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September 2012

Indian call money rates moved in a narrow 7.9-8.10% range during August due to comfortable liquidity position in the system. Liquidity in the banking system improved further in the month post the 1% reduction in statutory liquidity ratio (SLR) to 23% for banks from August 11.

Gilt prices rose slightly in the month amid high volatility, with the yield on the 10-year benchmark 8.15%, 2022 bond ending at 8.24% on August 31 compared to 8.25% on July 31. Prices were down earlier in the month on the back of improved global risk appetite due to upbeat US job data, and as a rise in global crude oil prices led to concerns over persisting high inflation. Sentiments were dented further after the RBI deputy governor said that an interest rate cut was likely only if the inflation rate shows signs of coming down in a sustained manner. Further selling was seen after the RBI governor said that inflation in India is too high and needs to fall further, and added that the central bank is worried that India's sovereign rating might be downgraded. Bonds also reacted negatively after the Indian finance minister said that there was no plan to increase prices of fuels and fertilisers; the remark raised concern over the government's subsidy burden and the wide fiscal deficit. Later in the month, gilt prices plunged further as higher than expected GDP growth rate of 5.5% for April-June 2012 dashed hopes of an interest rate cut by the RBI. 

Fall in prices was, however, erased on expectations that the finance minister would build pressure on the RBI to cut the repo rate at its next policy review in September and on expectation of fiscal reforms by the government in the near future. Sporadic value buying and short-covering also supported bond prices. Bonds also gained as weak industrial output reading in June and a sharp fall in WPI inflation in July strengthened chances of a rate cut by the RBI at its next monetary policy review. Strong demand for gilts at the weekly auctions during the month also boosted sentiments. Prices got further support after the finance minister approved up to 49% foreign direct investment in insurance and pension sectors.

SBI Mutual Fund - Debt Market Review

Macro Forecast
We expects 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. The pressure on the 10-year G-sec yield would continue even if the RBI cuts the repo rate more sharply as compared to our earlier expectation, during the rest of the fiscal year.