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Another Sleepy Week

Yields continued to harden, with the 10-year yield touching a six-month high of 5.34 per cent. Even though liquidity was comfortable, the proposal of a huge 'market stabilisation bond' did the damage.

The carnage in the bond markets continued for the sixth week in a row. The news that the central bank has proposed a huge Rs 40,000 crore for a 'market stabilsation bond' unnerved the markets. Though the proposal is yet to get government's approval, this resulted in the 10-year yield (GOI 2014 7.47%) touching a six-month high of 5.34 per cent on Tuesday.

This bond is meant to manage liquidity that has been rising due to strong dollar inflows. The plan is that the government would issue bonds to RBI, which in turn would sell them in the market whenever necessary to manage excess liquidity. The government is likely to hold discussions with RBI officials on February 23 to finalise various related issues including the bond's duration.

Later in the week yields dropped a little due to rumours that a forthcoming auction would be in the form of a floating rate bond. RBI is supposed to issue 20-year bond worth Rs 5,000 crore in the last week of February. A floater would be a welcome move since it will provide investors' with a hedge against interest rate risks as the coupon would be reset at regular intervals. The issue is expected to receive good response in the market. Consequently, the 10-year benchmark yield came down by 2 basis points to close at 5.32 per cent on Friday--up 5 basis points over the week.

The market largely ignored rising inflation as the finance minister once again reiterated its stance of attaining 4-4.5 per cent inflation by the end of March. Wholesale inflation rose to 5.91 per cent in the week ending February 7 as against 5.8 per cent in the previous week. However, a strong revival in the economic growth may keep the prices firm in coming weeks, which is unlikely to support low inflation. The Central Statistical Organisation's quick estimates showed that the economy grew by 8.9 per cent in the third quarter of FY 2003-04. This is even better than the second quarter growth of 8.4 per cent.

Liquidity remained comfortable this week too. The daily average subscription to RBI Repos stood at Rs 40,694 crore this week-- up 8.6 per cent over last week. Call rates too remained the below the repo rate of 4.5 per cent.

The rupee, however, took a breather in its relentless rise to close at Rs 45.25/$ on Friday with a loss of 2 paise over the previous week. The rupee has, in fact, gained 46 paise against the dollar in the last six weeks due to huge dollar inflows. Forex reserves touched a high of $107.51 billion in the week ended February 13 from $106.61 billion in the previous week.

Outlook
February and March have traditionally been low trading months for the debt market due to year-end profit booking by banks. High inflation and concern over the market stabilisation bonds are further adding pressure on the bond market. Even though liquidity is comfortable, the rise in bond yield is expected to stabilise once the status on these bonds becomes clear.