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May 2014

Call money rates ended at 8.70-9.00% on April 30, 2014 compared with 10-10.50% on March 28, 2014. Call rates were on the lower side earlier during the month due to improvement in the liquidity condition on government spending. Liquidity also improved following redemption of 7.37%, 2014 gilt worth over Rs 40,000 cr on April 16, state development loans and Treasury bills (T-bills). To improve liquidity, the Reserve Bank of India (RBI) had also conducted three-day and 13-day term repo auctions for notified amounts of Rs 20,000 cr and Rs 60,000 cr, respectively, on April 4. Call rates, however, started rising later in the month as demand for funds from banks increased to meet their reserve needs and as liquidity tightened due to an increase in currency circulation amid the ongoing general elections. 

Government bond prices ended lower in April, with the yield on the 10-year benchmark 8.83% 2023 paper rising to 8.83% on April 30, 2014 compared with 8.80% on March 28, 2014. Prospects of rising borrowing costs - after the RBI cut the amount of funds banks can borrow via the LAF repo window - dampened market sentiments. In its monetary policy review in March, the RBI reduced the amount banks can borrow via the LAF repo window to 0.25% of the bank's net demand and time liabilities even as it kept its key policy rate unchanged at 8.0%. Gilt prices also came under pressure due to a rise in the WPI inflation data which stoked the fear that the central bank might not be done with monetary tightening yet. Gilt prices were also dented by inflation fears after the IMD forecast below average rainfall and a weak rupee during the month.

 

Further decline in gilt prices was, however, restricted as strong demand was seen for central government G-sec and state government loan auctions during the month.  Bond prices also rose due to intermittent value buying and the release of slightly lower-than-expected US jobs data. Persistent buying by mutual funds helped gilts rise further.

 Macro Forecast

We expect 10-year g-sec yield to settle around 8.2 to 8.4% by March-end 2015. Tight liquidity and limited downside to policy rates during the fiscal to limit the downside to yields.

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