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The Bloodbath Continues

Indian debt markets seem to be passing though a rough patch. Fear of a hike in domestic interest rate on account of the uninterrupted rise in global oil prices has sent the bond markets in a tailspin. The 10-year yield has climbed to 6.57 per cent.

The turmoil in the bond markets continued for the second consecutive week. After a 36 basis points rise last week, the yield on the 10-year benchmark (GOI 2014, 7.37 per cent) edged up another 19 basis points this week to close at 6.57 per cent on October 8, 2004. Though inflation fell to 7.38 per cent, the sharp rise in global oil prices with Nymex crossing $53 a barrel, have raised concern over the interest rate hardening, resulting in panic like situation in the bond market. There was lack of buying interest in the market - the average daily trading volume remained low at Rs 2,327 crore as against over Rs 3,800 crore in the month prior to previous week.

The bond yields rose in each trading session. Even the Finance Minister's soothing comments failed to buoy market sentiments. On Monday, the Finance Minister had said that the inflationary pressure across regions had been driven by oil and commodity prices. Therefore, the reversal of interest rates by RBI should be, and would be undertaken cautiously. Growth and price stability cannot be viewed as two irreconcilable goals.

The main worrying factor for the market participant has been the surging international crude oil prices. This week, the Nymex crude oil price touched $53 per barrel, raising fear that the Indian companies may soon have to raise domestic fuel prices, which may further prop up the already high inflation. However, the inflation fell to 7.38 per cent for the week ended September 25, 2004, from 7.80 per cent in the previous week.

On Thursday, RBI Governor Y.V. Reddy said that the recent spurt in global oil prices was a matter of concern but the country had sufficient forex reserves to handle the situation. Therefore, we are better equipped than on earlier occasions. But bond markets remained in bear grip and by Thursday, the 10-year yield had touched 6.57 per cent.

Though the easing inflation number came on Friday, the bond yields continued to rise, though marginally. Reason: the RBI's announcement that the government would auction Rs 6,000 crore worth of fixed-rate bonds instead of the market expectation of floating rate bonds on Monday. The floating rate bonds are good option in such a scenario, as it acts as a hedge against the interest rate hike.

The liquidity was a bit tight this week and the call rate remained in the higher band of 4.40-4.60 per cent throughout the week. The daily average subscription to RBI's one-day repo too fell to below Rs 10,000 crore as against Rs 15,000 crore in the previous week.

The rupee touched a three-month closing high of 45.81/$ on Friday – a gain of 9 paise over the week. The rupee appreciated on account of good foreign investment inflows ahead of the big IPO of NTPC and some recent support coming from the Central Bank. Foreign investments have also increased in anticipation of good results of the Indian companies, which will start flowing in the coming week.

Outlook
As per the RBI's new borrowing calendar, the government will auction Rs 6,000 crore of fixed-rate bond on October 11, 2004. Since the liquidity is slightly tight in the market, it could further dampen the market sentiment. The inflation is also expected to rule firm, as there is no sign of fall in oil prices in the near term. Though both the government and the RBI is keeping a close eye on inflation and oil prices, market is expecting a rate hike in the forthcoming monetary policy to be announced on October 26. Thus, the market will get the direction post policy announcement. Till then, investors are expected to remain cautious with an upward bias on bond yields.