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Nervous, Confused....Bond Street

War fears and negative diplomatic developments dragged down both the forex and bond markets during the week, but for the optimism that flowed through the end, the markets recouped the losses. But uncertainty will still prevent action.

War fears and negative diplomatic developments dragged bonds and rupee lower this week. The government security prices shed more than one rupee across the medium to long end. However, sentiment went for a turnaround at the end of the week, with clearer indication that diplomatic initiative is being preferred over any military action. Gilt prices recovered by more than 50 paisa at the medium-end, while mild gains at long-end indicated that market participants were still wary of taking a long-term view. The yield on the 10-year benchmark paper that went up by 34 basis points since the attack on parliament, recovered a mere 6 basis points in the end.

On war fear rupee tumbled 43 paisa against the US dollar (0.9% fall) to reach its all time low of Rs. 48.26. Till last week, Indian rupee held steady against the US dollar, while major Asian currencies fell. The sudden weakening was mainly triggered by war fears. The week being the fortnightly reporting for banks, the call rates firmed up to 8.75 percent, with unwilling lenders amidst uncertainty. Similar sentiment prevailed for RBI repo auctions too as players preferred not part away with cash.

While the global slowdown and the consequent fall in exports has lead the economy trackers to lower their growth estimates to below 5 percent, the finance ministry reiterated its belief of strong enough economic fundamentals to withstand the war and continuance of soft interest rate regime. This has failed to enthuse the bond market, apprehensive of fiscal slippage in the event of war. If these fears gain ground, India's oil import bill may also rise along with the firming up of international oil prices. The oil prices jumped by almost $2 (over 10%), with the news of production cut of 1.5 million barrels a day by OPEC. The rising oil prices and escalating border tensions will make it tougher to dismantle the administered price mechanism (APM) of oil. Moreover, measures to boost economy could slip down from the government's agenda.

The sustained uncertainty in the last week and lackluster trading interest on the year-end prevails on weak market sentiments. The liquidity infusion of Rs 2000 crore for banks and the depressed bond values should boost market. Moreover, with rupee's fall below the RBI's stated comfort level might lead to the central bank's intervention. However, uncertainty with fears of war will remain the key market driver.