The disappointment over RBI's monetary policy didn't last long and bond yields soon stabilised at pre-policy levels. Presenting his first Monetary Policy Review on November 3, Dr Y. V. Reddy left all the key interest rates – bank rate, repo rate and CRR – unchanged. On the positive side, he has upgraded the GDP forecast to 6.5-7 per cent with an upward bias, and lowered the inflation outlook to 4-4.5 per cent with a downward bias for 2003-04. Dr. Reddy has also said that RBI is looking at alternatives to its open market bond sales to sterilise rupee liquidity that is being created by its interventions in the forex market.
Indian bond yields surged on Monday after RBI belied the market expectation of a bank rate cut. The yield on the 10-year benchmark (GOI 2013, 7.27%) touched a high of 5.23 per cent in intra-day trades. But the yield came off that level in later trading sessions, helped by easy liquidity and a low inflation forecast. The sentiment was further buoyed by RBI deputy governor Rakesh Mohan's statement that inflation risk was low in the farm-dependent economy following ample rains. Meanwhile, inflation based on wholesale price index fell to 4.96 per cent for the week ended October 25, 2003 from 5.01 per cent in the previous week.
However, bond yields rose slightly towards the end of the week due to profit booking by some traders ahead of the auction. On Friday, the RBI conducted a scheduled auction of 9-year floating rate bond worth Rs 5,000 crore. Consequently, the yield on the 10-year benchmark, after touching a low of 5.05 per cent, finally closed the week at 5.07 per cent on Friday – down 2 basis points over the week.
The liquidity has improved in the market due to rising forex inflows. The excess liquidity was reflected in the overwhelming response at RBI's repo auction. The average daily subscription to RBI repos rose dramatically to over Rs 15,000 crore against a meagre Rs 4,000 crore in the previous week. Call rates too remained below the repo rate of 4.5 per cent. The average trading volume also witnessed a sharp rise after two weeks of lacklustre trading. Despite all these, there are lingering fears that RBI may conduct an open market operation to absorb some liquidity after the scheduled auction of floating rate bonds.
The rupee continued to strengthen this week and closed at Rs 45.29/$ on Friday – with a gain of 3 paise over the week. Despite strong dollar inflows by foreign funds and exporters, the rupee traded in a narrow band with state-run banks mopping up dollars and preventing the rupee's gain.
Highlights of the Monetary Policy
1. Bank rate remains unchanged at 6 per cent.
2. Cash Reserve Ratio (CRR) kept unchanged at 4.5 per cent.
3. Repo rate too remains at the existing level of 4.5 per cent.
4. GDP growth in 2003-04 is placed at 6.5-7 per cent, with an upward bias, as against 6.0 per cent envisaged earlier.
5. Inflation forecast reduced to 4-4.5 per cent, with a downward bias, as against 5-5.5 per cent projected earlier.
Outlook
With inflation coming down, the yield on longer-tenure bonds should ease further. On the other hand, the increasing fear of OMO due to existing excess liquidity may keep the market players cautious. Otherwise, with no scheduled auctions left in November, this excess liquidity will continue to push bond prices upward.
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