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Yields in a Free-fall

Yield on the 10-year benchmark dipped to a historic low of 7.14%. The yield on the new bonds and the higher secondary market yield are likely to set the range for the near-term movements.

The bond market floated upwards on auction day. The week's auction of Rs 7,000 crore received an encouraging response. Prices were bid up and the yield on the 10-year benchmark (11.03%, 2012) dipped to 7.16 per cent on Thursday. It fell further on Friday to close at a historic low of 7.14 per cent.

RBI auctioned Rs 4,000 crore worth of 10-year paper at a cut-off yield of 6.85 per cent and Rs 3,000 crore worth of 7-year paper at a cut-off yield of 6.65 per cent on Thursday. With this, the government completed 5 per cent of its borrowing target for the fiscal 2002-03. However, the lower yields fixed by the RBI on the newly issued bonds are likely to dampen interest in these bonds since the yields are well below secondary market levels. The fall in price of the newly issued 6.85 per cent 2012 bond to below par (Rs 99.95) on Friday was the first sign of fading interest.

There was abundant liquidity in the market after the year-end requirement was over and overnight call money rates remained below the key repo rate for most of the week. However, the call rate closed a tad higher at 6.00-6.10 per cent level on Friday. RBI mopped-up a record Rs 30,055 crore from the money market through a one day repo auction on Thursday. This was the biggest amount mopped-up in a repo auction since RBI started the LAF (Liquidity Adjustment Facility) in June 2000. Since call rates dipped to below repo rate of 6 per cent, banks parked the heavy CRR built-up during the year-end into the repo auction.

The rupee fell sharply this week. It hit a new low of 48.885 against the dollar on Wednesday before closing at Rs 48.835 to a dollar on Friday, down 4 paisa over the week. Contraction in export receipts coupled with uncertainty over possible government debt prepayment and rising global oil prices hit demand. The price of Brent crude oil has risen by more than 6 dollar per barrel in March alone. The country's external debt stands at 100.3 billion dollar as on March 2001. However, the government has rejected RBI's proposal of prepaying government's external debt out of the burgeoning forex reserves, as it would mean a trade-off between lower external debt and a higher fiscal deficit. Currently, India's reserves stand at Rs 53.317 billion and the fiscal deficit for this financial year is estimated at 5.7 per cent of GDP, as against 5.1 per cent for the fiscal 2001-02.

The yields on the new bonds issued in the auction were well below that of comparable securities in the secondary market. By setting low yields RBI has once again hinted at its softer interest rate stance. This should bring the yields of the secondary market securities in line with the newly issued bonds. Abundant liquidity should reinforce the downward movement. But, we cannot completely rule out a rise in yield on the newly issued bonds so that it aligns with secondary market yields. The two yields could set a floor for near-term market movement.