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Uncertainty Shrouds Bond Market

The week saw yields move up thanks to tight liquidity and war jitters in the Gulf region. The yield on the 10-year benchmark inched up by 1 basis points. Looking ahead, market is likely to remain range-bound.

Mounting fears about US-Iraq war saw yields rise after seven consecutive weeks of falling. What shape things will take should be clear on Monday when the United Nation's Inspectors report on Iraq will be presented in the UN Security Council.

Liquidity remained tight through the week following last week's OMO. As a result, the yield on the 10-year benchmark (2013, 9.81%) after touching a low of 5.85 per cent on Wednesday, closed at 5.91 per cent – up just 1 basis points (bps) over the week. That apart, the rise in inflation -- from 3.34 per cent in end-December 2002 to 3.66 per cent for the week ended January 4, 2003 -- dented market sentiments.

Also, the week witnessed average daily trading volumes plunge by 40 per cent due to tight liquidity. Trading was largely concentrated at the longer-end of the curve. However, yields on the longer-tenure gilts remained unchanged over the week.

Following on the lines of the gilt market, corporate bond market too adopted a cautious approach. Yields on corporate bonds also firmed up as banks pulled out their investments from mutual funds to meet liquidity requirements. This compelled funds to sell securities. As a result, the rise in corporate bond yields was more pronounced than in the case of gilts. And the spread between the 5-year benchmark corporate bond and the similar-tenure GOI security widened, from last week's 39 bps to 42 bps.

Liquidity crunch in the market was reflected in the form of higher call rate, which remained above the repo rate of 5.5 per cent till Thursday. However, since banks had met their reserve requirements well in advance by pulling out investments from bonds and mutual funds, the call rate finally closed in the 5.20-5.40 per cent band on Friday. Tight liquidity also saw daily average repo auction attract just Rs 1,106 crore, which was 20 per cent of last week's amount. This compelled the central bank to set a lower cut-off price at the weekly 91-day T-Bill auction. Consequently, yields on T-Bill rose from last week's 5.41 per cent to 5.57 per cent.

The forex market, however, remained unaffected due to global happenings, such as rising oil prices, etc. Sustained forex inflows and weakening dollar globally led to India's forex reserve touch $72.4 billion in the week-ended January 17, 2003. Rise in reserves was also on account of surge in deposits from NRIs in the Gulf region. The rupee ended the week 5 paisa stronger against the dollar at Rs 47.89.

Outlook
The market is likely to be cautious ahead of the United Nation's report on weapon inspection on Iraq, which is due on Monday. However, with liquidity remaining tight, yields on the Indian bond market may be range-bound. Moreover, if a war breaks out, oil prices will rise further, which could fuel inflation thus affecting bond prices in the near term.