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Government securities

A Government security is a tradable instrument

issued by the Central Government, State

Governments or Semi-government (including

local authorities like city corporations andmunicipalities, autonomous institutions like port

trusts, improvement trusts, state electricity

corporations, public corporations and other govt

agencies like IDBI, IFCI, SFCs, NABARD, LDBsetc). It acknowledges the Governments debt

obligation.

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Types of government securities

Central government can issue

Treasury Bills

Government dated securities or bonds Special rupee securities for paying India's

subscription to IMF, IBRD, ADB, IDA and

so on. Non-negotiable and non-interestbearing claims

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cont..Special Securities: Government of India also

issues, from time to time, special securities toentities like Oil Marketing Companies, Fertilizer

Companies, the Food Corporation of India, etc.,as compensation to these companies in lieu ofcash subsidies.

These are

usually long dated securities, , not eligible asSLR securities but are eligible as collateral formarket repo transactions.

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cont.. STRIPS (Separate Trading of Registered

Interest and Principal of Securities) : The

instruments wherein each cash flow of the fixed

coupon security is converted into a separatetradable Zero Coupon Bond and is traded. For

example, when Rs.100 of the 8.24% GS2018 is

stripped, each cash flow of coupon (Rs.4.12

each half year) will become coupon STRIP andthe principal payment (Rs.100 at maturity) will

become a principal STRIP.

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cont.. State governments can issue only bonds

or dated securities, which are called the

State Development Loans (SDLs).

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Dated Government Securities

Dated Government securities are long

term securities and carry a fixed or

floating coupon (interest rate) which ispaid on the face value, payable at fixed

time periods (usually half-yearly). The

tenor of dated securities can be up to 30

years.

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Coupon : 7.49% paid on face value

Name of Issuer : Government of India

Date of Issue : April 16, 2007

Maturity : April 16, 2017

Coupon Payment Dates : Half-yearly (October16 andApril 16) every year

Minimum Amount of issue/

sale: Rs.10,000

Nomenclature of a dated fixed coupon Government security containsfollowing features - coupon, name of the issuer, maturity and face value.

For example, 7.49% GS 2017 would mean

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6.05% GS 2019 FEB,

6.05% GS 2019 JUNE,

Nomenclature of G-Secs

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Payment days for coupon and

redemption proceeds If the coupon payment date falls on a

Sunday or a holiday, the coupon payment

is made on the next working day.

if the maturity date falls on a Sunday or a

holiday, the redemption proceeds are paid

on the previous working day.

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Types of dated G-secs

Fixed Rate Bonds Bonds on which the

coupon rate is fixed for the entire life of the

bond. Most government bonds are issued

as fixed rate bonds.

For example: 8.24% GS2018 was issued on

April 22, 2008 for a tenor of 10 years

maturing on April 22, 2018.

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Types of dated G-secs cont..

Floating Rate Bonds Bonds on whichcoupon is re-set at pre-announcedintervals (say, every six months or one

year) by adding a spread over a baserate*.

* Usually base rate is the weighted averageof cut-off yield of the last three 364-dayTreasury Bill preceding the date of issue ofthe g-sec

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Zero Coupon Bonds Zero coupon bondsare bonds with no coupon payments butare issued at deep discount and redeemed

at face value. Inflation Indexed Bonds Bonds on which

amount of principal is linked to an

accepted index of inflation (say, WPI) witha view to protecting the holder frominflation.

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Bonds with Call (buy-back) and Put (sell)

Options at par value.

T

he option on the bond can usually beexercised after completion of five years

from the date of issuance on any coupon

date falling/due.

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Forms of government securities

Stock certificates

Promissory notes

Dematerialized forms by openingSecurities General Ledger (SGL) account

with RBI

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Government securities as

promissory notes

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Mode of issuing G-secs

Issued by Public Debt Office (PDO) of the

Reserve Bank. It acts as the registry / depository

of Government securities and deals with the

issue, interest payment and repayment ofprincipal at maturity.

Issued by inviting applications from the public

unlike auctioning ofT-Bills

No prospectus is issued rather app are invited

by giving press communiqu by RBI

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Mode of issuing G-secs cont..

The budgeted amount of issue in a givenyear is raised in tranches so as to avoidflooding of market with these securities

that in turn may lead to crowing out ofprivate sector.

In case of SDLs, oversubscription of one

state govt can be transferred to other govtwhere loan is still open for subscription atthe option of subscriber.

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Mode of issuing G-secs cont..

On tap stocks: No single date for issue

and redemption as the size of the issue is

huge and continuous. RBI purchases and

gradually sells. Similarly, gradually buys

and redeem the securities until a small

portion of the securities remain

outstanding. Hence, process of issue andredemption is continuous.

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Participants of G-sec market

Central, state and semi government authoritieswhere holdings represents inter govt transfer offunds.

Banking sector comprising of RBI, SBI, other commercial banks, RRBs, Co-operative banks,NABARD

Insurance companies

Primary dealers

Provident funds and Pension funds FIIs with quantitative limits

Companies to manage their portfolio risk

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Issuing process of G-secs

Earlier the interest rates were

administered but now these are fixed by

inviting bids from the participant through

auctions.

An auction may either be yield based or

price based.

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Issuing process of G-secs cont..

Yield Based Auction

A yield based auction is generally conducted

when a new Government security is issued.

Investors submit bids for yield up to two decimal

places (for example, 8.19 per cent, 8.20 per

cent, etc.).

Bids are arranged in ascending order and the cut-off yield is arrived at the yield corresponding to

the notified amount of the auction.

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The cut-off yield is taken as the coupon rate

for the security.

Successful bidders are those who have bidat or below the cut-off yield.

Bids which are higher than the cut-off yield

are rejected.

For instance, notified amount was Rs. 1000

cr.

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Details of bids received in the increasing order of bid yields

Bid No. Bid YieldAmount of bid (Rs.

crore)

Cummulative amount

(Rs.Cr)

1 8.19% 300 300 Accepted

2 8.20% 200 500 Accepted

3 8.20% 250 750 Accepted

4 8.21% 150 900 Accepted

5 8.22% 100 1000 Acc+prop

6 8.22% 100 1100 Acc+prop

7 8.23% 150 1250 Rejected

8 8.24% 100 1350 Rejected

The issuer would get the notified amount by accepting bids up to 5. Since the bid

number 6 also is at the same yield, bid numbers 5 and 6 would get allotment pro-rata

so that the notified amount is not exceeded. In the above case each would get Rs. 50

crore. Bid numbers 7 and 8 are rejected as the yields are higher than the cut-off yield.

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Successful bidders are those who have bid

at or above the cut-off price.

Bids which are below the cut-off price arerejected. An illustrative example of price

based auction is given below:

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Details of bids received in the decreasing order of bid price

Bid no. Price of bidAmount of bid

(Rs. Cr)

Cumulative

amount

1 100.31 300 300 Accepted

2 100.26 200 500 Accepted

3 100.25 250 750 Accepted

4 100.21 150900

Accepted5 100.20 100 1000 Acc+prop

6 100.20 100 1100 Acc+prop

7 100.16 150 1250 Rejected

8 100.15 100 1350 Rejected

The issuer would get the notified amount by accepting bids up to 5. Since the

bid number 6 also is at the same price, bid numbers 5 and 6 would get

allotment in proportion so that the notified amount is not exceeded. In the

above case each would get Rs. 50 crore. Bid numbers 7 and 8 are rejected as

the price quoted is less than the cut-off price.

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An investor may bid in an auction under either ofthe following categories:

Competitive Bidding: In a competitive bidding, an

investor bids at a specific price / yield and isallotted securities if the price / yield quoted iswithin the cut-off price / yield.

Competitive bids are made by well informed

investors such as banks, financial institutions,primary dealers, mutual funds, and insurancecompanies.

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Non-Competitive Bidding: With a view toencourage the participation of retail investors, anopportunity is given to them participate in theauction process, through the scheme of non-

competitive bidding (introduced in January2002).

Non-competitive bidding is open to individuals,HUFs, RRBs, co-operative banks, firms,companies, corporate bodies, institutions etc.

Under the scheme, eligible investors apply for acertain amount of securities in an auction withoutmentioning a specific price / yield.

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Such bidders are allotted securities at the

weighted average price / yield of the

auction.

In every auction of dated securities, a

maximum of 5 per cent of the notified

amount is reserved for such non-

competitive bids.

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Trading of G-secs

Till 2002, OTC market where trading of theGovernment securities was done telephonicallybetween buyer and seller.

Buyers and sellers have to physically submitttheir transfer forms for transfer of theGovernment securities and cheques forsettlement of the funds to the Reserve Bank ofIndia.

Manual operations being inefficient and oftenresulted in delays.

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Trading of G-secs cont..

Hence, Negotiated Dealing System (NDS)

was introduced in February, 2002 to

automate the process of trading and

settlement.

The Negotiated Dealing System (NDS) has

two modules one for the primary market

and the other for the secondary market.

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NDS Primary Market Module

This platform allows participants to

electronically submit their bids in theprimary auctions and receive allotment

reports.

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Main features of the primary auction platform are:

Creation of issues - The Reserve Bank creates asecurity issue giving the details of the security, the totalamount (notified amount) and bidding date and timings,

etc. Submission of bids Member participants can click on

the issue number and electronically submit bids byspecifying the amount and price/ yield at which they arewilling to buy the securities.

Processing of bids The Reserve Bank processes thebids and arrives at the cut-off price/yield depending onthe format of the auction.

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Allotment advice Once the cut-off price/ yield isdecided, the Reserve Bank accepts all the bidsabove/below and up to this cut-off price/yield. Thesystem automatically generates participant-wise reports

of successful bids and electronically sends them to theparticipants.

Settlement The system generates a settlement reportgiving details of the amounts that each member has topay and the quantity of securities to be issued to each

participant. Based on this report, funds account of eachmember with the Reserve Bank is debited and securitiesaccount of each member with the Reserve Bank iscredited.

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NDS Secondary Market Module

Secondary market trading in Government

securities happen over-the-counter (OTC) over

phone. Players are required to report secondary

market trades on the NDS. Once they complete

the reporting process and the NDS system

accepts trades, the data automatically flows to

the Clearing Corporation of India Ltd. (CCIL) for

clearing and settlement. This avoids paper

based settlement process.

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NDS OM System: Introduced in August, 2005.

The NDS-OM is an electronic, screen based,anonymous, order driven trading system fordealing in Government securities. The ReserveBank owns NDS-OM and CCIL maintains it.

Members can place bids (buy orders) and offers(sell orders) directly on the NDS-OM screen.

Being order driven, the system matches all bids

and offers on price/time priority and ensures thetrading of the security without actually disclosingthe identity of the buyer and seller.

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Clearing and settlement of the transactionsaffected via CCIL

Thus, the NDS-OM facilitates straight-

through-processing (STP), that is, all thetrades on the system are automaticallysent to the CCIL.

NDS-OM system captures over 80 per centof the trading volume in Governmentsecurities.

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How do the Government

securities transactions settle?In Primary Market

Once the allotment process in the primary auction isfinalized, the successful participants are advised of theconsideration amounts that they need to pay to the

Government on settlement day. The settlement cycle for dated security auction is T+1,

whereas for that ofTreasury bill auction is T+2.

On the settlement date, the fund accounts of theparticipants are debited by their respective considerationamounts and their securities accounts (SGL accounts)are credited with the amount of securities that they wereallotted.

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Settlement cycle of G-secs

In Secondary Market

All outright secondary market transactions

in Government Securities are settled onT+1 basis. However, in case of repo

transactions in Government securities, the

market participants will have the choice of

settling the first leg on eitherT+0 basis orT+1 basis as per their requirement.

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Redemption of government

securities

Redemption by the concerned

governments directly in primary market

Redemption through RBI in secondarymarket

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securities cont..Redemption by the concerned governments

directly in primary market

Redemption by conversion: Refinancing of existing securities near maturity by converting

these into new securities. Redemption by advance conversion: Refunding

of existing securities before maturity by reissuingsame securities.

Objective of conversion and reissue is to lengthenthe maturity structure of government debt and toreduce the volume of cash repayment of loans

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securities cont..

Redemption by Cash financing: It is the

process of redeeming existing securities

from the proceeds of newly issued

government securities

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securities cont..

Redemption through RBI in secondary market

Grooming: The process whereby RBI gradually

acquires the securities (nearing maturity) from

the secondary market and redeem theseregularly just to avoid one time pressure on

government exchequer.

Switching: It is the process of converting the

govt. security nearing maturity into a new

security. Or converting by interchanging the

securities of one participant (generally a bank) to

other.

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Role of RBI in G-sec market

Most active participant in the government

securities market.

Initiates the issuing process of g-secs and also

underwrites the issue to gradually sell thesecurities in the open market to avoid crowding

outprivate sector participants

Settlement of the transactions through CCIL by

facilitating the net transfer of funds and

securities between buyers and sellers.

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Role of RBI in G-sec market cont..

Helps in the redemption of the securities

by switching and grooming activities.

Mainly switch operations.

Acts as a mediator between purchaser

and seller (which is generally a bank) in

triangular switch program.

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Role of G-secs in liquidity

management Working of two major techniques of monetary control of

RBI namely OMO and SLR are conducted throughgovernment securities to stabilize the money supply inthe economy.

Entity wise SLR Requirement: Rural Co-operative Banks = 25% of their Demand andTime Liabilities

Regional Rural Banks (RRBs) = 25% of their Demandand Time Liabilities

Scheduled UCBs have to hold 25 per cent of their SLRrequirement in Government and other approvedsecurities.

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management cont..

Non-scheduled UCBs: with Demand and TimeLiabilities (DTL) more than Rs. 25 crore have tohold 15 per cent of their SLR requirement inGovernment and other approved securities.

Non-scheduled UCBs with DTL less than Rs. 25crore have to hold 10 per cent of their SLRrequirements in Government and otherapproved securities.

Provident funds, superannuation funds andgratuity funds = 55% of the investible funds

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management cont.. Liquidity Adjustment facility (LAF): LAF is a facility

extended by the Reserve Bank of India to the scheduledcommercial banks (excluding RRBs) and primary dealersto avail of liquidity in case of requirement or park excess

funds with the RBI in case of excess liquidity on anovernight basis against the collateral of Governmentsecurities including State Government securities.

The operations of LAF are conducted by way of repurchase agreements with RBI being the counter-party

to all the transactions. The interest rate in LAF is fixed by the RBI from time to

time.

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management cont..

RBI can also issue notes against the

backing of government bonds apart from

gold and foreign exchange. Hence, these

are the ultimate sources of liquidity.

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Trends in secondary G-sec market

Central govt securitiesYear Total

(in crores)

Outright

(in %)

Repos

(in %)

State

g-sec

2000-01 698146 73 27 29702001-02 1474365 77 23 6131

2002-03 1783187 72 28 9259

2003-04 2436598 63 37 25826

2004-05 2145029 41 59 35233

2005-06 2035669 32 68 67209

2006-07 2788903 23 77 63225

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Reasons for lesser developed

secondary market for g-secs Institutional investors like PFs, pension funds,

LIC and other statutory financial institutionsholds these securities till maturity and arereluctant to trade these in secondary markets.

Thus, there is lesser availability of floating stockin market for trading.

Dealing is only confined to Mumbai market thatconstitute more than 90% of the transactions.Lack of active nationwide market.

Central bank preference of refunding rather thancash redemption

Lack of varieties of instruments in the market.

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