The Indian bond market was on a high this week. Abundant liquidity, falling inflation and increasing expectations of a repo rate cut saw bond prices move up across-the-board. The inflation based on wholesale price index fell to 6.03 per cent in the week-ended May 3, 2003. Expectations of a repo rate cut was strengthened with the government's sub-committee on Employees' Provident Fund (EPF) hinting of a possible reduction in EPF rate from the existing 9.5 per cent to 8-9 per cent.
Contrary to market expectations, RBI deputy governor Rakesh Mohan has ruled out any cut in the repo rate in the immediate future. Consequently, the yield on the 10-year benchmark (2013, 9.81%), after hitting an intra-day low of 5.79 per cent, ended the week at 5.81 per cent on Friday—down 8 basis points (bps) over the week. The average daily trading volumes also increased from Rs 4,000 crore last week to Rs 7,200 crore this week.
What caught everyone's attention this week was FIIs making a net investment of Rs 802 crore in the Indian debt market on Tuesday—the highest in a single day so far. Relatively higher interest rates in India compared to overseas gilt markets have created an arbitrage opportunity for FIIs. In the US, the return on the 1-year bond is 1.2 per cent and in the UK it is 3.29 per cent (as on May 17, 2003). In India though the 91-day T-bill offers around 4.5 per cent return.
On Monday, the RBI conducted the scheduled auction of Rs 5,000 crore of GOI 2014 floating rate bond. The yield for the first half-year was kept at 5.09 per cent, which was higher than what the market had expected (5.05 per cent). But this didn't affect the market sentiment, as the bond is unlikely to witness active trading in the secondary market.
Following in the footsteps of g-sec yield, the yield on corporate bonds too moved downwards. The spread between the benchmark 5-year corporate bond and the g-sec of similar-maturity narrowed down from 35 bps at the start of the week to 20 bps by Friday. This propelled buying interest in the less liquid segment of the corporate bond market.
The rally in bond market was largely liquidity-driven. An ample evidence of this was the amount of bids received in daily repos, averaging over Rs 17,000 crore as against Rs 10,000 crore last week. Call rates too remained comfortable in the 4.75-5 per cent range.
As for the forex market, the rupee gained a whopping 24 paisa to close the week at Rs 46.90/$ on Friday. Robust dollar inflows and the weakening dollar globally saw the rupee touch an intra-day high of Rs 46.85/$ the same day. However, with RBI stepping in, the rupee's appreciation was curtailed somewhat. The premium on the six-month forward, after hitting a low of 0.29 per cent on Wednesday, moved back to last week's level of 1.05 per cent on Friday. Meanwhile, India's forex reserves touched a high of $72.225 billion for week-ended May 16, 2003.
Outlook
Abundant liquidity in the system will continue to push bond prices upwards. Also, the outcome of the labour ministry's meeting on May 31, 2003, on reduction of EPF rate, will set the pace of things in the bond market. An EPF rate cut could lead to a short-term rally. However, with no scheduled auction in the coming week, high inflation or an OMO could spoil the party.
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