Call money rates moved in a broad range of 7.00-8.80% in June; they were on the higher side for most parts of the month. Demand for funds from banks to meet their daily and weekend reserve needs, to make short-term loans and spruce up their balance sheets towards the quarter-end pulled up the call rates. Outflow of funds on account of excise, sales and corporate advance tax payments by corporates also put pressure on the call rates. Some easing in the rates was seen on tracking an intermittent fall in CBLO rates, and as the liquidity condition improved after the Reserve Bank of India (RBI) conducted two term repo auctions for notified amounts of Rs 10,000 each on June 18 and June 20.
Government bond prices declined in the month, with the yield on the 10-year benchmark paper 8.83%, 2023 rising to 8.74% on June 30 from 8.64% on May 30, 2014. Gilts were primarily hit by a rise in crude oil prices due to the ongoing crisis in Iraq, which triggered concerns that inflation may rise further in India as the country is a major importer of crude oil. Rise in domestic wholesale inflation to a five-month high of 6.01% in May from 5.20% in April, dashing hopes of an interest rate cut by the RBI in coming months, dealt another blow to sentiments. Gilt prices slipped further as foreign institutional investors (FIIs) were forced to stop their bond purchases in the earlier part of the month after they crossed the gilt investment limit of 90%. Hopes that the government may raise FII debt limits were dashed after Finance Secretary Arvind Mayaram and RBI Deputy Governor H R Khan clarified that no discussions for the same had taken place. The safe haven asset was affected further on reports that the RBI was considering the issue of a new 10-year bond as the current benchmark's outstanding figure has reached Rs 69,000 cr, and on the government’s decision to extend excise duty cuts for six months until December 31. A partial devolvement of the 8.27% 2020 gilt during the RBI's weekly auction in the last week of the month also affected sentiments for gilts.
The decline in gilts was arrested after the RBI, in its second bi-monthly policy review on June 3, left the repo rate unchanged at 8% and said a faster-than-anticipated disinflation could give it some headroom to ease the policy stance. The central bank also lowered SLR to 22.5% from 23% effective the fortnight beginning June 14. Gilt prices rose as market participants were bullish on expectations of purchases from FIIs. Positive CPI-based inflation data for May also cheered investors; data showed that retail inflation for May had eased to 8.28% from 8.59% in April. Sporadic value buying and appreciation in the rupee against the dollar and some weak economic data from the US also limited gilt losses.
We expect 10-year G-sec yield to settle around 8.6% by March-end 2015. Higher than budgeted government borrowings and limited downside to policy rates during the fiscal to limit the downside to yields.