Strong rally in short-term bonds was witnessed this week. Key triggers — new hopes of bank rate and repo rate cut with contrary pointers from RBI and reduced size of the last scheduled auction of the season. But, the US-Iraq conflict hurt bonds towards the end of week. The 10-year benchmark (GOI 2012 7.40%) lost 40 paisa while the 7-year actively traded GOI gained 28 paisa over the week. Overnight call rates were calm and sizeable subscriptions of RBI repo continued this week as well.
Government bonds were edgy in the beginning with UTI bailout package and spurt in oil prices. But RBI's statement of a bank rate of not more than 50 bps followed by denial of a rate cut boosted bonds. RBI also reduced the amount of two long-dated securities to be auctioned on Monday—by Rs 1000 crore.
Then the markets ignored the denial and took the sharp drop in T-Bill yields as a pointer to a repo rate cut. The 91-D T-Bill was issued at a cut-off yield of 5.69%--even less than the repo rate of 5.75%, while the 364-D T-Bill was issued at 5.88%--10 bps below the last cut-off price. The two T-Bill yields have remained constant since July. In line with the bullish underlying market, this week, the short-term gilt funds gained more than medium and long-term gilt funds.
The likely US attack on Iraq caused worries of a bloat in oil import bill. The government bond yields fell more towards the end of the week. The 10-year benchmark firmed up by 4 bps. Even the domestic currency at its low of Rs 48.44/$, firmed up by 14 paisa to reach Rs 48.58/$ towards end.
However, with foreign exchange reserve swelling to 61 billion dollars till August 30, RBI is gradually relaxing the rules on foreign exchange flows. For instance, resident Indians can now repay their foreign loans (from relatives abroad) after an year instead of seven years moratorium earlier. For medical treatment abroad, the residents Indians are no longer required to produce an estimate of medical expenses to get securing foreign exchange.
Notwithstanding the US-Iraq conflict, the bond markets should have a comfortable week ahead. Two auctions, 15- and 20-year term worth Rs. 7,000 crore are slated for Monday. A sharp surge in yields post-auction could prompt an action from RBI. RBI also converted some of its special securities in to dated securities, indicating its preparedness to sell these securities in open market.