* Global economic recovery and macro data key to interest rate movements
* Gilt prices could rally with state loan auctions warding off fears of an OMO
* Rupee likely to appreciate if there is no intervention by the RBI
This week is not expected to witness any outflows except for the treasury bill auctions. There will an outflow of Rs 2,750 crore on account of the auctions.
While Rs 1,500 crore will go out of the system owing to the treasury bill auction, another Rs 1,250 crore will be sucked out on account of the auction of state government loans slated to be held on August 13.
On the other hand, liquidity continues to find its way into the system in the form of portfolio investments, foreign direct investments and trade inflows.
Inflows will be to the tune of Rs 6,769 crore on account of coupon redemptions and the maturing of gilts.
Despite hiking the notified amount for the 91-day treasury bill auction and the cap on NRE deposits, foreign exchange inflows continue unabated.
In the week ended July 25, forex reserves shot up to $84.9 billion. Backed by the inflows, both the foreign exchange and the domestic debt market are poised for a rally.
In fact, follows the intervention of the Reserve Bank of India in the forex and debt market, liquidity is increasingly becoming difficult to manage as most of it is getting parked with the RBI under repos.
Looking at the reserve money and broad money figures, it seems that repo has been the most effective tool for sterilising the system from the excess liquidity.
However, in the distant future, one factor that can cause discomfort is the surge in yields in the US bond market.
Signals of an economic recovery are lowering chances of a further cut in interest rates by the US Federal Reserve, leading to huge off-loading of treasuries by bond investors.
This has led to a rapid rise in treasury yields. The yield on the 10-year US note has risen to 4.3 per cent, from a 45-year low of 3.07 per cent hit in mid-June. The pace of this rise in US bond yields is the fastest in the last 40 years.
If this trend becomes consistent, inflows into the Indian banking system will see a drop. In that scenario, liquidity will become relatively tight and this will be felt even more if the credit demand grows.
Liquidity to keep call rates down
Interbank call money rates are expected to rule in the 4.75-5.0 per cent range despite the week marking the beginning of another reporting fortnight.
The ample liquidity in the system and the automatic cap of 5 per cent on the repo rate are the major reasons for the comfortable call rates.
Last week, call rates hovered in similar range except towards the end of the week when a slight pressure was felt owing to the covering up for the reporting Friday.
On a daily basis, repo subscriptions figured in the range of Rs 22,000-28,000 crore. However, towards the end of the week, the amount under repo fell below Rs 20,000 crore due to the auction of government securities for a total amount of Rs 9000 crore.
Treasury bills
There is not much activity expected in the treasury bill segment. The rise in yields last week has led to a flat yield curve where the long term interest rates have been falling without a corresponding fall in the short term.
Yields have gone up following the abundant supply of treasury bills after the notified amount for 91-day treasury bill auctions was trebled last week from Rs 500 crore to Rs 1500 crore as part of the measures adopted by the apex bank for liquidity management.
