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The Cut in Repo Rate Buoys the Market

The repo rate cut and the surfeit of liquidity, sparked off another round of gains. However, at these levels the yields are unsustainable.

Well aided by the comfortable liquidity in the system since last week, the RBI moved to signal softening of the short term interest rates by slashing its repo rate by 25 basis points to 6.50 per cent. With the repo rate cut, the differential between the repo and reverse repo rate stands widened at 2.25 per cent. Even as the RBI sucked out close to Rs. 34405 crores through its repo deals, with players covering their positions ahead of the reporting Friday, call rates ruled low in the 6.75-7 per cent range. Amid the comfortable liquidity, the yield in the 91 and 364 day Treasury bill auction dropped by 37 basis points.

This offered a smooth sail to the twin auction of GOI securities two Central Government papers-GOI 2013 and GOI 2021, which were hugely over subscribed. The lower than expected cut-off yield in the auctions, further signaling the bank's preference for softer interest rates, sparked off another round of gains in Government Securities, thus pushing the yields to dizzier lows. Currently the yield on 11.50% GOI 2011 is 9.806%, which is well below the ideal spread of 3.25-.50 per cent over the bank rate. This many market players feel is unsustainable. In a bid to maintain the comfortable liquidity, the center placed Rs 5000 crore worth of Central Government 2021 with RBI, thus completing over 35% of it gross borrowing programme.

The rally is spilling over to the corporate bond segment, which witnessed gains accompanied by increased trading volumes. In the backdrop of the CRR and the repo rate cut, primary activity too picked up as corporates moved in to cash in on the easy liquidity and are slated to bring forth new issues worth Rs 1200 crore in the next week.

With the month end dollar demand taking the rupee to Rs 47 levels, steady supplies ensured that the rupee stayed range bound. However, with the international rating agency Fitch revising India's sovereign ratings outlook to negative from stable, it closed the week lower at Rs 47.01. The forward premia opened the week at lower levels than the previous week's levels but close at marginally higher levels following the spot rupee.

Outlook
With expectation of a bank rate cut already discounted for, the eventual rate cut may not offer any much fresh gains. With the market players perceiving the rupee to be over-valued the RBI may not be averse to the rupee sliding a bit lower. However, with FIIs turning net sellers in the light of the FITCH downgrade, a sustained selling could put pressure on the INR. The Government has pruned expenses to hold last year's fiscal deficit at 5.21% against the estimated 5.1%. However, with the bleak economic outlook and the possibility of lower revenue collection, doubts about the size of the current years borrowing do arise. This is likely to put pressure on interest rates in the medium term.