Inflation is seen a key determinant of market movement; 10-year benchmark gilt yield likely to be in 7.60-7.70 per cent range; rupee is seen under pressure, likely to fall below 46 per dollar mark.
Liquidity: Cost of funds a worry
Liquidity per se is no longer likely to bother the banking system, but the cost at which it becomes available could become a major concern.
Inflation escalated during the week ended May 13 to 4.32 per cent from 3.96 per cent a week earlier on rise in prices of food articles and dealers expect it to lend a hardening bias to yields on government bonds.
During the fortnight ended May 12, current and savings account balances with banks fell by Rs 42,887 crore (Rs 428.87 billion). Accretion to term deposits in 2006-07 thus far has been less than in the previous year despite interest rates rising by as much as 200-250 basis points in the last few months.
Dealers said these factors point to a further increase in costs of resources, as banks would have to tap alternative and more expensive sources of funds on top of having to pay higher interest on term deposits.
A major source of accretion to liquidity in the last one month or so was spending by the Centre. The government has exhausted all its cash balances with the Reserve Bank of India and for the first time in 20 months availed of ways and means advances during the week ended May 19 to bridge the gap in receipts and expenditure. The government spent over Rs 60,000 crore (Rs 600 billion) of cash in just over a month.
Gilts: Yields to head north
Yields on government bonds are expected to rise further with supply pressure continuing to be a drag on the market.
If high inflationary expectations get rooted, then there's a likelihood of banks cutting their statutory liquidity ratio holdings to close to the minimum required to stop further depreciation losses.
The yield on the 10-year benchmark bond has risen beyond 7.50 per cent, the level when the RBI announced the 2006-07 annual policy.
The bearishness in the market has not only erased the 20 basis points rally triggered by RBI decision to leave rates steady, but has pushed yields much beyond the level just prior to the announcement of the 2006-07 annual policy.
The 10-year yield was 7.62 per cent on Friday last week, up from 7.50 per cent prior to the policy announcement. Dealers said the 10-year benchmark yield would be in the 7.60-7.70 per cent range this week.
The market has already factored in around 5 per cent hike in fuel prices. If the government goes ahead with a much more aggressive fuel price hike, bearishness would tighten its grip on the government securities market.
The RBI will auction treasury bills worth Rs 3,500 crore (Rs 35 billion) this week, including Rs 1,500 crore (Rs 15 billion) under the market stabilisation scheme. The banking system would witness net inflow of Rs 638.97 crore (Rs 6.38 billion) this week on account of Rs 4,138.97 crore (Rs 41.38 billion) of coupon payments on various securities.
Call Money: In 5.4-5.6% range
The overnight call money rates are expected to remain in the 5.4-5.6 per cent range, the level seen over the past couple of weeks as there is ample liquidity in the system.
The average absorption of liquidity through reverse repo window was Rs 63,768 crore (Rs 637.68 billion) last week, higher than Rs 55,000 crore (Rs 550 billion) a week earlier.
ICICI Securities said the re-introduction of MSS after appearing to rule it out during the annual policy is seen as a signal from RBI that it doesn't want short-term rates to settle too close to the overnight rate.
The combination of oil prices around $70 a barrel, the imminent domestic fuel price hike and uncertainty over peak US Federal funds target rate have sowed seeds of doubt about an inter-policy rate hike by the RBI.
The suspicion is that comments by RBI officials are aimed at keeping the doubt alive. The recent across-the-board rate hikes by public sector banks also pointed at their medium term expectation of higher rates.
Rupee: To be under pressure
Dealers expect rupee to be under pressure as oil prices remained above $70 a barrel and on the likelihood of foreign institutional investors continuing to sell their investments in the equity market and converting the proceeds into dollars for transferring their investments to other markets.
FIIs have been reducing their investment positions in India and other emerging markets. FIIs sold over $2.5 billion worth of shares in 12 sessions till Friday. Dealers expect the rupee to fall below the 46 per dollar mark this week.
The rupee would be under pressure because of demand for oil imports and the weak undertone in the equity markets leading to more FII outflows.
The country's trade deficit is also widening. The trade deficit in April 2006 was $4.21 billion, higher than $2.90 billion in March 2006. The deficit was $3.85 billion in April 2005. The trade deficit is likely to widen further because of high oil prices.
India imports about two-thirds of its oil requirements. The depreciation of the rupee vis-a-vis the dollar, despite the US currency's gains in foreign exchange markets overseas, is a positive.
The overvaluation of the rupee in terms of the six-country real effective exchange rate has dropped to 2.8 per cent from around 8 per cent at the start of April 2006.
Recap: The rupee closed on Friday at 45.89 a dollar, down 33 paise since the beginning of the week.
The forward premiums hardened slightly on Friday and the six-month forward premium was at 1.12 per cent. Dollar appreciated against major currencies and was trading at 1.27 against the euro, 1.87 against the pound and 112.45 against the yen.
Corporate Bond: Issuances unlikely
The corporate bond market is expected to remain dull as it is devoid of any primary issuances from corporates and trading in the secondary market hardly exists as banks, the major investors in this market, continue to stay away.
Banks are refraining from investing in corporate bonds for fear of having to book depreciation losses, after making substantial provisions in the fourth quarter of 2005-06.
Banks are encouraging corporates to go for term loans rather than opting for bond issues as it does not involve any investment depreciation and interest rates on loans are the same as bond yields now. In normal times, bond yields are higher than interest rates on loans.
Recap: The corporate bond spreads on one-year triple A-rated bond was 79.73 basis points, on three-year triple A-rated bond 104.42 basis points and on five-year triple A bond 92.23 basis points.
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