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• Bonds rallied buoyed by hopes of a monetary easing by the Reserve Bank of India (RBI) beginning with additional cash infusions into a slowing economy.Reflecting the anticipation the price of the ten-year benchmark bond, the 8.79 per cent coupon falling due in November 2021 rose to 103.24 (face value 100) last week. At this price the yield translated to 8.30 per cent. The previous week the security had ended at Rs 101.47 or 8.56 per cent. RBI’s deputy governor Subir Gokarn had said in Singapore that interest rates had peaked, triggering the rush for bonds.

• Bonds were also buoyed by return of cash collected as third quarter advance taxes to the banking system. Traders estimated that about Rs 40,000 crore had come back to the banking system. The easing of cash conditions also manifested in the inter bank collateralised borrowing and lending obligations markets where the rates stayed close to the RBI overnight lending rate of 8.5 per cent. At the same time, bank overnight cash borrowings at the weekend liquidity adjustment facility auctions dropped to Rs 92,370 crore or slightly under 2 per cent of the aggregate deposits, or closer to the RBI’s comfort zone of one per cent.

• Traders said that the major reason for the reduced cash deficit was partly due to the deposit inflows into the banking system from non-residents and cash surplus corporates that have deferred investm-ents. The deferral of investments in turn has led to a low demand for term credit.But there were also fears that inflation could return to haunt the economy. Says Bank of Baroda’s chief economist Rupa Rege Nisure, “Inflation is far from being under control, therefore expecting any easing of monetary policy at this juncture is premature.”

• The concerns were reinforced by spikes in the Indian oil import prices. India’s oil import basket price last weekend was $113 a barrel as tensions between US and Iran mounted. India imports approximately 4 lakh barrels of oil from Iran per day. At this price working capital demand from refineries alone is estimated at Rs 1,500 crore ($271.2 million) per day.Absence of demand for term credit was evident from the trends in the corporate bond markets. Barring entities like the National Highways Authority and financial institutions, most issuers stayed away. The last entrant into the corporate bond markets was Indian Hotels in November last. Traders said that till the first half of December last year, borrowers in the private placement markets were entirely financial institutions, mostly public sector or quasi public sector. Since then even these issuers have vanished, they added.

• As a result the preference remained for low risk sovereign bonds. The interest in sovereign demands manifested in last weekend’s government borrowing auctions. The bids were at least 2.5 times more than offered amount of Rs 14000 crore. Till the middle of Decembers the bids were barely 1.5 times more than the offered amounts.The demand for bonds was that some cash easing could take place. Most bankers have been pushing for a reduction in the cash reserve ratio by 0.5 per cent, which would release about Rs 30,000 crore into the banking system or reinstating interest on CRR balances.

• But rating agency Crisil’s chief economist DK Joshi said, “The major worry is the slowdown in the Gross Domestic Product. Any monetary easing is a reaction to this worry.”Worries over a slowdown also echoed among global rating agency economists closely tracking the Indian economy. Moody's Analytics have already put the forecast for India’s 2012 GDP growth at 6 per cent, well below the government’s estimate of 7.5 per cent. Moody's senior economist Glenn Levine said, “GDP for all of 2012 is expected to rise only 6 per cent.”However a slowing economy is not the only worry. The rupee is expected to remain volatile in the near future in view of a looming recession in Europe that is a large export destination for India. Moody’s associate economist Fred Gibson said, “India will continue to run sizeable trade deficits which alongside a fiscal shortfall and deteriorating economic outlook will continue to put downward pressure on the rupee in 2012.”

• The forecasts come even as the country’s foreign exchange reserves dipped below the $300 billion for the first time since December 2010. Yet demand for foreign currency is unlikely to ease, though supplies mostly from capital account inflows have shrunk. The shrinking supplies and increased demand have begun reflecting in the forward foreign currency markets. There were more sellers for forward dollars six months and buying spot. Such swaps have resulted in keeping long forward premia low and short forward premium high. One month forward premium was 7.62 per cent though six-month premium was 5.87 per cent.

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