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September 2013

Call money rates remained high in August - near the marginal standing facility (MSF) rate of 10.25% - due to the liquidity squeeze in the banking system after the Reserve Bank of India (RBI) tightened its monetary policy in July. Call rates also felt the pressure following (1) strong demand from banks to maintain their mandatory reserves amid tight liquidity, (2) outflows towards service tax payments in the early part of August and (3) higher borrowing by banks to invest in short-term fixed income instruments such as cash management bills (CMBs) which offered higher yields. 

Gilt prices fell sharply in August, dragged down by the Indian rupee falling to record lows, despite fresh measures by the RBI and the government to stem the fall in the currency. The yield on the 10-year benchmark paper 7.16%, 2023 ended at 8.60% on August 30, 2013, up 43 bps compared to closing of 8.17% on August 19; the yield was however sharply lower compared to its five-year high level of 9.13% reached on August 19. Additional liquidity tightening measures announced by the RBI in the month in the form of weekly auction of CMBs worth Rs 22,000 cr to address exchange rate volatility also dampened sentiments for gilts. Prices were also affected as the government's proposals to lower the current account deficit were seen lacking in specifics. Sentiments were dented further after the July’s wholesale price index (WPI) inflation rate came in above the RBI's comfort level, further complicating the central bank’s efforts to prop up the rupee. Fear of more liquidity tightening steps by the RBI also pulled down prices. The market was also worried about the possible increase in the government's food subsidy burden and eventually fiscal deficit due to the passage of the Food Security Bill. Increasing odds of a sovereign ratings downgrade due to the fiscal concerns added to the pressure on gilts. 

Further decline in gilt prices was capped after the central bank announced measures to check the rise in yields and revive banks' demand for dated securities. The RBI said that banks can transfer bonds to their held-to-maturity portfolios and mark them at prices applicable as of July 15. RBI's decision to buy back bonds worth Rs 8,000 cr in the last week of the month also soothed sentiments. Bond prices got further support after the rupee recovered from its all-time low on RBI's decision to open the dollar window for oil companies. Prices rose after the government hiked gold and silver import duty to reduce the country’s current account deficit. 

Macro Forecast 

We revised forecast for 10 year G-sec yields to settle 7.5-7.7% by March-end 2014 due to expected increase in government borrowings from budgeted levels, tighter liquidity, and lower likelihood of any further repo rate cut until March 2014.