T-bill auction hints further rate cut

Investors actions are a better determinant of their expectations than words. The market behavior in the latest Treasury bill auction, held two days back, noticeably reflects that the investors foresee a much greater likelihood of an interest rate cut in the upcoming monetary policy. Investors, wholeheartedly, tendered bids in the auction; total participation stood around Rs.297 billion. As the average participation stood around Rs.81 billion in the previous three treasury-bill auctions, there was an apparent improvement in the appetite for treasury papers. Hence, the auction drew the total participation to target ratio of around 4, which is higher compared to the average ratio of around 1.7 for all auctions held in the 2QFY12. Auctions for 6-month and 12-month maturity paper attracted the major crowd, accounting for nearly 80 percent of the total bids placed. Investors try to lock their investments primarily in longer tenure papers, when expectations of a rate cut abound to book capital gains and reduce reinvestment risk. Above all, lenders demonstrated were seen placing lower bids. Hefty participation and lower bids hauled down the cut-off yield on 3-month, 6-month and 12-month paper by 18 bps, 20 bps, and 16 bps, respectively, compared to the last auction held earlier this month. In light of possible decline in the discount rate, the 12-month paper is trading at a considerable discount; close to 34 bps, to the key rate. The longest tenure paper traded at an average discount of 11 bps during the 2QFY12. Behind the expectation that the interest rate will decline is a single digit inflation rate in December. Higher energy costs, along with higher wheat support price, will most likely swell inflation data for January, but there is a good chance that inflation will remain in the vicinity of 9.5 to 10.5 percent in January. With average monthly inflation at around 10.89 percent during 1HFY12, policymakers intent of keeping eal rates at zero, even if inflationary pressure goes up a few notches in January, there is still room for a further 50-100 bps cut in the discount rate in the upcoming monetary policy.