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Searching for Stability

Despite reiteration of a lower inflation outlook by both RBI and the government, bond yields continue to rise. Unless the current inflation of over 5 per cent comes down, yields are likely to stabilise at current level.

This week, government bonds lost all the gains made during the initial few trading sessions and bond prices closed almost unchanged at last week's level. Initially, bond prices rose on the back of easy liquidity and RBI governor Y. V. Reddy's reiteration of a benign inflation outlook. But bond prices fell later in the week after RBI governor's comment that non-food credit may pick up in the coming months. As a result, the yield on the 10-year benchmark (GOI 2013, 7.27%), after touching a low of 5.06 per cent on Tuesday, closed the week at 5.09 per cent on Friday – up 2 basis points.

That apart, a high inflation figure released on Friday added to the fear that RBI would keep rates steady in the near term after the central banks of UK and Australia hiked rates last week. The inflation based on wholesale price index rose to 5.01 per cent for the week ended November 1, 2003 from 4.96 per cent in the previous week.

But the market sentiment improved after the finance ministry said in its Mid-year Review that inflation is expected to be in the region of 4 per cent. The finance minister has also said that the rates on small savings schemes and administered rates needed to be reviewed as a priority. But the most encouraging part of the review has been the finance ministry's confidence in the economy. He expects the Indian economy to grow at over 7 per cent this year on the back of a sustained industrial recovery and a strong monsoon-led agricultural rebound. His expectation is more optimistic than the 6.5-7 per cent growth projected by the RBI in its Monetary and Credit Policy on November 3.

The fresh government curbs on external commercial borrowings (ECBs) could also weigh on the sentiment, thus having an impact on liquidity. The finance ministry has imposed the end-use restriction on ECBs over $50 million, lowered the interest rate spread and made it compulsory to park unused proceeds abroad. Moreover, banks, FIs and NBFC have been debarred from tapping ECBs. This week, however, liquidity remained comfortable as the average daily subscription to RBI repos stood at Rs 13,600 crore – a bit lower than last week's level. The call rate too remained below the repo rate of 4.5 per cent over the week.

The rupee turned weaker by 14 paise this week to close at Rs 45.42/$ on Friday. Though there was continuous forex inflows, it was aggressive dollar buying by state-run banks, on behalf of the RBI, which dragged the rupee down. RBI has been buying dollars to curb a sharp rise in the rupee. Meanwhile, India's forex reserves rose to $93.21 billion in the week ended November 7, 2003 from $92.6 billion the previous week.

Though both RBI and the government have projected a lower inflation for the year, the higher inflation figures at present are weighing on the market. Thus, unless inflation comes down, yields are likely to stabilise at current levels. Moreover, as the RBI governor expects non-food credit to pick up very soon amid industrial recovery, banks may reduce their exposure to government bonds in order to meet corporate lending. This could have an impact on the bond prices. But for the meantime, interest rates are likely to remain unchanged at the current level and a range-bound market lies ahead.