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Bonds Fight Back

With Bush going all out to wipe out Saddam and Co., optimism replaced pessimism in the bond market. Since the market expects it to be a short war, crude oil prices came down drastically, which helped bond prices firm up.

War acted as a blessing in disguise for the bond market. As crude oil prices came crashing down and with a marginal improvement in liquidity, bond prices inched up towards the weekend. At the start of the week though, bond prices were under pressure due to tight liquidity and the uncertainty over the war. However, the minute US-led forces started raining bombs on Iraq, bonds bounced back on the expectation that it would be a short war. Consequently, the yield on the 10-year GOI benchmark (2013, 9.81%) after touching a high of 6.48 per cent on Monday ended the week at 6.35 per cent on Friday.

Though the trading activity was weak initially, it improved towards the end of the week. Volumes surged from an average Rs 1,600 crore in the first three trading sessions to touch Rs 4,440 crore on Friday. Incidentally, much of the trading was concentrated in the medium-to-long end of the curve. Short-term securities were clearly not the flavour of the week.

Apart from that, advance tax outflows created liquidity crunch in the system. The quarterly tax payments (estimated at Rs 10,000 crore) are collected by state-run banks on behalf of the government. Now with banks transferring these collections to the central bank, liquidity is expected to be tight in the near term too. Thus, call rates remained above the repo rate of 5 per cent. The tight money supply was also reflected in high reverse repo bids aggregating Rs 2,770 crore in the last three trading sessions. However, call rates fell to 5-5.1 per cent on reporting Friday, as banks had already met their reserve requirements.

The domestic currency turned weaker ahead of the war to touch Rs 47.745/$ on Wednesday. The main cause was the impact of war on crude oil prices. But as oil prices crashed, the rupee firmed up to end the week at Rs 47.67/$. The price of Brent crude came down from $33.72 per barrel the previous week to $26.67 per barrel this week. However, reports of oil-field fires in southern Iraq may threaten global efforts of maintaining stability in global oil supply.

In an interesting move, on Friday, the Reserve Bank of India announced the launch of a new savings taxable bond (coupon rate: 8 per cent). This bond will not have any cap on investment. This non-tradable new avtaar of RBI Relief bond will have a maturity of six years. Interestingly, charitable institutions, trusts and universities, can also invest here. Prior to this, this scheme was open only for individuals. This will be in addition to the 5-year, 6.5 per cent tax-free savings bond announced earlier in the month, which will be open only to individual investors. Post-Budget 2003-04, the RBI had decided to stop issuing new Relief Bonds.

Outlook
Oil prices may have fallen sharply in the last few days, but it's still not clear how long the war will last. If it lasts longer than expected, oil prices will spiral up, which, in turn, will impact inflation. The ripple-off effect will be felt on bond prices as well. Although liquidity is tight, it is a short-term phenomenon. The start of the new financial year should take care of this. However, banks will continue to book profits in gilts ahead of the financial year-end.