Bond markets welcomed the new financial year with a lot of fanfare. Thanks to ample liquidity as well as fresh funds finding their way into the system, government bond prices rallied (by Rs 1.50-Rs 4) across the maturity spectrum. Overall, the yield curve moved down by 30-40 basis points (bps) and the yield on the 10-year benchmark moved back to its post-Budget level of 5.97 per cent. Trading volumes were initially low but surged to nearly Rs 6,000 crore in the last trading session, with medium-to-long-term securities accounting for a huge chunk.
That markets were flush with funds can be ascertained from the fact that Rs 21,035 crore went into RBI repos. Call rates went much below the repo rate of 5 per cent as banks had already met their fortnightly reserve requirements. After hovering in the 5.25-6.75 per cent range for nearly two months, call rates touched a low of 3 per cent during the week. Another factor that contributed to liquidity was the apex bank's dollar mopping-up exercise. The fiscal-year end saw a surge of dollar inflows on account of conversion of dollar-denominated depository receipts, export remittances and foreign currency loans. As a result, the domestic currency gained whopping 15 paise over the week, ending the week at Rs 47.40/$. If the Reserve Bank of India wouldn't have stepped in to prevent a further rupee appreciation, the rupee could have made some more gains.
With market participants anticipating an early end to the war as US forces moved closer to Baghdad, sentiments in the bond market improved further. The markets had already turned bullish on expectations of a bank rate cut. However, it is possible that players may continue to build up long positions untill the Credit Policy is announced on April 29. The RBI's annual report on currency and finance though, released this week, has once again highlighted that despite a series of bank rate cuts in the past five years, lending rates for borrowers have not come down drastically and this has retarded economic growth. In fact, the central bank had reiterated this point in its October 2002 Credit Policy, when it cut the bank rate, CRR and repo rate by 0.25 per cent each. It is quite possible that this may not happen this time.
Outlook
The bullish sentiment in the bond market may be visible next week too, even though the government will kickstart its borrowing programme with Rs 9,000-crore twin auction of gilts of 10-20 year maturity. As is the case usually, the month of April has ample liquidity in the system, which is sucked out once the government starts to borrow. Over the past four years, the yield on the 10-year benchmark paper has fallen sharply during March-end and mid-April than the whole of the first quarter.
The RBI usually completes 60-65 per cent of its total borrowings in the first half of the fiscal, but this time the scheduled borrowings for the first half are nearly 50 per cent of the total target. Therefore, gilt yields may come under pressure in the second half of the fiscal. More so if there is credit offtake, which will divert bank funds from bond markets to the borrowers.
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