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March 2012

Call money rates hovered at 8.00-8.90% during February compared with 8.00-9.50% seen a month ago amidst continued liquidity squeeze in the banking system. The cut in the bank’s cash reserve ratio (CRR) by the Reserve Bank of India (RBI) in the previous month was not enough to ease the situation. Borrowings by banks to meet their reserve needs for the reporting fortnight kept liquidity under stress. The sharp rise in call rates were, however, averted as banks intermittently borrowed from RBI’s repo tender and the CBLO market. Banks on an average borrowed over Rs 1 lakh cr daily through the repo tender in February. Meanwhile, RBI Governor said that the central bank will consider further cuts in banks' CRR to tackle the tightness in liquidity.

Gilt prices remained strong as the central bank continued purchasing gilts via open market operations (OMOs) to address the severe strain on liquidity. The yield on 10-year benchmark 8.79% 2021 closed down at 8.20% on February 29 compared with 8.24% on January 31. Gilt prices also rose after the Wholesale Price Index (WPI) inflation rate fell to three-year low of 6.55% in January and on weaker-than-expected industrial output growth in December, which further strengthened hopes that the RBI might ease its monetary policy soon. Bond prices got further support due to bullish cut-offs set by RBI at the weekly auction indicating strong demand and after minutes of the RBI’s January monetary policy meeting showed that four of the seven external members had favored a cut in the repo rate.

Gains, however, got capped to a large extent as uncertainty loomed over the RBI’s weekly bond purchases, especially when liquidity was showing some intermittent signs of improvement - this led market participants to doubt the central bank’s move to conduct OMOs in that week. Meanwhile, RBI Deputy Governor said that the selection of securities for bond purchases under OMOs is driven by the need to maximise the liquidity infusion. Persistent rise in crude oil prices also stoked the fear of rise in inflation and eventually a delay in lowering of key interest rates by the RBI. Pressure on bonds was also witnessed due to profit booking and as participants trimmed their position to make room for bond supply at the weekly auctions.

Macro Forecast
CRISIL Centre for Economic Research (CCER) expects yield on the benchmark 10-year paper will be in the range of 7.3% to 7.5% by the March-end 2013. Although government borrowing pressure would remain high during the year, crowding out of private sector investment is unlikely due to weak economic activity. Yields will soften due to (a) lower inflation expectations and (b) monetary easing by RBI.