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February 2013

Interbank call money rates moved in the broad range of 7.65-8.10% during the month. Rates were on the lower side earlier in the month due to moderate demand for funds from banks. However, as the month progressed, rising demand for funds from banks pulled up the rates. Demand rose on reporting fortnights and due to extra borrowing to meet reserve requirements since the Indian market was closed on January 25 and January 26 (government holidays). Intermittent liquidity squeeze in the money market caused by outflows related to service tax, excise and customs duties also kept the rates firm. To ease the liquidity squeeze in the system, the Reserve Bank of India (RBI) reduced the cash reserve ratio (CRR) of scheduled banks by 25 bps to 4% during its monetary policy review on January 29; the cut will be effective from the fortnight beginning February 9. The reduction in CRR will inject around Rs18,000 cr of primary liquidity into the banking system.

Domestic government bond prices rose during the month on hopes of a cut in the repo rate during RBI’s third quarter review of monetary policy on January 29. Yield on the 10-year benchmark 8.15%, 2022 bond fell to 7.91% on January 31 compared with 8.05% on December 31, but up 11 bps from its two-and-a-half-year low of 7.80% reached on January 14. Hopes of rate cut strengthened after the data showed a contraction in India's industrial sector in November and a fall in India’s headline inflation rate for December. These hopes came true later in the month after the RBI, in its third quarter monetary policy review, cut the repo rate by 25 bps to 7.75%. Bonds gained further during the month on expectation that the RBI may reintroduce its open market operations (OMOs) following intermittent higher subscription at the RBI's liquidity adjustment facility (LAF) window during the month. Investors cheered the government's decision to hike rail passenger fares, proposal to sell diesel to bulk buyers - such as cement, mining and power companies - at non-subsidised prices and the decision to allow oil marketing companies to revise diesel prices. These measures could aid the government in meeting its fiscal deficit target of 5.3% of GDP for the current financial year and thus abated fears of additional government borrowing during the fiscal.

Some gains were, however, capped earlier in the month as hopes of a rate cut by the RBI dimmed after the RBI governor, Mr D. Subbarao, said that although inflation has declined, it is still high and monetary and fiscal policies have limited room for reviving growth. Gilts were also affected by the central bank’s move to cut CRR, which dampened hopes of purchases of gilts by the central bank via OMOs.