To what can we attribute this liquidity?

According to data released by the RBI in its weekly statistical supplement (WSS) on Saturday, growth in the deposit base for scheduled commercial banksduring the last fortnight of the previous fiscal totalled Rs 18,934 crore. This figure was Rs 19,387 crore in 1997-98. The abrupt spurt in year-end deposit basis is a seasonal phenomenon, attributed primarily to "window-dressing" by banks.

However, to the extent that a significant portion of this liquidity does not reverse in the following month it adds significantly to short-term liquidity. If we look back to April 1998, outstanding amounts in RBI repo were between Rs 12,000 crore-Rs 14,000 crore during April 4-7, while the average repo outstanding figure for the entire month of April was close to Rs 9,000 crore.

The current liquidity overhang seems to be a repeat of April-1998. Assuming that there is no immediate reversal of this deposit growth, a possible outcome of large scale government spending, we can expect the current run in short-term bullishness to sustain for the next couple of weeks.

Political uncertainty hits rupee

Possibility of a break in the ruling coalition caused the rupee tocross 42.70 against the dollar. The exchange rate has since then settled near 42.66 levels reportedly on intervention from RBI and SBI. Though we expect political uncertainty to continue, the extent of control wielded by the RBI should be able to contain most pressures.

Auctions, on-tap sales absorb Rs 9,000 cr

A 10-year auction for Rs 3,000 crore on April 6, re-issue of 12.40 per cent 2013 on private placement-cum-tap sales at Rs 101.40 for Rs 3,000 crore on April 7, followed by a seven-year auction on April 9 for Rs 3,000 crore completed Rs 9,000 crore gross borrowing for the fiscal in the first week.

To complete the picture, the first ten-year state loan issuance for Rs 3,675 crore at 12.25 per cent was announced. The sale will be held on April 21. Given the significant liquidity overhang in the system, the auctions and the on-tap sales received overwhelming response, pushing the yield curve down by more than 10 basis points. The ten-year auction cut off at 11.99 per cent, the seven-year at11.68 per cent, while the on-tap issuance collected Rs 3,000 crore on the opening day. The current bout of liquidity is not expected to sustain beyond two weeks. Though Rs 9,000 crore has already been borrowed by the government, this is only the beginning. Further, there would be state loan issuances, certainly not lower than 1998-99 gross levels. The long-end of the yield curve would be brought under increasing pressure in the near future. However, at this stage we recommend a moderate increase in portfolio duration, keeping in mind the current liquidity situation. A 10 per cent portfolio weight in the ten-year category should achieve this objective. We, however, continue to overweigh the short-to-medium end.

Corporate paper

With the sovereign borrowing programme off to a flying start, the market for corporate paper did not witness much activity. There were a few primary issuances at 9.8 per cent-10 per cent, while one and two month levels were near 9 per cent - 9.25 per cent and 9.5 per cent and9.75 per cent levels. We do not expect yields to decline further, however, secondary activity is expected to pick up in this segment over the coming weeks. FI yields declined because of increased liquidity and lack of primary supply. The 4.5-year yield on ICICI paper declined from 13.7 per cent at fiscal-end to 13.36 per cent.