In yet another high trading week, Indian bond prices rose across the board. In the first few days, it was the low inflation number and ample liquidity that drove up the bond prices. Later in the week, RBI's announcement of not raising the auction amount for the next week's scheduled auction did the trick. Overall, the yield on the 10-year benchmark government security (2013, 7.27%) fell 0.04 per cent to close at a new low of 5.6 per cent on Friday. Inflation has also fallen sharply to 4.65 per cent for the week ended July 12 against 5.15 per cent in the previous week.
Barring Wednesday, the trading volume remained high during the week, averaging Rs 7,418 crore a day. The trading activity was hit on Wednesday due to the bandh in Mumbai. Despite this, the auction of state government bonds worth Rs 8,000 crore received a good response on Wednesday. Thus, it hardly affected the liquidity in the system and consequently, bond prices continue to rise during the week.
But most of the rise in bond prices came on the last trading session. On Friday, bond yields plunged to new lows after the central bank's announcement that it would conduct the scheduled auction of Rs 9,000 crore in the next week. The market was expecting a higher amount of auction following the excess liquidity in the system. This implies that RBI may not conduct an open market operation next week. This triggered buying interest in the bond market. On August 7, 2003, RBI will issue Rs 6,000 crore worth of 5-10 year bonds and Rs 3,000 crore worth of over 20-year bond.
Though yields fell across the board, much of the fall was seen in the 7 to 15-year segment of the yield curve -- these bonds are also the most liquid ones in the market. Thus, the yield curve became more flat this week. For instance, the spread between the 5-year and the 10-year GOI security narrowed to 0.40 per cent this week as against 0.44 per cent in the previous week.
The excess liquidity in the market has been the main reason driving bond prices upwards. Moreover, this week, the debt market witnessed an inflow of about Rs 2,230 crore from coupon payments, and redemption of government securities and treasury bills. Consequently, except for the Wednesday—the day of the bandh—the daily average subscription to RBI repos remained high during the week, averaging Rs 29,617 crore. The call rates too ruled below the repo rate of 5 per cent.
The central bank's intervention in the currency market has been the key reason for the excess liquidity in the system. With sustained forex inflows, the RBI has been mopping up dollars in exchange for the rupee. The rupee, however, turned weaker by 3 paise this week to close at Rs 46.17/$ on Friday due to the strengthening dollar in the overseas market.
Outlook
Comfortable liquidity should continue to drive bond prices up, and inflation numbers will be keenly watched for any possible signals from the RBI.
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