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Waiting for the Budget

A surprise drop in inflation and strong economic growth data helped in bringing back some cheers for the debt market. The US Fed's rate hike didn't have much impact.

The markets felt relieved on an unexpectedly low inflation data for the week ended June 19, temporarily allaying fears of an immediate rise in domestic interest rates. Consequently, the yield on the 10-year benchmark bond (GOI 2014, 7.37%) ended the week at 5.81 per cent, down a basis point from the previous close. Strong economic data indicating a GDP growth of 8.2 per cent in fiscal 2003-04 as compared to a mere 4 per cent growth in the last fiscal also had a positive impact.

In another major development, the US Federal Reserve in its policy meeting on June 30 announced its first rate hike in four years by 0.25 percentage points from a 46 year low of one per cent. But the rate hike decision didn't have much impact on the markets as the news was in line with market expectations. The US Fed also reiterated its stance of a measured approach towards interest rate hike in the future as well.

In the corporate bond market, the yield on the 5-year benchmark bond fell 15 basis points (bps) to close at 6.40 per cent over the previous week. On the other hand, the yield on the 5-year government bond (GOI 2009, 11.99%) fell 2 bps to close at 5.41 per cent over the week. The spread between the corporate bond and the federal bond of the same maturity narrowed down 4 bps over the week to 96 bps last Friday.

Inflation based on Wholesale Price Index for the week ended June 19, dropped marginally to 5.87 per cent from 5.89 per cent a week ago, despite a hike in domestic oil prices announced by the new government last month. This was well below the market's expectation of 6.10 per cent. It has risen sharply in the past few weeks on account of rise in vegetable oil prices coupled with a hike in LPG, petrol and diesel prices. The price of Brent crude also fell to $34.33 per barrel on Thursday from $35.05 per barrel, a week before.

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 issue for a total of Rs 8,000 crore which sailed through quite comfortably following ample liquidity in the market. In fact, the 7-day repo outstanding at the RBI window rose to Rs 64,270 crore last Friday from Rs 56,815 crore the previous week. The call rate hovered in a range of 4.00-4.25 per cent over the week.

In the currency market, the rupee depreciated 5 paise against the US dollar to close at Rs 45.88 on Friday. The sentiment had been fairly subdued on account of dollar demand from oil companies, weaker foreign capital inflows and fears of the Union Budget. India's foreign exchange reserves dipped to $119.41 billion in the week ended June 25 from $119.93 billion in the previous week.

Markets are displaying caution before the Budget, which is amply reflected in the low market activity. The daily average volume in the wholesale debt market fell by a whopping 26.4 per cent this week to Rs 2594.62 crore.

Outlook
All eyes are now set on the Annual Budget to be tabled before the Parliament on July 8, which will clearly spell out the government's spending programme, and how it plans to fund the spending. Moreover, the market will also be looking forward to the new government's stance on the small savings rate. And not to forget, the inflation number. Till then yields are likely to move in a narrow range.