The usual phenomenon of easier rates in the second week of the reporting fortnight should push rates down. However, the state loan auction scheduled for April 21 and the expected uncertainly on the forex front should result in tightness. We expect call rates to stay near 8 per cent this week too.

Forex jitters on political turmoil may persist

With the government facing a confidence motion which could swing either way, there was some pressure on the currency. The rupee dropped to a low of 42.87/$ on Thursday but has since recovered to 42.72/$. With the government having lost the vote of confidence in the parliament, the forex market is expected to be under pressure this week. The role of the central bank would be significant in this context.

Treasury bill yieldsreflect short-end tightness

Short-term tightness impacted the 14-day T-bill auction. The cut-off yield increased to 7.84 per cent from 7.32 per cent, while Rs 26 crore and Rs 7 crore devolved on RBI and primary dealers respectively. The 91-day T-bill auction was however fully subscribed, and the cut-off declined from 8.56 percent to 8.44 per cent.

Gilts steady, expected to decline this week.

Gilts prices remained steadys during last week despite tighter call money rates. The Rs 4,000-crore of 12.60 per cent 2018 security was re-issued, privately placed with the RBI and subsequently placed on the OMO sale list at 12.45 per cent yield. Given the current political status and its possible impact on forex markets, we do not expect further rate cuts in the immediate future. This would adversely impact market expectations. We, therefore, recommend increased weight in the shorter end, considering the uncertainty expected in the market.

What can we expect in the credit policy?

The RBIGovernor has made it clear in his last two credit and monetary policy statements that the April credit policy would focus on structural issues. Short term measures on interest rates and liquidity have been delinked from the policy statements and have been implemented whenever market conditions have required intervention. However, considering the pace of the current borrowing programme, many participants expected a marginal reduction in CRR. RBI has already completed Rs 13,500 crore of the Rs 84,000 crore gross borrowing programme. Two interpretations can be attempted in this context. We can attribute part of the borrowing to RBI negating short-term liquidity surplus in the banking system as well as proceed as fast as possible on the borrowing programme. On the other hand, the pace of government expenditure would also have necessitated part of the borrowing. If the current political turmoil continues, there is reason to believe that the gross borrowing estimate would be under under pressure, particularlyduring the later part of the fiscal year.

In the first case, a relaxation of liquidity would negate RBI's monetary policy itself. Considering the next case, RBI would want to retain as much of "reserve liquidity" in the system to tackle future contingencies, particularly keeping in mind the pace of monetary growth in the economy. Added uncertainty injected due to the status of the current budget proposals would alter the pace of government expenditure.

Further, till such time a "stable" government assumes office at the centre, forex volatility would remain a continuing concern to the central bank. We, therefore, believe that a CRR cut is more likely at a later date when market liquidity is further strained to support the fiscal excesses of the government.

We expect the main thrust of the credit policy to be on structural issues. Frequent pressures on short-term liquidity in the past few months have exposed the weakness of the various liquidity adjustment facilities. An active repo market is essentialfor smooth functioning of the debt market. The repo market needs to be both deepened and broadened, which would require standardised guidelines on accounting and settlement procedures. The October 1998 credit policy had proposed the introduction of interest rate swaps.

Lack of depth in the inter-bank term money market coupled with undue dependence on the call money market to fund medium and long-term asset positions has resulted in significant asset-liability mismatches.

The introduction of interest rate swaps, primarily as a market hedging mechanism assumes importance in this context. The forthcoming credit policy is expected to provide guidelines for the introduction of interest rate swaps.

(For the week ending April 24, 1999)