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April 19, 2001
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Fund managers stumped, seek new avenues to park funds

Priya Ganapati in Bombay

The Reserve Bank of India's Monetary and Credit Policy for 2001-02 has sent fund managers and asset management companies scurrying to find alternatives to park their surplus funds.

The RBI declared that steps would be taken to move towards a pure inter-bank call money market. It also announced that settlement in government securities would be on a T plus1 basis, as opposed to the T = 0 basis that is prevalent today.

Together these two announcements have fund managers donning their thinking caps and looking for alternatives to the call money market.

While these directives have not entirely been unexpected, the fact that non-banking non-bank institutions like financial institutions, mutual funds and insurance companies have to now finally move out of the call money market, seems to slowly sink in.

Currently mutual funds are permitted to lend directly in the call/notice money market. But on the recommendations of Narasimham Committee II, the RBI had formed a technical group, which included representatives from RBI, non-banks and banks to recommend a strategy for gradually phasing out non-bank participation.

The group submitted its report in March and based on that the RBI has announced a four-step process to be implemented by the end of this year.

As per stage I, with effect from May 5, 2001 non-banks would be allowed to lend up to 85 per cent of their average daily lendings in call market during 2000-01. Soon, this is expected to be reduced to 10 per cent and finally non-banks will not be permitted to lend in call/notice money market.

Also, the RBI has removed immediate settlement on the call money market. Currently, transactions in government securities are required to be settled on the trade date or next working day unless the transaction is through a broker of a permitted stock exchange in which case settlement can be on T plus 5 basis.

But with effect from June 2, 2001, all transactions settled through the delivery versus payment system of RBI will be on T plus 1 basis.

Through this RBI expects to provide a certainty to market participants in respect of demand for settlement funds for securities transactions on the day of settlement. It estimates that this will improve cash and liquidity management among money market participants and have a stabilising influence on the call money market.

But the result of this diktat is that fund managers have a surplus on day one they cannot immediately park their money and will have to wait for day two to deploy their funds. Fund managers also do not have access to buying government access on T = 0 basis.

All this means that mutual funds and other non-bank entities would have to look for alternatives to park their surplus money.

But the RBI's directive is in line with international market practices.

An estimated 90 per cent of the transactions in the US are settled on T plus 1 basis. Which means that mutual funds, financial companies and insurance companies participate actively in the repo market rather than the call money market.

However, the lack of a vibrant repo market can lead to problems in India. The repo market in its current form is viewed to be extremely cumbersome when compared to the call money market.

"The RBI has not yet provided anything concretely on the repo market front. The RBI has promised some measures on that front but it is going to be difficult for non-bank entities to function with no access to the call money market," Nilesh Shah, chief investment officer Templeton Asset Management Limited told

The RBI is trying hard to assuage the fears of Shah and others of his clan. It has proposed the establishment of a Clearing Corporation by which repo operations would become more efficient. The RBI has also promised that it would become to undertake repo transactions in non-government securities.

It envisages that eventually both call money market and repo/reverse repo market combined with market for other money market instruments like term money, commercial paper, certificates of deposit and treasury bills would constitute an integrated market for equilibrating short-term funds for both banks and non-banks.

"It is true that there is not a conducive repo market now but there are steps being taken to get there. Also, we were expecting this transition from call money market to repo to happen at some time or the other. This is not unexpected as it was being discussed for the last six months. The RBI had called us for a meeting on this and these steps have been taken only after taking our views into account," says an assistant vice-president with Birla Sun Life Asset Management Limited.

While he conceded that it would take some time to adjust to the repo market, he is satisfied with the measure taken by the RBI to ensure smooth phasing out of non-bank institutions from the call money market.

"We are still working out our numbers to see if our lending for this fiscal is below 85 per cent as stipulated in the policy. The numbers are not clear yet but I think we should be able to meet the conditions," he assured when asked if Birla Sun Life would be able to comply with RBI's directive.

But fears about the consequences of having an immature repo market coupled with T plus 1 settlement period is gnawing away the debt fund managers.

"There is definitely going to be a little impact on the returns provided by mutual funds. However, this will be quite insignificant. But in a money market every paisa counts so we have to work out measures to get over this situation," Shah laments.

Others are, however, more optimistic. "You can plan things one day in advance. Though it is going to be quite difficult I am sure it can be done," says the senior executive from Birla Sun Life.

Sandesh Kirkire, vice-president (fixed income and securities), Kotak Mahindra Asset Management, seconds this. "As the fund manager I am always aware of the inflow so according to it I can take the position for the next day. But of course, there is the facility of 24 hours redemption which we cannot provide in the future. The flexibility of 24-hour redemption will be lost. What we will try to do is provide redemption on T plus 2 basis and give the investor NAV on T plus 1 basis," he explained.

Thus, the overall sentiment in fund managers seems to be positive.

"The setting up of the Clearing Corporation is expected to impart greater transparency to the Debt, money and foreign exchange markets.

This, along with other changes, will allow greater flexibility to the RBI in fine tuning it's short-term interest rate indications, ease settlement procedures considerably and contribute to increased market efficiency," elaborates Milind Barve, managing director, HDFC Mutual Fund.

"With these measures the RBI is trying to make the market more collateralised. These steps would ensure that the market is strong and to an extent becomes more robust," Kirkire declares.

Though he admits that the repo market is more difficult to work in than the call money market he is confident that the steps taken by RBI would make it attractive soon.

"In this policy, what the RBI is trying to do is force funds like us to get into the repo market. The repo market being slightly more cumbersome was being avoided by us. Another reason that the call money market was being preferred is that investors wanted clear, easy money and borrowers too were comfortable giving it that way. However, the new system will bring in greater strength to the markets," he explains.

But another consequence of having a pure inter-bank call money market is the fear that it will create a monopoly of large lenders in the system.

"Normally, non-bank financial institutions act as a counter to large lenders like nationalised banks. Borrowers sometimes depend on these institutions to prevent a monopoly. But now the nationalised banks might be in a position to control the market. It is a very small possibility, but the possibility is still there," Shah warns.

The rest of the credit policy seems to run along expected lines and except for these clauses the sentiments to the policy seem to be fairly neutral.

While managers are happy that the forecast on the economy is fairly positive and the RBI has taken measures to fortify the weakest link in the chain--the co-operative banks-- there seems to be little enthusiasm over the rest of the announcements.

"Frankly speaking, the credit policy this year was a non-event. Most of the important pronunciations like cut in interest rates had already been made. And the rest of the announcements were along expected lines. In all, its an average policy with no surprises," the senior executive from Birla Sun Life Asset Management Limited said.

Monetary & Credit Policy 2001-2002 (First Half)
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