Indian call money rates hovered in the range of 7.25-8.05% during September. The rates were down earlier due to sufficient liquidity in the system. However, rates spiked later due to rise in demand for funds from the banks ahead of their reporting fortnights and due to payment towards July-September corporate advance tax. Meanwhile, RBI cut the cash reserve ratio (CRR) of scheduled banks by 25 bps to 4.5% of their net demand and time liabilities (NDTL) effective the fortnight beginning September 22, 2012; consequently, around Rs17,000cr of primary liquidity is expected to be injected into the banking system.
Gilt prices rose in the month with the yield on the 10-year benchmark 8.15%, 2022 bond ending at 8.15% on September 28 as compared to 8.24% on August 31. Hopes of a rate cut by the RBI on the possibility of a fuel price hike (which would help the government keep its fiscal deficit under check), and the step towards fiscal consolidation that might encourage the RBI to do its part for supporting growth boosted sentiments earlier. However, these hopes got dashed even after the government hiked diesel prices because August inflation numbers came in higher than expected, which erased the possibility of a rate cut. However, investors’ sentiments strengthened after weak data on July industrial output strengthened hopes of a rate cut by RBI. Gilt prices received further support after the government kept its Oct-Mar borrowing unchanged, easing fears of a higher than scheduled bond supply. The government will borrow Rs 2 lakh cr on a gross basis in the second half of the fiscal year, with weekly auction size of Rs 12,000-13,000 cr. Prices gained on hopes of further measures from the government to boost investments and limit fiscal slippage.
A further fall in yields was however restricted after Power Minister Veerappa Moily said that bonds issued against restructured liabilities of state power distributors would be given the status of Statutory Liquidity Ratio (SLR) securities. The uncertainty over timing of any future rate cuts also weighed on the bonds after the RBI said that inflationary pressures were preventing it from lowering the repo rate. Investors are also concerned over the upside risk to inflation following the announcement of a third round of quantitative easing by the US Federal Reserve, which is likely to push up global commodity prices.
We expect the yield on benchmark 10 year G-sec to settle around 8.0-8.2% by March-end 2013 as government borrowing in 2012-13 would be higher than estimated earlier, given the higher fiscal deficit. This assumes a further repo rate cut of around 50 bps by the RBI during the rest of the fiscal year.