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December 2013

Call money rates moved in the broad range of 8.25-8.75% in November with the earlier part of the month witnessing a rise in rates due to surge in demand from banks to meet mandatory reserve needs for the daily reserve requirements and reporting fortnight. Demand for funds was firm as banks borrowed to meet excise and service tax outflows. Further rise in call rates was capped by an improvement in liquidity in the banking system due to open market operations (OMOs) and 11-day term repo by the Reserve Bank of India (RBI) in mid-November. Sharp decline in rates was seen at the end of month with call rate falling below the RBI’s repo rate of 7.75% due to low demand from banks and as mutual funds deployed heavy funds in the collateralised segment. 

Government bond prices fell sharply in the month with yield on the 10-year benchmark 7.16%, 2023 bond rising to 9.04% on November 29 from 8.62% on October 31. Sentiments were hit earlier due to the pressure of heavy supply from a weekly auction. Prices fell amid concerns of further currency depreciation in the wake of demand for dollars from oil marketing companies returning to the foreign exchange market. Bond prices were also affected after ratings agency S&P said it may cut India's rating to speculative grade next year if the new government seems incapable of reversing the trend of low economic growth. The 10-year benchmark bond came under pressure as it was seen unattractive due to its high outstanding amount. Fall in the rupee coupled with higher CPI-based retail inflation reading also dented sentiment for bonds. Worries of tapering of stimulus measures by the US Federal Reserve in the coming months further reduced the appetite for gilts. Intermittent profit sales weighed on the prices to certain extent. 

Further fall in bond prices was capped after RBI Governor Raghuram Rajan said that market interest rates suggest some liquidity tightness and the RBI will conduct an open market bond purchase auction worth up to Rs 8,000 cr on November 18. Bond prices also gained on Economic Affairs Secretary Arvind Mayaram's comments that the RBI is examining the pros and cons of raising the cap on investments by FII in gilts and that the central bank is also likely to send a proposal for India's inclusion in the JPMorgan Bond Index. Sporadic rupee appreciation and gilt purchase by the RBI under OMOs also supported the prices. Prices were boosted further after the government decided to issue a new 10-year benchmark bond. Lower-than-expected cut-off yields at the gilt auctions and strong demand at the auction of the new 10-year 8.83%, 2023 gilt helped the prices. Heavy purchases of gilts by state-owned banks and the absence of any negative triggers on interest rates also boosted bond prices.


Macro Forecast
We expect another 25 basis point hike in the repo rate due to high inflation expectations. In addition, we expect the liquidity conditions to remain tight which will also put upward pressure on yields. Therefore, we except yield on 10 year G-sec to settle between 8.3–8.5% by March-end 2014.