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Inflation has the Last Laugh

High inflation continues to haunt the debt market fuelling concerns over rise in domestic interest rates. The 10-year benchmark yield shot up to a 10-month high of 5.44 per cent.

The fear continued in debt markets as fresh inflation data propelled concerns about a rise in interest rates. The WPI rose exorbitantly for the third consecutive week to 5.55 per cent in the week ended June 5 from 5.03 per cent, a week earlier. The sentiment in the market had been subdued amid fears of rise in global interest rates which in turn will put intermittent pressure on the RBI to discontinue its three-year-old soft monetary policy stance, given the domestic economy's stellar growth and inflationary pressures. Hike in domestic oil prices also weighed on the sentiment.

Consequently, the yield on the 10-year benchmark bond (GOI 2014, 7.37%) closed at 5.44 per cent - up 5 basis points (bps) over the week. In the corporate bond market, the yield on the 5-year bond rose 11 bps at 6.15 per cent, as on Thursday. On the other hand, the yield on the 5-year government bond (GOI 2009, 11.99%), closed at 5.19 per cent, up 14 bps over the previous week. The spread between 5-year corporate bond and government security widened to 100 bps on Thursday from 98 bps last Friday.

Inflation based on Wholesale Price Index soared for the third successive week. It rose to 5.55 per cent in the week ended June 5, compared with 5.03 per cent a week before. This was well above the market's expectation. However, the price of Brent crude was $36.31 per barrel on Friday, up from the previous week's price of $35.74 a barrel in the previous week.

On Thursday, the RBI undertook a twin-bond auction under the regular market borrowing programme. The central bank auctioned a 24-year and an 11-year bond for a total of Rs 9,000 crore which led to the liquidity tightening in the market. This was widely reflected in the daily subscription to RBI's 7-day repo, which fell from Rs 17,735 crore on Monday to Rs 7,395 by Thursday. The total outstanding amount at the RBI window (both 7- and 14-day repo combined) also increased to Rs 61,795 crore this Friday from Rs 57,020 crore in the preceding week. However, the call rate hovered between 4.25-4.50 per cent on Friday.

In the currency market, the rupee lost a whopping 51 paise against the US dollar last week to close at Rs 45.67/$ on Friday. This depreciation was spurred by hefty dollar purchases by foreign banks coupled with the regular demand from oil companies. India's foreign exchange reserves fell to $119.35 billion on June 11 from $119.68 billion a week earlier due to a decline in the value of the foreign currency assets.

After a 17 per cent rise in the previous week, the daily average volume in the wholesale debt market fell by 4 per cent this week to Rs 3,381 crore.

Outlook
In the coming week, inflation could rise further due to a moderate hike in domestic oil prices, thus exerting greater pressure on the government to go for the rate hike. All eyes are now set on the month-end US Fed Reserve meeting. Though a rise in US interest rates looks possible, yields are very much likely to remain range-bound till then.