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Past Corrected, Future Tense

Despite being granted an exemption from the transaction tax that was proposed in the Union Budget on July 8, debt markets remained edgy as inflation continued to maintain its upward trend.

Completely negating the impact of exemption granted by the Finance Minister from the transaction tax on bond transactions, the debt market remained flat amid fears of high inflation data for the week ended July 10, 2004. As a result, the yield on the 10-year benchmark bond (GOI 2014,7.37%) closed at 5.94 per cent –down just a basis point over the previous week.

Indian bond market breathed a sigh of relief after the government decided to exempt bond transactions from the 0.15 per cent transaction tax proposed earlier in the Union Budget on July 8. Although the yield on the benchmark bond touched a low of 5.84 per cent on the first day of the week on optimism that the government would review its stance on the proposed transaction tax, the fear of high inflation and the postponement of a decision on the EPF rate negated the impact of a scaleback by the government on the controversial tax proposal. Thus, the yield climbed back to 5.94 per cent on Friday.

Inflation based on Wholesale Price Index continued to climb for the third consecutive week to 6.52 per cent for the week ended July 10 -- a rise of 36 basis points over the preceding week. Though the prices of primary articles declined, the rise in inflation was primarily due to the firming up of steel and fuel prices. Also, the deficiency in rainfall is likely to have some impact on inflation in the coming weeks. Nevertheless, it would broadly be determined by the direction of international oil prices and global interest rates. The price of Brent crude also increased to $38.26 per barrel last week from $37.88 per barrel.

In the corporate bond market, the yield on the 5-year benchmark corporate bond rose 2 basis points to close at 6.58 per cent over the previous week. On the other hand, the yield on the 5-year government bond rose 5 basis points to close at 5.64 per cent over the week. However, the spread between the corporate and the federal bond further narrowed to 93 basis points this week from 95 basis points in the previous week.

The liquity in the market remained comfortable, with the average weekly subscription to RBI's 7-day repo registering an 8 per cent increase over the week. Also, the 7-day repo outstanding at the RBI window rose to Rs 55,110 crore compared to Rs 50,665, a week earlier.

In the currency market, the rupee depreciated 38 paise against the US dollar to close at a one-year low of Rs 46.32/$ on Friday due to sustained dollar demand from banks and oil companies. Also, poor rainfall and political opposition to reforms by a key government ally is keeping the foreign fund inflows at bay. However, India's foreign exchange reserves rose to $121.1 billion on July 16 from $120.78 billion a week earlier.

The daily average volume in the wholesale debt market rose 8 per cent this week at Rs 2,298 crore. Though the volumes dipped sigtnificantly on Tuesday to around 1,559 crore, it picked up momentum after the Finance Minister's announcement of granting a transaction tax exemption on debt trading.

Outlook
RBI will auction 6.35-per cent state government loans amounting Rs 8,600 crore on July 28. Considering high liquidity, this would hardly have an impact on the market. The government's next auction is scheduled for the first week of August.

The exemption granted from the transaction tax is good news for the debt market. Hence, the market volumes are expected to see a surge in the coming weeks. Still, markets are a bit wary over the firm trend in inflation figures. Though, the curently high inflation was due to the lower base effect, any further rise could put pressure on the central bank to re-think on its interest rate stance. The US Fed has alread raised the interest rate by 25 basis points last month.