Though the CRR hike had a dampening effect on the market, the fall in inflation and excess liquidity helped in calming market sentiment to some extent. Hence, the yield on the 10-year benchmark government bond (GOI 2013, 7.37%), after touching an intra-day high of 6.20 per cent on Monday, closed at 6.10 per cent on Friday – up 15 basis points over the week.
The market was totally surprised once the CRR hike was announced on September 11, resulting in a sharp rise in bond yields on Monday. But, as the market players realised that the RBI's move to raise banks' CRR was largely intended at checking inflation rather than a sign of an early interest rate hike, the bond yields came off their highs. The inflation, which had touched a new three-and-a-half year's high of 8.33 per cent for the week ended August 28, finally eased to 7.81 per cent for the week ended September 4, 2004.
The CRR hike of 0.5 per cent (in two phases of 0.25 per cent each on September 18 and October 2, 2004) is likely to squeeze out Rs 8,500 crore from the system as banks will have to place additional deposits with the RBI. However, this is hardly going to affect the market liquidity as the total outstanding amount at the RBI repos is comfortably placed at an average Rs 35,000 crore. However, on Friday, the call rate surged above the repo rate to 4.75-5.00 per cent due to high demand for cash to meet quarterly advance tax payments and also due to the day being the reporting Friday.
During the week, the market got some mixed signals from the RBI officials. On Tuesday, one of the top RBI officials said that more monetary steps would be taken, if needed, to check inflation. Moreover, on Thursday, the RBI Deputy Governor KJ Udeshi said that a liquidity overhang and the past downward movement in rates seemed to have spurred a sense of complacency among banks. Both these statements once again raised concerns that the increase in interest rate could be in sight. Hence, the 10-year yield once again climbed to 6.13 per cent on Thursday. But, on Friday, the fall in inflation number brought some relief to the market players and the 10-year yield came down to 6.10 per cent.
The rupee rose to a two-month high of 45.86/$ on Wednesday following the weakening US dollar, which fell internationally after a record gap in the US current account. However, the rupee lost some of its gains to close at 45.88/$ on Friday – a gain of 39 paise over the week – as India's trade deficit widened to $10 billion in the first four months of the fiscal 2004-05 from $6.6 billion a year ago.
Outlook
From September 18, the first CRR hike of 0.25 per cent will come into effect. This is unlikely to affect the market liquidity, as we are flush with funds. The 10-year bond yield has now risen 15 basis points post CRR hike. However, with inflation expected to fall further, the bond yields are likely to ease a bit. But a lot will depend on the government's borrowing programme. On September 20, the government will announce its borrowing calendar for the second half of the current financial year ending March 2005. A higher borrowing can dampen the market sentiment. On the other hand, a low borrowing target could act as a trigger. All eyes will also be set on the RBI as to what action it takes, in case, inflation fails to come down.
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