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January 2014

Call money rates ended higher in the month to end at 8.75-8.85% on December 31 as compared with 7.35-7.50% on November 29. In the earlier part of the month, call rates were on the lower side due to comfortable liquidity position in the banking system, subdued demand from banks for funds, spending by the government and inflows from RBI's dollar swap windows. However, later in the month, call money rates went up as banks borrowed funds to meet reserve requirements, and corporate advance tax outflows put pressure on liquidity deficit in the banking system.

Government bond prices fell during the month, with the yield on the new 10-year benchmark paper 8.83%, 2023 rising to 8.82% on December 31, compared with 8.74% on November 29, while yield on the erstwhile benchmark 7.16%, 2023 rose to 9.12% on December 31, compared with 9.04% on November 29. Sentiments were hit as fears of a rate hike by the RBI were re-ignited following disappointing WPI and CPI inflation data for November. Bond prices also fell on concerns that the government may conduct debt switch operations in the near future. Prices fell further as the US Fed announced it is going to taper its bond purchases from January 2014 by $10 bn. Continuous supply of G-secs via weekly auctions also kept up the pressure on gilts during the month. 

Further fall in gilt prices was, however, capped as the market cheered the RBI’s decision to keep interest rates unchanged at its mid-quarter policy review. RBI Governor Raghuram Rajan’s comment that the current status quo announced in the policy meet did not mean a pause in tightening of interest rates, however, disappointed market participants. Intermittent strength in the rupee against the dollar also supported gilt prices.

 * Note - 10 year benchmark movement represented by 7.16% 2023 bond till December 9th and later represented by 8.83% 2023 bond.

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