Constraints on the Market
The market, which is still in the early stages of development, suffers
from several deficiencies. Unlike developed markets where transactions
are financially driven, our market is dominated by merchant flows. There
is lack of depth and liquidity in the Spot as well as Forward Markets.
The forward rates reflect demand and supply rather than interest rate
differentials due to the absence of integration between the money and
forex markets and restrictions placed on borrowing/ lending in the
international market as well as on running overdrafts in the Nostro
accounts for periods beyond five days. On account of ceilings on open
position and gaps, there is a virtual absence of market making and
position trading ....... (Some major mind-set changes have taken place
in the Credit Policy dated April 15, 1997, which should considerably
ease these constraints)
Measures are therefore called for to strengthen the institutional
framework of the forex market by making it more competitive, improving
market making, expanding geographical coverage and strengthening
financial linkages.
On the Debt Market
Subjecting inter - bank liabilities (including CDs and Deposits) to CRR
has deterred the emergence of a deep and liquid term money market in
India as the surpluses and deficits tend to get equilibrated at the very
short end, resulting in high volatility of the "Call" market and all
interbank activity getting restricted to 13 days. The absence of such a
market inhibits the RBI from using the market to transmit signals
relating to its interest rate policy. It also results in difficulties in
banks managing their asset - liability mismatches and hedging their
interest risk.
It is recommended that CRR requirements on net Inter - bank liabilities
be removed to foster the development of a term money market. This would
no doubt imply that inter - bank assets cannot be offset for purposes of
reserve requirements. However, as observed, the netting concept is not
significant at the level of the individual banks where net inter - bank
assets are more than inter - bank liabilities, as in such cases inter -
bank liabilities are treated as zero rather than negative. Once the
reserve requirement is removed, participants other than commercial banks
may also be allowed to access the market for borrowings. This
recommendation has been accepted vide the Credit Policy dated April 15,
1997.