The yields on the Indian government bonds seem to be in a free-fall. After two consecutive weeks of 10 basis points fall in the 10-year yield, it fell another 9 basis points this week. Excess liquidity and the expected reduction in the bank rate in the forthcoming monetary policy has been the main factor pushing bond yields down. However, the yields ruled firm in the last trading session due to rise in inflation and profit booking by some traders. Consequently, the yield on the 10-year benchmark (GOI 2013 7.27%), after hitting an intra-day low of 4.94 per cent on Thursday, finally closed at 4.97 per cent on Friday.
The inflation based on wholesale price index rose to 5.08 per cent in the week ended October 4, 2003 from 5.03 per cent in the previous week. However, this should not be a cause of concern for the bond market as it is mainly due to relatively low prices at the same time last year. And it is unlikely to affect the market expectation of a bank rate cut. Finance Secretary D.C. Gupta's statement that the interest rates environment was soft has strengthened the expectation of a bank rate cut.
That apart, excess liquidity due to increasing forex inflows has been pushing up bond prices recently. However, the week's auction of state government bonds worth Rs 6,500 crore led to some liquidity tightening initially, but it improved in the later trading sessions. The call rate remained below the repo rate of 4.5 per cent throughout the week.
This week, RBI had also raised the cut-off price at its weekly auction of 91-day treasury bills and the fortnightly auction of 364-day treasury bills. As a result, the yield on the 91-day treasury bills fell to 4.42 per cent from 4.46 per cent in the previous week and that on the 364-day treasury bills fell to 4.37 per cent from 4.51 per cent a fortnight ago. It means that the yield on the treasury bills have fallen below the repo rate of 4.5 per cent. This could well be an indication of a further reduction in the repo rate.
Though there has been across the board fall in the yields, much of the fall has been at the medium-to-long end of the maturity spectrum, thus making the yield curve flat. As a result, the spread between a 5-year and 15-year bond has narrowed to 70 basis points this week as against 77 basis points in the previous week.
In the forex market, the rupee gained 4 paise over the week to close at Rs 45.34/$ on Friday. On Tuesday, the rupee touched a low of Rs 45.69/$ due to cash dollar shortage, but rebounded later in the week following the robust foreign fund inflows and on the news that the Moody's is likely to upgrade the country's foreign currency rating. Meanwhile, India's foreign exchange reserves rose to $90.36 billion in the week ended October 10 from $87.738 billion in the previous week.
Outlook
The yield on the 10-year benchmark has come down by nearly 28 basis points since September 29 – the day government announced the lower borrowing target for the second half of the 2003-04. Further fall in yields may be expected at a slower pace due to the rise in inflation and the schedule auction of Rs 5,000 crore on Tuesday.
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