Comment

The market will now look ahead into the growth and inflation data and start factoring in rate cuts by the Reserve Bank of India before the policy meet in January.

The trend for inflation and growth is down and there is clamour from all quarters for rate cuts in order to spur growth.

The index of industrial production (IIP) numbers for September 2008 came in better than expected at 4.5% against expectations of 4.1%. The IIP number last year was 7%. There are expectations amongst economists that IIP numbers could go negative in the next few months.

Inflation as measured by the wholesale price index (WPI) came in at 8.98% for the week ended November 1, 2008, against market expectations of 10.45%. The fall in oil prices below $60/barrel has also eased inflation concerns.

The sharp fall in inflation has underlined the fall in price pressures on the back of weakening economic growth. The RBI will now look to cut rates more aggressively given that inflation is a non-event.

The market is worried on the extent of government borrowing. The government is slated to borrow Rs 9,000 crore for the rest of this fiscal. Expectations are that the government will borrow anywhere between Rs 15,000 crore and Rs 25,000 crore more.

However, the market will focus on rate cuts and worry about the excess government borrowing once the borrowing comes through. This focus on rate cuts will take yields down.

The government has increased its overdraft facility with the RBI through the ways and means advances (WMA) from Rs 8,000 crore to Rs 20,000 crore. The government has gone into deficit with the RBI for Rs 5,260 crore and this may see an increase given the government needs funds for its off-budgetexpenses.

Liquidity was tight last week despite the 50 basis points (bps) cut in cash reserve ratio (CRR) releasing Rs 20,000 crore into the system. The bids for repo at 7.5% touched Rs 12,000 crore. Overnight rates moved up to repo levels of 7.5% from 6% levels seen in the previous week. Liquidity may ease given banks being well covered in their products going into the reporting week. Overnight rates are likely to hover around repo levels.

Government bonds
Government bonds saw yields move down week-onweek. The benchmark ten-year bond yield closed lower by 24 bps, with the 8.24% 2018 bond closing the week at 7.45% levels. The 7.95% 2032 bond yield moved down by 26 bps week on week to close at 8.10% levels.

The government bought back market stabilisation (MSS) bonds for Rs 10,000 crore last week. The bonds bought back were the 6.65% 2009 bond for Rs 5,000 crore and the 5.87% 2010 bond for Rs 5,000 crore. The government bought the bonds back at yields of 6.78% and 6.88% respectively.

The government held bond auctions for Rs 10,000 crore last week. The bonds auctioned were the 7.56% 2014 bonds for Rs 6,000 crore and the 7.95% 2032 bond for Rs 4,000 crore. The cut-offs came in at 7.38% and 8.22%, respectively. The bonds rallied after the cut-off and yields are likely to drop further given rate-cut expectations.
Treasury bills, corporate bonds and overnight index swaps

Treasury bill (T-bill) yields were lower in the auction last week, with the cut-off on the 91-day T-bill auction held on the November 12 coming in at 7.35% against a cut-off of 7.39% in the previous week. The 182-day T-bill auction saw the cut-off at 7.21% against a cut-off of 7.38% in the previous auction. The RBI is this week auctioning Rs 5,000 crore of 91-day T-bills and Rs 2,000 crore of 364-day T-bill under regular auction.

Corporate bonds saw yields move down as government bond yields fell.
Ten-year benchmark bond yields came off by 10 bps to 11.20% levels. Yields at the short end of the curve held steady, with one-year certificate of deposits trading at 10.50% to 11% levels. The market will gauge incremental supply and liquidity outlook before taking a call on direction on yields from current levels.

OIS saw the curve fall on the back of lower inflation numbers. The five-year OIS yield closed down 25 bps at 6.30% levels and one-year OIS yield closed down 30 bps at 5.80% levels. The one-over-five spread steepened by 5 bps to close at 55 bps levels.
OIS yields are likely tostay bullish given rate cutexpectations.

Disclaimer: The author is senior fund manager - fixed income, IDFC Mutual Fund. Views are personal.