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Back to Where They Started

Bond markets reacted favourably to the 25 basis point rate cut by the US Federal Reserve, but the RBI dampened sentiment by ruling out a repo rate cut in the immediate future.

This week too debt markets were on a roll and once again government bonds touched lifetime lows. But this could not be sustained and yields hardened towards the end of the week to close unchanged. The yield on the 10-year benchmark GOI security (2013 9.81%) thus ended the week at 5.73 per cent. Inflation-based on the Wholesale Price Index (WPI) moved down sharply from 5.44 per cent a week earlier to 5.05 per cent, for the week-ended June 7, 2003. This 0.39 per cent fall was led by a sharp dip in fuel and edible oil prices.

Through the week all eyes were trained on the US Federal Reserve and true to expectations it cut the Fed rate by 25 basis points (bps) to 1 per cent. Expectations of this rate cut had seen the benchmark 10-year government security close at a lifetime low of 5.70 per cent on Monday itself. Fears of an open market operation by the RBI, however, resulted in yields hardening by1 bps on Tuesday. Yields continued to be range-bound on Wednesday only to firm up towards end-week. The RBI's statement that current macroeconomic conditions did not warrant a repo rate cut for some time as inflation and monsoon trends were still not clear enough was responsible for this rise in gilt yields.

The central bank also announced that it plans to raise an extra Rs 7,000 crore during the first three weeks of July on account of excess requirement of funds by the government. This is in addition to a scheduled auction of Rs 14,000 crore. Governor Bimal Jalan's statement that it wasn't a liquidity management exercise helped steady sentiments.

Liquidity in the system also increased substantially. This could be seen from the call rate, which hovered in the 4- 4.25 per cent range on Friday. The average daily repo subscriptions (Rs 25,223 crore) were also nearly 40 per cent greater than what it was the previous week. The average daily volumes in the debt market, however, fell to Rs 5,775 crore, as against Rs 6,136 crore the previous week.

This week also saw the launch of interest rate futures in India. The first order was placed by the finance minister Jaswant Singh on the trading system of the NSE on Tuesday. This will allow participants to take a view on the future movements of interest rates and hedge their underlying positions accordingly.

The rupee's runaway march against the dollar continued with the domestic currency gaining 14 paisa over the week. So far in June, the rupee has gained 69 paisa over the dollar. This is also the fourth consecutive week in which the rupee has appreciated against the dollar.

Outlook
A Rs 12,000-crore bond auction is scheduled for July 1, 2003. This could tighten liquidity in the short run. Continuing forex inflows should, however, make up for this and keep liquidity comfortable. In all, which way bond markets will be headed will be determined by the RBI statements on a possible repo rate cut.