Call money rates hovered in the range of 10.10-10.25% for most parts of September on strong demand from banks to cover their fortnightly reserve requirements. Outflows of Rs 50,000-60,000 cr by the middle of the month towards quarterly corporate advance tax outflows also put pressure on liquidity during the month. Rates, however, retreated later in the month to 9.4-9.5% due to realignment to the new marginal facility rate (MSF); the Reserve Bank of India (RBI) cut the MSF rate by 75 bps to 9.50% at its policy review. Some liquidity squeeze also eased after the government redeemed Rs 46,000 cr of the 7.27%, 2013 bond.
Gilt prices declined in September, weighed down primarily by the unexpected rate hike by the RBI at its mid-quarter monetary policy review; the central bank hiked the repo rate to 7.5%, the first hike by the central bank since October 2011, to tame resurgent inflationary pressure in the domestic economy. The yield on the 10-year benchmark paper 7.16%, 2023 ended at 8.77% on September 30, 2013, up 17 bps from 8.60% on August 30, 2013. Caution ahead of the release of the US non-farm payroll data for August affected the sentiments; positive US jobs data increases the likelihood of the US Federal Reserve (Fed) rolling back its monthly bond purchase programme. Concerns that the RBI may not scale down sales of its cash management bills and fears of a potential military conflict in the Middle East weighed on bond prices. Fall in bond prices was also seen following S&P’s remarks that there is a 33% chance of India rating downgrade over the next two years. Further fall was seen due to sporadic decline in the Indian rupee and caution ahead of key domestic economic indicators. Sharp decline in gilts was witnessed after the RBI devolved Rs 4,000 cr of gilts on primary dealers at its Rs 15,000 cr auction held on September 23. Bonds further weakened on fiscal worries after Petroleum Minister Veerappa Moily denied any plan to increase prices of diesel and liquefied petroleum gas.
Further fall in gilts was capped as sentiments got a boost after the US Fed’s decision to continue its stimulus package. Prices also gained due to a rise in the rupee after the RBI's newly-appointed governor, Raghuram Rajan, introduced a few rupee supportive measures. Intermittent short covering by investors and de-escalation of US-Syria tensions aided bond prices. More respite for gilts came in the form of partial rollback of the liquidity tightening measures by the RBI at its policy review. Better-than-expected demand at the Rs 14,000 cr gilt auction on September 27 supported the prices.
We revised forecast for 10 year G-sec yields upwards and now expected to settle around 7.8 to 8% by March-end 2014. Tighter liquidity, rising inflationary expectations and the lower likelihood of further repo rate cuts until March 2014 are expected to keep government bond yields firm.