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A Wake-up Call

With special securities converted into bonds by RBI, it put a stop to yield slide. The yield on the 10-year benchmark closed at 6.02 per cent. The cut-off yield to be set in the forthcoming auction would chart the course of price movement in the future.

The RBI finally woke up this week to check the yield slide. The central bank converted Rs 20,000 crore worth of ad-hoc T-Bill (special securities) into four government securities. This move will give the RBI greater flexibility to conduct an OMO. Therefore, the yield on the 10-year benchmark (7.40%, 2012), after falling below 6 per cent on Thursday, firmed up to 6.02 per cent on Friday. However, over the week, the yield was down 19 basis points (bps).

The yield on the new 10-year benchmark (9.81%, 2013) fell 2 bps more than the former benchmark, finally, closing the week at 6.05 per cent. As for corporate bonds, the yield fall was relatively less vis-a-vis GOI securities yield. Consequently, the spread between the 5-year benchmark corporate bond and the similar-tenure GOI security widened, from last week's 31 bps to 41 bps.

The fall in yield was accompanied by a 25 per cent rise in average daily trading volumes over last week, with more activity concentrated in long-maturity paper. That apart, the lower cut-off yield set at the 91-day T-Bill auction also attracted buying interest. The RBI decided to retain the notified amount for its 91-day Treasury bill auctions at Rs 10,000 crore for the next four weeks. This, to some extent, may check the yield fall for shorter-tenure instruments.

In the last couple of weeks, RBI has been issuing T-Bills at below repo rate of 5.5 per cent. It's an indication that the apex bank is comfortable with low yields, which further strengthens the markets' belief of a repo rate cut. Even in the money market, ample liquidity pushed the call rate below the repo rate. Between Thursday and Friday, an average Rs 13,000 crore a day went into repo auctions. The call rate finally ended the week in the 5.25-5.35 per cent band.

Excess liquidity coupled with increasing forex inflows may put pressure on RBI to reduce the repo rate. India's forex reserve crossed the $70-billion mark in the week-ended December 27, 2002. The rise in foreign inflows together with weakening dollar globally saw the rupee touch 2002's high of Rs 47.94/$ on Monday. However, dollar buying by state-run banks on RBI's behalf prevented further rupee appreciation. The rupee closed at Rs 48.01/$ -- one paisa weaker against the dollar

With yields falling, banks are also gearing up to slash deposit rates. Currently, SBI offers a 6.5 per cent interest on over a 3-year bank deposit, whereas, the yield on 10-year GOI bond is hovering around 6 per cent. While a cut in deposit rate is imminent, reduction in lending rates may not be in the offing, as banks won't be willing to compromise on their interest income.

Outlook

The conversion of special securities into bonds has raised the fear of RBI intervention. This is likely to check the fall in yield at middle and long-end of the curve. That apart, the apex bank will conduct a Rs 5,000-crore auction (of 15-year GOI securities) on Monday. The cut-off yield to be set is likely to chart the future course of bond price movement. The markets are expected to be range-bound in the coming week.