Role of Money Market in India

In this article we will discuss about the Role of Money Market in India.

Like in any market, certain goods are traded in the money market too. The good that is bought and sold in the money market is money or near-money financial assets. More precisely, the money market is a market for short-term money and financial assets that are close substitutes for money.

Financial assets of long-term maturity is very much the domain of the investors of the capital market where these long- term securities are traded. ‘Short-term’ in the Indian context means generally a period up to one year.

The term ‘close substitutes for money’ means any finan­cial asset which can be quickly converted into money with minimum transaction/conversion cost.

As we shall see later, the existence of money market helps solve the problem of liquidity management of bodies like corporate banks, financial institutions and the like. It is the money market which meets short-term requirements of borrowers and provides profitable avenues to the lenders.

The broad objectives of the money market are to provide:

(a) An equilibrating mechanism for evening out short-term deficits and surpluses,

(b) A focal point for central bank intervention for influencing liquidity of the economy, and

(c) An access to the users of short-term money to meet their requirements at reasonable price.

The short-term money market in India consists of markets for inter-bank call and short notice money, treasury bills, commercial bills, commercial papers, certificates of deposit and inter-bank partici­pations. What is significant is that all these markets are closely inter-linked. The major participants in the money market are the commercial banks, finan­cial institutions, corporations and individuals.

The larger the number of participants, greater will be the depth of the market. Unlike the stock market where trading is done on the floor of the stock exchange, trading in the money market is conducted over tele­phone followed by written confirmation from both the borrower and the lender.

Unlike the capital market which has seen con­siderable innovation and change during the last ten years or so, the money market in India until 1988 re­mained narrow and was circumscribed by tight reg­ulation over interest rates and participants in each of its segments. The secondary market was ill- developed and lacked liquidity and depth.

The mar­ket was lopsided with few predominant lenders and a large number of borrowers. Bulk of transactions were undertaken in call and short notice money mar­ket. The interest rates in the money market were tightly regulated since 1973; the ceiling of 10% rate of interest in the call and short notice money market continued upto April 1989.

The Committee to Review the Working of the Monetary System (1985) (appointed by the Reserve Bank of India) under the Chairmanship of noted economist Late Sukhamoy Chakravorty recom­mended an indepth study of the issues relating to the development of the money market.

Accordingly, the RBI in 1986 appointed a Working Group on the Money Market under the Chairmanship of Shri N. Vaghul (the present chairman of Industrial Credit and Investment Corporation of India Ltd. (ICICI)) to review the Indian money market and make rec­ommendations for the development of the money market.

In its report submitted in January 1987, the Group put forth a four-pronged strategy as under:

(i) Attempt should be made to widen and deepen the money market by selective increase in the number of participants so as to ensure adequate supply of funds.

(ii) Endeavour should be made to activate the ex­isting instruments and to develop new instru­ments so as to have a proper mix of instruments suited to different requirements of borrowers and lenders.

(iii) Attempt should be made to work out an orderly move away from administered interest rates to market determined interest rates to import a de­gree of flexibility,

(iv) Attempt should be made to create an active sec­ondary market, if necessary, by setting up new institutions to impart liquidity to the money market instruments.

Based on the strategy, the Group made a num­ber of recommendations which include:

(a) Limited freeing of interest rates in the money market,

(b) Activation of existing instruments like commer­cial bill and introduction of new instruments viz., commercial paper (CP) and certificates of deposit (CD) as new instruments in the money market, and

(c) Setting up of a Discount and Finance House of India (DFHI) to develop an active secondary market for the money market instruments.

Fol­lowing the recommendations of the Working Group, RBI took a number of steps to widen and deepen the money market by selective increase in the number of participants and introduction of new money market instruments like CP and CD. Interest rates have been freed.

The Dis­count and Finance House of India (DFHI) has also been set up to deal in money market in­struments and provide liquidity in the money market.

The RBI has also issued broad guide­lines to allow banks and their subsidiaries to set-up Money Market Mutual Funds (MMGS) which will pool investors funds through MMF Units/deposit accounts and invest these funds in money market instruments to enable small investors to get the money market related yield.