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A Good Recovery

A lower government borrowing target for the remaining half of the fiscal and some soothing comments from the government officials saw the bond yield calm down. However, inflation continued to rise, though marginally.

Indian bond investors took a sigh of relief in the week gone by. Despite rise in domestic inflation and a third successive rate hike by US Fed, Indian bond prices edged up. This was largely due to the lower government borrowing target set for the second half of the financial year 2004-05 and some soothing comments coming from the government officials. As a result, the yield on the 10-year benchmark closed 7 basis points lower over the week at 6.03 per cent.

There was some liquidity tightening in the week following the 0.25 per cent CRR hike coming into effect from September 18, 2004. The CRR hike squeezed out nearly Rs 4,000 crore from the market as banks had to keep this additional amount with the RBI as part of their CRR obligation. Hence, the call rate moved in a higher band of 4.40-4.75 per cent throughout the week. The daily average subscription to RBI's 1-day Repos also fell to Rs 8,000 crore from over Rs 20,000 crore in the previous week. The RBI had announced a 0.50 per cent hike in the CRR earlier this month to contain inflation. The second increase of 0.25 per cent will come into effect coming Saturday (October 2, 2004).

On Monday, the government came out with its borrowing calendar for the second half of the financial year 2004-05, which was much lower than the market expectations. As against the market expectation of Rs 55,000 crore, the government will borrow Rs 44,000 crore during October 2004 and March 2005. This buoyed the market sentiment. The lower borrowing target was made possible by higher receipts from the state debt swaps. Accordingly, the 10-year yield came down to 6.11 per cent on Tuesday from 6.14 per cent at the beginning of the week.

On Wednesday, however, the 10-year yield once again climbed back to 6.14 per cent as the US Fed raised the key federal-funds rate by 0.25 per cent to 1.75 per cent for the third time in a row. That apart, the firming global oil prices also dampened the market sentiment. The US Brent Crude has touched a new high of $44.92 per cent barrel this Friday – up from $41.18 per barrel the previous Friday. The rise in global oil prices pushed down the Indian rupee too to 45.94/$ on Friday – a loss of 2 paise over the week – after touching a high of 45.84/$ on Tuesday.

In the last two trading sessions, the markets got some good news. Reports that the finance ministry has temporarly postponed the issuance of bonds under the Market Stabilisation Scheme (MSS) combined with statements wherein the Prima Minister hinted at a stable interest rate scenario boosted market sentiment. On Thursday, the Prime Minister Manmohan Singh said that the hike in interest rate was not the right way to contain the supply side-fuelled inflation. And regarding the issuance of bonds under MSS, one of the top government official said that there are no such plans as of now and the borrowing will depend on the market dynamics. Both these comments helped in restoring investor sentiments and the 10-year yield fell to 6.08 per cent on Thursday.

Inflation rose, though marginally, to 7.87 per cent for the week ended Septmeber 11, 2004 from 7.81 per cent in the prevuious week. But this hardly affected market players, as the Finance Secretary D.C. Gupta said that the government was committed to keeping prices stable and will take more fiscal measures, if needed, to curb inflation. He further added that the RBI was closely watching the interest rate scenario and the Fed rate increase does not necessarily mean each country has to follow suit. Hence, the 10-year yiled closed the week at 6.03 per cent on Friday.

The lower borrowing target set by the government in the remaining half of the financial year 2004-05 and the stable interest rate scenario in the near term is good news for the market. As per the new borrowing calendar there is no auction in the coming week. The next auction is scheduled for October 4-11 for Rs 6,000 crore worth of 10-14 year bond. Hence, the liquidity is likely to come back to normal with call rates easing to below repo rate levels. However, post-October 2, when the second CRR hike of 0.25 per cent will come into effect, we may witness some tightening in liquidity.

Since the government is commited to take the necessary steps to contain inflation, the bond prices are expected to remain stable with an upward bias in the coming week. The only cause for concern is rising global oil prices. Hence, bond price movement will also be guided by the way international oil prices move in the coming week.