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A Worrisome Week

Despite a smart gain in the rupee and OPEC's decision to raise output to curb burgeoning oil prices, Indian debt markets remained weak. Inflation crossed 5 per cent after 11 weeks.

There was a general decline in sentiment in Indian debt markets on concerns that the new left-backed government would go back or at least slow down several economic reforms. The market was also reeling under worries that high global oil prices may force local state-run oil companies to raise fuel prices. Though the new government reiterated its stance on not hiking fuel prices in the current fortnight, inflation rose to 5 per cent this week. Thus, the yield on the 10-year benchmark (GOI 2014, 7.37%) closed at 5.27 per cent - up 4 basis points over the previous week.

The fall in the corporate bond market was in line with that of the G-sec market. The yield on both 5-year corporate bond and the corresponding government security rose by nearly 5 basis points. Thus, the spread between the 5-year corporate bond and government security slightly narrowed to 97 basis points against the preceding week's 99 basis points spread.

Inflation rose to 5.02 per cent for the week ended May 22 -- up 0.35 per cent over the previous week. The inflation figure has crossed the 5 per cent mark after a span of 11 weeks. Inflationary fears are being fanned by high crude prices, which are hovering close to their 21-year highs amid fears that terrorist attacks could disrupt supplies from Saudi Arabia. However, the OPEC's decision to hike output by 2.5 million barrels a day in July and August, led to Brent crude prices falling from $38.6 per barrel on Wednesday to $37.16 per barrel on Friday.

On Wednesday, RBI auctioned Rs.1,500 crore 91-Day Treasury Bills under the market stabilisation scheme. On Thursday, The RBI also auctioned a new 12-year bond and re-issued a 24-year bond for a total of Rs 10,000 crore which led to some liquidity tightening in the market. Subscription to RBI's 7-day repo fell from Rs 21,250 crore on Monday to Rs 8,450 by Friday. This tightening of liquidity led to an increase in call rates, which touched 5.5-6 per cent on Friday. However, the total outstanding amount at the RBI window (both 7-day and 14-day repo combined) remained high at Rs 67,445 crore on Friday.

In the currency market, the rupee appreciated smartly by 35 paise against the US dollar this week to close at 45.12/$ on Friday amid lack of dollar demand from corporates and importers. Renewed portfolio investment inflows and export proceeds also gave the underlying support that helped the rupee gain. India's foreign exchange reserves surged to $119.82 billion in the week ended May 28 from $118.57 billion, a week earlier.

The constant decline in trading volumes for the past few weeks continued with the daily average volume in the wholesale debt market falling by another 3 per cent this week to Rs 3,001 crore.

Outlook:
The unexpectedly strong US jobs growth data confirmed a strengthening economy could soon push US interest rates higher. This could affect the market sentiment in the coming weeks. Thus, the rate outlook and inflation would be of greater concern. As oil is India's largest import item, state-run oil product companies are seen left with little recourse than to hike fuel prices shortly if global crude prices remain firm despite OPEC's decision to raise its output ceiling.