Interbank call money rates moved in the range of 7.00-7.35% in the month amid moderate demand for funds from banks. Call rates dipped to around the 7.25% range in the month compared with above 7.50% in the previous month as rates moved downward in line with the 25 bps cut in Repo rate to 7.25% by the Reserve Bank of India (RBI) at its policy review on May 3. Further fall in call rates were capped amid intermittent liquidity squeeze in the banking system to meet reporting fortnight requirements.
Indian government bond prices surged in the month primarily on hopes of further rate cuts by the RBI in the wake of current macroeconomic situation in the country. Rate cut by the central bank, the third quarter percentage cut in the current calendar year spruced up hopes of continuing easing measures by the central bank to aid growth in the country. A sharp dip in India’s headline wholesale price index (WPI) to below the RBI’s threshold comfort level also aided market sentiments of further rates by the central bank. WPI inflation rate fell to a 41-month low of 4.89% in April against 5.96% in March. Market also drew support from RBI Governor D. Subbarao's remark that the central bank will purchase gilts via open market operations (OMOs) as per standard practice, when required. Strong demand at the gilt auction conducted during the month also aided rise in bond prices. Bonds also rose after the chief economic adviser to the finance ministry said that the government might consider increasing foreign institutional investors' (FII) investment limit in government debt. Investors also drew comfort from the fall in global crude oil prices, which is beneficial for cooling domestic inflation and lowering the current account deficit (CAD). Prices also rose on sporadic value buying in longer-dated securities ahead of the issuance of a new 10-year paper. The auction of the new 10-year benchmark 2023 paper was aggressively bid and closed the day of issuance at 7.16% yield; the paper closed the month at 7.24% yield on May 31, Meanwhile, yield on the current 10-year benchmark 8.15%, 2022 bond fell to 7.44% on May 31, 2013 compared with 7.73% on April 30, 2013.
Gains in prices were however reduced as the RBI in its policy review guidance said that widening CAD and growth-inflation dynamics limits scope for further easing of policy rate. Sentiment was also dampened further after the RBI in line with the reduction in mandated statutory liquidity ratio (SLR) holding, proposed to cap the proportion of banks’ SLR holdings under the HTM (Held-to-Maturity) category at 23% of their demand and time liabilities from 25% earlier. Sporadic profit booking and improvement in global risk appetite also limited the gains in gilt prices.
We expect yield on the 10 year G-sec to settle around 7.7-7.8% by March end 2014. The 25 bps cut in repo rate to lower the floor of the yield. Subdued inflationary expectations and continued open market operations (OMOs) by the RBI to keep upward pressures off the yield.