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July 2013

Call money rates traded in the range of 7.10-7.60% in June with rates declining in the second half of the month - amidst comfortable liquidity in the banking system. The liquidity situation had improved following inflows on account of payment of oil subsidy by the government, redemption of state loans, and interest payment for government bonds.

Gilt prices fell sharply in June as the sharp depreciation of the rupee against the dollar erased hopes of a rate cut by the Reserve Bank of India’s (RBI’s) at its next policy review on July 30; a weak rupee negatively impacts India’s high current account deficit (CAD), thereby delaying rate cuts. Bonds were also down after the US Federal Reserve Chairman Ben Bernanke said that the US central bank may scale back its bond purchase programme later this year. These comments exacerbated foreign institutional outflows (FII) from Indian debt markets, thereby pulling down prices further. Appetite for bonds also remained weak ahead of the release of the balance of payments data for January-March 2013. Yield on the new 10-year benchmark paper 7.16%, 2023 ended at 7.44% on June 28 against 7.24% on May 31. The yield on the erstwhile 10-year benchmark 8.15%, 2022 ended at 7.61% on June 28, compared with 7.44% on May 31.

Further decline in gilt prices was, however, capped on intermittent value buying and following lower than expected inflation based on the Wholesale Price Index (WPI) inflation and trade deficit numbers for May. Sentiments were also supported by the surprise announcement of open market operations (OMOs) to purchase gilts worth Rs 7,000 cr by the RBI. Prices rose further due to revision of India’s rating outlook to stable from negative by Fitch Ratings.  A better-than-expected CAD number for January-March 2013 and some recovery in the Indian rupee also helped cap losses for gilts later in the month. Sporadic appreciation in the rupee against the US dollar also augured well for bond prices.

*Note: From June 24, 2013 the 10 Year Benchmark has changed from 08.15% CGL 2022 to 7.16 GSL 2023

Macro Forecast
We expect yield on the 10 year G-sec to settle at around 7.3-7.5% by March-end 2014 against 7.7-7.8% expected earlier. The revision takes into account our expectation of lower inflation in 2013-14 and a 25-50 basis point cut in the repo rate during the rest of the fiscal. OMOs by the RBI and the government's commitment to containing fiscal deficit will keep G-Sec yields subdued.