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Oh Boy! They Continue to Fall

The week's OMO failed to check the fall in gilt yields. The yield on the 10-year benchmark ended the week down 13 bps. Going ahead, yields are likely to fall further owing to persistent dollar buying by RBI, which will increase liquidity, notwithstanding an OMO though.

This week, in a bid to suck out excess liquidity, the Reserve Bank conducted an OMO worth Rs 11,000 crore. This prevented a further yield fall during mid-week. This was short-lived though, as yields continued to slide after the RBI governor stated that the apex bank wasn't targeting yields and that the auction was just a liquidity mop-up exercise. Consequently, the yield on the 10-year benchmark (2013, 9.81%) after touching a low of 5.87 per cent on Thursday, ended the week at 5.9 per cent – down 13 basis points (bps). Apart from this, trading volume too surged by 30 per cent over last week.

The RBI conducted auctions of 5.87 per cent 2010 GOI security (Rs 5,000 crore) and 6.25 per cent 2018 GOI security (Rs 6,000 crore) on Thursday. The cut-off price set for the latter was slightly higher than market expectations. This obviously means that there is more interest at the longer end of the curve vis-a-vis short-term securities. A fact that was confirmed by the lower cut-off price set at the 7-year bond auction. Thus, the rally at the shorter-end may slow down.

The OMO, however, managed to tighten liquidity in the call money market, with call rates touching a high of 6.5 per cent on Friday. That apart, the outflow towards daily repo auction dipped to Rs 1,363 crore on Friday -- one-fifth of the daily average. Tight liquidity also compelled the RBI to accept reverse repo bids for Rs 130 crore. The RBI accepted the last reverse repo bid in November 2002.

This liquidity tightening affected corporate bond markets too. However, the fall in corporate bond yields was relatively less vis-à-vis gilts. Thus, the spread between the 5-year benchmark corporate bond and the similar-tenure GOI security widened to 39 bps from last week's 36 bps.

On the currency front, the rupee ended the week four paisa stronger against the dollar. With continuous forex inflows and healthy export receipts, the rupee touched a high of Rs 47.92/$ on Tuesday. However, the state-run bank's intervention on RBI's behalf led the rupee to close at Rs 47.93/$ on Friday. The central bank has been buying dollars in the forex market to prevent rupee appreciation. Meanwhile, India's forex reserves rose to Rs $71.35 billion in the week ended January 10, 2003.

This week also marked the opening of gilt trading on the Indian bourses. The NSE recorded volumes of Rs 1.42 crore in the first trading session, while at the BSE it was just Rs 0.48 crore. Targeted at retail investors, the minimum investment needed to participate is Rs 1,000. This could make g-secs a good alternative to bank fixed deposits and post office savings. However, whether this will attract retail participation is a debatable question. Since there is very slight day-to-day movement in gilt prices and a high trading cost, small investors may resist exploring debt market through this route. That apart, even from the capital gains point of view, gilt mutual fund is a better option for its portfolio management skill and tax benefits.

Since the auction of Rs 11,000 crore was almost fully subscribed, market sentiments appeared to be bullish. Provided there is no OMO, yields are expected to fall further due to central bank's persistent dollar buying, which will boost money supply in the market. However, the fear of RBI's intervention is likely to prevent a steep yield fall.