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Yields Touch New Low

Excess liquidity and a fall in inflation saw the bond prices rise across maturities. In a high trading week, the yield on the 10-year benchmark hit a new low of 5.66 per cent.

The Indian bond markets saw the revival of buying interest this week. The fall in inflation, abundant liquidity and RBI Governor Bimal Jalan's statement ruling out an immediate open market sale were largely responsible for this. Bond prices across the board went up by 14-100 paise this week. The yield on the 10-year benchmark government security (2013, 9.81%) fell 0.05 per cent over the week to end at a new low of 5.66 per cent on Friday. Inflation based on wholesale price index has fallen to 5.15 per cent for the week ended July 5, 2003 from 5.32 per cent a week earlier.

Unlike the lackluster last week, which remained range-bound, the bond market witnessed one of the highest trading activities this week. Backed by excess liquidity and the expectation of a further fall in inflation, the government securities market recorded its highest ever turnover of Rs 10,471 crore on Friday. Overall, the daily average trading volume doubled this week over previous week.

Though yields fell across the board, the maximum fall was witnessed in the six-ten year segment of the yield curve. Consequently, the yield curve is becoming more and more flat day-by-day. The 10-year bond spread over the repo rate has narrowed to just 0.66 per cent now.

Liquidity in the market has been the key driver in recent months. This week, it got a further boost as the central government paid Rs 2,500 crore as premium to banks that swapped high-yielding bonds for lower-yielding ones last Saturday. Moreover, the market witnessed an inflow of Rs 1,186 crore from coupon payments, and redemptions of government securities and treasury bills. Thus, the daily average subscription to RBI repos remained high during the week, except for the last trading session as it was a reporting Friday. Given that there is no scheduled auction in the coming week, most market participants preferred gilts instead of investing in repos, which resulted in a higher turnover on Friday. The call rates too remained below the repo rate of 5 per cent during the week.

In the forex market, the rupee gained 13 paise against the dollar this week to closed at Rs 46.13. Steady inflows from export proceeds and expatriate remittances were largely responsible for the strengthening of the rupee. However, the rupee touched an intra-day low of Rs 46.11/$ on Friday, but the state owned banks' intervention on behalf of the RBI checked the rupee from further appreciation. Meanwhile, India's foreign exchange reserves rose to $84.1 billion in the week ended July 18, 2003 from $83.3 billion a week ago.

Outlook
The market participants are expecting the inflation rate to come down this week too. A fall in inflation would give a greater leeway to RBI in maintaining its soft interest rate stance. Though RBI has ruled out the repo rate cut for now, a low and stable inflation may compel the RBI to reconsider its view. With no scheduled auctions next week, bond prices are likely to remain range-bound. However, an open market operation by RBI cannot be ruled out, as there is excess liquidity in the system.