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While stocks cry over drought, funds-flush bonds peg hopes on a bank rate cut. The finance minister's tax-sops brought some cheer this week. But will he reduce the bank rate as well?

An upbeat Bond Street pushed the yields to almost 3-month lows. The reason: the FM doles out tax sops. Initially, with inflation last week moving up by 49 bps over the previous week, the bond yields started the week in the narrow range, with all eyes on the Rs 8,000 crore fresh auction. The newly-appointed finance minister opened up new investment option for investors in the form of tax-free bonds, offering 7% per annum as against the 8% per annum on the 5-year tax-free bonds currently in the market. This justifies the apex bank's soft interest rate bias. That apart, the government borrowing Rs 7,000 crore instead of the scheduled Rs 8,000 crore came as a breather.

Finally, the central bank set the yields on the re-issue of 9-year and 26-year maturity papers around market expectations, 7.24% and 7.92%, respectively. Thus, overall the bond prices went up by 11-80 paisa at the medium-to-long end of the curve, with maximum gains accruing from the 9-year and above 15-year segment. That apart, the sufficient liquidity in the system primarily getting a kicker from rising forex kitty saw the call rates move in the range of 5.55-5.75% range for almost fourth consecutive week. And quite understandably, the excess money was parked in RBI repo auctions which continue to receive daily subscriptions in excess of Rs 10000 crore for most part of July.

And on the forex front, the domestic currency opened the week at Rs 48.75/$ on import requirements and sharp appreciation of the dollar in international markets. However, soon the rupee gained 9 paisa on the release of data of robust export growth in June and the subsequent weakening of the dollar. This was short-lived as the gains were capped by state-run banks' intervention, which saw the rupee close higher by 35 paisa only.

Indeed, the finance minister's announcement of tax-sops, new bond scheme, UTI support may help him break ice with common man. But drought-like situation and the possible increase in expenditure thereof is likely to put the government in a tight spot for meeting its budgeted fiscal deficit target of 5.3%. Already, the finance ministry has asked for supplementary grant of Rs 8000 crore and the GDP growth estimates have been revised from 6% to 5.5% now. Under this backdrop, it is likely that interest rates will remain stable, auguring well for fixed income funds. Add to it the enhanced appeal in the form of increased exemption limit to Rs 15,000 under section 80L of the IT Act, which now covers the dividend income from mutual funds as well.

Outlook
No doubt that even the finance ministry wants lower interest rates as a 'step in the right direction', but the market expectations of a bank rate cut seems unlikely in the immediate term. In the absence of any rate cut, the total credit offtake from banks has risen 10.3% in the current fiscal as compared to a mere 2.4% rise in the corresponding period of last fiscal. So, any unwarranted rise on such hopes is likely to be offset by RBI operations.