As expected, it was a terrible week for the Indian debt markets. The yield on the 10-year benchmark government bond (GOI 2014, 7.37%) rose by 41 basis points over the week to close at 6.62 per cent on Friday. Besides the rise in global crude oil prices and domestic inflation, the US Federal Reserve too raised its key funds rate by 25 basis points on August 10 bringing down bond prices in India. The week also witnessed some mismatch in market liquidity post-auction on Monday, thus further affecting the sentiment. All this led to a sharp drop in the volumes in the debt market. The average trading volume dipped to under Rs 2,000 crore during the week – down 16 per cent as compared to a week before.
On Monday, RBI auctioned Rs 8,000 crore worth 11-year floating rate bonds and 30-year fixed rate bonds as part of the government's borrowing programme. This led to some tightening of liquidity in the system. This was amply reflected in the sharp decline in the total outstanding amount at the 7-day repos – a fall to Rs 30,000 crore during the week against Rs 50,000-plus in the previous week. The call rate too crossed the repo rate of 4.5 per cent on Wednesday and Thursday. To make up for this short-term mismatch in the market liquidity, RBI conducted a reverse repo auction of Rs 5,000 crore on August 12 (Thursday).
Moreover, to overcome this liquidity problem, RBI announced that it will once again start holding one-day repos starting August 16, 2004 in addition to the existing 7-day and 14-day repos. The re-introduction of this overnight repo is expected to give more leeway and flexibility to banks and market participants as it will enable them to assess their liquidity position on a day-to-day basis and invest accordingly. Earlier, in April, RBI had stopped the one-day repos as a measure to contain liquidity and was replaced by longer-term 7-day and 14-day repos. During that period, the liquidity was more than comfortable.
However, the central bank has not touched the repo rate -- it remains unchanged at 4.5 per cent. This is the rate at which RBI holds repo auctions. By maintaining this rate, RBI has also eased concerns that it would raise interest rates in the near term following the two successive rate hikes in US, sharp rise in global oil prices and domestic inflation. On August 10, the US Federal Reserve has raised its key funds rate by 25 basis points to 1.5 per cent.
The rise in global crude oil prices seems to be unstoppable. On Friday, Brent Crude price touched $42.33 per barrel from $41.16 per barrel in the previous week. This sharp spurt in international oil prices is continuously raising fear of a high global inflation in times to come. The impact of this is already getting reflected in the Indian economy with domestic inflation touching 7.61 per cent for the week ended July 31, 2004 from 6.52 per cent in the previous week.
Despite a rise in international oil prices, the rupee gained 5 paise against the US dollar to close at 46.31/$ on Friday. RBI is not likely to let the rupee weaken any further largely to counterbalance the impact of rising oil prices on India's import bill. Oil accounts for 30 per cent of the India's total imports.
Outlook
The re-introduction of one-day repos from August 16, 2004 is likely to improve liquidity and may trigger more participation in the debt markets, especially from banks. An indication of improved market sentiment was already witnessed on Friday, the day RBI came out with the announcement, and bond prices recovered marginally. In addition, with no more auctions scheduled for the month of August, the liquidity is expected to be comfortable. But the rising international oil prices and domestic inflation still remains a cause of concern for the bond market. Hence, all eyes will be set on the coming week's inflation number.
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