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February 2012

Call money rates hovered in the 8.00-9.50% range, with the rates reaching the upper end of the band in the earlier part of the month due to firm demand from banks to meet reserve requirements amid a tight liquidity situation. To ease liquidity pressures, during its Q3 review of monetary policy on January 24, the RBI reduced the cash reserve ratio (CRR) of scheduled banks by 50 bps to 5.5% of their net demand and time liabilities (NDTL) from January 28, 2012. Reduction in the CRR will infuse Rs 32,000 cr in the banking system.

Gilt prices surged in January due to strong demand at weekly bond auctions and successful buyback of bonds by the RBI. The 10-year benchmark 8.79% 2021 yield closed at 8.24% on January 31; it had fallen to an eight-month low of 8.17% on January 19 after closing 8.56% on December 30. Bond prices rallied in the month as the RBI continued to buy gilts from the market through its open market operations (OMOs). Bonds also gained hoping on a sharp fall in December inflation and the RBI easing its tight monetary policy. These expectations were further boosted after the government and the central bank said that the fall in inflation in recent weeks could encourage the RBI to cut its benchmark interest rates going forward. Strong demand at the weekly gilt auctions and a sharp fall in weekly inflation numbers added to the gain in prices. RBI’s deputy governor saying that a few central banks have been investing in Indian government securities through foreign funds also provided support to gilt prices. 

Some gains were, however, capped by the RBI governor’s comments in the later part of the month that the central bank may not conduct more open market operations now, and it would like to watch the situation following the cut in banks' CRR. Some devolvement at the weekly auctions later in the month reflecting the lack of demand for bonds added to the losses. With December inflation at 7.47%, gains were further erased by the higher than expected numbers, thereby dashing hopes that RBI would lower its key interest rates. Sentiments were also dented by SEBI’s decision to withdraw the re-investment period facility for debt limits allocated to foreign institutional investors (FIIs), a move seen as a dis-incentive for FII investment in gilts. 

Macro Forecast
CRISIL Centre for Economic Research (CCER) expects yield on bench mark 10 year G-sec will be in the range of 7.3% to 7.5% by the March-end 2013. Although government borrowing pressure would remain high during the year, crowding out of private sector investment is unlikely due to weak economic activity. Yields will soften due to (a) lower inflation expectations and (b) monetary easing by RBI.