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Going Seems Good

Gilts settled in a narrow range this week, with the yield on the actively traded 11.50% GOI 2011A falling from 7.71% to 7.68%. But in view of excess liquidity in the system, an OMO can't be ruled out.

Ample liquidity and the government's announcement that it would take further steps to ease border tensions saw prices of government securities firm up by 25-40 paise across maturities on Monday. Another two consecutive trading sessions saw gilt prices move up on improved market sentiments. However, this brief rally came to a halt over concerns about quarterly tax outflows, estimated at Rs 4,500 crore, scheduled for next week. To add to woes, RBI governor Bimal Jalan announced in a press conference that an OMO could be conducted if the need arose. The result: investors booked profits and, hence, the prices dipped.

Hence, through the week, gilts settled in a narrow range, with the yield on the actively traded 11.50% GOI 2011A falling from 7.71% to 7.68%. As for the yield on the 10-year benchmark (11.03%, 2012), it fell 3 bps, from 7.81% to 7.78%.

Since bond markets were flush with funds, call rates went below the repo rate (6%) on reporting Friday. Though for most part of the week, these rates hovered in the range of 6.10-6.20%. However, on Friday call rates ended significantly lower at 4.75-5.50%, as there was not much demand from banks to meet their reserve requirements on the reporting day. This was on account of preponement of the CRR cut. During the week, the apex bank accepted repo bids worth Rs 28,310 crore at a cut-off of 6%.

As for the rupee, it ended the week at Rs 49/$. Overall, the currency gained 1 paisa this week. With receding war fears, the rupee firmed up to Rs 48.99 to the dollar on Monday. However, dollar demand from importers saw the rupee slide to Rs 49 towards the close of the week.

On the economy front, the Index of Industrial Production (IIP) posted a 2.9% growth in April, up marginally against the 2.6% growth registered over the corresponding month last year. While manufacturing continued to lag behind, electricity and mining clocked substantial growth, up 4.9% and 4.6%, respectively. Consumer goods sector also displayed considerable improvement in its performance, posting a 4.7% growth -- almost double the growth of 2.5% registered in April last year. All this indicates that an industrial turnaround may well be under way.

Outlook
With war clouds disappearing, bonds could be in for a brief rally. Governor Jalan reiterated this week that softer interest rate bias would continue. In fact, he did not rule out a bank rate cut in the event of a change in current liquidity conditions. But in view of high liquidity in the system, the overhang of an OMO prevails. This will hold bond prices.