The Reserve Bank of India has implied on the need for rebalancing of portfolios by market participants with a rise in interest rates imminent.

In its Annual Report 2003-04, the central bank said that developments in international financial markets who are in the process of preparing for a reversal in the interest rate cycle will have a strong bearing on the behaviour of domestic financial markets.

It has categorically suggested that a northward movement of international interest rates, rising inflation and pick up in the real activity are likely to impact the domestic interest rates and the financial market players would have to manage these challenges.

As far as money market is concerned, with overnight call rates remaining at sub-repo levels (that is below 4.5 per cent), the turnover will decrease from the call market to other money market instruments, the annual report said.

To be precise, the daily average turnover in the newly operationalised collateralised borrowing and lending obligation increased from Rs 47 crore (Rs 470 million) in April 2003 to Rs 2,506 crore (Rs 25.06 billion) in March 2004. Till July 2004, the daily average turnover increased substantially to Rs 4,508 crore (Rs 45.08 billion) with weighted average rate working to 3.96 per cent.

Similarly, there has been modest depreciation in the rupee exchange rate against dollar in the first quarter but expectations relating to near term continue to be indicate stable conditions in the foreign exchange market.

It stated that the rupee started coming under pressure during May 2004 on account of turbulence in the equity market, cash dollar shortage and rising global oil prices.

Following heavy selling by the foreign institutional investors in May, a task force was set up to keep a vigil on market developments.

However on account of slowdown in capital flows and higher demand for foreign exchange by corporates, the rupee depreciated by 6.5 per cent during April -July 2004 and traded in the range of 43.57 -46.45 to a dollar.

The central bank maintained that hardening of international crude prices and likely increase in value of imports will be more be absorbed by sustenance of robust growth of exports of merchandise and services.

It believed that the current account is expected to remain in surplus while the net capital flows are likely to remain positive.

Nevertheless, it had warned the market participants that  the domestic price situation and global interest rate movements would have implications for yields in the government securities market in 2004-05.

Commenting on the yield curve, the report said during 2004-05, yields at the longer end started edging from May 2004 reflecting uncertainty in the market conditions, expectation of raising interest rates by the US , rising crude prices and increase in inflation rate.

The report also hinted that with the return of inflation worldwide and raising of policy rates by several central banks along with reversal of ample international liquidity conditions would impact the domestic financial markets.