Interbank call money rates moved in a narrow range of 7.80-8.15% during most of the month. However, rates ended the month sharply up at 8.50-9.50% as most state-owned banks avoided lending on the last day of the quarter. Meanwhile, call rates rose during the month due to increased borrowings by banks to meet outflow towards advance tax payments and to meet fortnightly reserve needs for the Reporting Fortnights and ahead of the Christmas holidays. Further rise in call rates was capped on comfortable liquidity in the system and as some banks lent funds at a lower rate after borrowing excess funds from the central bank's repo window.
Domestic government bond prices rose during the month with the yield on the 10-year benchmark 8.15%, 2022 bond falling to 8.05% on December 31, the lowest level in five months and compared with 8.18% on November 30. Sentiments for gilts were boosted on hopes of a cut in the repo rate in January 2013 and as fears of additional government borrowing via dated securities eased. Prices also rose after the expectations of market participants materialised following the Reserve Bank of India’s (RBI’s) announcement that it will purchase gilts via open market operations (OMOs) amid strained liquidity condition due to advance tax outflows. Sentiments received a fillip as the government raised the limit on foreign institutional investment (FII) in gilts by $5 bn by creating a new category of investment; there are no restrictions on residual maturity in this category. Bonds also gained sharply as lower-than-expected headline inflation for November raised hopes for a RBI rate cut in the medium term. The headline inflation rate based on the wholesale price index (WPI) fell to a 10-month low of 7.24% in November compared with 7.45% in October.
However, gains were checked at regular intervals as uncertainty lingered over the RBI’s OMO announcement in the near future after the central bank lowered the notified amount of gilt purchases to Rs 8,000 cr as compared with the previous rounds of OMOs worth Rs 12,000 cr each. Bonds also came under pressure after the RBI refrained from lowering a repo rate cut at its mid-quarter policy review on December 18, 2012. Investors, however, breathed a sigh of relief as the RBI left the Cash Reserve Ratio (CRR) unchanged at its policy review, keeping up hopes of OMOs in the near future. Intermittent profit booking also restrained further rise in gilt prices.
We expect that high government borrowings due to a higher-than-budgeted fiscal deficit will keep the yield on the 10-year government security firm at around 8.1% by March 2013.