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Yields on a Decline

With abundant liquidity in the system, bond markets continued to have a good time in a short trading week. However, a high inflation could throw a spanner in the bond party.

Bond markets stayed in a comfortable zone as ample liquidity kept the buying momentum alive. Easy money supply despite an auction outflow of Rs 9,000 crore kept call rates in the 4.25-4.80 per cent band—nearly 20-50 basis points (bps) below the repo rate of 5 per cent. Thus, market participants parked funds in RBI repos, which received inflows to the tune of Rs 77,549 crore over the week. However, the key development of the week was inflation touching almost 6 per cent till March 22. At this rate of inflation, the real rate of return on bank savings account works out to be minus 2.5 per cent. The one-year bank fixed deposit would also not fetch anything as very few banks are offering a 6 per cent nominal interest rate.

However, government security prices did not show any signs of nervousness despite a rise in inflation. The reason: expectation of an early end to the war, which would lead to a fall in crude oil prices thereof. Already, Brent crude has registered a 27 per cent fall in prices from its high pre-war levels. Gilt prices though started the week on a subdued note ahead of the twin auctions.

Heavy subscriptions to both auctions confirmed that there was ample liquidity in the system. The cut-off yield of 5.97 per cent on the re-issue of 7.37 per cent, 2014 security disappointed market participants who were expecting the yield to be set at 5.93 per cent. On the other hand, a lower-than-expected cut-off yield, which was set on the 20-year security, boosted buying at medium-to-long end of the curve. Major gains over the week though accrued to short-to-medium end of the curve, where the number of trades was relatively high and yield contraction was in the range of 10-15 bps. The yield on the benchmark 10-year security shed 11 bps over the week to close at 5.86 per cent.

A strong rupee caved in—down 6 paise in a day to reach a low of Rs 47.47/$ during the week—following dollar demand from big corporates. However, as the demand for dollars reduced, the Indian currency moved back to touch Rs 47.39/$, marginally higher than previous week's close of Rs 47.40/$. The apex bank once again reiterated the fact that high NRI remittances and deposits were not the only reason for ballooning foreign exchange reserves. As per the Reserve Bank data, a 2.3 per cent growth in NRI deposits during April-December 2002 was similar to what it was in the corresponding period in the last fiscal.

The coming week will see a twin-auction worth Rs 7,000 crore in long-maturity government securities. Huge buying interest in medium-term securities should continue next week as oversupply at the long-end of the curve may prevent buying interest here. Besides this, inflation could move upwards if the OPEC countries decide on a cut in oil supply in their meeting, scheduled for April 24. This move could lead to a rise in crude oil prices.