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Bond Prices Improve Further

With strong liquidity, lower oil prices and falling inflation rate, bond prices recovered last week with the benchmark yield dropping 12 basis points

It was another good week for bond investors. Comfortable liquidity in the market, falling international crude oil prices and lower inflation are the reasons for the improvement in the sentiment. The yield on the 10-year benchmark (GOI 2015, 7.38%) fell by 12 basis points to close at 6.64 per cent. Just the previous week, the yield had fallen by 45 basis points.

The market opened on Monday with an upbeat note and the benchmark yield fell 3 basis points for the sixth consecutive day to 6.73 per cent. The rupee closed at nearly its eight-month high of Rs 43.65. On Tuesday, the trend was reversed as the bond market turned cautious as investors would get ready for a Rs 4,000 crore state loan issues. The yield on benchmark inched 2 basis points higher. The central bank sold treasury bills and state government loans, each amounting to Rs 4,000 crore on Wednesday. This auction went off smooth due to ample liquidity in the system. On Wednesday and Thursday, the sentiment improved with falling international crude prices and expectations of lower inflation. The benchmark yield fell to 6.71 per cent by Thursday. On Friday, a lower than expected inflation number led the yield to fall as low as 6.64 per cent.

For the week ending November 27, 2004, inflation rate fell to 7.3 per cent from 7.34 per cent in the previous week. This buoyed market sentiment as the market was expecting inflation to go up to 7.6 per cent. Finance Minister P. Chidambaram said the worst was over and inflation would decline further once global oil prices eased. Indian government also announced that its GDP grew by 10.1 per cent in the year till October 2004. This announcement brought some profit-taking.

International crude oil prices have started falling with the Brent price falling to $37.38 a barrel. Even during the previous week, petroleum prices had fallen. Liquidity was pretty comfortable with call rates hovering between 4.5-4.75 per cent through the week. Though the dollar closed on a weak note on Monday at Rs 43.65/$, it ended the week at a two-week low at Rs 44.76/$. The dollar has appreciated against the euro and the yen.

The spread between the 5-year corporate bond and 5-year government security increased from 21 basis points to 60 basis points, indicating a change in preference towards government bonds.

Outlook
The central bank will auction treasury bills amounting to Rs 2,000 crore on December 15, of which Rs 1,500 crore will be under the market stabilisation scheme. With no scheduled government securities auction for the year, liquidity will remain strong. Inflation will start falling due to the falling international crude oil prices. Interest rates suddenly seem to be coming under control, at least in the immediate term.