After six consecutive weeks of fall, Indian bonds made marginal gains this week. The yield on the 10-year benchmark (GOI 2014, 7.37%) closed at 5.26 per cent on Friday – down 6 basis points over previous week. Initially, bond yields calmed down, helped by the rumour that Thursday's scheduled auction would be of floating rate bonds. But once RBI confirmed that the auction would be of fixed rate bonds instead of a floating rate bond, the market turned weaker.
Moreover, the government's proposal of the Rs 60,000-crore Market Stabilisation Fund (MSF) against market expectations of Rs 40,000 crore, affected the sentiment. MSF will be used to offset excess liquidity in the market, which has been on a continuous rise due to robust dollar inflows. But as these bonds will be sold over the year and not at one go, market participants heaved a sigh of relief. Consequently, the yield on the 10-year benchmark dipped to 5.23 per cent by Wednesday.
However, this easiness was short-lived and the yield on the 10-year benchmark shot up to 5.26 per cent in the next two trading sessions. Reasons: a higher cut-off yield set at the Thursday auction and the lower-than-expected fall in inflation. RBI auctioned a 15-year bond at 5.8096 per cent, slightly above the market expectation. Inflation fell to 5.84 per cent in the week ending February 14 against 5.91 per cent in the previous week. This is much higher than RBI's estimate of 4-4.5 per cent inflation by March 2004. Though RBI deputy governor Rakesh Mohan has once again reiterated of achieving this target, there is increasing expectation that it will not be met amid strong growth in the Indian economy. Thus, the bad news for the debt market is likely to continue for some time.
Despite rise in bond prices, trading volumes remained low over the week. On Tuesday, trading volumes dipped to Rs 2,100 crore against the daily average of nearly Rs 3,000 crore. This was mainly because employees of state-run banks took part in a nationwide strike on Tuesday. Banks are one of the dominant players in the Indian government securities market.
Liquidity in the system remained high. The daily average subscription to RBI repos stood at Rs 40,573 crore, the same level as in previous week. Call rates too stood below the repo rate of 4.5 per cent in all trading sessions.
After taking a breather last week, the rupee gained 2 paise against the dollar this week and closed at Rs 45.24/$ on Friday. India's forex reserves rose to $107.68 billion in the week ended February 20 from $107.51 billion in the previous week.
Outlook
Though liquidity is comfortable, a stubbornly high inflation in recent times is haunting the Indian bond market. Moreover, with no more auctions scheduled in the near term, there is a probability that RBI may start using the Market Stabilisation Fund to manage liquidity. Thus, Indian bond yields are likely to remain range bound in the coming week.
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