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Huge surplus SLR will provide the required liquidity buffer
December, 20th 2010

The markets ended last week with a large shortage of liquidity, aggregating at . 1,40,000 crore, after the tax outflows exited the system. With the new fortnight beginning this week, banks are expected to cover CRR requirements aggressively , and thus call rates could remain in the 6.75-7 % range. While demand for money would be strong, the large surplus SLR in the system would provide the necessary liquidity cushion.

Overall incremental liquidity would be balanced, as the slated outflows of . 11,000 crore on account of the central government auctions would be offset with the . 12,000-crore weekly open market operations (OMO) announced last week. The slated state government auctions of . 3,600 crore also should be offset by net maturing Treasury Bill amounts. Thus, the call rates are expected not to spike. However, inter-bank term rates, especially the 4-month tenor and beyond would remain bid. Certificate of deposit rates would find a good support at 9.50% for 1-year tenor, though 3-month CDs should remain capped at around 9%.

About the government securities, benchmark 7.80% 2020 had ended last week on a positive note at 7.94%. We expect the OMO to show aggressive buyback prices to boost liquidity in the system, and that should keep security prices underpinned . The markets would keenly await announcement of security details and good buying interest could be seen in those securities as well as in the state government auctions.

However, markets would continue to remain overall cautious , keeping a wary eye on liquidity. Deposit growth in the markets at around 16% has been lagging the advances growth by a large margin, and the next quarter would also see some disinvestments as well as further advances growth. The recent hikes in base rates by some banks and also deposit rate hikes could correct this imbalance partly. Markets would also remain cognisant of the fact that food inflation has remained sticky, although at lower levels. US interest rates have also shown a sharp spike recently and global commodities prices also have remained bid.

Also, increasingly, as the base-year effect wears off, we could see inflation fears resurfacing, and rate hike possibilities would remain high. Thus, security prices would not show any runaway moves, and would be ranged.

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