``There is a surfeit of liquidity in the system and as we approach the end of the year, banks are holding more cash. In the absence of any alternative for deployment of funds, money is moving into gilts,'' says Shekhar Sathe, CEO, Kotak Mahindra AMC. ``Call rates have been subdued during this period, range-bound between 6-8 per cent. Thus, gilts are a clear investment alternative,'' adds S Kannan, vice-president and head, Escorts Asset Management. Industry sources say there has not been any significant pick-up in credit offtake while everything is quiet in the forex markets. ``No wonder, this has given a further impetus to investments by banks in the highly liquid gilts market,'' points out a fund manager.

There are various estimates on additional liquidity in the system, varying between Rs 8,500 to 12,000 crore. One, The Reserve Bank of India has pumped an estimated Rs 4,000 crore to take care of any possible Y2K-related problems. ``From the onset of December, the cash in the hands of banks is being treated as part of cash reserve ratio. This is estimated to be over Rs 4,000 crore,'' points out a fund manager. To sample the gains registered by gilt funds, consider this. The gilt fund from Dundee Mutual Fund has seen its NAV move up by 2.76 per cent from Rs 10.50 on November 15 to Rs 10.79 on December 6. This translates into an annualised return of 45.82 per cent! ``We had anticipated this kind of a rally in the gilt prices and invested in the long-end of market. In some of the securities, the gains have been in excess of Rs 2,'' says Akhilesh Gupta, fund manager, Dundee Sovereign Trust.

While prices of gilts did drop on Wednesday, they recouped most of their losses on Thursday. ``With prices moving up so sharply, profit-booking was expected. Besides, RBI's statement that liquidity on account of Y2K was temporary (available till January 31), helped cool down prices,'' says a gilt fund manager. ``The buying resumed on Thursday and we expect prices to move up by another 10-15 paise in the next few days before markets slow down from December 15,'' adds Gupta. Fund managers expect unwinding of positions to take place towards end of January, 2000, leading to a drop in prices. ``A one-time impact will be there as players sell securities in anticipation of a squeeze on liquidity with money for tackling Y2K problem moving out of the system. Those who are holding long-term paper will certainly like to move out and be in cash,'' comments a fund manager.

On the other hand, a number of aggressively-priced triple A debt papers have hit the market to take advantage of the excess liquidity. ``The artificial liquidity created in the system is driving companies to tap the market for funds. While BPCL offered 12 per cent for five year paper, Exim Bank offered 11.90 per cent for the same duration. The lower coupons have triggered a rally in the secondary debt market,'' says a debt market dealer. The coupon for the HDFC issue, being determined by book-building, is also expected to be below 12 per cent. ``Banks are putting money in other triple A corporate papers with their exposure to IDBI and ICICI over,'' adds a fund manager.