Liquidity Tight, Yields Firm Up

Though inflation and global crude oil prices eased a bit, tight liquidity and expectation of higher inflation continue to haunt Indian markets


It's getting tougher day-by-day. The markets already reeling under the impact of repo rate hike and tight liquidity saw the bond yields climbing to new highs this week. The actively traded bond (GOI 2015, 7.38%) touched a two-year high of 7.29 per cent on Monday before closing at 7.23 per cent on Thursday--up six basis points over the week. Indian debt markets were closed on Friday on account of Diwali.

On Monday, RBI continued with its schedule auction of Rs 2,000 crore six-year bond and Rs 6,000 crore 28-year bond. But before the auction, the yield on actively traded bond rose to 7.34 per cent on tight liquidity concern. But as the cut-off yield at the six-year bond auction turned out to be lower than market expectation, the yield cooled-off to 7.29 per cent. Sentiment was also revived as the bonds were fully bid at the auction.

The next day, market received some good news. India's expenditure secretary Dhirendra Swarup said that the government's borrowing calendar could be adjusted and timed according to liquidity in the market. He further added that the government was on track to meet forecasts for the fiscal deficit and borrowing for 2004-05. This was followed by one of the government official saying that the government had held cash surpluses worth Rs 20,500 crore with the RBI on November 6, three days before it had raised Rs 8,000 crore from the market. Both these comments buoyed market sentiment.

Then the lower global crude oil prices and hope that the coming scheduled bond auction (slated for November 16 to 24) could be postponed or cancelled amid tight liquidity pepped up market sentiment on Wednesday. The London Brent crude was down at $43.59 a barrel on Wednesday from $45.88 per barrel in the previous week. But the biggest concern remains that of liquidity crunch. The week only witnessed an aggregate Rs 340 crore in the daily reverse repo auction. Hence, to provide liquidity support, RBI infused an aggregate Rs 32,835 crore in the market via repo auction. Call rate remained in the high band of 5.9-6.25 per cent over the week.

The last trading session (Thursday) was rather lacklustre (low trading volume of Rs 1,200 crore) as most market players preferred to remain in sidelines ahead of a long weekend. But bond yields went up as US Fed raised its key funds rate by 25 basis points to 2 per cent for the fourth time this year. The US Fed has said that the interest rates would be raised at a measured pace going forward. Hence, the drop in inflation failed to cheer market on Thursday. The inflation based on Wholesale Price Index (WPI) fell to 7.06 per cent in the year to October 30 from 7.38 per cent a week before.

The rupee continued its gaining streak for the fourth straight week. With strong foreign investments and falling international oil prices, Indian currency closed at a new five-month high of 45.15/$ on Friday--a gain of 5 paise over the week.

Outlook
The bond yields are likely to move in a narrow range due to tight liquidity in the market. Though the coming week would see an inflow of Rs 3,426 crore from interest payments on G-secs and the maturity of T-bills, still all eyes will on the RBI's decision on the forthcoming auction. As per the borrowing calendar, RBI is supposed to conduct an auction of Rs 5,000 crore bond between November 16 to 24. If this auction gets cancelled, as most of the players are expecting, then bond prices may recover, as liquidity will not be affected. Otherwise, to ease market liquidity RBI will have to continue pouring in money via repo auction. And as usual, among other things, the movement in domestic inflation and international oil prices will be closely watched indicators.

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