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A Flat Market

After some initial gains, bond prices dipped after RBI announced an open market operation. Inflation continued to rise but as it remained below market expectation, sentiment improved by the weekend.

Indian bond market witnessed a mixed trend last week. Initially, the surplus liquidity and the expectation of higher investments by pension funds and banks in the New Year kept the markets in good stead. However, bond prices dipped mid-week after RBI announced an open market operation (OMO) in addition to the scheduled auction in the coming week. But bond prices recovered most of their losses in the last trading session as the rise in inflation was below market expectation. Consequently, the yield on the 10-year benchmark (GOI 2013, 7.27%), after touching a high of 5.13 per cent, ended the week unchanged at 5.12 per cent. The yield on the new 10-year benchmark (GOI 2014, 7.37%) too closed the week flat at 5.13 per cent.

The most striking news of the week was an 8.4 per cent GDP growth registered by the Indian economy in the quarter ending September 2003 vs 5.2 per cent growth a year ago. This makes India one of the fastest growing economies of the world. However, inflation continued its rising trend for the sixth straight week. The inflation based on Wholesale Price Index climbed to 5.63 per cent for the week ending December 20, largely because of a hike in fuel prices. This could be a concern for the bond market as well as the RBI, which has kept the inflation target of 4-4.5 per cent for 2003-04.

This week, RBI announced that it would conduct an OMO of Rs 5,000 crore for an 18-year bond on January 7, in addition to the scheduled auction of Rs 5,000-crore 11-year bond on January 6, 2004. This, along with the expected sale of state government bonds, is likely to affect market sentiment marginally as pension funds and banks would increase their investments in bond markets in the coming weeks. Pension funds have received Rs 8,000 crore as interest income from the state-run deposit schemes for the year ending 2003. A large part of this money is expected to find its way to the bond market.

That apart, liquidity remained comfortable in the bond market due to regular intervention by RBI in the currency market. Liquidity surpluses, as reflected at the daily average subscription to RBI repo auction rose to Rs 30,750 crore -- an increase of 11 per cent over previous week. And, on Friday, this figure touched a record high of Rs 40,055 crore. The call rate too remained below the repo rate of 4.5 per cent over the week.

The rupee, after moving in a narrow band of Rs 45.57-45.60 against the US dollar for a large part of the week, closed lower at Rs 45.71/$ on Friday – a loss of 13 paise over the week. This was largely on account of heavy demand by corporates and banks. The central bank, however, continued its intervention in the currency market in order to stop the rupee from appreciating further. Meanwhile, India's forex reserves rose to $100.59 billion in the week ended December 26, 2003 from $100.049 billion the previous week. On Friday, RBI said that the Indian government had repaid bilateral foreign currency loans worth $576.84 million ahead of the due date in the three months to December 2003.

Outlook
All eyes will be set on the inflation numbers and the two auctions of 11-year and 18-year bonds next week. The yields set on these bonds will give direction to the debt market. Liquidity is expected to remain comfortable due to larger investments by pension funds and RBI's intervention in the currency market, which would offset the auction outflow. The market is also expecting some goodies from the three-day SAARC summit starting Sunday in Islamabad.