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Heaving a Sigh of Relief

Bonds made a comeback this week amidst comfortable liquidity and easing war fears. However, the outlook still remains cautious ahead of the state government auction next week and rising inflation. Bond markets are expected to take a direction from the Budget.

Bears finally paved the way for bulls this week. Bond markets, after a four-week-long bear spell, ended the week on a positive note. Reduced tensions in the Gulf region coupled with comfortable liquidity saw yields drop sharply across maturities in the first three days of the week. However, with the central bank announcing the auction of state government bonds, yields firmed up in the subsequent trading sessions. Consequently, the yield on the 10-year benchmark (2013, 9.81 per cent), after falling to 6.31 per cent on Wednesday, closed the week at 6.59 per cent -- down 17 basis points (bps) over the week. A rise in the cut-off yields at the 91-day and 364-day T-bill auctions also dampened market sentiment.

After two weeks of low trading activity, market participants made a comeback. The daily average trading volume rose by 60 per cent over last week to touch Rs 3,500 crore. However, towards the end of the week, volumes had dipped on concerns over tightening liquidity ahead of the auction of state government bonds of Rs 7,325 crore next week. Next month too there will be another auction of Rs 6,826 crore.

This week though there was ample liquidity in the system. The call rate remained below the repo rate of 5.5 per cent through the week. On Friday, it closed in the 4-4.5 per cent band, as most banks had covered their reserve requirements ahead of the reporting Friday. Comfortable liquidity was also reflected in the rise in daily average subscription to RBI repos, which rose from Rs 2,162 crore the previous week to touch Rs 7,000 crore this week.

In an interesting move, the Reserve Bank of India (RBI) has expanded the repo market by allowing mutual funds, non-banking finance companies, housing finance companies and insurance firms registered with their respective regulators to carry out such transactions, effective from March 3, 2003. Currently, only banks and primary dealers in gilts, holding a current account with the RBI, are allowed to deal in repo market. This move is likely to increase liquidity in the system.

The yields in the corporate bond market also fell initially amidst comfortable liquidity. The yield on the 5-year benchmark corporate bond closed at 7.1 per cent on Monday as against 7.26 per cent last Friday. But rising inflation and the auction announcement saw a reversal in trend and the yield moved up to touch 7.35 per cent on Friday. In comparison to gilts, the rise in yield was more steep here. Therefore, the spread between the 5-year benchmark corporate bond and a similar-tenure GOI security widened from last week's 74 bps to 90 bps.

In the forex market, the rupee bounced back this week. Last week, due to war fears, the domestic currency had turned weaker (15 paisa) against the dollar. This week, the rupee strengthened by 13 paisa and closed at Rs 48.72/$ on Friday. Increasing exports, rising foreign fund investments and expatriate remittances have contributed to a steady flow of dollars into the domestic market. India's forex reserves rose from $74.667 billion in the previous week to touch $75.283 billion in the week-ended February 14, 2003.

Outlook
Bond market will be on edge ahead of the state government bond auction on Tuesday, as it will tighten liquidity. With the Budget next week, debt market is expected to take direction from it. Investors are expecting that the government will cut rates on small-saving schemes. If that happens then the bond market will once again turn bullish. Last year, the government had reduced the rate on small-saving schemes from 9.5 per cent to 9 per cent.