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Resilient Markets Survive US Attacks

War continues to be the weak point for markets. Any twist of events will be a double whammy for bonds since the rupee could turn volatile and delay the rate cut

The much feared and anticipated US attacks on Afghanistan took off this week. The constant pounding of Afghan cities largely remained a one-side affair with little retaliation from the Taleban regime. Amidst the roar of B-2 bombers and swoosh of cruise missiles in the neighbourhood, the bond markets were a picture of poise and resilience with a marginal loss. Jalanspeak promptly extinguished the initial smoke, which had pulled down bond prices by over 80 paise on Monday. The RBI governor reiterated that bias towards softer interest rates would continue. However, prices again dropped towards the end after the announcement of twin auctions with sentiment largely hit due to the auction size of Rs 8,000 crore. The sale of sovereign bonds comes after more than month as markets have now stabilised with yields near historical lows.

The rupee, which plunged to an intra-day low of 48.22 on fears of spurt in oil prices, was also talked up along with dollar sales by state-run banks. The domestic currency finally ended the week strongly at 48.02, spurred by easier international crude oil prices despite US attacks and absence of FII redemption. Barring a brief jump to 7.75% levels on Friday, call rates remained largely steady in the range of 6.90-7.15% on the back of ample liquidity. With fears of tight liquidity, most participants have covered positions ahead of the auction on Monday.

Economy in a Groove
The slowdown continues to gather momentum with a sharper-than-expected slump in industrial production. The index of industrial production rose 2.2% in April-August this year compared to a 5.6% growth for the same period last year. Much of the slowdown is attributed to the manufacturing sector, which also accounts for 70% of total exports. Thus, growth here is likely to dip further amidst the current gloom and volatility in the global economy. A faltering industrial growth also translates into lower profits and hence, pulls down tax collections. This could see a higher-than-budgeted borrowing from the government for meeting its routine expenditure and impact its resolve to pump prime the economy. Already, the fiscal deficit (April to August) has reached 48% of the budgeted figure for the current financial year.

While inflation continues to be benign, there is little to cheer since it means weakening demand sluggish economic growth. The liquidity overhang continues in the system with unabated growth in bank deposits, especially after recent volatility in bond markets. Last but not the least, the government may now find it difficult to take some hard decisions like subsidy rationalisation with approaching elections in Uttar Pradesh. Thus, the current scenario demands more pro-active measures to raise cash from alternative sources including speedy disinvestment of PSUs. With government's pump priming in a limbo, it strengthens the case for lower interest rates.

Outlook
The sentiment is now bit cautious with players on sidelines in the absence of a clear direction on interest rates. Prices have been in a narrow range as the market awaits rate cut before the mid-term review on October 22. The auction of Rs 8,000 crore, the largest single auction so far, have added to the uncertainty with players worried on the impact on yields and liquidity. Although there have been no unexpected events during the war with muted reactions, not-so-vocal protests and stable oil prices, the markets are still apprehensive.

The Monday auction is likely to sail through with ample money in the system. While call rates may momentarily firm up, it is unlikely that RBI would allow liquidity tightening at this juncture – it has repeatedly shown its resolve to prevent panic with reverse repos and buybacks. On the other hand, if the rate cut fails to materialise, there could be a sell-off in the markets. The war continues to be the weak point for markets. Any twist in events there will be a double whammy for bonds since the rupee could turn volatile and delay the rate cut.