Foreign exchange inflows will be the key driver

WEEKLY MONEY & CURRENCIES

Liquidity: High comfort levels
Liquidity continues to remain comfortable although the Reserve Bank of India announced an auction of government bonds and treasury bills under the market stabilisation scheme.

According to dealers, the RBI may prefer to use liquidity from the system rather than resort to swaps. This is because it has already announced the auction of treasury bills and government bonds.

Governmental expenditure continues, but advance tax outflows are expected to come back into the system. The central government's deposits with the RBI fell from Rs 60,691 crore to Rs 16,615 crore in the week ended January 4.

Call rates: Steady times
The rates at which banks lend and borrow funds among themselves are likely to rule around 6-7 per cent due to the relaxed liquidity situation. Liquidity may not tighten despite the measures announced by RBI since there are no major outflows slated next week.

The cash-rich mutual funds might not lend money due to fears of redemption by banks and retail investors for participating in the upcoming IPOs. Therefore, the interest rates on collateralised lending and borrowing obligation (CBLO) may rule a tad higher.

Treasury bills: High yields
The RBI will auction 91 day and 364 day treasury bills for the notified amount of Rs 3500 crore and 3000 crore respectively. After a 3-week hiatus, the MSS auction resumed this week, thanks to the easy liquidity situation.

Under MSS, the RBI issues bonds and treasury bills to suck out excess liquidity from the system. Dealers are of the view that since the liquidity will be absorbed through auction of government bonds and treasury bills, the interest rates on the shorter end of the yield curve may move up slightly.

Corporate bonds: Plentiful
There may be bond issues at the longer end of the yield curve. Dealers are of the view that both, Indian Railway Finance Corporation (IRFC) and Power Finance Corporation (PFC) are scouting for quotes to raise long term bonds. Public sector banks such as Bank of Baroda and Punjab National Bank are also following suit.

The subsidiaries of State Bank of India are expected to float certificate of deposits (CDs) to raise funds for three month to one year maturity periods.

G-sec: Rally ahead
The government securities market is poised for a rally. According to dealers, the market has many positive triggers. Banks have been bullish since there are no auctions slated in this financial year. The government stretched itself in June 2007 by borrowing excessively to buy RBI's stake in State Bank of India.

The RBI may slash the quantum of its borrowing, if not cancel it completely, according to dealers. The yields on US treasury bonds have been falling, tracking the recessionary trends in the US economy.

The yield on 10-year treasury bonds has fallen 4.60-4.70 per cent to 3.81 per cent. The liquidity has improved markedly, with the RBI intervening to buy dollars and sell rupees.

Moreover, the robust tax collection could lead to a lower borrowing pogramme in fiscal 2008-09 compared with 2007-08. Therefore, banks are cautiously arranging securities for a time when there will be no major supply of papers.

In this backdrop, the benchmark ten year paper will move in the range of 7.50-7.60 per cent.

Rupee: Strength abounds
The spot rupee is expected to appreciate further on the back of forex inflows towards the upcoming initial public offers.

Dealers, however, said that the quantum of inflows might not be very large since most foreign institutional investors have not repatriated their money after booking profits in calendar year 2007.

The dollar-denominated investments continue to be in India. The RBI could check the rupee appreciation by buying dollars, said a dealer with a private sector bank.

However, the rising crude prices may push the oil companies to opt for a forward cover for dollars. In this backdrop, the rupee dollar rate is expected to rule in the range of 39.15-39.50 to a dollar.

Post script
Volumes in the government securities market reached a high of Rs 18,000 crore, on account of easy liquidity.