Despite Bimal Jalan reducing both the bank rate and the cash reserve ratio by 0.25 per cent each, bond markets didn't display any enthusiasm. Markets had largely discounted rate cuts but some policy announcements dampened market sentiments. First, the much-expected repo rate cut did not materialise. Second, the RBI expressed serious concerns over the rate of growth in inflation. And third, that the bank rate will stay at 6 per cent till the next Credit Policy is announced in October 2003 send signals that days of low interest rates are over. All this saw the benchmark 9.81% GOI 2013 rise from 5.89 per cent to an intra-day high of 5.97 per cent on April 29 (the day the Credit Policy was announced).
In fact, the government bond prices had started the week on a nervous note expecting that the apex bank may decide against reducing interest rates on account of high inflation. The WPI-based inflation moved up from 6.17 per cent to 6.47 per cent for the week-ended April 12, 2003. Also, the liquidity in the system remained comfortable as inflows to the RBI repos exceeded Rs 20,000 crore on a daily basis and call rates hovered in the 4-4.50 per cent range. However, post-Monetary Policy, bond markets were volatile. While the 10-year benchmark fell to 5.88 per cent following RBI governor's statement that 'we maintain a soft stance on repo rate'. It moved up to 5.93 per cent on Friday ahead of the scheduled Rs 9,000-crore auction on Saturday and bankers' strike.
The key policy initiatives that could impact bond markets are:
l The interest rate on backstop facility has been re-set at reverse repo level of 7 per cent. This will aid borrowers in meeting their short-term liquidity requirements at low interest rates from the RBI.
l Non-banking entities' call lending limits reduced from 85 per cent to 75 per cent of their average lending in 2000-01. This will reduce investment avenues for debt-based funds untill an active alternate market for deploying short-term surpluses is put in place.
l Non-banking entities are allowed to provide unconditional and irrevocable guarantee for credit enhancement for commercial paper issues. This will allow below top-rated companies to issue commercial papers and, hence, improve the supply of short-term instruments in the market.
That apart, the announcement of government buyback of high coupon and illiquid government securities from banks is likely to benefit both the government and banks. While the buyback would reduce the interest payout burden for the government, banks will get an opportunity to realise capital gains by selling illiquid securities at a premium to the market price.
As for fixed income investors, they may once again see a drop in fixed deposit rates. As an immediate reaction to the bank rate cut, the State Bank of India reduced the prime lending rate as well as the fixed deposit rate by 0.25 per cent each.
Outlook
The yield that will be set for the twin-auction of 20-year and 10-year maturity papers is likely to give direction to the bond market next week. With inflation fears still prevalent, market participants expect that both securities will be auctioned at higher yields to keep the real interest rates positive. However, one should keep in mind that the transporters' strike along with a rise in crude oil prices saw inflation rise. Now with the strike over and crude oil prices coming down, inflation should not be a cause of concern for bond markets.
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