It was one of the most volatile weeks for the Indian bond market. The political drama on selection of the prime ministerial candidate and the uncertainty over the new government policies and the cabinet formation overshadowed the RBI's Annual Policy Statement. The yield on the 10-year benchmark (GOI 2014, 7.37%) moved in a broad range of 5.25-5.18 per cent before closing at 5.19 per cent on Friday – down just one basis point over the week.
Initially, the fear of political instability was so high that both equity and debt market opened the week on a disastrous note. While the Sensex tanked 11 per cent, the yield on the 10-year benchmark rose to a two-and-a-half month high of 5.25 per cent on Monday. However, the bond market recovered the following day as RBI kept all the key interest rates – bank rate, repo rate and CRR unchanged in its Annual Policy Statement.
On Tuesday, RBI governor, Dr YV Reddy presented the Annual Policy Statement for 2004-05. Apart from keeping interest rates at current levels, the RBI continued to hold the soft and flexible interest rate stance, which it has been maintaining for the past three years. Thus, the RBI's current policy stance remains status quo, to pursue an interest rate environment that is conducive to maintaining the momentum of growth and price stability. The real GDP growth for 2004-05 has been placed in the range of 6.5-7 per cent, assuming sustained growth in the industrial sector, normal monsoon and good performance of exports.
The only cause for concern is the higher inflation expectation. In FY 2004-05, RBI expects inflation to be at 5 per cent. This is higher than the current inflation of 4.2 per cent (for the week ending May 8, 2004). This is understandable following the sharp rise in global oil prices. The price of Brent crude was $38.11 per barrel on Thursday from $ 30-33 per barrel one month back. In addition, the lagged effect of the persistence of excess liquidity on aggregate demand cannot be ignored as it could have some potential inflationary impact.
This week too, the liquidity in the market remained high. Total outstanding repo amount at the RBI window (both 7- and 14-day repo combined) stood at a high Rs 69,315 crore on Friday. The call rate too remained below the repo rate of 4.5 per cent.
Interestingly, the volume in the Wholesale Debt Market is on a consistence decline. In the last five weeks the daily average turnover have fallen from Rs 7536 crore in the week ending April 16 to Rs 4336 crore in the week ending may 21, 2004.
Though the overall market sentiment remained cautious, but the heat of unstable government had a larger affect on the corporate bond market. The yield on the 5-year benchmark corporate bond rose 6 basis points this week to close at 5.84 per cent. Thus, the spread between the yield on the 5-year corporate bond and that on the government bond of similar maturity widened to 98 basis points from 87 basis points in the previous week.
In the currency market, the rupee registered its first weekly gain after five weeks to close at Rs 45.29/$ on Friday – a gain of 31 paise. Earlier, the rupee hit an eight-month low of Rs 46.01/$ in the intra-day trade on Monday on fears that FIIs would reduce positions following the slowdown in economic reforms. However, the rupee recovered following the Prime Minster designate Manmohan Singh's comment that major reforms would continue.
Outlook
All eyes are now set on the formation of the new government in terms of its economic policies and the investment plans for the future. Higher spending would translate into higher borrowing by the government. And since these investments have a longer gestation period, this may result into a higher fiscal deficit. The rising global oil price is also a challenge for the new government as the domestic oil companies are putting pressure to raise domestic oil prices. A rise in domestic oil price would push up domestic inflation, thus putting a pressure on bond yields.
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