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Inflation Falls Further

Though inflation fell, the yield on the 10-year benchmark bond went up by 12 basis points to 6.7 per cent last week. The government said that it would curb the excess liquidity to control inflation.

The two week trend of falling interest rates reversed with the yield on the 10-year benchmark bond (GOI 2015, 7.38%) increasing by 12 basis points. Inflation fell to 7.02 per cent for the week ending December 4 from 7.3 per cent the previous week. Under pressure from the Left parties, the government is expected to hike interest rates on employee provident funds by 100 basis points to 9.5 per cent. Though the market was expecting oil companies to reduce petrol and diesel prices, there was no such move. International crude oil prices rose by 14 per cent last week.

On Monday, the yield on the benchmark went higher as liquidity tightened from 4.6-4.8 per cent in previous week to 4.75-5 per cent. Finance Minister P Chidambaram tabled the Mid-year Review of the economy and said he was optimistic and positive about the economy in 2004-05. Industrial growth increased to 8.4 per cent in the period April-October 2004 from 6.2 per cent in the same period last year.

On Tuesday, the market readied itself for an imminent rate hike by the US Fed that day. Liquidity tightened further. The markets weakened further and the benchmark yield fell to 6.72 per cent. The US Fed raised federal funds rate by 25 basis points to 2.25 per cent. On Wednesday, the markets closed at 6.75 per cent with expectations that the oil refining companies would reduce prices with falling global oil prices. On Thursday, the yield fell to 6.72 per cent as the central government announced that it would increase employee provident funds' rate to 9.5 per cent. Oil companies said they may not reduce petrol and diesel prices, which would bring down inflation. By Friday, liquidity in the market came under further pressure as the Finance Minister announced that it was necessary to curb inflation. Call rates increased to 5.75-6 per cent from 4.75-5 per cent on Thursday. There was a marginal recovery though in the 10-year benchmark to 6.7 per cent as inflation eased further. The rupee strengthened vs the dollar by 82 paise to Rs 43.94 to the dollar.

Outlook
The government is all set to curb the excess liquidity in the system due to foreign exchange inflows. FIIs have invested over $8 billion so far in Indian stock markets this year. The Finance Minister as well as the Reserve Bank of India Governor want to reduce the liquidity. Due to this, inflation should fall but the rising oil could put an upward pressure on interest rates.