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Stability Reigns

Despite auction outflows and rise in inflation, Indian bond markets remained stable in a high trading week. Reasons: comfortable liquidity and RBI Governor's reiteration of a benign inflation outlook.

Indian bond markets remained stable in the week ended January 9, 2004. Though inflation continued its rising trend for the seventh straight week, ample liquidity kept the bond markets in good stead. RBI governor's comment that India's inflation outlook continues to be benign despite a larger-than-expected rise in prices in the last two months helped in soothing the market sentiment. The week's two bond auctions of Rs 5,000 crore each also sailed through comfortably. Thus, the yield on the 10-year benchmark (GOI 2014, 7.37%) moved in a narrow range of 5.1-5.12 per cent and finally closed at 5.11 per cent on Friday – down 2 basis points over previous week.

Inflation, based on Wholesale Price Index, inched up to 5.75 per cent for the week ended December 27, 2003 from 5.63 per cent in the previous week. The sharp increase in inflation in the last few months is primarily on account of rise in prices of fruits, vegetables, mineral oils, fuels, and cotton textiles. The inflation, however, is expected to come down in the coming months, though marginally, as the government has slashed excise and custom duties on various manufactured goods and imports with effect from January 9, 2004.

On Tuesday, RBI auctioned a 7.38-per cent, 2015 bond worth Rs 5,000 crore. The yield on the new bond was in line with market expectations. On the following day, RBI also conducted an open market operation (OMO) of Rs 5,000-crore, 5.87-per cent, 2022 bond. The cut-off price set in the OMO was a bit lower than the market expectation, which resulted in the hardening of yields across maturities. The 10-year yield climbed to 5.12 per cent on Wednesday. This was also affected by the RBI Deputy Governor Rakesh Mohan's comment that food prices had not declined as per the expectations. But, market sentiment softened in the later trading sessions after RBI Governor said that markets had been stable and movements had been in line with the central bank's monetary policy stance.

Despite the two auction outflows aggregating Rs 10,000 crore, liquidity in the bond markets remained comfortable. In fact, on Tuesday, subscription to RBI repos touched an all-time high of Rs 47,720 crore. Over the week, the average daily subscription to RBI repos rose by 27 per cent over previous week to Rs 39,171 crore. Call rates remained below the repo rate till Thursday. On Friday, however, the call rate climbed to 5-6 per cent due to large demand from banks to meet the reporting Friday requirement.

Interestingly, RBI had lowered the cut-off price at its fortnightly 364-day treasury bills auction, which resulted yields rising to 4.39 per cent from 4.32 per cent a fortnight ago. However, the cut-off price and the subsequent yield at the weekly auction of 91-day treasury bills will remain unchanged.

The rupee ended its two-week long trend of losses against the dollar and closed at an eight-month high of Rs 45.45/$ on Friday - up 26 paise over week. Huge trade remittances and FII investments in the Indian stock markets are the reasons for the rupee's appreciation. The absence of RBI intervention also helped the rupee to gain.

Outlook

Going ahead, Indian bond markets are expected to remain stable, as there are no more auctions scheduled for the month. However, RBI may consider more OMOs due to excess liquidity in the markets. There will be an on-tap sale of Maharashtra state government bonds of Rs 3,000 crore on January 12. The inflation number will be the most keenly watched figure in the coming weeks.