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While the need for long termfinancing is met by the capitalor financial markets, moneymarket is a mechanism which

deals with lending and borrowing of shortterm funds. Post reforms period in Indiahas witnessed tremendous growth of theIndian money markets. Banks and otherfinancial institutions have been able tomeet the high expectations of short termfunding of important sectors like theindustry, services and agriculture. Func-tioning under the regulation and control ofthe Reserve Bank of India (RBI), the Indianmoney markets have also exhibited therequired maturity and resilience over thepast about two decades. Decision of thegovernment to allow the private sectorbanks to operate has provided much needed healthy competition in the moneymarkets, resulting in fair amount ofimprovement in their functioning.

Money market denotes inter-bank mar-ket where the banks borrow and lendamong themselves to meet the short termcredit and deposit needs of the economy.Short term generally covers the time periodupto one year. The money market opera-tions help the banks tide over the tempo-rary mismatch of funds with them. In casea particular bank needs funds for a fewdays, it can borrow from another bank bypaying the determined interest rate. Thelending bank also gains, as it is able to earninterest on the funds lying idle with it. Inother words, money market providesavenues to the players in the market tostrike equilibrium between the surplusfunds with the lenders and the require-ment of funds for the borrowers. Animportant function of the money market isto provide a focal point for interventions ofthe RBI to influence the liquidity in thefinancial system and implement othermonetary policy measures.

Quantum of liquidity in the bankingsystem is of paramount importance, as it is

an important determinant of the inflationrate as well as the creation of credit by thebanks in the economy. Market forces generally indicate the need for borrowingor liquidity and the money market adjustsitself to such calls. RBI facilitates suchadjustments with monetary policy toolsavailable with it. Heavy call for fundsovernight indicates that the banks are inneed of short term funds and in case of liq-uidity crunch, the interest rates would goup.

Depending on the economic situation and available market trends, theRBI intervenes in the money marketthrough a host of interventions. In case ofliquidity crunch, the RBI has the option ofeither reducing the Cash Reserve Ratio(CRR) or pumping in more money supplyinto the system. Recently, to overcome theliquidity crunch in the Indian money market, the RBI has released more thanRs 75,000 crore with two back-to-backreductions in the CRR.

In addition to the lending by the banksand the financial institutions, various com-panies in the corporate sector also issuefixed deposits to the public for shorterduration and to that extent become part ofthe money market mechanism selectively.The maturities of the instruments issuedby the money market as a whole, rangefrom one day to one year. The money mar-ket is also closely linked with the ForeignExchange Market, through the process ofcovered interest arbitrage in which the for-ward premium acts as a bridge between thedomestic and foreign interest rates.

Determination of appropriate interestfor deposits or loans by the banks or theother financial institutions is a complexmechanism in itself. There are severalissues that need to be resolved before theoptimum rates are determined. While theterm structure of the interest rate is a veryimportant determinant, the differencebetween the existing domestic and interna-

Growth of Money Market in India

ARTICLE

Capital investmentis the backbone ofevery developingeconomy. It is alsoconsidered to beone of the mostimportantdeterminants of therate of growth ofan economy andthe governments inthe developingcountries strivevery hard to ensurethat the level ofcapital investmentis kept high. Toaugment theinternal investmentpotential, thegovernments in thedevelopingcountries aim atachieving higherinflows of foreigninvestment, bothas FDI as well asFII.

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ARTICLE

tional interest rates also emerges asan important factor. Further, thereare several credit instruments whichinvolve similar maturity but diverse-ly different risk factors. Such distor-tions are available only in develop-ing and diverse economies like theIndian economy and need extra carewhile handling the issues at the policy levels.

Diverse Functions

Money markets are one ofthe most importantmechanisms of any deve-loping economy. Instead

of just ensuring that the money mar-ket in India regulates the flow ofcredit and credit rates, this mecha-nism has emerged as one of theimportant policy tools with the gov-ernment and the RBI to control themonetary policy, money supply,credit creation and control, inflationrate and overall economic policy ofthe State.

Hence, the first and the fore-most function of the money marketmechanism is regulatory in nature.While determining the total volumeof credit plan for the six monthlyperiod, the credit policy also aims atdirecting the flow of credit as perthe priorities fixed by the govern-ment according to the needs of theeconomy. Credit policy as an instru-ment is important to ensure theavailability of the credit in adequatevolumes; it also caters to the creditneeds of various sectors of the econ-omy. The RBI assists the governmentto implement its policies related tothe credit plans through its statuto-ry control over the banking systemof the country.

Monetary policy, on the otherhand, has longer term perspectiveand aims at correcting the imbal-ances in the economy. Credit policyand the monetary policy, both com-plement each other to achieve thelong term goals determined by thegovernment. It not only maintainscomplete control over the credit creation by the banks, but also keeps

a close watch over it. The instru-ments of monetary policy, includingthe repo rate, cash reserve ratio andbank rate are used by the CentralBank of the country to give therequired direction to the monetarypolicy.

Inflation is one of the seriouseconomic problems that all thedeveloping economies have to faceevery now and then. Cyclical fluctua-tions do affect the price level differ-ently, depending upon the demandand supply scenario at the givenpoint of time. Money market ratesplay a major role in controlling theprice line. Higher rates in the money

markets reduce the liquidity in theeconomy and have the effect ofreducing the economic activity in thesystem. Reduced rates, on the otherhand, increase the liquidity in themarket and bring down the cost ofcapital substantially, therebyincreasing the investment. Thisfunction also assists the RBI to con-trol the overall money supply in theeconomy. Such operations supple-ment the efforts of direct infusion ofnewly printed notes by the RBI.

Future of Open Markets

Financial openness is said tobe a situation under whichthe residents of one countryare in a position to trade their

assets with residents of anothercountry. A slightly mild definition ofopenness may be referred to asfinancial integration of two or moreeconomies. In recent years, theprocess of globalization has madethe money market operations andthe monetary policy tools quiteimportant. The idea is not only toregulate the economy and its moneymarkets for the overall economicdevelopment, but also to attractmore and more foreign capital intothe country. Foreign investmentresults in increased economic activity, income and employmentgeneration in the economy. Free andunrestricted flow of foreign capitaland growing integration of the global markets is the hallmark ofopenness of economies.

Indian experience with openmarkets has been a mixed one. Onthe positive side, the growth rate ofthe country has soared to new levelsand the foreign trade had been grow-ing at around 20 per cent during thepast few years. Foreign exchangereserves have burgeoned to signifi-cantly higher levels and the countryhas achieved new heights in theoverall socio-economic develop-ment. The money market mecha-nism has played a significant role inrapid development of the countryduring the post-reforms era.

On the flip side, the post-reforms period has witnessed rela-tively lesser growth of the social sector. Money market mechanismhas kept the markets upbeat, yet thesocial sector needs more focusedattention. With the base of the econ-omy now strengthened, the moneymarket mechanism must also focuson ensuring that proper direction isprovided to the credit flows so thatthe poorest sections of the societyalso gain.

Instead of just ensuring that themoney market in India

regulates the flow of credit andcredit rates, this mechanismhas emerged as one of the

important policy tools with thegovernment and the RBI tocontrol the monetary policy,

money supply, credit creationand control, inflation rate andoverall economic policy of the

State.

T H E C O M P E T I T I O N M A S T E RAvailable as Print Edition also for Rs 50 per copy from your local newspaper agent

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