Stabilisation Scheme (MSS), which is primarily used by the Central Bank for managing enduring nature of liquidity in the system especially liquidity infused by capitals flows, was used through

desequestering to partly fund the GFD alleviating pressure on fresh govt borrowings. An amount of Rs. 12,000 crore (Rs. 120 billion) was, accordingly,

transferred from the MSS cash account to the regular cash account of the Central Government in March 2009. Further, an amount of Rs. 28,000 crore (Rs. 280 billion) was de-sequestered from the MSS cash account in May 2009 against the approved market borrowing programme for 2009-10. The monetary policy maintaining appropriate liquidity in the system also helped debt management policy to complete such a large Govt borrowing programme in a non-disruptive manner in 2008-09 and 2009-10. The Reserve Bank responded by injecting liquidity in the system through conventional OMO, provision of liquidity through repos and term repos under LAF, unwinding of MSS balances and CRR reduction. The unwinding of MSS balances not only created scope for adequate liquidity expansion by the Reserve Bank without expanding its balance sheet in any significant measure, but the timing of the unwinding could also be modulated in such a way that the large borrowing programme of the government was managed smoothly without exerting undue market stress. The cumulative impact of the various liquidity measures put in place since mid-September 2008 augmented actual/ potential liquidity in the system on the aggregate by Rs. 561,000 crore (Rs. 5610 billion) up to September 2009. Reliance on T Bills : As issuance of Govt dated securities was already bloated, it was difficult to fund the large increase in gross fiscal deficit (GFD) entirely through dated securities during 2008-09. Thus, debt managers in consultation with Central Government resorted to usage of Treasury bills to partly fund the increased GFD. The net issuances of Treasury Bills during 2008-09 amounted to Rs. 69,564 crore, contributing to financing 21.3 per cent of GFD (as per the revised estimates) as against a negative contribution of 1.8 per cent to GFD financing in 2007-08 (-Rs. 2301 crore). Shortening of maturity: India had sufficiently long weighted average maturity of the outstanding public debt (i.e. 10.59 years as on end-March 2008) and this provided an opportunity to the debt manager to shorten the weighted maturity for lowering effective borrowing cost without compromising rollover risk. Accordingly, the weighted average maturity of the dated securities issued during 2008-09 and 2009-10 was shortened, which in turn helped in

moderating somewhat the weighted average yield on the dated securities issued during this period. The average maturity increased to 11.62 years in 2010-11 from 11.16 years in 2009-10. Multiple Calendars: The gross market borrowing programme of the Central Government (dated securities and 364-day Treasury Bills) was about 181 per cent of the budget estimate for 2008-09 and the net borrowing, about 210 per cent of the budget estimates. During the first half of the year, the auctions for dated securities were broadly in accordance with the relevant issuance calendar. For the second half, though, three additional calendars were issued in supersession of the scheduled issuance calendar, which became necessary to meet the additional expenditure approved under supplementary demands for grants. The weighted average cost of market borrowings moved upwards up to August 2008 but decelerated subsequently, up to January 2009, largely reflecting the pattern in monetary policy rates. Due to higher than expected borrowing programme by both the Central and the State Governments, however, the weighted average cost of borrowings moderately increased thereafter. For the year as a whole, the weighted average yield was lower than in 2007-08. Issuance of G- Sec on a back to back basis to Open Market Purchase : Brazil, another emerging market (EME), also faced challenges in sovereign debt management during crisis. There was an upward spike in yield of Govt bonds as foreign investors sold off these bonds. In view of this, Treasury effectively conducted simultaneous buyback and sell auctions of bonds and these interventions were quite successful in stabilizing yield immediately. In India, we also witnessed some upward spike in yield of Govt bonds on account of liquidity tightening, resulting from large scale capital flow reversals, and not because of sell off pressure from foreign investors as their exposure in Govt bonds remain insignificant. However, exposure limit of FIIs in Govt bonds has been enhanced from US$ 5 billion to US$ 10 billion recently. The measures undertaken by Reserve Bank of India to make available sufficient liquidity in the system helped in containing hardening of yields. The feedback from the banks and PDs indicated that floating rate bonds (FRBs), by reducing their portfolio duration, could insulate investors from the

interest rate risk and enable them to undertake asset liability management in a more effective manner. It was also felt that the FRBs could turn out to be cost effective for the Government vis--vis fixed rate bonds. The product design of FRBs was changed in consultation with the market participants, permitting re-issuance of FRBs, and thereby enabling build up of liquidity. Accordingly, the Reserve Bank, after a gap of 5 years, issued 11-year FRBs on December 21, 2009. Subsequently, FRBs were reissued on January 25 and April 26, 2010. In India, primary dealers (PDs) are committed to underwrite minimum 50 per cent of the notified amount and additional 50 per cent of notified amount is underwritten by them through auction. So, PDs underwrite 100 per cent of the notified amount of Govt dated securities and they are paid commission for this. It may be pointed out that PDs played a vital role in successful completion of large increase in Govt borrowings during the crisis period. Reserve Bank as a debt manager increased the communication with market participants through press releases, meetings, publications to assess their requirements as well as to inform them about evolving circumstances and policy decisions. For instance, a bi-monthly meeting with PDs and other market participants was started. SDL bunching : Keeping in view the requirements of cash management, private credit off-take, management of State debt, etc, the borrowing calendar of GoI has generally planned to raise 60% or more of the annual market borrowing in the first half of the financial year, avoiding bunching of issuances. Bunching of SDL issuances in the fourth quarter of 2008-09 in pursuance of counter-cyclical measure in the wake of global financial crisis resulted in higher cost of borrowing as reflected in higher spread of 236 bps over and above the comparable GoI dated securities yield. Subsequently, the issuances of SDLs were spread across the year evenly, bringing down the spread to 45 bps in 2010-11 from 86 bps in 2009-10. While efforts are currently on towards designing an SDL calendar, SDL auctions are now being carried out once in a fortnight, imparting an element of predictability in SDL issuance. SDL spread:

3. Post Crisis challenge in debt management Huge borrowing : The expansionary stance of the fiscal policy eventually resulted into higher govt market borrowings during 2008-09 and 2009-10. The gross market borrowing of the GoI was estimated at Rs. 149,780 crore (Rs. 1497.80 billion) in the Union Budget 2008-09, which was aimed at carrying forward fiscal consolidation path set in over the last few years. However, actual Govt market borrowings during 2008-09 amounted to Rs. 273,666 crore (Rs. 2736.66 billion), significantly higher (about 83 per cent) than the budget estimates. The gross market borrowing further increased by around 65 per cent to Rs. 451,000 crore (Rs. 4510 billion) during 2009-10 reflecting continued expansionary fiscal stance. It was really challenging for the debt manager to accomplish such a large Govt market borrowings programme in a non-disruptive manner especially in an environment of uncertainty and heightened risk aversion among investors in the backdrop of intensified volatility in financial markets. The gross market borrowings of the GoI for the current financial year (2010-11) are projected at Rs. 4,47,000 crore and of which about 84 per cent has been raised successfully so far. The aggregate amount raised during the first half of 2008-09 (April-March) was Rs.1,06,000 crore, which was Rs.10,000 crore more than the amount indicated in the issuance calendar. The issuances were largely in accordance with the calendar for the first half of the year. The auction schedule for the second half of 2008-09 was, however, revised upward due to the increased demand for liquidity as well as the substantial increase in Government borrowings. Due to the sharp increase in government spending and deceleration in tax revenues, the Reserve Bank, in consultation with the Central Government, issued three additional indicative calendars on December 5, 2008, January 6, 2009 and February 10, 2009 and accordingly, Rs.1,16,000 crore additional (about 42 per cent total borrowing during 200809) was raised between December 2008 and March 2009. The borrowings of sub-national governments also increased by two-thirds approximately during 2008-09 as compared to 2007-08 as they also undertook counter-cyclical measures in the back of global crisis. The subnational governments raised a gross amount of Rs. 118,138 crore (Rs.

1181.38 billion) from market during 2008-09. During 2009-10 also, despite an increase in borrowing requirements, the sun-national governments completed their market borrowing of Rs. 131,122 crore (Rs. 1311.22 billion) smoothly given the comfortable liquidity conditions in the market. Need for streamlining SDL issuance Need for strengthening the PD system Need for continued coordination with monetary / liquidity policy : Notwithstanding the relatively lower budgeted market borrowings of the Central Government in 2011- 12, managing the borrowing programme would be a challenge in view of tight liquidity conditions and high level of excess SLR holdings of the banks and nonavailability of MSS securities for unwinding. Accordingly, the conduct of the market borrowing programme will be influenced by the ability of the Government to rein in the fiscal deficit and its financing by way of market borrowings at the budgeted level coupled with the monetary policy actions that anchor inflationary expectations. 4. Development and regulation of financial markets / products

Plugging in regulatory gaps: Launching of new product with safeguards Reintroduction of IRF Information and transparency practices World class payment and settlement system: An efficient and well run
payment system is sine-qua-non for the efficient functioning of any economy. The smooth functioning of the market infrastructure for enabling payment and settlement systems is essential for market and financial stability, as also for economic efficiency, and for the smooth functioning of financial markets. The settlement of government securities transactions in secondary market is being done on a Delivery versus Payment mechanism (DvP) (mechanism which helps to eliminate the risk that the seller will give out securities but not receive corresponding funds from the buyer and vice versa) in the books of RBI since 1995. In July 1995, when this mechanism was first introduced, the RBI followed DvP-I mechanism wherein both securities and funds are settled on a gross basis (that is, each transaction is settled individually). Though this helped to reduce the risk as stated above, it still did not provide an arrangement whereby settlement failures did not take place i.e., defaults in settlement of SGL transactions. The Clearing Corporation of India Limited (CCIL) which started its

operations along with NDS from February 15, 2002, acts as a central counterparty and provides guaranteed settlement of transactions in government securities to its members (all NDS members are members of CCIL). This aspect of CCIL, which acts as a clearing house for government securities transactions, takes care of the risk of default to trading members mentioned above. With CCIL stepping in to provide guarantee for settlement, the risk of settlement failures in government securities market has been mitigated to a great extent thereby providing further fillip to secondary market transactions. The CCIL has in place risk management systems to limit settlement risk and operates a settlement guarantee fund (SGF) backed by lines of credit from commercial banks. The contributions to SGF are made by the members. Daily exposure limits are monitored and requirements for additional margin contributions from members are calculated by CCIL and obtained from respective members. The transactions in secondary market for government securities are obtained by CCIL from the NDS as well as the NDS-OM systems. These transactions are then cleared, exposure limits calculated, margin contributions obtained from members and then net obligations of the members are arrived at by CCIL for both funds and securities. The obligations for both funds and securities are then sent to RBI Mumbai for settlement under DvP mechanism. When CCIL and NDS were initially operationalised, the system of DvP-II mechanism was followed wherein securities were settled on a gross basis while funds were settled on net basis (setting off receipts and payments). Since April 2, 2004 the DvP-III mechanism is being followed whereby both securities (security-wise) and funds are netted. This helps to reduce liquidity requirements for settlement. The securities obligations are settled at Mumbai PDO in the Securities Settlement System and the funds are settled in Mumbai DAD. Enhanced FII limit in tune with Financial Stability : FII investment limit in G-Secs has been raised from $ 5 billion to $ 10 billion, additional $5 billion investment would in securities with residual maturity of over five years. The enhancement of FII limit in G-Sec would not lead to volatility in the g-sec market because the present policy would prompt the FIIs to invest in medium to long term g-secs and due to the provision of withholding tax on repatriation of interest income, situations of volatile outflows from the g-sec market would be pre-empted and therefore it will not lead to volatility in yields in the g-sec market. Self Regulation: Currently, the element of self regulation is provided in the market through the medium of Fixed Income Money Market and Derivatives Association of India (FIMMDA), Primary Dealers Association of India (PDAI) and Association of Mutual Funds of India (AMFI). Though there is no regulatory oversight of RBI over these SROs, the RBI is engaging them in a consultative process. FIMMDA and PDAI have served as crucial

layers between the regulator and the market, and have contributed to developing new benchmarks and products in addition to providing training and development support to the market participants. They have formed guidelines for dispute resolution mechanisms and developed standard practices and codes of conduct for market players. FIMMDA has been associated closely with RBI in bringing about uniform accounting practices for repos / ready forward contracts and master repo agreements used by participants. Both FIMMDA and PDAI are represented in the Technical Advisory Committee of the RBI on Government Securities and Money Markets. FIMMDA is also involved in the task of valuation of all Central Government securities.