Definition of Money Market

The money market is a regulated platform that enables short-term lending and borrowing of funds. The Money Market provides opportunities for individuals and institutions to engage in short-term borrowing and lending high-quality debt securities with a maturity of one year or less. This contributes to the smooth operation of the financial system.

Governments, banks, and other large entities can sell short-term securities in this marketplace to fulfil short-term cash requirements. Additionally, individual investors can invest small amounts in low-risk opportunities.

The money market trades various financial instruments, including Treasury bills, certificates of deposit, commercial paper, bills of exchange, repurchase agreements, banker’s acceptance, etc. Large companies needing short-term funds can borrow directly from the market through their dealer.

In this market, entities seeking short-term funds request them from banks and other financial institutions. Money Market efficiently allocates funds. It fulfils the short-term fund requirements of various economic participants.

Its primary objectives are to offer short-term financing, manage liquidity, make low-risk investments, establish benchmark interest rates, and maintain market stability and transparency. Additionally, it seeks to implement monetary policy.

How Does The Money Market Work In India?

Various participants such as individual investors, the Government of India, corporations, and financial institutions, interact to operate the money market. They use short-term borrowing and lending to meet immediate cash needs. They also manage liquidity. Following is an explanation of how the money market operates in India:

1) Entities needing short-term funds, such as governments or corporations, turn to the money market to fulfil immediate financial obligations.  The money market instruments are issued to raise funds, which involves borrowing from investors quickly.

2) Borrowers issue instruments with different maturities, interest rates, and credit ratings. These include Treasury bills, commercial paper certificates of deposit, and repurchase agreements. These instruments are highly liquid and considered low-risk.

3) Investors with surplus funds seek short-term investment opportunities in the money market. The money market instruments are issued by borrowers.  In return, they receive interest payments or discounts on tools, which act as their returns on investment.

4) Money market instruments can be traded on a secondary market. This offers investors the opportunity to buy and sell them before maturity. This secondary market enhances liquidity. Investors can access their funds before the instrument matures.

5) Money market funds pool investments from institutional and individual investors in a diversified portfolio of money market instruments. These funds allow investors to participate indirectly in the money market. They benefit from professional management 

6) The money market operates within a regulated environment. Rules and regulations are enforced and monitored by the regulatory bodies. They ensure transparency, stability, and fair practices, thus maintaining the market’s integrity and reliability.

Types of Money Market Instruments in India

Certificate of Deposits

A certificate of deposit, or CD, is a financial instrument that provides fixed returns and can be issued by various financial institutions in India. It is governed by transparent rules specified by the Reserve Bank of India (RBI). Currently, it is issued only in dematerialised form. CDs have fixed or floating rates of return. They are issued at a discount to their face value. They have a pre-defined maturity period and can be traded on the money market. Any resident of India can invest in CDs. Investors can trade them on money markets, just like shares. This means that investors cannot hold onto their investments once they mature. Unlike recurring or fixed deposits, if they need quick access to funds.

The key characteristics of Certificate of Deposit (CD) in India include:

1. Maturity Period: CDs can mature in at least 7 days or more than 1 year in India. The minimum denomination for an Indian CD is Rs. 5 lakh, and higher-value CDs are available in Rs. 5 lakh multiples.

2. Issuers: All India Financial Institutions, including commercial banks, regional rural banks, small finance banks, etc. are authorised to issue CDs according to current RBI regulations.

3. Loan Availability: Banks can only offer secured loans against CDs without a lock-in period. They are prohibited from repurchasing CDs before maturity. The rate of return on CD is determined after considering the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)

4. Issuance and Transferability: CDs are exclusively issued in dematerialised (Demat) form. They are held at a SEBI-registered depository in India. Demat CDs can be freely transferred to other eligible investors through secondary markets like recognised stock exchanges

Treasury Bills

Treasury bills, or T bills, are the government’s short-term money market instruments. They allow the government to borrow money at discounted prices and repay the full value at maturity.

The government backs these bills and provides investors with secure and highly liquid investment options. They are issued by the Reserve Bank of India on behalf of the Government of India as promissory notes. This aims to meet the government’s short-term financial needs.

Treasury bills are available for four periods: 14, 91, 182, and 364 days. This allows investors to benefit from a discounted purchase price and increased redemption value.

Zero-coupon debt instruments like Treasury bills don’t pay interest. Instead, they are discounted. At maturity, they receive their full face value.

T-bills are popular low-risk investments with better returns than fixed deposits of the same tenure. This makes them suitable for conservative investors.

Reserve Bank of India (RBI) issues treasury bills through regular auctions on the E-Kuber platform. Individuals, banks, trusts, and institutions can purchase these T-bills. The minimum investment amount is Rs. 10,000, and investments must be in multiples of Rs. 10,000.

Upon maturity, the maturity value is credited to the investor’s account. Treasury bills can be purchased through RBI’s retail direct scheme account or primary or secondary stock exchanges. Banks can use T-bills to obtain funds under the repo rate and fulfil their SLR requirements.

In India, returns from treasury bills are subject to tax under STCG as per investors’ applicable tax slab rates. No TDS is deducted from income at the time of redemption. This removes the hassle of claiming it if the investor does not fall under the taxable income bracket.

Commercial Papers

Commercial paper is an unsecured money market instrument issued as a promissory note by high-quality corporations. Collateral security does not usually back it. Its maturity can range from 7 days to one year. Only firms with excellent credit ratings can sell it at a reasonable price. Typically, it is sold at a discount from face value. It can be issued in denominations of Rs. 5 lakh or multiples thereof.

In 1990, commercial paper (CP) was introduced in India. It allowed top-rated corporate borrowers to diversify short-term borrowing sources and provided an instrument to investors. Primary dealers and all-India financial institutions were permitted to issue CP to meet short-term funding needs. Commercial paper is typically used to finance short-term liabilities such as payroll, accounts payable, and inventories.

Issuance of commercial paper should be within limits set by the issuer’s Board of Directors or credit rating agency. It can be issued in dematerialised form. It must be held in dematerialised form by banks, financial institutions, and primary dealers.

Commercial paper transactions are also actively traded in the Over the Counter (OTC) market. They must be reported on the Fixed Income Money Market and Derivatives Association of India (FIMMDA) reporting platform within 15 minutes of trade.

Banker’s Acceptance

A Banker’s Acceptance (BA) is a document issued by a commercial bank to guarantee future payment. It is a short-term debt instrument often used in international trade. Durations range from 30 to 180 days. Due to bank backing, it provides a reliable funding source for traders and is considered safe.

For instance, an American purchaser places an order with an Indian fabric exporter. To secure payment, the exporter utilises the Banker’s Acceptance provided by their bank, such as Union Bank of India. This instrument assures the exporter of payment within a specified timeframe, typically up to 180 days, upon delivery of goods.

Repurchase Agreements

Repurchase Agreements, also known as repos or buybacks, are formal agreements in which one party sells security to another with the promise of buying it back later. This form of short-term borrowing is primarily used by dealers in government securities to raise short-term capital.

The seller buys security back in a repo at a slightly higher price, which represents an implicit overnight interest rate. Repurchase agreements are not just a financial concept but a practical tool commonly used in the Central Bank’s open market operations.

Reserve Bank of India (RBI) uses open market operations (OMOs) to regulate the economy’s liquidity and impact interest rates. OMOs involve the purchase and sale of government securities, also referred to as G-secs, in the open market.

The central bank uses Open Market Operations (OMO) to control the money supply and regulate interest rates in an economy. Central banks purchase or sell government securities through OMO in the open market.

Functions Of The Money Market In India

The money market serves a variety of important functions in the financial system. 

1. Facilitating Short-Term Borrowing and Lending: The money market provides a platform for short-term borrowing and lending through instruments such as treasury bills, commercial paper, and certificates of deposit 

2. Providing Liquidity Management Tools: It offers various instruments. These help financial institutions and investors manage their short-term liquidity needs efficiently 

3. Offering Financing for Working Capital Needs: The money market plays a crucial role in the economy. It enables businesses to access short-term funds, ensuring working capital requirements are met, and operations run smoothly 

4. Serving as Benchmark for Interest Rates: Rates in the money market significantly influence short-term interest rates. This affects borrowing and lending rates across the economy 

5. Supporting Monetary Policy Implementation: Central banks use the money market to implement monetary policy. They influence short-term interest rates and money supply

6. Enabling Investment Diversification and Risk Management: Investors can diversify portfolios and manage risk by investing in money market instruments with varying maturities and credit qualities 

Taxability Of Money Market Instruments In India 

1) Treasury bills

T-bill returns in India are subject to short-term capital gains (STCG) tax based on the investor’s income tax slab rate. This tax treatment applies irrespective of the tenure of T-bills. For instance, if an investor falls under the 30% tax bracket and earns INR 1,850 in interest from a T-bill, they would owe INR 555 in taxes INR 1,850 x 30%. One benefit of T-bills is that individual investors are not required to pay the tax deducted at source TDS. Upon maturity

2) Certificates of Deposit

a) Regular Certificates of Deposit:

The interest earned on regular CDs is subject to taxation based on the investor’s or the individual’s or the entity’s eligible income tax slab. According to Section 80TTA of the Income Tax Act 1961, investors are eligible for a deduction of up to Rs. 10000 in a financial year. If interest income exceeds Rs. 10,000 per year, then a 10% tax will be deducted at the source. This TDS will be done by the bank or applicable rate based on the investor’s tax status.

b) 1099-INT form:

Banks issue Form 1099-INT annually to report the amount of interest earned by investors for that year. This form provides important details. It includes the total interest amount and any applicable tax withholdings. Each taxpayer must receive a copy of this form.

Failure to report interest income might result in penalties. Proper documentation is essential for filing taxes accurately. Investors should ensure they review their 1099-INT thoroughly. Understanding the implications can help in effective tax planning.

3) Commercial Papers

In India, the difference between the issue price and face value of commercial papers is treated as a discount, not interest paid. The Income Tax Act’s provisions for deducting tax at source do not apply to commercial paper transactions. Instead, the Assessee is taxed on the previous year’s total income, which occurs in the relevant assessment year.

Frequently Asked Questions (FAQs)

What’s the normal tenure of maturity for money market instruments?

Money market instruments often mature in fortnights: 7 days, 14 days, one month, 3 months, 6 months, 9 months, or one year.

Who participates in the Money Market in India?

The main players in the organised Money markets in India are the RBI, Banks, non-banking financial companies (NBFCs), mutual funds, big corporations, and insurance companies.

Which money market instrument doesn’t have tax deducted at source (TDS) to be cut from taxable income?

Usually, taxable income derived from Treasury bills doesn’t attract TDS.

What’s the Banker’s acceptance?

A banker’s acceptance is a financial instrument used for short-term transactions. The process of applying for a banker’s acceptance resembles that of a short-term loan. It involves various checks related to credit and collateral. A banker’s acceptance serves as a payment method guaranteed by the bank. This effectively mitigates transaction-related risks for both importers and exporters.

What’s the maturity period in the Banker’s acceptance? 

The Banker’s acceptance represents future payment promised by the bank. It typically matures within 30 to 180 days.

Are CODs taxable under the Income Tax Act of India? 

Yes, income derived from COD is fully taxable under the Income Tax Act of 1961 in India in a financial year.

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