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Nervousness Prevails

Bond prices stayed range-bound this week. Concerns over US-Iraq war and tight liquidity kept players on the sidelines. Liquidity is likely to improve next week but with tensions still on in the Middle East, caution will rule the market.

This week, the bond market remained range-bound. The yields moved up initially though, due to tight liquidity ahead of the state government bond auction, advance tax payments and war fears. The government conducted the auction of the 10-year state government bond (6.75%) for Rs 7,553 crore on Wednesday. However, since the market had discounted all this, the yields moved down in the remaining trading sessions. Consequently, the yield on the 10-year benchmark (2013, 9.81%) after touching a high of 6.49 per cent on Monday closed at 6.34 per cent on Thursday. Over the week, the yield moved up just 2 basis points (bps).

The US and the UK's decision to delay the vote on the Iraq issue in the UN Security Council provided some relief to the market. However, there wasn't too much activity in the debt market. The average trading volume dipped by 40 per cent, from Rs 3,100 crore the previous week to Rs 1,900 crore this week. Moreover, the lower-than-expected cut-off price set for the 91-day T-Bill auction also hurt the market sentiment.

Thanks to advance tax outflows and the state government bond auction, liquidity was tight this week. This was amply reflected in higher call rates, which remained above the repo rate of 5 per cent. The subscription towards daily repo auction also came down to less than Rs 1,000 crore. However, this is expected to be a short-term phenomenon. With no more auctions left for March and the completion of the advance tax outflows, liquidity situation will be better in the coming weeks. Banks will continue to book profits though, ahead of the financial year-end.

Corporate bond market also remained sluggish. The yield on the 5-year benchmark corporate bond inched up just 2 bps to close the week at 6.77 per cent. And the spread between the 5-year benchmark corporate bond and a similar-tenure GOI security widened from last week's 42 bps to 46 bps this week.

War fears took their toll even on the rupee, which turned weaker by one paisa against the dollar. The domestic currency ended the week at Rs 47.66/$. The rupee could come under pressure if oil prices rise once war happens. Meanwhile, India's forex reserves rose from $72.88 billion the previous week to $73.74 billion in the week-ended March 7, 2003. With government buying dollars to pre-pay some hard currency loan, forex reserves were depleted by $2.48 billion the previous week.

As for the economy, the industrial sector is on a recovery path. According to the CSO, India's index of industrial production (IIP) grew by 6.4 per cent (year-on-year) in January this year. A robust growth (6.9 per cent) in the manufacturing sector ensured this. This is likely to increase credit off-take, which has already gone up by Rs 9,858 crore in the last one month. This, in turn, will generate higher demand in the economy.

The bond market lacks direction right now. Although the government, by reducing the small-savings rate, has shown that it is committed to a soft interest rate regime, it is external factors that has hurt market sentiment. Unless situation improves in the Gulf region, we continue to maintain a cautious outlook for the week.