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March 2011

Inter-bank call money rates moved in the range of 6.40-7.00% during the month, as demand remained strong from banks to meet their reserve requirements. Further rise in rates were however capped on improvement in liquidity scenario in the system. 

Gilt yields fell in February with the yield on the benchmark 7.80%, 2020 paper ending at 8.01% on February 28 as compared to 8.14% on January 31. Gilt prices rose on signs of improvement in liquidity, fall in inflation, diminishing concerns over aggressive monetary tightening by RBI and the positive announcements in Union Budget (presented on February 28). Gilt prices also received a boost as the government decided not to conduct an auction to compensate for the truncated borrowing in December. The government had borrowed Rs 10,000 cr less in December than its scheduled borrowing due to the liquidity crunch in the banking system. Later in the month, a senior Finance Ministry official said that the government may not borrow any more funds in rest of FY11. Sentiments were also boosted after the government announced a lower-than-expected net market borrowing target for FY 12 in the budget. The government said that it will borrow Rs.3.43 lakh cr from the market on a net basis during FY12 compared with Rs.3.45 lakh cr in FY11. It also announced a lower-than-estimated fiscal deficit projection at 4.6% of the GDP for FY12. Positive sentiments were further reinforced as Budget also announced a hike in the FII limit in corporate bonds which raised hopes that the government may follow suit for gilts; though market was disappointed after the government did not hike the FII buying limit in gilts. Meanwhile, further rise in gilt prices were capped on profit selling. Gilt prices were also weighed down on concerns that surge in crude oil prices may push domestic inflation higher, thereby leading to the possibility of a rate hike by RBI.


Macro Forecast
Concerns over rising inflation and tight liquidity are likely to stabilise the yield on the 10-year G-sec at 8.1-8.3% by end-March 2011. We expect the 10-year yield to settle a lower range by end-March 2012 at 7.9-8.2% with the likelihood of lower inflation, improved liquidity given rising capital inflows, a lower government borrowing limit and the monetary policy stance turning from tight to neutral towards end-FY12.