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April 2011

Due to strong demand from banks to meet their reserve requirements inter-bank call money rates remained high in the range of 6.7-7.6% for most parts of the month. Advance tax outflows of around Rs 50,000 cr for the January-March quarter put additional pressure on the rates. The rates were also pushed higher on expectations of further rate hike by the RBI as it would increase borrowing costs in the overnight market. Rates ended the month higher at 9.00-9.25% on March 31 as banks showed reluctance to lend due to the financial year end.
Gilt prices moved in a narrow range thereby ending the month slightly higher as compared to the previous month. The yield on the benchmark 7.80%, 2020 paper finished at 7.98% on March 31 as compared to 8.01% on February 28. Sentiments got a boost earlier in the month after the government, in the Union Budget, announced that it will borrow Rs 3.43 lakh cr from the market on a net basis during FY12 compared with Rs 3.45 lakh cr in FY11, which was lower than the market expectations. Further, in the borrowing calendar announced later in the month, the government said that it will borrow Rs 2.5 lakh cr in the first half of 2011-12, on a net basis, it will borrow Rs 1.9 lakh cr in April-September. Both these numbers were lower than expected resulting in positive sentiments for gilts. Further a lower-than-estimated fiscal deficit projection at 4.6% of the GDP for FY12 and increase in the FII limit in corporate bonds also augured well for the gilts. Buying also took place on view that government may not raise more funds through bond auctions for the rest of FY11 which was later confirmed by the government. Prices got further support after the central bank hiked the repo and reverse repo rate on expected lines, by 25 bps each to 6.75% and 5.75% respectively in its mid-quarter policy review on March 17. Buying was also witnessed by banks to boost their portfolio valuations before FY11-end. 

Rise in the prices was however capped as a spike in crude oil prices revived concerns regarding high domestic inflation which may prompt an aggressive rate hike by RBI. Intermittent rise in weekly inflation also stoked the fear of an interest rate hike by the RBI. Sentiments for bonds were also dented after RBI raised its March-end inflation projection to 8% from 7% in its mid-term policy review.

Macro Forecast

Short term rates have moved up over the last quarter as tight systemic liquidity coupled with large supply from banks resulted in money market rates moving up to near 10.20% in the 3 month segment towards end Mar11. As the frictional liquidity pressures would start unwinding in the quarter, the short term money market rates are expected to ease substantially going forward, especially in the first half of Apr 11. However, the structural factors would take time to unwind and the rollover of CD’s towards May-June could again put an upward pressure on rates, even as the peaks witnessed in the Jan-Mar 11 quarter are unlikely to be retested. The Government’s fiscal position has been better than market expectations which led to a rally in g sec yields after the Union Budget. In view of the under budgeting of subsidies the eventual evolution of the borrowing program would still be challenging, especially in a stubbornly inflationary scenario. However, continued global uncertainty, recent growth in Bank NDTL and bleak prospects of growth in the developed economies along with RBI’s current significant moves to tackle inflation would keep a check on rising bond yields beyond a certain yield level and point of time. On balance, it is expected that interest rates would see an upward bias and peak out in this quarter.