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July 2011

Call money rates moved in the range of 7.50-7.75% in the month due to steady demand from banks to meet their reserve requirements. In between there were some aberrations in the month when rates rose higher than the range on sudden rise in demand on reporting fortnight days and after call rates adjusted itself upwardly to revised report rate viz. Repo rate of 8.00%. The month however saw some improvement in the liquidity situation especially in the early part of the month following redemption of government bonds and as payments towards corporate advance tax started coming back in to the system.

Gilt prices fell in the month primarily dragged down by a higher than expected rate hike by the RBI. The central bank in its first quarter policy review on July 26, hiked the repo rate by 50 bps to 8%, 11th increase since March 2010, consequently the pegged rates of reverse repo (100 bps below repo) and Marginal Standing Facility (MSF) (100 bps above repo) stood revised at 7% and 9% respectively. The monetary measures pushed yield of the 10-year benchmark 7.80% 2021 paper that was trading down at 8.29% on July 25 compared with 8.33% yield on June 30, up 16 bps to close the month at 8.45% yield. Sentiments turned sour further after RBI maintained its anti-inflationary stance in the policy citing inflation is still over a comfortable level, thereby implying chances of more monetary tightening actions. Meanwhile, during the month, fear that the government may overshoot its borrowing target in second half of current fiscal dented market sentiments further. Prices were also affected by government’s announcement that it would conduct the gilt auction worth Rs 10,000 cr originally scheduled for the week ending September 23 in the week ending August 19 instead. Intermittent profit booking led by sporadic rise in crude oil prices also induced some losses for gilts in the month.

Macro Forecast

The aggressive monetary action and signs of moderation in growth combined with a weak global macro economy could keep domestic demand pressures in check. We expect that RBI monetary policy would increasingly factor these developments in the future.