It was a relatively silent week for the Indian debt markets. The yield on the 10-year benchmark government security (2014, 7.37%) moved in a narrow range of 5.89-5.95 per cent and closed at 5.94 per cent on Friday – up a basis point over the week. Inflation, however, continued to haunt the market as it rose to a new three-and-a-half year high of 8.33 per cent for the week ended August 28, 2004.
In an interesting move, on Saturday, the RBI raised banks' Cash Reserve Ratio (CRR) by 0.5 per cent to curb excess liquidity in the system. This hike will come into effect in two phases. While the first increase of 0.25 per cent (from current 4.5 per cent to 4.75 per cent) will come into effect on September 18, the second 0.25 per cent increase (to 5 per cent) will come into effect on October 2, 2004. According to RBI, the above measures are consistent with the present stance of monetary policy to meet credit growth and to support investment and export demand, given the current liquidity conditions.
Moreover, with effect from September 18, 2004, banks will be paid interest at the rate of 3.5 per cent per annum on their eligible cash balances maintained with RBI under CRR requirement as against the current practice of payment of interest at the Bank Rate (6 per cent per annum). However, RBI would continue to pursue its medium-term objective of reducing CRR to its statutory minimum of 3 per cent while retaining the option to use the CRR in both directions for liquidity management, as and when essential, in addition to other instruments.
Coming to the week's story, the market sentiment got buoyed after the government's announcement that the forthcoming auction on September 9 would include a floating rate bond and a short-term bond. Both these instruments are good investment options during uncertain times. Thus, the 10-year yield dipped to 5.89 per cent on Monday. However, in the next two trading sessions, bond prices fell (yields rose) as market players sold bonds ahead of the auction. The 10-year yield climbed to 5.95 per cent on Wednesday.
On Thursday, the RBI auctioned Rs 10,000 crore bonds spread over three instruments – Rs 4,000 crore of 9-year floating rate bond, Rs 3,000 crore of 5-year bond and Rs 3,000 crore of 18-year bond. The auctions were poorly bid with cut-offs coming at much lower prices as compared with market expectations and the floating rate bond was not fully subscribed. The recent relaxation in banks' investment norms also didn't help. However, the favourable comments from Finance Minister that interest rates were likely to be stable in the medium term, was the only solace for the bond market.
Then came the inflation number on Friday. The inflation based on the Wholesale Price Index climbed to a new three-and-a-half year high of 8.33 per cent for the week ended August 28, up from 8.17 per cent in the previous week. However, investors didn't react in panic, as this was expected as the figure included the impact of truckers' strike and the subsequent rise in food prices. The market also heaved a sigh of relief as global crude oil prices declined mid-week. The Brent crude fell to $40.36 per barrel on September 9, but it once again shot up to $42.37 per barrel on September 10.
Despite the auction outflow of Rs 10,000 crore the liquidity in the market remained comfortable. The daily average subscription to RBI's 1-day repos stood at Rs 25,589 crore and the total outstanding at the 7-day repos was also comfortably placed at over Rs 13,000 crore throughout the week. The call rates too remained in the 4.25-4.5 per cent band over the week.
In the forex market, Indian rupee hit a four-week closing high of 46.265/$ on Friday – a gain of 3 paise over the week. Reason: the declining value of the US dollar vs the euro following US Fed chief Greenspan's lukewarm economic outlook.
Outlook
The RBI's recent measure to hike CRR by 0.5 per cent is an indication that the upward revision in the domestic interest rate is not far. Though it has mainly been done to curb the excess liquidity in the market, it may be a pointer towards interest tightening. Moreover, the reduction in the interest rate for banks' CRR balances may annoy banks. Thus a tough week lies ahead for the bond market investors.
The movement in international oil prices will also be critical as it has once again moved up on Friday after declining in the initial few days of the week. The expectation of a fall in inflation is the only positive factor to watch for. Overall, the market movement will largely depend on how the market participants react to the RBI's current measure.
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