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A Comfortable Run

Ample liquidity in the system led RBI to reduce repo rate by 25 bps, bringing the bond markets alive. The yields fell by 20-30 bps. It appears that the momentum is back, but is it for real?

Some life was injected into an otherwise lifeless bond market when the central bank, RBI -- sticking to its softer interest rate policy -- reduced the repo rate by 25 basis points, from 6% to 5.75%. Repo deals become a lucrative avenue for participants each time the overnight lending rates fall below the repo rate mark. This rate cut couldn't have come at a more opportune time. Consider this: call rates, for the first time in the current fiscal, hovered in the 5.25-5.85% for the whole week due to comfortable liquidity in the system.

Government securities, which started off on an okay note, gained momentum post-repo cut, as investors placed their bets on longer-tenure securities hoping that RBI would announce a cut in the bank rate. However, the interest this week was in the illiquid segment. By Thursday, for instance, the actively-traded 2012 GOI 7.40% and 2011 GOI 11.03% were up Rs 2 from last week's level. In contrast, the inactive GOI 2015 10.47% gained Rs 3. Realising that rate cut wouldn't happen at least immediately, the euphoria ended and the players booked profits. Nonetheless, gilts folded up the week with yields falling by around 20-30 bps across the maturity spectrum.

The reason for rate cut hopes dimming perhaps was a robust 5.4% GDP growth registered in fiscal 2001-02, thereby indicating the improving health of the Indian economy. More than that, while the RBI has cut the bank rate by 100 bps since January 2001, banks have hardly reduced their lending rates but deposit rates have come down by 100 bps. In fact, as a part of its last credit policy, RBI had asked banks to reduce the spreads over PLR and also make them public. However, they have avoided reducing the spread from the current level of 4%, as they believe it will hurt their margins.

On the other hand, the rupee continued its upward journey against the dollar, though it hardened intermittently on spurt in import demand. With mid-week buoyancy in US equities, the US dollar firmed up against the yen and the euro but slipped subsequently following the discovery of accounting frauds both in WorldCom and Xerox.

Once Bitten Twice Shy
While the scars of the recent gilt scam are yet to fade, SEBI, in an attempt to prevent similar scams has asked all mutual funds to settle their entire gilt transactions in the demat mode. Earlier, funds holding gilt securities worth Rs 10 crore or more were required to conduct transactions in the demat form.

Outlook
With Rs 7,000-crore auction scheduled for next week, the secondary market yields may start in a narrow range, with a limited downside. The post-auction movement will get guidance from the yields, which RBI sets for new issues.