This Article is From Nov 23, 2011

We expect the G-Sec markets will be range bound with negative bias

We expect the G-Sec markets will be range bound with negative bias
On 2 July 2010, the Reserve Bank of India announced an inter-meeting rate hike of 25 bps in repo rate and reverse repo rate to 5.5% and 4% respectively. The RBI also extended the liquidity measures (second Liquidity Adjustment Facility (LAF) in the afternoon and additional liquidity support for banks to the extent of upto 0.5% of NDTL) announced in May'10 until July 16, 2010. The key reasons were strong underlying growth momentum and evidence of demand-side pressure on inflation and broad based rise in inflation. We expect that the RBI will hike the rates by another 25 bps in the policy on 27 July 2010.

Tight liquidity, double-digit inflation, strong IIP reading, fear of rate hike and fuel prices hike kept the fixed income market very cautious. The G-sec market traded in the range of 7.46 - 7.65% but most of the time above 7.55%. Call and short-term rates spiked up by 75 - 100 bps.

The big event was the de-regulation of petrol and increase in prices of diesel, kerosene and LPG. In the short run, it will result in inflationary pressure. However, in the long term it will be very positive for the fiscal deficit, as in India fuel prices are partially subsidized. Both the IIP and the inflation numbers printed higher than expectations. The actual readings were as follows:

• April Industrial production came very strongly at 17.6% YoY v/s 14.3% survey, with the key surprise factor being the 73% rise in capital goods

• May Inflation came in higher than expected at 10.2% mainly due to higher prices in metals, textiles, wood and transport equipment Liquidity condition was tight through out the month due to the advance tax outflow and 3G and BWA payments. The net average borrowing by banks from the RBI under LAF amounted to approx Rs.48,600 crore during the month. We expect liquidity conditions to be tight at least until mid-July and therefore repo rate will be the effective policy rate.

In the near term, we expect the G-Sec markets will be range bound with negative bias. However, in the medium term, we are positive on G-Secs due to the likely positive impact of 3G & BWA auction and of partial deregulation of fuel prices on the fiscal deficit, expectations of falling inflation in the 2nd half, expectations of calibrated monetary tightening by the RBI and global uncertainties.

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