ASIAN DEVELOPMENT BANK

Operations Evaluation Department

PROJECT PERFORMANCE EVALUATION REPORT

FOR

INDIA

In this electronic file, the report is followed by the Management response.

Performance Evaluation Report

Project Number: PPE: IND 29701

Investment Number: 7122-IND
December 2005

IND: SBI DFHI Limited

Operations Evaluation Department

 CURRENCY EQUIVALENTS
Currency Unit – Indian rupee/s (Re/Rs)

At Appraisal At Project Completion At Operations Evaluation

(November 1995) (July 2001) (September 2005)
Re1.00 = $0.02970 $0.02136 $0.02273
$1.00 = Rs33.660 Rs46.820 Rs43.990

ABBREVIATIONS

ADB – Asian Development Bank

CCIL – Clearing Corporation of India Limited
DFHI – Discount Finance House of India Limited
FY – fiscal year
GDP – gross domestic product
IPO – initial public offering
FIRR – financial internal rate of return
NDS – negotiated dealing system
OEM – Operations Evaluation Mission
PCR – project completion report
PPER – project performance evaluation report
PSOD – Private Sector Operations Department
RBI – Reserve Bank of India
RRP – report and recommendation of the President
SBI – State Bank of India
SBIGL – SBI Gilts Limited
SBICAP – SBI Capital Markets Limited
SBI DFHI – SBI DFHI Limited
T-bill – treasury bill

NOTES
(i) The fiscal year (FY) of the Government ends on 31 March. FY before a calendar year
denotes the year in which the fiscal year ends, for example, FY2000 ends on 31
March 2000.

(ii) In this report, “$” refers to US dollars.

Director General : B. Murray, Operations Evaluation Department (OED)

Director : D. Edwards, Operations Evaluation Division 2, OED

Team Leader : T. Ito, Evaluation Specialist, Operations Evaluation Division 2, OED

Team Members : V. Ramos, Evaluation Officer, Operations Evaluation Division 2, OED
R. Perez, Senior Operations Evaluation Assistant,
Operations Evaluation Division 2, OED

Operations Evaluation Department, PE-675

 CONTENTS

Page

BASIC DATA ii
EXECUTIVE SUMMARY iii

I. INTRODUCTION 1

II. PROJECT DESCRIPTION 1

A. Background 1
B. Rationale 2
C. Deal Processing 2
D. Expected Outcomes 3
E. Progress Highlights 3

III. EVALUATION 4
A. Development Outcome 5
B. Investment Outcome 13
C. ADB’s Effectiveness 14
D. Overall Rating 16

IV. ISSUES, LESSONS AND FOLLOW-UP ACTIONS 16

A. Issues 16
B. Lessons Learned 17
C. Follow-Up Actions 18

APPENDIXES
1. Evaluation Standards 19
2. Statistical Data 22
3. Chronology of Government Securities Market Reforms 26
4. Key Infrastructure for the Government Securities Market 28
5. Summary of Financial Statements of SBI Gilts Limited and SBI DFHI Limited 30
6. Financial Internal Rate of Return on the Asian Development Bank’s Investment
in SBI DFHI Limited 32

Attachment: Management response

The guidelines formally adopted by the Operations Evaluation Department on avoiding conflict
of interest in its independent evaluations were observed in the preparation of this report. The
fieldwork was undertaken by Susan Thomas (international consultant, debt market specialist)
and Renuka Sane (research assistant) under the guidance of the mission leader. To the
knowledge of the management of the Operations Evaluation Department, there were no
conflicts of interest of the persons preparing, reviewing, or approving this report.
 BASIC DATA

Investment No. 7122-IND: SBI DFHI Limited (formerly SBI Gilts Limited)

Key Investment Data ($ million equivalent)

As per ADB Actual
Document
Amount Approved 4.50
Amount Disbursed 4.19

Terms of Equity Investment:

- No. of Shares 15,000,000 15,000,000a
- Par Value per Share Rs10.00 Rs10.00b
- Dividends Cash Cash
- Divestment Mechanism Sale Sale

Key Dates Expected Actual

Fact-Finding 24–31 Mar 1995
Appraisal 24 Jul–4 Aug 1995
Investment Negotiations 19–20 Oct 1995
Board Approval 19 Dec 1995
Subscription Agreement 29 Oct 1996
Letter Agreement 29 Oct 1996
Disbursement 5 Mar 1997

Key Performance Indicators (%): Appraisal PCR PPER

Financial Internal Rate of Return 12.0 Not computed 18.3c
Borrower SBI DFHI Limited
Country India
Type of Business Primary dealer in Government securities
Project Title Investments in Debt Market Securities

Mission Data No. of Missions No. of Person-Days

Fact-Finding 1 24
Consultation 1 2
Appraisal 1 15
Negotiations 2 22
Investment Review 4 14
Operations Evaluation 1 28

ADB = Asian Development Bank, DFHI = Discount Finance House of India Limited, PCR = project completion report,
PPER= project performance evaluation report, SBI = State Bank of India.
a
Since the merger of SBI Gilts Limited with DFHI Limited in FY2004, ADB has held 1,363,266 shares of SBI DFHI
Limited.
b
Since the merger of SBI Gilts Limited with DFHI Limited in FY2004, the par value per share has been set at Rs100.
c
The assumptions in this calculation include (i) ADB’s divestment on 31 March 2006, (ii) no increase in net worth
and no dividend paid to ADB in FY2006, and (iii) the 30 June 2005 exchange rate of Rs43.52 = $1.00.
 EXECUTIVE SUMMARY

On 19 December 1995, the Asian Development Bank (ADB) approved an equity

investment of Rs150 million ($4.5 million equivalent) in SBI Gilts Limited (SBIGL) (the Project),
together with equity investments of Rs715 million ($21.2 million equivalent) in SBI Capital
Markets Limited (SBICAP) and Rs145 million ($4.3 million equivalent) in SBICAP Securities
Limited. SBIGL, the main focus of this project performance evaluation report, was incorporated
on 7 March 1996 and became operational on 1 July 1996. ADB subscribed Rs150 million ($4.19
million equivalent at disbursement) on 5 March 1997. SBIGL’s total paid-up capital was Rs1,000
million, of which 85% was contributed by the State Bank of India (SBI) and its affiliated
institutions and 15% by ADB.

The purpose of the Project was to support the formation of an accredited primary dealers
network that would provide an impetus for active trading in Government securities. The
expectation was that SBI would (i) reduce its shareholding in SBIGL to less than 50% within 4
years of the date of incorporation of SBIGL; and (ii) arrange for the divestment of ADB’s
shareholding at the same price at which SBI sold it shares. SBIGL was also to make a public
offering of its shares within 4 years of the date of incorporation. At the time of investment
approval, ADB assumed that the divestment of its shares would take place within 6 years of the
date of incorporation. The financial internal rate of return on the ADB investment in SBIGL was
estimated at 16.5% in rupee terms and 12.0% in dollar terms.

The main project developments are as follows. First, the Government securities market
grew steadily during fiscal year (FY) 1997–FY2004, but experienced a setback in FY2005.
Second, SBIGL was profitable during FY1997–FY2003. Third, SBIGL merged with the Discount
and Finance House of India Limited (DFHI) in FY2004 and was renamed SBI DFHI Limited (SBI
DFHI). Following the merger, ADB owned 4.69% of SBI DFHI’s total shares. Fourth, SBI DFHI
was profitable in FY2004, but recorded a net loss in FY2005. Fifth, ADB received dividends
every year throughout the investment period except FY2005. Sixth, divestment of SBI’s and
ADB’s shareholdings and SBI DFHI’s initial public offering (IPO) have not yet materialized.

This report rates the development outcome of the Project as satisfactory for two main
reasons. First, the investee company contributed to establishing and maintaining the primary
dealer system, which in turn served the development of the Government securities market as
originally envisaged. Second, without the presence of SBIGL and SBI DFHI, the absorption of
primary dealers in the primary market, especially at the initial stage and during the FY2005
market downturn, would have been insufficient.

This report rates the investment outcome of the Project as satisfactory. The Operations
Evaluation Mission estimated the financial internal rate of return of this investment to be 18.3%
in dollar terms, compared with the 12.0% estimated at appraisal, assuming that ADB would
divest on 31 March 2006. As this estimate suggests, the investment return has been highly
satisfactory. However, effective measures to mitigate the market risk and the exit risk are not in
place, and thus the final investment outcome remains uncertain.

This report rates ADB’s effectiveness as partly satisfactory because even though ADB’s
investment was timely and complemented its public sector operations, the quality of ADB’s work
in terms of processing and monitoring fell short of expectations. ADB’s demonstration role also
appears to be diminishing.

On the basis of the foregoing, the overall rating of this Project is satisfactory.
iv

This report identifies four key lessons as follows:

(i) ADB equity investments require a workable and viable exit mechanism. Planned
IPOs are often not a workable mechanism, because they depend on the nature
of the investee, on a sponsor, and on industry and market conditions. ADB
cannot rely solely on IPOs, and therefore needs to pursue a put option
incorporated in a letter agreement or shareholders agreements. To make such
an option enforceable, the method of revaluating an investee at ADB’s
divestment should be carefully discussed during processing and stated in the
agreements.
(ii) If an investee company proposes a merger or acquisition, both the Private Sector
Operations Department and the Office of the General Counsel should carefully
examine the implications of such a proposal and give prompt feedback to the
investee. ADB may need to pursue a put option if it cannot agree to the proposal.
To increase clarity and predictability, the subscription agreement should contain
a clause specifying the necessary procedures if the investee decides to pursue a
merger or acquisition.
(iii) The quarterly private sector investment management note should elaborate and
update the status of projects that deviate significantly from their original scope
and plan. Extra attention should be paid to monitoring such projects. In the case
of this Project, the reluctance of the sponsor to divest its shareholding and of the
investee company to undertake an IPO are major deviations.
(iv) ADB approved this Project in conjunction with the investment in SBICAP, but the
investment in SBICAP was monitored and evaluated separately. ADB
headquarters administered this Project, whereas the India Resident Mission
administered the investment in SBICAP, and a project completion report was
prepared only for this Project. An assessment of the complementarity of the two
investments is beyond the scope of this project performance evaluation report.
To the extent possible the monitoring and evaluation of closely related projects
sharing the same sponsor should come under the purview of one investment
officer and a project completion report and project performance evaluation report
should be prepared that cover all associated projects.

Considering the diminishing demonstration effect of this Project, the accumulated net
worth of SBI DFHI, the investment returns to date, and the limited prospects for privatizing SBI
DFHI, ADB should develop an exit strategy from this investment taking market conditions into
account. SBI, as the sponsor of this Project, can be a possible counterpart for sales of SBI DFHI
shares held by ADB.

Bruce Murray
Director General
Operations Evaluation Department
 I. INTRODUCTION

1. This project performance evaluation report (PPER) assesses the Asian Development
Bank’s (ADB’s) equity investment in SBI DFHI Limited (SBI DFHI, the Project), formerly SBI
Gilts Limited (SBIGL).1 In line with the good practice standards identified by the Evaluation
Coordination Group of Multilateral Development Banks on Private Sector Operations,2 this
PPER focuses on three project dimensions: development outcome, investment outcome, and
ADB’s effectiveness.

2. An Operations Evaluation Mission (OEM) visited India from 8 to 20 September 2005.

The OEM met with representatives of the Ministry of Finance, the Reserve Bank of India (RBI),
the State Bank of India (SBI), SBI DFHI and other financial institutions participating in the
Government securities3 market, the International Monetary Fund, and the International Finance
Corporation. This PPER incorporates the OEM’s findings, the observations of relevant ADB
staff, and a review of reports and documents related to this Project. The draft PPER was
circulated to SBI DFHI and within ADB. Comments received were considered when finalizing
the PPER.

II. PROJECT DESCRIPTION

A. Background

3. In the early 1990s, the Government of India initiated a comprehensive economic

reform program that ADB supported through its Financial Sector Program4 and Capital Market
Development Program.5 One of the aims of these programs was to develop the Government
securities market. The Financial Sector Program supported the introduction of a treasury bill
(T-bill) auction, whereas the Capital Market Development Program supported the introduction
of a primary dealer system for T-bills and dated securities. Primary dealers were expected to
ensure the orderly primary distribution of new issues of Government securities, to be market
makers for Government securities that would increase liquidity in the secondary market, and
to serve as conduits for RBI’s open market operations. In November 1995, RBI licensed six
primary dealers,6 including SBI.

1
ADB. 1995. Report and Recommendation of the President to the Board of Directors on Proposed Investments in
Debt Market Institutions in the Republic of India. Manila. (Investment 7122: SBI Gilts Limited, approved on 19
December 1995, for Rs150 million [$4.5 million equivalent at approval].)
2
Evaluation Coordination Group of Multilateral Development Banks on Private Sector Operations, Working Group on
Private Sector Evaluation. 2001. MDB-ECG Good-Practice Standards for Evaluation of Private Sector Operations.;
Walter I. Cohen and Associates, LLC. 2005. Second Benchmarking Review of ECG Members’ Evaluation Practices
for the Private Sector Investment Operations Against Their Agreed Good Practice Standards. Preparation of ADB’s
evaluation guidelines on private sector operations is under way.
3
Government securities in this report refer to securities issued only by the central Government.
4
ADB. 1992. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India
for the Financial Sector Program. Manila. (Loan 1208-IND, approved on 15 December 1992, for $300 million.)
5
ADB. 1993. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India
for the Capital Market Development Program. Manila. (Loan 1408-IND, approved on 23 November 1993, for $250
million.)
6
The initial six primary dealers were Securities and Trading Corporation of India Limited, Discount and Finance
House of India Limited, SBIGL, ICICI Securities Limited, PNB Gilts Limited, and Gilts Securities Trading
Corporation Limited.
2

4. ADB’s policy dialogue on improving the efficiency of Government-owned banks focused

on SBI,7 its associate banks, and other affiliates, which are collectively referred to as the SBI
group—India’s largest financial conglomerate. In response to a changing policy environment,
the SBI group formulated a restructuring plan. To reorient securities businesses under the plan,
SBI Capital Markets Limited (SBICAP)8 was to spin off its brokerage activities to a new
subsidiary, SBICAP Securities Limited. SBI planned to set up SBIGL as a primary dealer of
Government securities.

B. Rationale

5. SBI recognized the need to sponsor a primary dealer for Government securities not only
for its investment banking interests, but also to support RBI’s efforts to establish a Government
securities market. A primary dealer was necessary to achieve integrated, full-service investment
banking operations within the SBI group, complementing both SBICAP and SBICAP Securities
Limited. The SBI group requested ADB to support its restructuring process through equity
investments in SBICAP, SBICAP Securities Limited, and SBIGL. ADB agreed because (i) the
proposed investments in the three institutions were in line with ADB’s strategy and policy
dialogue with the Indian authorities to develop India’s capital markets, (ii) the participation of
ADB would provide an impetus to the SBI group’s privatization program, (iii) the backing SBI
provided to these institutions would be solid, (iv) the SBI group had good management teams
and a large pool of trained professionals in banking and financial services, (v) the proposed
investments were expected to have a positive impact and a significant demonstration effect on
other public sector financial institutions in India, and (vi) the management of SBI supported
capital market reforms. Overall, this Project is a good example of ADB’s private sector
operations supporting broader policy dialogue undertaken by the public sector side of ADB. In
addition to supporting the Government’s reform program, the activities of the public sector side
of ADB helped develop a better enabling environment for the private sector in the Government
securities market.

C. Deal Processing

6. Subsequent to the concept clearance in March 1995, ADB fielded processing missions
between April and August 1995. On 19 December 1995, ADB approved its equity investment of
Rs150 million (about $4.5 million equivalent) in SBIGL, together with equity investments of
Rs715 million (about $21.2 million equivalent) in SBICAP9 and Rs145 million (about $4.3 million
equivalent) in SBICAP Securities Limited.10

7
Since the 1980s, the Government has gradually sold SBI shares to individuals and institutions. As of 30 September
2005, RBI held 59.73% of SBI’s shares. The other major shareholders included foreign institutional investors
(11.86%); American Depository Receipts and Shares, and Global Depository Receipts (7.88%); Indian individuals
(5.68%); Indian banks and other financial institutions (5.34%); and Indian corporate bodies, trusts, or partnerships
(1.73%).
8
SBICAP was incorporated in 1986 as a wholly-owned merchant banking subsidiary of SBI.
9
ADB’s equity investment in SBICAP was disbursed in January 1997, and this equity investment is still in ADB’s
portfolio. The quarterly report on private sector operations for the quarter ended 30 September 2005 gave this
investment an RR-5 (substandard) risk rating and assessed its operational status as “problems in full operation
stage.” A project completion report on SBICAP has yet to be prepared.
10
Even though SBI incorporated SBICAP Securities Limited in 1998, no securities trading took place because of the
declining Indian economy. SBICAP, which was already overcapitalized at that time, took over instead and
incorporated the originally proposed securities trading business into its existing legal structure and business
operations. Eventually, ADB’s equity investment in SBICAP Securities Limited was canceled on 17 September
1999.
 3

7. SBIGL, which is the main focus of this PPER, was incorporated on 7 March 1996 and
became operational on 1 July 1996. ADB finalized the Subscription Agreement with SBIGL and
the Letter Agreement with SBI on 29 October 1996. Upon fulfillment of predisbursement
conditions, for example, the adoption of an operating policy statement, the appointment of an
independent external auditor, and the submission of relevant legal documents, ADB subscribed
Rs150 million ($4.19 million at disbursement) on 5 March 1997. SBIGL’s total paid-up capital
was Rs1,000 million, of which 85% was contributed by SBI and its associate banks and
subsidiaries and 15% was contributed by ADB.

D. Expected Outcomes

8. The purpose of ADB’s investment in SBIGL, as stated in the report and recommendation
of the President (RRP) (footnote 1), was to support the formation of an accredited primary
dealers network to facilitate active trading in Government securities. ADB considered its support
to the Government securities market as beneficial to the debt market, because the yield curve
for Government securities would serve as a benchmark for pricing debt instruments in other risk
categories. The OEM concurs with this view.

9. The Letter Agreement stipulates that SBI will (i) reduce its shareholding in SBIGL to less
than 50% within 4 years of the date of incorporation of SBIGL, and (ii) arrange for the
divestment of ADB’s shareholding at the same price at which SBI divests it shares. The
subscription agreement stipulates that SBIGL will make a public offering of its shares within 4
years of the date of incorporation. At the time of investment approval, the divestment of ADB’s
shares from SBIGL was expected to take place 6 years from the date of incorporation. The
financial internal rate of return (FIRR) on ADB’s investment in SBIGL was estimated at 16.5% in
rupee terms and 12.0% in dollar terms, based on a price-earning ratio11 of 9 and the projected
earning per share of Rs2.77 in the sixth year.12 This calculation assumed that SBIGL would not
pay any dividends to ADB during the entire investment period.13

E. Progress Highlights

10. A project completion report (PCR) on the equity investment in SBIGL was circulated in
July 2001.14 The PCR assessed project implementation as successful for several reasons. First,
SBIGL maintained its business scope as originally envisaged, and its performance was
satisfactory in terms of financial position, profitability, quality of management, and risk control
systems. Second, SBIGL remained an active player in both the primary and secondary markets
for Government securities. Third, ADB received dividends totaling $1.12 million from Fiscal Year
(FY) 199715 through FY2000. The PCR considered that calculating the FIRR of this investment
would be premature and provided limited information on its development outcomes, especially
the performance of the Government securities market.

11. The PCR highlighted two outstanding issues. First, the reduction of SBI’s shareholding
to less than 50% and the listing of SBIGL’s shares on the stock exchange within 4 years of the
date of incorporation of SBIGL had not materialized. The PCR stated that ADB would enter into

11
The RRP did not indicate the basis of this price-earning ratio.
12
The RRP did not discuss the reason for this 2-year discrepancy between the company’s initial public offering and
ADB’s divestment.
13
The RRP did not indicate the basis of the zero dividend scenario throughout the investment period despite the
projected steady increase in profits.
14
ADB. 2001. Project Completion Report on the Equity Investment in SBI Gilts Limited in India. Manila.
15
SBI DFHI’s financial year corresponds to that of the Government.
4

discussions with SBIGL’s management to develop a strategy for listing SBIGL in the next 2
years. Second, ADB had not discussed the divestment of ADB shares in SBIGL with SBI and
SBIGL. The PCR recommended that ADB monitor and actively seek divestments in the coming
years.

12. The OEM largely verified the PCR’s findings. The Project’s outcome can be summarized
as follows. First, the Government securities market steadily grew during FY1997–FY2004 but
experienced a setback in FY2005. Second, SBIGL was profitable during FY1997–FY2003.
Third, SBIGL merged with the Discount and Finance House of India Limited (DFHI) in FY2004
and was renamed SBI DFHI. Fourth, SBI DFHI was profitable in FY2004, but recorded a net
loss in FY2005. Fifth, ADB received dividends every year throughout the investment period
except FY2005. Sixth, the two issues highlighted in the PCR remain unresolved, and the Project
remains in ADB’s portfolio.

III. EVALUATION

13. The method of deriving performance ratings drew on the good practice standards
(footnote 2). Table 1 shows the performance ratings for the three key dimensions and
underlying indicators for the Project.16 Appendix 1 defines the dimensions, indicators, and 4-
point ratings scale referred to in Table 1. This chapter elaborates on the OEM’s findings as the
bases of the performance ratings for each dimension and indicator. The last section of this
chapter provides the overall project rating.

Table 1: Evaluation of Investment 7122-IND: SBI DFHI Limited

Partly
Item Unsatisfactory Satisfactory Satisfactory Excellent
Development Outcome √
Capital Market
Development √
Business Success √
Private Sector
Development √

Investment Outcome
(return on equity) √

ADB’s Effectiveness √
Screening, Appraisal,
and Structuring √
Supervision and
Administration √
Role and Contribution √
ADB = Asian Development Bank, SBI DFHI = SBI DFHI Limited.
Source: Operations Evaluation Mission.

16
The good practice standards suggest that the synthesis ratings for the three dimensions (development outcomes,
investment outcomes, and ADB’s effectiveness) reflect summary qualitative performance judgments based on the
underlying indicator ratings. The standards assume that the synthesis ratings for the three dimensions are not a
simple average of the indicator ratings.
 5

A. Development Outcome

14. The good practice standards suggest that the rating of the development outcome of
financial market operations be based on a project’s (i) contributions to the development of the
country’s private sector and/or the development of efficient capital markets, (ii) contributions to
the company’s business success, (ii) economic viability, (iii) contributions to the country’s living
standards, and (iv) environmental sustainability. For this Project, the OEM identified the
Project’s contributions to capital market development17 and private sector development and the
investee’s business success as the underlying indicators for the development outcome. The
assessments of the Project’s economic viability18 and the contribution to the country’s living
standards19 are integral to the assessments of capital market development in this evaluation.
The OEM did not consider environmental sustainability to be relevant to this Project.

1. Capital Market Development

15. The OEM rated the Project’s contribution to capital market development as satisfactory
based on the assessments in paras. 16–21.

a. Performance of the Government Securities Market

16. Table 2 shows the key performance indicators of the Government securities market,
extracted from Appendix 2. The assessment of these indicators can be summarized as follows:
(i) the outstanding stock of Government securities20 steadily increased from 15% of gross
domestic product (GDP) as of the end of FY1996 to more than 30% as of the end of FY2005; (ii)
the average maturity of dated securities issued during FY2002–FY2005 was more than 14
years, compared with less than 6 years in FY1996; (iii) the maximum maturity of the securities
reached 30 years, compared with 10 years in FY1996; and (iv) the market turnover of
Government securities21 increased from 52% of the outstanding stock of securities from FY1996
to 359% in FY2003, but dropped to 127% in FY2005. These performance indicators suggest
largely satisfactory progress in achieving the Project’s purpose with some reservations about
the market setback in FY2005. This setback reflected the reversal in interest rates trends, which
had constantly fallen during FY1996–FY2004. The ensuing paragraphs further assess these
indicators and other relevant information.

17
This PPER assesses the Project’s contribution to capital market development separately from its contribution to
private sector development for the following reasons. First, development of the Government securities market, the
primary purpose of this Project, might not immediately enhance private sector activities given the predominance of
state-owned financial intermediaries and institutional investors in India. Second, the Government securities market
might not immediately lead to a better corporate debt market. Third, privatization of SBI, a secondary purpose of
this Project, could be considered as a separate issue from market development.
18
The good practice standards suggest that the economic viability of financial sector operations should be rated on (i)
whether the subprojects financed are economically viable; (ii) whether the project has led to the use of economic
viability criteria, or economic internal rate of return, in the intermediary’s investment decisions; and (iii) whether the
project has resulted in benefits to the economy. The first and second criteria are not relevant to this Project. The
third criterion is covered in this evaluation under the assessment of capital market development.
19
The good practice standards suggest that a project’s contribution to the country’s living standards should be rated
based on the project’s economic benefits and costs to those who are neither its owners nor its financiers. This
subject is covered in this report under the assessment of capital market development.
20
Government securities in India comprise T-bills and dated securities. Dated securities are issued at maturities
greater than 1 year. Most dated securities bear coupons. T-bills are short-term instruments typically with a maturity
of 92 days and 364 days. In the past, the Government also issued 14-day and 182-day T-bills. The OEM could not
obtain consistent year-end data on the outstanding balance of 91-day T-bills, therefore Government securities here
refer only to dated securities and 364-day T-bills.
21
Government securities here include all dated securities and T-bills with different maturities in circulation.
 6

Table 2: Key Government Securities Market Indicators, FY1996–FY2005

FY1996– FY2000–
Item Unit FY1999 FY2003 FY2004 FY2005
A. Performance Indicators
1. Outstanding Balance of Dated
Securities % of GDPa 14.1–17.9 19.7–27.4 29.9 29.9
2. Outstanding Balance of T-billsb % of GDPa 0.7–1.2 0.8–1.5 1.2 1.1
3. Turnover Ratio of Government
Securitiesc % 52.0–136.4 151.0–358.7 312.9 126.9
4. Average Maturity of Dated
Securities Issued During the Year Years 5.5–7.7 10.6–14.3 14.9 14.1
5. Minimum and Maximum
Maturities of Dated Securities
Issued Years 2–20 5–25 4–29 5–30

B. Memorandum Items
1. Gross Fiscal Deficit of the Central
Government % of GDPa 4.9–6.5 5.4–6.2 4.5 4.5d
2. Weighted Average Cost of the
Dated Securities Issued During
the Year % 11.9–13.8 7.3–11.8 5.7 6.1
3. Net Market Borrowing by the % of the 39.5–55.5 62.1–71.8 72 33.1
Central Governmente gross fiscal
deficit
4. Issuance of Dated Securities Rs billion 309–778 866–1,760 1,870 1,050
5. Issuance of 91-day T-Bills Rs billion 132–252 71–264 365 1,022
6. Issuance of 364-day T-Bills Rs billion 18–162 130–261 271 481
GDP = gross domestic product, FY = fiscal year, T-bill = treasury bill.
a
GDP is provisional for FY2003 and estimated for FY2004 and FY2005.
b
This refers to 364-day T-bills only.
c
See footnote 21.
d
The fiscal deficit in FY2005 is an estimate.
e
Market borrowing refers to dated securities and 364-day T-bills.
Sources: Appendix 2; Center for Monitoring Indian Economy (memorandum items 4–6).

17. During FY1996–FY2003, the central Government budget deficits were sustained within
the range of 4.9% to 6.5% of GDP, while the proportion of net market borrowing increased from
39.5% to 71.8% of the Government’s budget deficit. This led to the increase in the outstanding
stock of Government securities as a percentage of GDP. This trend changed when the
Government embarked on a process of fiscal consolidation by enacting the Fiscal Responsibility
and Budget Management Act in 2003. Pursuant to this act, budget deficits were reduced to
around 4.5% of GDP in FY2004 and FY2005. In FY2005, international interest rates and
international crude oil prices rose, contributing to an increase in inflation. This led to a tightening
of domestic monetary policy and a rise in the yield of Government securities (Figure 1). In
response, the Government increased nonmarket borrowing22 for deficit financing in FY2005.

22
According to official statistics, nonmarket borrowing by the Government includes small savings, state provident
funds, special deposits, reserve funds, and 91-day T-bills. The OEM could not obtain the breakdown of nonmarket
borrowing in FY2005 so that it could do a detailed analysis of the outcome of the increased reliance on nonmarket
borrowing by the Government.
 7

Figure 1: The Zero Coupon Yield Curve as on 1 March (1998-2005)

Yield (%)

Maturity (Years)

Source: National Stock Exchange, Wholesale Debt Management Segment.

18. The significant increase in liquidity of Government securities during FY1996–FY200323

helped price discovery as reflected in the finer bidding patterns emerging in auctions and the
narrow spreads in the secondary market. The increased primary issues and secondary market
transactions of Government securities, complemented by the diversification of debt
instruments24 (Appendix 3), led to the entry of additional private sector primary dealers (para.
19). However, the rise in interest rates during FY2005 resulted in a drop in the turnover ratio
from 313% in FY2004 to 127% in FY2005 (Figure 2). This suggests that the development of a
secondary market in Government securities remains below its potential.25 The inadequate depth
and breadth of the market relates to (i) the commercial banks’ and Life Insurance Corporation of
India’s ownership of the majority of dated securities in circulation; and (ii) the large portion of the
holdings of dated securities by commercial banks and the Life Insurance Corporation of India
being statutorily mandated investments.26 Recently, cooperative banks, regional rural banks,
mutual funds, and nonbank finance companies have entered the Government securities market,
but their trading activities remain limited.
23
This partly reflected mutual funds’ active participation in the secondary market during this period in conjunction with
the launching of fixed income schemes.
24
These included floating rate bonds introduced in 1995, capital indexed bonds introduced in 1997, and interest rate
futures introduced in 2003.
25
In contrast, liquidity in the stock market remained largely consistent across episodes of much higher fluctuations in
the index price.
26
For this reason, a large portion of the market trading volume typically ends once the securities are placed with
commercial banks and the Life Insurance Corporation of India. Consequently, of 140 to 170 dated securities in
circulation, only 10 to 20 have significant liquidity. Little liquidity is available for dated securities that are more than
3 years old.
8

10-year zero coupon security yield (%)

Figure 2: Secondary Market Turnover and Dated Security Yield (10-year)

Turnover ratio (%)

Year

Source: National Stock Exchange, Wholesale Debt Management Segment.

b. Roles of Primary Dealers

19. India had largely achieved interest rate liberalization by the mid-1990s. This laid the
foundation for the development of the Government securities market, which in turn formed the
basis for the establishment of the yield curve of debt instruments. In 1996,27 RBI took the key
step of introducing primary auctions28 at the issuance of dated securities. To facilitate primary
auctions, RBI introduced the primary dealer system (described in the box) to assist price
discovery and to develop the secondary market. Initially, licenses were given to six public sector
financial institutions, including SBIGL. Subsequently, RBI issued primary dealer licenses to 12
additional financial institutions. Following the merger of SBIGL and DFHI in FY2004, 17 primary
dealers were operating. Of these, eight are promoted by public sector banks and public financial
institutions, six by foreign banks, two with the collaboration of foreign security houses, and one
by local nonbanking finance companies. The extent of operational diversification varies across
primary dealers.29

27
The RBI started primary auctions of T-bills in 1992.
28
Initially, RBI resorted to uniform price auctions, which since 1999 have progressively been replaced by multiple
price auctions.
29
Tentative information obtained by the OEM suggested that five primary dealers, including SBI DFHI, had their
revenues driven mostly by primary dealer business in Government securities.
 9

Box 1: Primary Dealer System

Primary dealers are responsible for ensuring the success of primary auctions of dated
securities through a system of annual bidding commitments, annual success ratios, and
underwriting of the auctions. RBI sets the annual requirement for bidding commitments for
primary dealers based mainly on their capital size. The underwriting commitments, as the
exclusive opportunity given to primary dealers, are decided separately prior to the actual auction
for primary issuance. Primary dealers bid to underwrite various amounts at various commission
rates. RBI decides on the actual allotment of the underwriting commitment by primary dealers
after considering the commission sought, the amount that succeeded in the primary auction,
and the permitted range for devolvement and RBI’s underwriting. Primary dealers also bid in the
primary issue auction and must fulfill their annual commitment across all the primary auctions
conducted during the year. To ensure that bidding is not too defensive, RBI mandates a 40%
success ratio. Unlike the underwriting auction, primary dealers compete with other auction
participants, mainly RBI-registered financial entities, in the primary bidding auction.a Primary
dealers are given access to the RBI repo market, the call money market, and the RBI liquidity
adjustment facility for their funding and liquidity management. There is no underwriting
procedure for T-bills, and for primary dealers, bidding commitments are fixed at a flat
percentage of the notified amount for each auction (determined at the beginning of the year).
a
To enable small investors to participate in the primary auction, RBI introduced a scheme for noncompetitive bidding
in January 2002. The scheme provides for the allocation of 5% of a notified amount at the weighted average of
accredited bids.

20. Most people interviewed by the OEM acknowledged the contribution of the primary
dealer system, complemented by other relevant reforms and market infrastructure
development30 (Appendixes 3 and 4), to the development of the Government securities market
during the past decade. During FY2001–FY2004, primary dealers continuously absorbed more
than half the Government securities issued in the primary market. Their turnover represented
more than 20% of secondary market transactions. However, the primary dealers’ absorption of
Government securities at primary auctions dropped to 28.5% in FY2005, reflecting their
reluctance to hold securities in an environment of rising interest rates. As a result, primary
dealers’ turnover of Government securities in the secondary market dropped to 17.7% in
FY2005. The contracted activities of primary dealers are closely related to the accounting norm,
requiring mark-to-market reevaluation of all securities in hand on primary dealers financial
statements.31 The lack of interest rate hedging instruments also explained the primary dealers’
prudent stance during the adverse market conditions.32 According to OEM interviewees, most
primary dealers, especially those specializing in Government securities trading, recorded
financial losses in FY2005.

30
The major achievement in this area included the negotiated dealing system and the Clearing Corporation of India
Limited, both operationalized for Government securities transactions in February 2002. The commencement of
Government securities trading on the three stock exchanges (the National Stock Exchange, the Bombay Stock
Exchange, and the Over-the-Counter Exchange of India) as of January 2003 was another major achievement.
31
A different accounting standard is applied to commercial banks in the revaluation of Government securities
categorized as held to maturity.
32
Reflecting the volatility in interest rates, over-the-counter markets have emerged for interest rate swaps and
forward rate agreements. Given the short-term nature of these instruments, the risks associated with holding
Government securities can only be partially hedged.
10

c. Investee’s Presence in the Market

21. Table 3 indicates that SBIGL (FY2001–FY2003) and SBI DFHI (FY2004–FY2005)
constantly played a lead role in the primary market. Their secondary market transactions were
limited to 2.9% to 4.6% of primary dealers’ total turnover during FY2001–FY2004, but increased
to 8.8% in FY2005.

Table 3: Primary Dealers’ Market Shares in Government Securities, FY2001–FY2005

(%)

Primary Market Secondary Market

SBIGL and SBI
Absorption by DFHI Primary Dealers SBIGL and SBI
Primary Dealers/ Absorptiona/ Turnover/ DFHI Turnovera/
Total Amount Absorption by Total Market Turnover by
Year Issued Primary Dealers Turnover Primary Dealers
FY2001 70.6 11.2 26.7 4.6
FY2002 70.5 9.2 22.8 2.9
FY2003 65.1 8.8 21.6 3.2
FY2004 56.0 11.3 25.1 3.1
FY2005 28.5 12.7 17.7 8.8
FY = fiscal year, SBIGL= SBI Gilts Limited, SBI DFHI = SBI DFHI Limited.
Note: Given the use of multiple sources, this table is highly tentative.
a
FY2001–FY2003 for SBIGL and FY2004–FY2005 for SBI DFHI.
Sources: Reserve Bank of India. 2005. Report of the Internal Technical Group on Central Government Securities
Market. Bombay; State Bank of India. 2005. Annual Report 2004–2005. Bombay; SBI DFHI data.

2. Business Performance of SBI Gilts Limited and SBI DFHI Limited

22. The OEM rated the investee’s business performance as satisfactory33 based on the key
financial ratios of SBIGL (FY1997–FY2003) and SBI DFHI (FY2004–FY2005) (Table 4).

33
The good practice standards suggest that a project’s contribution to a company’s performance should be rated on
the basis of its contribution to the financial intermediary.
 11

Table 4: Key Financial Ratios of SBIGL and SBI DFHI, FY1997–FY2005

(%)

FY FY FY FY FY FY FY FY FY
Item 1997 1998 1999 2000 2001 2002 2003 2004 2005
Return on Average Assets 4.4 12.8 6.1 3.3 3.1 9.1 9.8 12.6 (5.1)
Return on Average Capital 11.7 25.7 20.8 20.2 18.4 37.3 26.7 26.8 (9.4)
a
Trading Income/Total Income 25.4 14.9 5.6 10.6 12.3 46.5 47.1 43.3
a
Interest Income/Total Income 74.6 83.4 85.0 88.2 87.3 53.3 52.8 56.7
a
Underwriting Fees/Total Income 0.0 1.7 9.4 1.2 0.4 0.2 0.1 0.0
Securities Held/Total Capital 251.7 140.2 419.1 525.6 486.8 338.6 224.7 198.9 112.2
Underwriting/Total Bidding Success 0.0 118.3 249.9 107.3 94.8 94.6 86.9 74.2 46.3
a
Noninterest Expense/Total Income 7.0 2.1 2.1 2.0 1.8 1.6 2.2 2.1
Total Capital/Total Assets 37.6 68.3 19.7 14.3 19.9 29.7 45.4 47.5 63.9
Current Assets/Short-Term
Borrowing 8.3 13.0 21.7 28.8 3.6 (1.1) (4.0) 8.8 74.7

Market Shares in Primary Auctions 15.3 19.3 18.1 3.2 7.9 6.5 5.7 6.3 3.6
Market Shares in Secondary Trading 10.9 12.8 15.8 5.8 1.2 0.7 0.7 0.8 1.6
FY = fiscal year, SBI DFHI = SBI DFHI Limited, SBIGL = SBI Gilts Limited.
Note: Given the use of multiple sources, this table is highly tentative.
a
The summary financial statements submitted by SBI DFHI Limited’s management to the Operations Evaluation
Department indicated that its total income in FY2005 was negative because of large trading losses, making financial
ratios not applicable.
Sources: Appendix 5; SBI DFHI data.

a. SBI Gilts Limited (FY1997–FY2003)

23. SBIGL remained profitable during FY1997–FY2003, with a return on capital in the range
of 18% to 27% from FY1998 (Table 4). During FY1999–FY2001, SBIGL maintained a relatively
large portfolio of Government securities that amounted to more than 400% of capital, while
increasing short-term borrowing in FY1999–FY2000 and decreasing current assets in FY2001.
The entry of 12 additional primary dealers into the market from FY2000 led to SBIGL having a
reduced market share in both primary and secondary markets. The new management that took
over in FY2001 emphasized profits rather than turnover, resulting in a significant contraction in
the secondary market share. As a result, during FY1999–FY2001, more than 85% of SBIGL’s
income came from interest income rather than from trading income. Subsequently, SBIGL
progressively reduced its total holdings of Government securities from 487% of capital as of the
end of FY2001 to 225% as of the end of FY2003, taking advantage of the secular downward
trend in market interest rates. During this period, SBIGL was highly profitable, resulting in an
increase in net worth from Rs1,817 million as of the end of FY2001 to Rs2,740 million as of the
end of FY2003. Income from underwriting fees remained marginal throughout the period.

b. Merger of SBI Gilts Limited with Discount Finance House of India

Limited

24. In 1988 RBI, together with public sector banks and other financial institutions, formed
DFHI, one of the oldest money market players in India outside the banking system. After
obtaining its primary dealer license in 1996, DFHI shifted its operational focus to Government
securities and became the second largest primary dealer in terms of net worth (as of the end of
FY2003). In FY2003, SBI bought DFHI’s shares from the Industrial Development Bank of India,
the Unit Trust of India, and the Life Insurance Corporation. As a result, the proportion of SBI’s
12

shareholding in DFHI increased from 29.05% as of the end of FY2002 to 55.13% as of the end
of FY2003. The merger of SBIGL with DFHI was a strategic decision by SBI as the sponsor of
the two primary dealers. The High Court of Judicature in Bombay sanctioned the proposed
amalgamation of SBIGL with DFHI in July 2003. The effective date of the merger was 23 April
2004. The shareholders of SBIGL were issued 1 share of Rs100 of DFHI for every 11 shares of
Rs10 each that they held. This swap ratio was determined based on the independent valuation
of shares conducted by two external auditing firms. By the end of March 2005, SBI owned
67.01% of the total of 29,090,906 shares, ADB owned 4.69%,34 and other banks and financial
institutions owned the rest.

c. SBI DFHI Limited (FY2004 to date)

25. In FY2004, SBI DFHI recorded profits of 12.6% of average total assets, reflecting the
downtrend in yields of Government securities. SBIGL’s and SBI DFHI’s operational data indicate
that the merger resulted in an increased market share in the primary market, but not in the
secondary market, in FY2004. The operational efficiency of SBI DFHI in FY2004, measured by
the ratio of noninterest expense to total income, was comparable to that of SBIGL prior to the
merger. As of the end of FY2004, SBI DFHI’s total capital (as a percentage of total assets) was
also at the same level as that of SBIGL as of the end of FY2003. The rise in interest rates in
FY2005 resulted in a substantial trading loss of Rs1,795 million and a net loss of Rs940 million
(equivalent to 5.1% of average total assets). During FY2005, SBI DFHI, like many other primary
dealers, reduced its market share in the primary market. The information submitted by SBI DFHI
indicated that other public sector primary dealers35 recorded equivalent losses in FY2005. The
management of SBI DFHI explained that the loss in FY2005 was a natural consequence of the
drop in prices of Government securities, given that SBI DFHI had to fulfill a significant bidding
commitment and achieve the success ratio required by RBI. The management expected
improved performance in the first half of FY2006 compared with the same period in FY2005.

3. Private Sector Development

26. The OEM rated the Project’s contribution to private sector development as partly
satisfactory. While the Project and ADB’s overall policy dialogue in the financial sector
contributed to the entry of 12 private sector primary dealers, little progress has been made in
privatizing the SBI group companies, including SBIGL and SBI DFHI.

27. During appraisal, ADB considered that equity participation would provide an impetus to
the SBI group’s privatization program, as stated in the RRP. The letter agreement and the
subscription agreement stipulated as follows:

Within 4 years from the date of incorporation of the Company, or at a later date
as the Bank may otherwise agree, the Sponsor shall reduce its shareholding in
the Company to less than 50%, and ensure that the combined share ownership
in the Company of the Sponsor’s majority-owned subsidiaries is reduced to less
than 50% (which form of reduction in ownership may include divestment by the
Sponsor and issue of new Shares in the Company) subject to obtaining all
applicable governmental and other approval. (Paragraph 1 [e], Letter Agreement)
34
The Subscription Agreement ensures ADB’s representation on the board of SBIGL as long as ADB holds 5% or
more of the issued share capital of the company. With lower ADB shares after the merger, and no revisions
initiated on the Subscription Agreement, ADB’s representation on the SBI-DFHI’s board is no longer ensured.
35
These included Securities Trading Corporation of India Limited, PNB Gilts Limited, and Gilt Securities Trading
Corporation Limited. These primary dealers are similar to SBI DFHI in terms of operational scope.
 13

The Company shall undertake, in consultation with the Bank, to make a Public
Offering of its Shares at a price of not less than Rs10 for each share within 4
years from the date of the Company’s incorporation or by a later date as the
Bank shall otherwise agree. (Section 3.07. [a], Subscription Agreement)

28. Notwithstanding the foregoing, SBI’s management informed the OEM that it did not
intend to reduce its shareholding in SBI DFHI to less than 50%, as a reduction in shareholding
of subsidiaries through an initial public offering (IPO) is not in accordance with SBI’s current
corporate policy. Given that SBI DFHI is unlikely to require any additional capital in view of its
high net worth, SBI DFHI’s management understandably does not consider an IPO to be
necessary at this juncture.

29. SBI has undertaken a gradual process of organizational reforms since the mid-1990s
following the recommendations of an international consulting firm. As a result, the organization
became flatter, forming specialized business units for each market segment, namely, small and
medium enterprises, microcredit, rural credit, and so on. This has improved efficiency and
expedited decision making. However, little progress has been made in privatizing SBI and its
group companies. In view of market imperfections and the remaining weaknesses in the current
primary dealer system that surfaced during the market setback in FY2005, the OEM justified
continued public sector ownership in some primary dealers, including SBI DFHI, at least as a
transitional measure. Assessing the justification for continued public sector ownership in SBI
and other group companies is beyond the scope of this PPER (para. 45).

30. The entry of 12 primary dealers sponsored by private sector financial institutions as of
FY2000 promoted competition in the Government securities market and contributed to the
increased liquidity during FY2000–FY2004. People interviewed by OEM suspected that
sophisticated risk management skills introduced by primary dealers sponsored by foreign
financial institutions might have had some spillover effects on the local financial industry,
possibly contributing to a reduction of systemic risks in the market.

B. Investment Outcome

31. The OEM rated the investment outcome as satisfactory.36 If effective measures to
mitigate market risk and exit risk had been in place, the investment outcome could have been
assessed as excellent.

32. The OEM used the net asset value method37 to estimate the FIRR of the investment
based on the following: (i) ADB received dividends every year during FY1998–FY2004 that
totaled Rs184,909,000 (equivalent to about $4.0 million) and no dividend in FY2005; and (ii) SBI
DFHI’s net asset value was Rs9,581 million as of the end of FY2005. If ADB had divested all of
its shares at the end of FY2005, the FIRR would be 24.4% in rupees and 20.0% in dollars
(Appendix 6, tables A6.1 and A6.2). Using the same method and assuming that ADB would
divest on 31 March 2006, the FIRR would be 18.3% in dollar terms (Appendix 6, Table A6.3).
The assumptions in this calculation include no increase in net worth and no dividends paid to

36
The good practice standards suggest that the investment outcome should be rated based on “the investment’s
gross contribution in relation to the corresponding at-approval standards for minimally satisfactory expected
performance.”
37
The net asset value method is based on the book value of the company’s net worth.
14

ADB during FY2006 and that the 30 June 2005 exchange rate of Rs43.52 per $1 remains
constant. As the figures suggest, the investment return has been highly satisfactory and
exceeds the 12% FIRR in dollar terms estimated at appraisal.

33. The OEM initially planned to calculate FIRR projections also using the price-earning ratio
with reference to the industry average. However, the OEM subsequently discarded this
methodology for two reasons. First, the OEM could not obtain financial projections for SBI DFHI.
Second, because the earnings of primary dealers have been volatile in recent years, the price-
earning ratio is not a suitable indicator for making a valuation of primary dealers. Also only one
primary dealer is listed on the stock exchange, which significantly limits the availability of the
data required to implement this methodology.

34. The significant drop in liquidity of Government securities and the deterioration of primary
dealers’ performance in FY2005 suggest that this investment is exposed to considerable market
risk. Given the unlikely prospect of an IPO by SBI DFHI in the foreseeable future, a potential
difficulty in divestment is another risk associated with this investment. Representatives of SBI
and SBI DFHI indicated to the OEM their expectation of continued shareholding by ADB in SBI
DFHI. SBI DFHI’s management noted that they might consider a buy-back of shares rather than
an IPO if ADB decided to exit; however, consent from SBI DFHI’s more than 30 minority
shareholders would be required to pursue this option. SBI’s management did not comment
about the possibility of taking over ADB’s shares in SBI DFHI.

C. ADB’s Effectiveness

1. At-Entry Screening, Appraisal, and Structuring Work

35. The OEM rated ADB’s performance related to the Project’s screening, appraisal, and
structuring as partly satisfactory.

36. ADB’s performance before the subscription of shares was mixed. The Project was
relevant, because it complemented the Financial Sector Program (footnote 4) and the Capital
Market Development Program (footnote 5). Considering the large influence of the SBI group on
India’s financial system, ADB’s at-entry screening of this investment can be justified. OEM’s
review of the project file suggested that ADB adequately assessed the issues in the
Government securities market and the SBI group. The RRP appropriately highlighted the market
risk associated with this investment resulting from interest rate fluctuations and considered that
asset diversification would mitigate this risk. This consideration is questionable given the
specialized nature of SBIGL’s operations (which would constrain asset diversification) and the
lack of hedging instruments in the financial market.38

37. There is nothing to suggest that ADB had detailed discussions with SBI on the eventual
reduction of SBI’s shareholding in SBIGL, on an IPO by SBIGL, and on ADB’s exit policy. The
RRP was silent on an alternative mechanism that would ensure the divestment of ADB’s
shareholding other than via an IPO and the potential difficulty of ADB’s exit if an IPO turned out
not to be a realistic option. The letter agreement for the Project required SBI to arrange for
ADB’s exit only if SBI decided to divest its shareholding in SBIGL. The lack of a workable,
comprehensive exit mechanism for ADB was a major flaw in the project design.

38
International Finance Corporation staff interviewed by the OEM noted that the International Finance Corporation
decided not to invest in a primary dealer in India because of the high market risk associated with such an
investment given the lack of hedging instruments.
 15

2. Supervision and Administration

38. The OEM rated ADB’s performance related to supervision and administration as partly
satisfactory.

39. After the subscription, the Private Sector Operations Department at headquarters
administered this investment. ADB’s administrative performance was mixed. The OEM could not
fully clarify why the India Resident Mission administered the associated investment in SBICAP
but not this investment.39 ADB was represented on SBIGL’s board only during the earlier years
(FY1997–FY2000) of the investment.40 The OEM could not verify why this representation was
withdrawn.41 Throughout the investment period, SBIGL and SBI DFHI regularly submitted
performance review reports to ADB. Based on a review of these reports and attendance at
annual general meetings, supplemented by occasional correspondence, ADB officers have
updated the quarterly private sector investment management notes. Since 2003, ADB has
regularly proposed its exit from the investment as recommended in the PCR circulated in
August 2001.42 However, ADB’s response to the proposed merger of SBIGL with DFHI fell short
of expectations.43 ADB should have responded promptly to this proposal based on a thorough
assessment of the merger’s implications in consultation with the Office of the General Counsel.
Potentially, this merger could have offered an avenue for ADB’s divestment had the option been
pursued more vigorously.

3. Role and Contribution

40. The OEM rated ADB’s role and contribution as partly satisfactory.

41. SBI and SBI DFHI management explained the contributions of the ADB investment as
follows. First, this investment represented ADB’s tangible support for the financial sector
reforms initiated by the Government since 1991. Second, ADB’s broadly based strategic
thinking and international perspective brought benefits to SBIGL and SBI DFHI. Third, this
investment was associated with a significant demonstration effect that enhanced confidence in
the emerging Government securities market. However, the OEM did not consider ADB’s
39
According to PSOD, the reason for the separation of the supervision function of the two accounts is that SBICAP
was downgraded shortly after project approval because of a number of reasons, requiring closer monitoring
through the India Resident Mission. On the other hand, the PCR (para. 41) noted that “it makes sense to closely
involve ADB’s Resident Mission, which has staff with private sector experience (for SBIGL)” The OEM agrees with
the latter view. India Resident Mission is of the view that PSOD’s current system of assigning projects on an ad hoc
basis to resident missions should become more systematic and accountable so that the administration of private
sector projects would be more effective and efficient.
40
There is no record suggesting that the nominee director from ADB actually attended SBIGL’s board meetings,
whereas the OEM confirmed ADB’s representation at some of the annual general meetings of SBIGL and SBI
DFHI.
41
The PCR (para. 41) noted that “the Resident Mission of ADB in India played an active role on SBIGL’s Board as a
nominee director.” The OEM recognized the active role played by the India Resident Mission throughout the
investment period. However, the India Resident Mission officer was not designated as a nominee director on the
board of SBIGL at the time of the PCR according to the SBIGL’s annual report for FY2002.
42
The PCR (para. 38) noted that “ADB will enter into discussion with SBIGL’s management to develop a strategy for
listing SBIGL in the next 2 years. This will depend, however, on overall investment conditions in the Indian stock
market and the attractiveness of SBIGL to the investing public.” The OEM did not consider stock market conditions
or the attractiveness of SBIGL’s shares as major constraints to an IPO during FY2001–FY2003. Rather, it was the
reluctance of SBI and SBIGL as explained in para. 28.
43
SBIGL initially notified ADB about the proposed merger by means of a letter dated 27 May 2003; but the OEM
could not find any document substantiating a thorough assessment by ADB officers of this proposal soon after the
receipt of this letter or following ADB’s formal response to this letter.
16

contributions to SBIGL’s and SBI DFHI’s operations to have been fully tangible. Moreover, none
of the three private sector primary dealers interviewed by the OEM was aware of ADB’s
investment in SBIGL. This is understandable given that the annual reports of SBIGL (FY2001–
FY2003) and SBI DFHI (FY2004–FY2005) are not explicit about ADB’s shareholding in the
company. The OEM concluded that ADB played some demonstration role during the initial years
of that investment, but that such effects are diminishing.

D. Overall Rating

42. On the basis of the foregoing, the overall rating for this Project is satisfactory. This OEM
conclusion is based in particular on consideration of the following factors. First, the investee
company contributed to establishing and maintaining the primary dealer system. This, in turn,
supported the development of the Government securities market as originally envisaged.
Without the presence of SBIGL and SBI DFHI, the absorption of primary dealers in the primary
market, especially during the initial stage of its development and during the downturn of the
market in FY2005, would not have been sufficient. Second, to date the investment return has
been highly satisfactory and exceeds the 12% in dollar terms estimated at appraisal. However,
effective measures to mitigate the market risk and the exit risk are not in place, and thus the
final investment outcome remains uncertain. Third, ADB’s investment was timely and
complemented public sector operations, though ADB’s work quality fell short of expectations. If
ADB had a tangible exit policy for the Project, its overall rating might have been excellent.

IV. ISSUES, LESSONS AND FOLLOW-UP ACTIONS

E. Issues

43. In line with the 2003 Fiscal Responsibility and Budget Management Act, as of April 2006,
RBI will no longer play the role of underwriter of last resort in the primary auction of Government
securities. The new arrangement aims to tighten fiscal management, enhance the transparency
of the interest rate determination process, and make RBI’s open market operations more active
instruments for monetary control. The new arrangement is premised on a greater role for
primary market participants, especially primary dealers. However, most OEM interviewees
questioned the viability of the current primary dealer system given the underperformance of
primary dealers during the current period of rising interest rates. Because of this concern, RBI
set up the internal Technical Group on Central Government Securities Market to examine
reform options for the primary dealer system. Based on the group’s recommendations,44 RBI is
currently finalizing a reform plan. Implementation of this plan is expected to create a more
robust Government securities market.

44. In addition to reform of the primary dealer system, the development of a derivatives
market and the removal of existing entry barriers for individual investors45 should help deepen
and broaden the Government securities market. Progress in these areas may also serve to
44
The recommendations included (i) introducing a system of 100% underwriting commitment by primary dealers to
replace the current system of the 100% bidding commitment, (ii) giving primary dealers exclusivity in primary
auctions on a selective basis based on relative secondary market performance, and (iii) permitting short-selling by
primary dealers. Most primary dealers interviewed by the OEM supported these recommendations.
45
No explicit regulatory barrier hinders the entry of individual investors in the Government securities market, but the
presence of individual investors in the secondary market is negligible. One reason could be that the typical lot size
of Government securities in the secondary market is Rs100 million, which is prohibitive for individual investors.
While no rule prohibits individual investors from buying Government securities in smaller lots from banks or primary
dealers, the latter are not proactive in distributing Government securities to individual investors. Reportedly, the
dissemination of market information and settlement arrangements are also not investor friendly.
 17

develop the corporate debt market. India’s corporate debt market remains relatively
underdeveloped, with the outstanding amount estimated at around Rs1 trillion. To date, the vast
majority of corporate debt paper has been issued on a private placement basis, leading to a lack
of transparency and liquidity in the corporate debt market.

45. In the 1990s, the Government started diluting its equity in public sector banks in a
phased manner. A recent empirical study shows that in India, partially privatized public sector
banks outperformed nonprivatized public sector banks.46 On the basis of this observation, the
OEM generally supported the privatization of public sector banks; however, assessing the costs
and benefits, particularly of the SBI group’s privatization,47 is beyond the scope of this PPER.
ADB would need to undertake such an assessment should it consider participating in a project
sponsored by SBI or its affiliates in the future.

46. As explained earlier, the Private Sector Operations Department (PSOD) has proposed
its exit from the investment in the past but was not successful. Against this background, PSOD
will need to discuss with the South Asia Department broader ADB leverage that might be helpful
in devising an effective exit strategy.

F. Lessons Learned

47. ADB equity investments require a workable and viable exit mechanism. Planned IPOs
are often not a workable mechanism, as they depend on the nature of the investee, a sponsor,
the industry, and the market conditions. ADB cannot rely solely on IPOs, and therefore needs to
pursue a put option incorporated in a letter agreement or shareholders agreements. To make
such an option enforceable, the method of revaluation of an investee at ADB’s divestment
should be carefully discussed during processing and stated in the agreements.

48. If an investee company proposes a merger or acquisition, PSOD should carefully

examine the implications of such a proposal in consultation with the Office of the General
Counsel and provide prompt feedback to the investee company. ADB may need to pursue a put
option if it cannot agree to the proposal. The subscription agreement should contain a clause
specifying the agreed procedures if an investee company decides to pursue a merger or
acquisition. While such decisions cannot always be foreseen at the time of processing, a clear
understanding needs to be in place on how to deal with such situations should they materialize.

49. The quarterly private sector investment management note should elaborate on and
update the status of projects that have deviated significantly from the original scope and plan.
ADB should pay extra attention to monitoring such projects. In the case of this Project, the

46
Sathye, Milind. 2005. Privatization, Performance, and Efficiency: A Study of Indian Banks. Vikalpa 30 (1): 7-16.
Based on statistical evidence from financial data of 27 public sector banks (including SBI and its associated banks)
in 1998–2002, this study derived the following conclusions: (i) the financial performance of partially privatized
banks and their efficiency were significantly higher than those of nonprivatized public sector banks, (ii) the portfolio
quality did not differ significantly between partially privatized public banks and nonprivatized public sector banks,
(iii) the financial performance and efficiency of partially privatized banks seem to be catching up rapidly with those
of fully privatized banks, and (iv) the gradual privatization and well-developed financial markets seem to have
contributed to India’s success.
47
As concerns the SBI group companies, Sathye (footnote 46) did not detect any statistical evidence about the
effects of privatization. Sathye (p. 14) commented on this finding as follows: “The capital of the SBI is not directly
held by the Government of India [but held by RBI and other state-owned financial institutions] and the group
continued to enjoy the privileges of government business being routed through them. This scenario is different than
that of the nationalized banks [excluding the SBI group companies] where the Government of India held the entire
capital directly. As a result, ‘the marketization shock’ seems to have worked well with the nationalized bank cohort.”
18

reluctance of the sponsor to divest its shareholding and of the investee company to undertake
an IPO can be considered as major deviations that merited closer attention and more active
follow-up by ADB.

50. ADB approved this Project in conjunction with the investment in SBICAP. However,
monitoring and evaluation of the investment in SBICAP was undertaken separately: ADB
headquarters administered this Project, whereas the India Resident Mission administered the
investment in SBICAP. The PCR was prepared only for this Project. The assessment of the two
complementary investments is beyond the scope of this PPER. This experience suggests that to
the extent possible (i) the monitoring and evaluation of closely related projects sharing the same
sponsor should come under the purview of one investment officer, and (ii) the PCRs and
PPERs48 for the associated projects should be prepared simultaneously.

G. Follow-Up Actions

51. Given the diminishing demonstration effect of this Project, the accumulated net worth of
SBI DFHI (even taking into account the net loss in FY2005), the investment returns to date, and
the limited prospects for the privatization of SBI DFHI, ADB should develop an exit strategy from
this investment taking market conditions into account. SBI, as the sponsor of this Project, can
be a possible counterpart for sales of SBI DFHI’s shares held by ADB.

48
This consideration may be reflected to ADB’s evaluation guidelines on private sector projects, which is being
prepared.
 Appendix 1 19

EVALUATION STANDARDS

A. Development Outcome

1. These ratings measure Project’s contributions to (i) capital market development, (ii)
investee’s business performance, and (iii) private sector development:

(i) Excellent. A project with overwhelming positive development impacts and with
virtually no flaws. Indicates the type of project the Asian Development Bank
(ADB) should use publicly to illustrate the contribution of private sector
development.
(ii) Satisfactory. A project without material shortcomings or with some strong
positive aspects that more than compensates for shortfalls. The guideline
principle should be that if all ADB’s projects were rated satisfactory, it should just
be able to justify its existence as a development institution.
(iii) Partly satisfactory. A project with either minor shortcomings across the board or
some egregious shortcoming in one area that outweighs other generally positive
aspects.
(iv) Unsatisfactory. A project with largely negative aspects that clearly outweigh its
positive aspects.

1. Market Development

2. These indicators address the extent to which the Project contributed to sustainable
market development:

(i) Excellent. Considering its size, the project considerably contributed to market
development.
(ii) Satisfactory. The project had some, but no major, positive impact.
(iii) Partly satisfactory. The project had some negative impacts, but these are not
expected to be of long duration or broad applicability (for example, a failed
project without substantial negative demonstration effects).
(iv) Unsatisfactory. The project had negative impacts that are broadly applicable or
are expected to be of long duration or both.

2. Business Success

3. These indicators address the extent to which the Project contributed to the investee’s
operational performance:

(i) Excellent. The project substantially raised the investee’s profitability.

(ii) Satisfactory. The project had a neutral to positive effect on profitability.
(iii) Partly satisfactory. Project returns were sufficient to cover the cost of
associated debt, but did not provide adequate returns to equity holders.
(iv) Unsatisfactory. Project returns were insufficient to cover the cost of associated
debt.

3. Private Sector Development

4. These indicators address the extent to which the Project contributed to the sustainable
private sector development:
20 Appendix 1

(i) Excellent. Considering its size, the project contributed considerably to private
sector development.
(ii) Satisfactory. The project had some, but no major, positive impact.
(iii) Partly satisfactory. The project had some negative impacts, but these are not
expected to be of long duration or broad applicability (for example, a failed
project without substantial negative demonstration effects).
(iv) Unsatisfactory. The project had negative impacts that are broadly applicable or
are expected to be of long duration or both.

B. Investment Outcome

5. These ratings measure financial returns of ADB’s investment:

(i) Excellent. The financial internal rate of return (FIRR) of the ADB investment is
significantly higher than the expected returns cited in the original investment
proposal. Risks to a project’s future cash flow can be a factor for downgrading if
the investment remains in ADB’s portfolio.
(ii) Satisfactory. The FIRR is on a par with or marginally higher than the expected
returns cited in the original investment proposal. Risks to a project’s future cash
flow can be a factor for downgrading if the investment remains in ADB’s portfolio.
(iii) Partly satisfactory. The FIRR is lower than the expected returns cited in the
original investment proposal. Risks to a project’s future cash flow can be a factor
for downgrading if the investment remains in ADB’s portfolio.
(iv) Unsatisfactory. The FIRR is negative.

C. The Asian Development Bank’s Effectiveness

6. These ratings measure ADB’s overall performance related to the (i) Project’s screening,
appraisal, and structuring; (ii) Project’s supervision and administration; and (iii) role and
contribution:

(i) Excellent. ADB’s performance was exemplary.

(ii) Satisfactory. ADB’s performance was materially up to a high professional
standard.
(iii) Partly satisfactory. A material shortfall occurred in at least one area of ADB’s
performance.
(iv) Unsatisfactory. Shortfalls in several areas or an egregious shortfall in one area
led (or could have led, under less favorable circumstances) to an unsatisfactory
investment outcome.

1. Screening, Appraisal and Structuring

7. These indicators address to what extent ADB has professionally executed its front-end
work to a sustainable corporate performance standard.

(i) Excellent. ADB’s front-end work could serve as a best-practice example.

(ii) Satisfactory. Materially, ADB met good practice standards.
(iii) Partly satisfactory. A material shortfall occurred in at least one important area.
(iv) Unsatisfactory. Material shortfalls occurred in several areas, and a glaring
mistake or omission bordered on negligence in at least one important area.
 Appendix 1 21

2. Supervision and Administration

8. These indicators show to what extent ADB has executed its supervision, taking into
account that the appropriate level of supervision will depend on a project’s circumstances:

(i) Excellent. ADB has always kept itself promptly and fully informed about the
project’s and the company’s performance in all material areas and used this
knowledge proactively to improve the project’s development outcome and/or
ADB’s investment outcome.
(ii) Satisfactory. ADB has always kept itself sufficiently informed to react in a timely
manner to any material change in the project’s and company’s performance and
took timely action when needed.
(iii) Partly satisfactory. ADB’s supervision was insufficient to monitor the project’s
and company’s performance and/or ADB did not take timely and appropriate
action.
(iv) Unsatisfactory. ADB missed material developments and/or did not use
information to intervene in a timely and appropriate manner.

3. Role and Contribution

9. These indicators address the extent and relevance of ADB’s role and contribution:

(i) Excellent. ADB’s role was essential for the project to go ahead and ADB
contributed significantly to its success.
(ii) Satisfactory. ADB’s role and contribution were in line with operating principles.
(iii) Partly satisfactory. ADB’s role or contribution fell short in a material area.
(iv) Unsatisfactory. ADB’s role was not plausibly additional and ADB did not deliver
its expected contribution.
22 Appendix 2

STATISTICAL DATA

Table A2.1: Gross Domestic Product and Central

Government Deficit, FY1993–FY2005
(Rs billion)

GDP at Gross Central

Market Government
Fiscal Year Prices Deficit
1993 7,484 402
1994 8,592 603
1995 10,128 577
1996 11,880 602
1997 13,682 667
1998 15,225 889
1999 17,410 1,133
2000 19,368 1,047
2001 20,895 1,188
2002 22,720 1,410
2003a 24,633 1,451
2004b 27,600 1,233
2005c 31,055 1,392
GDP = gross domestic product.
a
Provisional.
b
Estimates.
c
Revised estimates.
Source: Reserve Bank of India. Database on India
Economy. Handbook of Statistics on Indian Company.
Available: http://www.rbi.org.in/scripts/Statistics.aspx.
 Appendix 2 23

Table A2.2: Outstanding Liabilities of the Central Government, FY1993–FY2005

(Rs billion)

182 and
Total Central 91-Day 364-day
Government Market Treasury Treasury
Fiscal Year Liabilities Loansa Bills Bills
1993 4,019 817 206 88
1994 4,780 1,106 326 84
1995 5,386 1,375 323 82
1996 6,062 1,695 438 19
1997 6,757 1,929 565 82
1998 7,783 2,490 16b 162
1999 8,918 3,116 15 102
2000 10,210 3,819 15 143
2001 11,685 4,537 19 163
2002 13,664 5,363 50 196
2003 15,592 6,742 97 261
2004 17,367 8,246 72 261
2005c 19,815 9,296 72 260
a
Market Loans comprise mainly dated securities.
b
Sharp decline in 91-day treasury bills is because of the conversion of ad hoc treasury bills into
special securities.
c
Estimate.
Source: Reserve Bank of India. Database on India Economy. Handbook of Statistics on Indian
Company. Available: http://www.rbi.org.in/scripts/Statistics.aspx.
 24 Appendix 2

Table A2.3: Maturity Pattern of Government Rupee Loans,a FY1993–FY2005

Rs billion Weighted
Outstanding Average
Outstanding Stock of Outstanding Yield
Stock of Maturity Stock of Issued
Maturity Under Between Maturity Total During the
Fiscal Year 5 Years 5 and 10 Years over 10 Years Outstanding Year (%)
1993 66 116 635 817 12.46
1994 237 246 623 1,106 12.63
1995 348 377 650 1,375 11.90
1996 650 514 531 1,695 13.75
1997 873 559 498 1,929 13.69
1998 1,020 1,017 453 2,490 12.01
1999 1,291 1,323 503 3,116 11.86
2000 1,430 1,477 912 3,819 11.77
2001 1,588 1,781 1,168 4,537 10.95
2002 1,642 1,908 1,814 5,363 9.44
2003 1,779 2,337 2,626 6,742 7.34
2004 1,848 2,552 3,846 8,246 5.71
2005 2,212 2,838 4,245 9,296 6.11
a
Government rupee loans comprise mainly dated securities.
Source: Reserve Bank of India. Database on India Economy. Handbook of Statistics on Indian Company.
Available: http://www.rbi.org.in/scripts/Statistics.aspx.

Table A2.4: Secondary Market Transactions in Government Securities,

FY1996–FY2005
(Rs billion)

Fiscal
Year Outright Repo Total
1996 638 480 1,118
1997 1,603 202 1,805
1998 1,592 317 1,908
1999 3,705 705 4,410
2000 4,869 1,138 6,007
2001 11,096 2,728 13,824
2002 13,500 4,890 18,390
2003 17,069 8,397 25,466
2004 11,878 14,969 26,846
2005 5,321 6,894 12,215
Source: Reserve Bank of India. Database on India Economy. Handbook of Statistics on
Indian Company. Available: http://www.rbi.org.in/scripts/Statistics.aspx.
 Table A2.5: Ownership of Central Government Securities Outstanding
as of the End of the Fiscal Year, FY1993–FY2004
(Rs billion)

Holders 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Total (I to IX) 816.9 1,105.8 1,375.2 1,695.3 1,928.9 2,490.2 3,116.0 3,818.8 4,536.7 5,363.2 6,742.0 8,246.1

I. Reserve Bank of India 86.4 33.1 34.5 152.2 66.7 319.8 339.5 317.9 417.3 409.3 529.0 410.2
(own account)
II. Commercial banks, of 528.1 795.1 945.9 1,090.5 1,302.1 1,436.9 1,836.1 2,316.9 2,767.1 3,254.6 3,942.2 4,562.1
which:
Scheduled commercial 527.9 794.9 945.9 1,090.5 1,302.1 1,436.9 1,836.1 2,316.9 2,767.1 3,254.6 3,942.2 4,562.1
banks (i + ii + iii)a
i. State Bank of India 188.7 268.0 318.2 353.9 401.0 401.1 559.8 758.9 1,052.2 1,245.4 1,468.2 1,531.4
and associates
ii. Nationalized banks 277.6 424.6 498.9 579.2 683.7 763.3 908.6 1,105.7 1,216.4 1,378.8 1,714.8 1,998.8
iii. Other scheduled 61.5 102.3 128.8 157.5 217.3 272.5 367.7 452.3 498.5 630.4 759.2 1,031.8
commercial banks
III. Life Insurance 133.5 186.3 236.3 302.2 382.9 465.1 567.9 703.9 842.7 1,071.4 1,302.9 1,597.2
Corporation of Indiab
IV. Unit Trust of India — 60.5 85.6 62.2 23.6 19.4 4.0 6.7 45.1 14.8 32.9 34.8
V. NABARD 17.7 16.9 18.6 14.2 13.4 13.4 13.1 12.9 12.1 12.9 12.3 20.5
VI. Employees Provident 6.2 6.2 6.2 10.0 18.5 27.8 42.7 60.7 87.3 110.1 135.5 166.8
Fund Scheme
VII. Coal Mines Provident 2.3 2.3 2.3 5.5 7.5 9.7 11.4 13.6 15.0 18.3 23.3 —
Fund Scheme
VIII. Primary Dealers — — — — — — — — 76.5 70.8 97.8 97.1
IX. Otherc 42.7 5.3 45.8 58.5 114.3 198.1 301.4 386.2 273.6 401.0 666.0 357.5
— = not available, NABARD = National Bank for Agriculture and Rural Development.
Note: The data represent the face value of interest-bearing, outstanding rupee securities excluding treasury bills; savings deposit certificates; other postal obligations; prize
bonds; expired loans; and interest-free, nonnegotiable, Government securities.
a
Excluding regional rural banks.
b
Represents the corporation’s investment of funds from its life insurance business and capital redemption insurance business in Government securities.

Appendix 2
c
Includes subscriptions made by the rest of the economy including, among others, all-India and some state-level financial institutions and/or corporations, plantation
provident funds, and refinancing institutions.
Source: Reserve Bank of India. Database on India Economy. Handbook of Statistics on Indian Company. Available: http://www.rbi.org.in/scripts/Statistics.aspx.

19
26 Appendix 3

CHRONOLOGY OF THE GOVERNMENT’S SECURITIES MARKET REFORMS

Year Reform Initiated Objective Remarks

June 1992 Introduction of auction method for To make Government Price discovery has
issue of Central Government yields market become very fine over a
Securities determined period of time.
December Introduction of the Reserve Bank Fine-tuning liquidity Precursor to Liquidity
1992 of India (RBI) repo auction Adjustment Facility
January Issued Zero Coupon Bond for the To add new instruments Securities Trading
1994 first time. Securities Trading and intermediaries Corporation of India and
Corporation of India commenced other Primary Dealers
operations (PDs) have become
important intermediaries
in the Government
securities market.
August Agreement between RBI and To do away with Improved cash
1994 Government of India on limiting automatic monetization management for
issue of ad hoc treasury bills Government and a
transparent issuance
process
March PD system introduced To strengthen the PD system has evolved
1995 market Intermediation as an important segment
and support primary of Government security
issue market.
July 1995 Delivery-versus-Payment (DVP) To reduce settlement We have now moved to
in Government securities was risk DVP-III.
introduced
September Floating Rate Bonds introduced To add more Floaters are now
1995 instruments becoming popular. 15–
20% of fresh Government
of India borrowing is now
through Floating Rate
Bonds.
January Technical Advisory Committee To advise RBI on Plays a pivotal role in
1997 constituted developing Government implementing RBI’s
security, money and reform agenda based on
foreign exchange a consultative approach
markets
March Introduction of Way and Means Discontinuation of Improved transparency
1997 Advances system for Centre automatic monetization and pricing as also
autonomy in monetary
policy making.
April 1997 The Fixed Income Money Market Introduction of self Improved practices. Repo
Dealers Association of India was regulation and market has been
established development of market developing.
practices and ethics
 Appendix 3 27

Year Reform Initiated Objective Remarks

July 1997 Foreign Institutional Investors To broaden the market Foreign Institutional
were permitted to invest in Investors have become
Government securities important players in the
market today, particularly
in Treasury Bill segment.
December Capital Indexed Bonds were To help investors hedge Efforts being made to
1997 issued inflation risk revitalize this product
April 2000 Primary Dealer Association of To improve secondary This has also helped
India was formed. Sale of market manage the overnight risk
securities allotted in primary
issues on the same day
June 2000 Introduction of Liquidity To manage short term Emerged as an important
Adjustment Fund liquidity mismatches monetary tool
May 2002 Compulsory holding of To improve settlement The progress of
Government securities in demat system dematerialization is being
form by RBI regulated entities monitored
June 2002 PDs were brought under the For integrated The position is being
Banking and Finance Service supervision of market reported periodically to
jurisdiction the Banking and Finance
Service
October Trade data of Negotiated Dealing To improve The measure is helping
2002 System is being made available transparency the small investors as
on RBI website well.
January Trading of Government securities To facilitate easier This has not taken off
2003 on stock exchanges access and wider very well. Efforts are on to
participation improve the position
February Regulated constituents permitted To widen the market Activity in repo market
2003 participation in repo markets has improved
June 2003 Interest Rate Futures introduced To facilitate Hedging of These futures have not
interest rate risk taken off
July 2003 Government Debt Buy-Back To reduce interest Other measures for active
scheme implemented burden of government consolidation being
and help banks offload considered
illiquid securities
March Introduction of DVP III To obtain netting Running successfully.
2004 efficiency and to enable
rollover of repos
April 2004 Introduction of Real Time Gross Real time, online, large Running successfully
Settlement value inter-bank
payment and
settlements
Source: Originally appeared in Reserve Bank of India. 2005. Report of the Internal Technical Group on Central
Government Securities Market.
28 Appendix 4

KEY INFRASTRUCTURE FOR THE GOVERNMENT SECURITIES MARKET1

A. Securities Settlement System

1. Settlement of Government securities and funds is being done on a Delivery vs.

Payments (DVP) basis in the books of the Reserve Bank of India (RBI) since 1995. A Special
Funds Facility from Reserve Bank for securities settlement has also been in operation since
October 2000 for breaking a gridlock situation arising from the course of DVP settlement. With
the introduction of Clearing Corporation of India Limited (CCIL) in February 2002, which acts as
clearing house and a central counterparty, the problem of gridlock of settlements has been
reduced. To enable Constituent Subsidiary General Ledger account holders to avail of the
benefits of dematerialized holding through their bankers, detailed guidelines have been issued
to ensure that entities providing custodial services for their constituents employ appropriate
accounting practices and safekeeping procedures. With the implementation of Real-Time Gross
Settlement (RTGS) System, Securities Settlement System will also be linked to RTGS System
to provide intraday liquidity to the market participants.

B. Negotiated Dealing System

2. The Negotiated Dealing System (NDS), which was operationalized on 15 February 2002,
provides based electronic dealing and reporting of transactions in money market instruments
(including repo), facilitates secondary market transactions in Government securities
disseminates information on trades with minimal time lag, and provides an online electronic
bidding facility in the primary auctions of Central/State Government securities, and OMO/LAF
auctions. This system is now being developed further so that anonymous based, order matching
trading can take place more efficiently and reduce telephone based trading. In addition, the
NDS enables “paperless” settlement of transactions in Government securities with electronic
connectivity to CCIL and the DVP settlement system at the Public Debt Office (PDO) through
electronic subsidiary general ledger (SGL) transfer form. All entities having SGL Accounts with
RBI were advised to join the NDS-CCIL system by 31 March 2003. In phase I B of PDO-NDS
Project, NDS was integrated with the securities settlement system and primary market
operations. Further, all the regional PDOs were interconnected and automated which resulted in
electronic maintenance of record of ownership of stock in physical and SGL form. This has
facilitated electronic transfer of record of ownership to any PDO in the country.

C. Clearing Corporation of India Limited

3. The CCIL has started clearing of transactions in Government securities and repos
reported on the NDS since 15 February 2002 and clearing of Rupees/US$ foreign exchange
spot and forward deals since 12 November 2002. Acting as a central counterparty through
novation, the CCIL provides guaranteed settlement and has in place risk management systems
to limit settlement risk and operates a settlement guarantee fund backed by lines of credit from
commercial banks. The netting of funds by CCIL reduces the liquidity requirements of the
market and thereby liquidity risk of the system. All the transactions in Government securities
concluded or reported on NDS have to be necessarily settled through the CCIL. CCIL has also
initiated another instrument called “Collateralized Borrowing and Lending Obligation” which is a
tripartite repo product for facilitating liquidity and cash management to other participants (Table
A4). There are so far 156 members of CCIL.

1
This section appears in Mohan, Rakesh. 2004. A Decade of Reform in Government Securities Market in India and
the Road Ahead. Reserve Bank of India Bulletin (November): 1019–1021.
 Appendix 4 29

Table A4: Increasing Transactions Conducted Through

Clearing Corporation of India Limited
(Amount in Rs billion – face value)

Share in the
Total SGL
Transaction on Outright Repo Transactions
CCIL Transaction Transactions Total (%)
2001–02 389 159 548 3.74
2002–03 10,692 4,632 15,324 78.92
2003–04 15,751 9,432 25,183 95.40
Sources: National Stock Exchange and Clearing and Corporation of India Limited.

D. Trading in Stock Exchanges

In order to facilitate easier access and wider participation in the Government securities markets,
a facility has been provided to buy and sell Government securities through the stock exchanges
(National Stock Exchange, Bombay Stock Exchange, and Over-the-Counter Exchange of India)
with effect from 16 January 2003. Given the reach of the stock exchanges screens, it is
expected that Government securities can be bought or sold throughout the country. Keeping in
view the interests of the small investor, the minimum order size has been kept low at Rs1,000
(face value). Trading though this facility is yet to develop in any substantive fashion and hence
needs further attention for the development of this facility. The technical infrastructure is,
however, now in place.
 SUMMARY OF FINANCIAL STATEMENTS OF SBI GILTS LIMITED AND SBI DFHI LIMITED

19
Table A5.1: Income Statements of SBI Gilts Limited (FY1997–FY2003) and SBI DFHI Limited (FY2004–FY2005)
(Rs million)

Appendix 5
Item FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005

A. Income
Trading Income 75.5 102.3 47.7 122.3 171.7 849.6 760.6 1,642.1 (1,795.0)
Interest Income 222.2 572.0 721.2 1,022.5 1,215.0 974.4 853.2 2,148.4 1,420.8
Underwriting Fees 0.0 11.7 79.5 14.3 5.5 4.3 1.4 0.3 5.7
Total Income 297.7 686.0 848.4 1,159.1 1,392.2 1,828.3 1,615.2 3,790.8 (368.5)

B. Expenses
Staff Costs 1.5 2.8 3.9 6.3 6.7 8.7 8.6 19.0 15.5
Establishment of Expenses 5.1 4.3 5.8 6.2 7.2 16.9 21.6 44.9 60.5
Miscellaneous Expenses 2.7 6.0 7.3 9.8 10.2 2.9 3.5 10.1 7.9
Provision for Stock on Hand 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Interest 40.7 204.6 396.2 632.8 842.8 587.1 499.2 945.9 491.4
Depreciation on Fixed Assets 0.4 1.0 0.8 0.7 1.4 1.4 2.3 5.0 4.2
Preliminary Expenses Written-Off 11.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total Expenses 61.6 218.7 414.0 655.8 868.3 617.0 535.2 1,024.9 579.5

Profit before Tax 236.2 467.3 434.4 503.4 523.9 1,211.3 1,080.0 2,765.9 (948.0)
Provision for Tax 107.1 160.0 147.0 188.0 205.1 436.3 401.0 990.3 (7.6)
Profit after Tax 129.1 307.3 287.4 315.4 318.8 775.0 679.0 1,775.6 (940.4)

Note: FY1997–FY2003 reflect the balance sheet of SBI Gilts Limited. FY2004 onwards reflects SBI DFHI Limited.
Source: SBI DFHI Limited.
 Table A5.2: Balance Sheets of SBI Gilts Limited (FY1999–FY2003) and SBI DFHI Limited (FY2004–FY2005)
(Rs million)

Item FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005
A. Net Worth and Liabilities
1. Shareholders' Equity
Paid-Up Capital 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 2,909.1 2,909.1
Reserves and Surplus 99.6 294.0 471.4 652.6 817.0 1,343.2 1,739.5 7,614.5 6,671.8
Total (A1) 1,099.6 1,294.0 1,471.4 1,652.6 1,817.0 2,343.2 2,739.5 10,523.6 9,580.9

2. Borrowing
Short-Term Borrowing 1,822.2 600.0 6,002.4 9,878.2 7,295.7 5,546.8 3,297.8 11,635.2 5,414.4
Long-Term Borrowing 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total (A2) 1,822.2 600.0 6,002.4 9,878.2 7,295.7 5,546.8 3,297.8 11,635.2 5,414.4

3. Deferred Tax Liability 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.0

Total 2,921.8 1,894.0 7,473.8 11,530.8 9,112.7 7,890.0 6,037.3 22,159.1 14,995.3

B. Application of Funds
1. Fixed Assets
Gross Fixed Assets 3.2 4.0 4.3 5.8 8.9 14.8 15.2 54.2 56.3
Less Depreciation 0.4 1.3 2.1 2.8 4.2 5.7 7.9 34.9 39.0
Net Fixed Assets 2.8 2.7 2.2 3.1 4.7 9.1 7.3 19.3 17.3

2. Securities Held, Net of Provisions 2,768.1 1,813.6 6,167.3 8,685.5 8,845.8 7,933.7 6,156.0 20,936.7 10,746.9
3. Current Assets 150.9 77.7 1,304.3 2,842.2 262.2 (58.7) (131.0) 1,024.2 4,045.0
4. Investments 0.0 0.0 0.0 0.0 0.0 5.0 5.0 178.2 178.2
5. Deferred Tax Assets 0.0 0.0 0.0 0.0 0.0 0.9 0.0 0.0 7.4
6. Deferred Revenue Expense 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.7 0.5

Total 2,921.8 1,894.0 7,473.8 11,530.8 9,112.7 7,890.0 6,037.3 22,159.1 14,995.3

Note: FY1997–FY2003 reflect the balance sheet of SBI Gilts Limited. FY2004 onwards reflects SBI DFHI Limited.

Appendix 5
Source: SBI DFHI Limited.

31
 32 Appendix 6

FINANCIAL INTERNAL RATE OF RETURN ON THE ASIAN DEVELOPMENT BANK’S

INVESTMENT IN SBI DFHI LIMITED

Table A6.1: Internal Rate of Return Using a Net Asset Value Method to Calculate the Share Value
at Exit Assuming the Asian Development Bank Divested on 31 March 2005, FY1997–FY2005
(Rs ‘000)

Item FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005
Investment (150,000)
Dividends Paid to
ADB 15,000 15,000 18,000 21,000 37,500 37,500 40,909
Divestment 449,100
Net
Inflow/(Outflow) (150,000) 15,000 15,000 18,000 21,000 37,500 37,500 40,909 449,100

IRR in Rs 24.37%
ADB = Asian Development Bank, FY = fiscal year, IRR = internal rate of return.
Source: Operations Evaluation Mission.

Table A6.2: Internal Rate of Return Using a Net Asset Value Method to Calculate the Share Value
at Exit Assuming the Asian Development Bank Divested on 31 March 2005, FY1997–FY2005
($)

Item FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005
Investment (4,192,286)
Dividends paid
to ADB 352,941 347,745 404,949 447,046 765,619 797,533 889,328
Divestmenta 10,262,794
Net Inflow/
(Outflow) (4,192,286) 352,941 347,745 404,949 447,046 765,619 797,533 889,328 10,262,794

IRR in $ 20.01%
ADB = Asian Development Bank, FY = fiscal year, IRR = internal rate of return.
a
Based on 31 March 2005 net asset value of Rs329.34 and exchange rate of Rs43.76/$1.00.
Source: Operations Evaluation Mission.

Table A6.3: Internal Rate of Return Using a Net Asset Value Method to Calculate the Share Value
at Exit Assuming the Asian Development Bank Will Divest on 31 March 2006, FY1997–FY2006 a
($)

Item FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006
Investment (4,192,286)
Dividends
paid to
ADB 352,941 347,745 404,949 447,046 765,619 797,533 889,328 0
Divestmentb 10,319,391
Net Inflow/
(Outflow) (4,192,286) 352,941 347,745 404,949 447,046 765,619 797,533 889,328 0 10,319,391

IRR in $ 18.29%
ADB = Asian Development Bank, FY = fiscal year, IRR = internal rate of return.
a
Assuming no increase in net worth and no dividends paid to ADB during FY2006.
b
Based on 31 March 2005 net asset value of Rs329.34 using the 30 June 2005 exchange rate of Rs43.52/$1.00.
Source: Operations Evaluation Mission.
MANAGEMENT RESPONSE TO THE PROJECT PERFORMANCE EVALUATION REPORT
FOR THE SBI DFHI LIMITED IN INDIA
(Investment 7122-IND)

On 10 February 2006, the Director General, Operations Evaluation Department, received

the following response from the Managing Director General on behalf of Management:

A. Overall Assessment

1. In general, Management finds the paper well prepared and very

comprehensive in the evaluation of the project and its implementation. The report
provides an excellent analysis of the growth of the Government Securities Market
in India over the last 10 years and the role that the investee company played in
promoting the accompanying capital market reforms. Management response
focuses primarily on the overall assessment and the lessons learned.

2. Management notes that the PPER rates the overall project as

satisfactory. While we can agree with this overall rating of the project, we would
have wished for OED to place more emphasis on the fact that ADB’s assistance,
through its Private Sector Operations Department (PSOD), to the establishment
of the leading primary dealer company in the country contributed significantly to
the development of the Government securities market. As stated in various parts
of the report, this project is a fine example of ADB's private sector operations
supporting broader policy dialogue undertaken by the public sector of ADB. The
investment in SBI DFHI Limited serves as a prime model for the successful
collaboration between the private and public sector side of ADB, whereby its
public sector side helped develop an enabling environment for the target sector
and PSOD then tested the robustness and market-friendliness of these policy
measures by participating in an actual transaction. Clearly, the outcome of ADB's
support to the Government's reform program was highly successful as evidenced
by the growth and turnover of the Government securities market over the last ten
years. We believe this positive achievement should have been reflected in a
higher rating with respect to the project’s development outcome.

B. Lessons Learned

3. Management notes that a number of the lessons learned focus mainly on

the fact that PSOD was not able to exit this investment as originally envisioned
through a public offering within 4 years from the date of the investment. To
address this issue, OED recommends that PSOD’s equity investments require a
workable and viable exit mechanism. In particular, it is suggested that PSOD
should not solely rely on an IPO and needs, therefore, to implement other
divestment modalities such as a put option to the sponsor or majority
shareholder. In this respect, PSOD agrees that an IPO is not always the best exit
option as it might be difficult to achieve in view of the illiquid and underdeveloped
state of many capital markets in ADB’s developing member countries. The
emerging markets in the region continue to remain somewhat volatile and
unpredictable, and it is not unusual for a planned IPO to be postponed for one or
 even several years until favorable circumstances exist which support a
successful public listing.

4. However, it should also be emphasized at this point that a put option is

not always commercial or legally viable, and in most cases would provide for a
price that is substantially lower than the market value of the shares. A put option
against other shareholders may result in consolidation issues for that shareholder
and a put option against the company itself may not always be easily
enforceable, depending on legal and regulatory framework in the relevant
country. Furthermore, ADB would take credit risk on the counterparty to the put
option, which may not financially be able to comply with terms of the put. It is,
therefore, essential that PSOD be given the autonomy to structure a workable
and viable exit mechanism suitable to the type of investment and the particular
characteristics and circumstances of each project.

5. In connection with the exit issue, it should also be highlighted that the
project has been highly successful in terms of the company's financial position,
profitability, quality of management and risk control systems. SBI DFHI has been
profitable from its start and has always paid a dividend to ADB—with the
exception of FY2005. As of December 2005, the company has almost returned
ADB’s investment of $4.19 million through dividend payments amounting to $4
million so far. The total net asset value of ADB's shares in the company is
currently valued at $10.2 million which will translate to an FIRR of roughly 18%
assuming ADB would divest on 31 March 2006. This is certainly an excellent
return on ADB's investment.

6. ADB continues to incorporate the lessons learned from its past

investments by improving transaction structures in order to allow for timely exits.
In this regard, PSOD has been able to negotiate put options in a number of its
recent equity investments1 and will consider put options in relation to equity
investments going forward.

C. Conclusion

7. Management agrees with the overall rating of the project and the report’s
conclusion that the investment in SBI DFHI Limited contributed to the
establishment of a primary dealer system in India which, in turn, supported the
development of the Government securities market. Management notes OED’s
comments regarding the desirability of a put option, but it also wishes to highlight
that the investment was timely and complementary to ADB’s public sector
operations and was highly successful in terms of the achieved and further
expected financial return to ADB.

8. In line with the report’s recommended follow-up actions, PSOD has

initiated discussions with the company and the SBI Group, its majority
shareholder, regarding the sale of ADB’s shares.

1
A put option is in place in the following investments: MON-7197: Trade and Development Bank of Mongolia; AFG-
7199: Afghanistan International Bank; PRC-7200: Credit Orienwise Group; PRC-7219: Bank of China, Ltd.