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August 2013

Call money rates rose sharply in July amid high volatility, with the rates soaring to over 10% near the end of the month due to strong demand for funds from banks as they clamored to meet their new target of maintaining the cash reserve ratio (CRR); the RBI hiked the minimum amount banks need to maintain under CRR on a daily basis to 99% of the requirement with effect from July 27 from 70% earlier. Other liquidity-tightening measures by the central bank during the month such as hiking the marginal standing facility (MSF) rate and reduction in borrowing limits for banks from the RBI’s liquidity adjustment facility (LAF) to curb exchange rate volatility added to the pressure on call money rates during the month. Earlier in the month, however, call rates remained low in the range of 6.30-6.60% due to a comfortable liquidity situation in the banking system, government spending and subsidy payment to oil marketing companies.

Gilt prices declined in July primarily due to the liquidity-tightening measures adopted by the RBI to stem the downfall in the rupee. During the month, the central bank hiked the MSF rate (Marginal Standing Facility) by 200 bps to 10.25% while keeping the Repo rate unchanged at 7.25%; set the overall limit for access to LAF (Liquidity Adjustment Facility) by each individual bank at 0.5% of its own NDTL (Net demand and time liabilities), and conducted an open market operation (OMO) to sell Gilts worth Rs 12,000 cr - over and above the normal government borrowing for the current fiscal, though at the gilt auction, the RBI could only sale around Rs 2,500 cr of gilts.

Worries that the central bank would initiate more such measures at its policy review held in the last week of the month also dragged down gilt prices in the month; the RBI maintaining status quo on its rates and not unveiling any more measures at its policy review, however, soothed nerves in the market. Among global factors, rise in global crude oil prices, which could impact India’s inflation and thus RBI’s monetary policy, pushed gilt prices down. Further, positive economic data in the US, which could add to the US Fed’s resolve to reduce stimulus measures in the country and lead to flight of foreign capital from India, also led to drop in gilt prices during the month. Yield on the 10-year benchmark paper 7.16%, 2023 ended at 8.17% on July 31, 2013, compared with 7.44% on June 28, 2013.

Further fall in gilt prices was capped due to recovery in the rupee after the RBI took steps to curb volatility in the foreign exchange market. Prices were also supported by US Fed chairman's remarks that indicated the central bank may not roll back its bond purchase programme soon. Some buying was also witnessed as the Securities Exchange Board of India (SEBI) sold the entire limit of Rs 23,661 cr for foreign institutional investment in gilts, indicating strong demand. Prices rose further after the RBI sold only a small fraction of the notified amount of gilts through its bond sale under its open market operations (OMOs) and after it rejected all bids at its Rs 12,000 cr treasury bills sale.


Macro Forecast

We expect yield on the 10 year G-sec to settle at around 7.3-7.5% by March-end 2014. Lower inflation in 2013-14 in the base case scenario and an expected 25-50 basis point cut in the repo rate during the rest of the fiscal will help lower yields. OMOs by the RBI and the government's commitment to containing fiscal deficit will also keep G-Sec yields subdued.