Primary and Secondary Market Segments of the Government Securities Market - Security Analysis and Investment Management

(a) Primary Market of Government Securities

Debt instruments are issued in the primary market where initially they are subscribed by the various investors who may not trade in them subsequently in the secondary market. The Reserve Bank of India issues government securities on behalf of the government.

The primary market operations of the Reserve Bank are mainly driven by the objectives of the debt management policy, which is to ensure funding of fiscal deficit from the market in a cost effective manner.

The primary market instruments are treasury bills and government dated securities. The central government mobilizes funds mainly through the issue of treasury bills and dated securities while state government does so solely through dated securities.

Treasury Bills

T-bills are short term obligations issued by the Reserve Bank on behalf of the Government of India through weekly and fortnightly auctions. Till 2000, there were 14-day T-bills, 91- day T-bills, 182-day T-bills, and 364-day T-bills. The 14-day T-bills were discontinued from May 14, 2001.

The 91-day auctions seek to manage the cash position of the government whose revenue collections are typically bunched towards the year end whereas revenue expenses are more evenly dispersed. Since April 1998, the practice of the notifying amounts in case of all auctions including 364-day T-bills has been introduced. The minimum denomination of 91-day T-bills is Rs.25,000 while that of 364-day T-bills is Rs.1,00,000. The 91-day auctions occur every Wednesday and the 364-day on Wednesday preceding the reporting Fridays (fortnightly). Auctions are open to all resident individuals and corporate. Settlement for the auction occurs on the following Friday for both 91-day and 364-day T-bills. In 2001-02, the dates of payment for both 91- day T-bills, and 364-day treasury bills had been synchronized so that they could provide adequate fungible stock of treasury bills of varying maturity in the secondary market.

Calendar for Auction of Treasury Bills Competitive Report, 2001-02

T-bills are issued through bidding wherein the competitive bidders are primary dealers, financial institutions, mutual funds, and banks. Besides these, individuals, corporate bodies, institutions, and trusts have been allowed to bid in government securities auctions. Bids can also be routed through both banks and primary dealers. Non-competitive bids are conducted to encourage participants who do not have sufficient expertise in bidding. The non-competitive bidders are state governments, municipalities, non-government provident funds, and other central banks. Non-competitive bids are kept outside the notified amount so that the non-competitive bidders do not face any uncertainty in purchasing the desired amount. Noncompetitive bidders are issued T-bills at the weighted average price determined in auction. The uniform price auction method is in use for selling T-bills. In such an auction, all successful bidders pay a uniform price, which is usually the cut-off price. There exists fixed calendars for auctions of all types of treasury bills and the auction is announced in advance through a public notification.

Government Dated Securities

The government of India securities are medium to long-term obligations issued by the Reserve Bank on behalf of the government to finance the latter’s deficit and public sector development programme.

Government securities are predominantly coupon bearing and the coupon is paid semi annually on a 30/360 days basis. However, there are floating rate or zero coupon securities also. No TDS is applicable. All government securities are SLR eligible. The central government securities are eligible for ready forward (Repo) facility, whereas state loans are not eligible for repos. These securities are highly liquid.

Primary Market Issuance of Government Securities

Government securities are issued either through (a) auction, (b) sale, or (c) private placement with the Reserve Bank. (a) Auction: Auction is a form of allocative mechanism whereby commodities and financial assets are allocated to individuals and firms, particularly in a market-oriented economy. The government’s preference for the auction system for selling securities stems from the ability of auctions to reveal more information about price determination and improve the allocation process. Auctions are designed to generate higher volumes for meeting the target market requirement without recourse to underwriting and/or devolvement, broaden participation to ensure that bids are not concentrated or skewed, and ensure efficiency through lowering the cost of borrowing for the government. In June 1992, the government switched from the fixed price tender offer to the auction system for sale of government securities. The government, as a part of its annual budget exercise, announces the borrowing programme for the financial year. The Reserve Bank, acting in the capacity of merchant banker for the government’s borrowing programme, raises money on behalf of the government by auctioning securities from time to time depending on the government’s need for money, interest rates, and liquidity in the banking system.

Non-Competitive Bidding

The Reserve Bank introduced non-competitive bidding with a provision for allocation of up to 5 percent of the notified amount in specified auctions of dated securities for allotment to retail investors on a non-competitive basis at the weighted average rate. The scheme was operational from January 14, 2002, with the auction of 15 year government stock. Retail investors such as individuals, firms, companies, corporate bodies, urban cooperative banks, institutions, provident funds, trusts, and any other entity as may be prescribed by the Reserve Bank are allowed to participate in auctions as non-competitive bidders. These bidders are required to submit their bids through banks and PDs. Allocation for non-competitive bidding is within the notified amount and if the amount tendered by the non-competitive bidders is less than the reserved amount, all participants receive the full amount and the shortfall is transferred to a competitive position. If the amount received is more than the reserved amount, a pro-rata allotment is made to applicants. A non-competitive bidder is permitted to submit only one bid in the auction with a minimum amount of Rs.10,000 and a maximum of Rs.1crore, Non-competitive bidders are issued securities at the weighted average price determined in competitive auctions. There does not exist a fixed calendar for auctions of dated government securities. However, the auction of a dated security is announced in advance through a public notification. The securities are issued to successful bidders in the form of stock certificates or by credit to their SGL account.

(b) Sale: Earlier, the Reserve Bank used to adopt the sale route instead of auctions. Here, the coupon rate and maturity are predetermined and the securities are sold to investors at par. This approach is used predominantly for state loans. Of late, some states have tried the auction method successfully. As part of its open market operations, the Reserve Bank often sells outstanding securities (devolved or privately placed with itself earlier) through its sale window at preannounced prices.

(c) Private placement with the Reserve Bank: There are times when there is very tight liquidity in the banking system or when investors expect very high yields on the one hand and on the other, the Reserve Bank to hold an auction/sale. The Reserve Bank then places the securities with it and funds the government. These securities are later sold in the market through its sale window at an opportune time. In this way, the Reserve Bank also signals its view on the interest rate. The Reserve bank’s ultimate objective is to move away from the primary market. Keeping this objective in view, a system of underwriting was oriented towards facilitating larger absorption by primary dealers.

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