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September 2011

Interbank call money rates moved broadly in the range of 7.50-8.30% in the month due to steady demand from banks to meet their reserve requirements. The rates also remained firm due to persistent demand for funds from banks to meet outflows of around Rs 68,000 cr towards advance tax payment for the July-September quarter. A hike in RBI’s key lending rate viz., the Repo rate at the central bank’s monetary policy meeting mid-month also added to the pressure on the interbank rates. 

Gilt prices fell during the month with the yield of the 10-year benchmark 7.80% 2021 paper closing at an eight week high of 8.44% on September 29 compared with 8.32% yield on August 30 (yields are inversely proportional to prices). Sentiments for gilts dampened during the month after RBI continued its monetary tightening spree, hiking its key rates by 25 bps in its mid-quarter policy review (the 12th rate hike since March 2010) and said it would have to persist with an anti-inflationary stance until a downtrend is seen in inflation trajectory. Consequent to the central bank rate hike, the revised repo rate now stands at 8.25%, while the pegged rates of reverse repo (100 bps below repo) and Marginal Standing Facility (MSF) (100 bps above repo) stood revised at 7.25% and 9.25% respectively. Sentiments for gilts turned further sour after the government increased its borrowing target for October-March FY12. As per the numbers released by the Economic Affairs Secretary, the government would increase its borrowing by Rs 52,800 cr to Rs 2.2 lakh cr in the second half of the fiscal year that begins on October 1, higher than the budgeted Rs 1.67 lakh cr. The government, however also said that it would borrow Rs 15,000 cr less through sale of T-bills and end the borrowing programme around February; adding that the extra borrowing will not crowd out private investment and the fiscal deficit target is unchanged as of now. Among other worries that dragged gilt prices during the month were, continuing higher weekly food inflation numbers, intermittent rise in crude oil prices and US yields and worries of an unscheduled bond auction by the government due to it’s inability to meet its divestment target for the year after it postponed the FPO of ONGC.

Short term rates have corrected substantially from the peal levels of March 2011. The improvement in the structural liquidity of the banking system and the Government moving form surplus to consistent WMA mode has resulted in liquidity deficit remaining within the RBI comfort range. The 3 month bank CD rates touched a peak of 9.40% during the Sep 11 quarter and largely remained in the range of 9% to 9.20%. In view of the need to support productive credit needs and to generate primary liquidity in a growing economy, we anticipate that the RBI may have to provide OMO support at some point in the coming months. Continued global uncertainty and growth in Bank NDTL as against incremental credit growth which are broadly supportive of bond yields would increasingly clash with incremental market appetite as the supply overhang continues for a while.