Bond yields harden on higher inflation rate

Government bonds rose today due to apprehensions of a liquidity crunch caused by the higher-than-expected inflation. Dealers said the 10.16 per cent rise in inflation for May, 2010 (over May, 2009), based on the monthly Wholesale Price Index, was above the market expectation of a 9.60 per cent rise. The annual growth in WPI rate for April 2010 was 9.59 per cent.

Concerns over the exit of Rs 25,000-30,000 crore out of the system as corporates pay the first instalment of advance tax were already weighing on market sentiments. The latest development further added to pressure on yields.

According to data available with the Negotiated Dealing System (NDS), yields closed two-eight basis points higher than Friday’s closing level. The yield on the benchmark 10-year paper (7.80 per cent government bond maturing in 2020) today closed at 7.69 per cent — up from 7.61 per cent seen on Friday. The rise was across-the-board.

Sonal Varma, India economist at Nomura Financial Advisory and Securities, said the rise in inflation cannot be explained by a weak base effect as the month-on-month print was higher in May than in April.

The liquidity condition remained tight and money market rates were at levels seen on Friday. The Reserve Bank of India infused Rs 41,220 crore on a net basis in the system through the Liquidity Adjustment Facility (LAF). On Friday, RBI had pumped in a net Rs 45,450 crore.

Srinivasa Raghavan, head of treasury, IDBI Gilts, said LAF borrowings had come off peak levels of Rs 65,000-67,000 crore early last week. This week, cash management bills worth Rs 15,000 crore would mature. Keeping in mind advance tax payments, the gap is estimated at Rs 10,000 crore.

“We expect yields to soften as the market will factor in the finance minister's statement on interest rates. The 10-year benchmark should rule around 7.60 per cent,” he said. Union Finance Minister Pranab Mukherjee said today in Patna he was not in favour of altering interest rates at present.

Last week, the yield on bonds had closed higher in the wake of a considerably higher-than-expected Index of Industrial Production for April 2010. Meanwhile, the Union government has decided to go ahead with the planned borrowing programme for this week.