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Bull Frenzy Unabated on Ample Liquidity

While the market feverishly hopes for a rate cut, bond prices could get a fresh

Bulls on Bond Street extended gains this week as hopes for a rate cut gathered momentum after Fed slashed interest rates for the ninth time in the current calendar. The key Federal Funds Rate is now down to 2.5 per cent while the domestic bank rate stays at 7 per cent, thus further widening the gap. Sentiment was also aided by absence of any direct confrontation as yet with United States stepping up its diplomatic parleys. The yield on the 10-year sovereign bond (11.5%, 2011) hit a new low of 9.3 per cent before it firmed up to 9.8 per cent on Friday. Thus, in less than fortnight, the yield on the benchmark has plummeted by nearly 100 basis points and mirrors the high-pitched volatility in bond markets.

After staying grooved to 47.86 levels, the rupee started the week with a dip of 13 paise against the dollar. While the domestic currency recouped some losses mid-week, it closed at a new low of 48.01 on Friday as banks bought dollars. Call rates remained below 7 per cent for the week as players had already met their fund requirement ahead of the reporting Friday. In fact, the liquidity glut in the market pushed down call rates below the repo yield of 6.5 per cent. No wonder, the RBI accepted bids worth Rs 18,770 crore in its repo auctions.

The Y V Reddy Committee on small savings has recommended a host of measures including market-linked coupon on small saving instruments and restricting tax sops to PPF. If implemented, these measures will dramatically alter the interest rate paradigm in the country. Currently, postal deposits like monthly income plan and Kisan Vikas Patra pay 9.5 per cent for about 5 years. On the other hand, the yield on the corresponding government security for 5 years is about 7.8 per cent. Thus, even if return on postal schemes were to be 0.5% higher than the five-year sovereign bond, it would ensure a sharp fall in government's annual interest payments (provided interest rates do not move up). The total postal savings corpus is pegged at Rs 2.50 lakh crores. However, the recommendations are unlikely to be accepted in toto since they are bound to hurt the retail investor.

Disinvestment – Finally, a Starter?
The government finally opened its disinvestment account for this fiscal with the sale of CMC and Hind Teleprinters (HTL). While the total amount of Rs 207 crore may not be a substantial kitty, there is at least a ray of hope and highlights the government's renewed vigour to sell public enterprises. That said, the Centre still has a Herculean task on its hands – going by its own target of unbundling 11 more companies in the current fiscal, the government has to sell one PSU every 16 days! Apart from providing political ammunition with customary hue and cry, there has been a severe paucity of bidders in most companies, barring IBP and ITDC. In fact, the government was lucky to get higher than the reserve price for both CMC and HTL, which attracted one and two bidders, respectively. The reason for lack of interest is obvious - apart from the usual rigmarole, several "family jewels" still use obsolete technology and offer outdated products and services with inefficient human resources. Thus, its surely a tightrope walk in the coming months.

A successful disinvestment programme not only reduces the government's borrowing from the market, which is an immediate benefit. It also sends a strong signal that the government is finally moving towards a definite role change – from an unviable and unwanted competitor, running sick PSUs, to an unbiased regulator and facilitator.

Outlook
While the mood is upbeat, players are now waiting for the next trigger to guide sentiment. The market hopes for a rate cut before the mid-term credit policy on October 22 and has already factored in a 50 basis point reduction at current levels. However, till that time, yields are likely to move in a narrow range with profit booking at higher levels. On the other hand, sentiment continues to be sensitive to events in Afghanistan. For instance, bond prices dipped on Monday this week as rumours of imminent US air strikes hit the market. Thus, in the event of a war, even a rate cut may prove adequate and bond prices could get a fresh drubbing.

It has been over a month now since the RBI has come out with an auction. With relative stability now coupled with ample liquidity, the market could soon see a fresh auction, provided guns remain silent in the war zone. The government has so far raised Rs 87,500 crore through market borrowings and private placements against the budgeted gross estimate of Rs 1.18 lakh crore for the current financial year.