Liquidity to ease on forex inflows

Auction results and dollar movement globally are key to the market

Yield on the ten-year benchmark paper is expected to rule in a wide range of 7.65-7.75 per cent

The spot rupee is likely to rule between 43.95 and 44.15 against the dollar

Liquidity Govt spend to aid

The liquidity situation is expected to ease this week following government expenditure and foreign exchange inflows. The market expects the government to spend for salary payments. In fact, the government has been engaged in expenditure over the past few weeks.

Meanwhile, the equity markets have been on a roll post-upgrade of India's sovereign rating to investment grade by international rating agency Standard and Poor's after a gap of 15 years. This is likely to ensure the continuity of foreign exchange inflows, which started last week, into the domestic market.

The spot rupee has appreciated from 44.31/32 to a high of 44.06/07 in the past week. However, in a bid to stem the strengthening, the RBI has been continuously intervening to suck out dollars from and infuse the equivalent amount of rupees into the market. This is in addition to the RBI's move to infuse rupees in the system through repo.

However, counter-demand for liquidity may arise when banks start setting aside funds for reporting Friday, next week. Funds will also be required for participating in auctions of government papers.

The week, therefore, will witness inflows of around Rs 3,000 crore through coupon redemption and government security maturity against outflows of Rs 9,000 crore towards government auctions.

Call Rates seen declining

Rates in the interbank call money market is likely to mellow from the highs of 8-8.5 per cent. While the market expects the government to spend primarily to meet salary payments, foreign exchange inflows may add to the liquidity indirectly. Following the buoyancy of the Indian equity market, portfolio investment is likely to continue with accelerated vigour. The bullishness in the domestic markets has been augmented by the recent S&P's upgrade of India to investment grade.

The RBI, on the other hand, is likely to intervene in the market by buying dollars and releasing equivalent rupees to stem rupee appreciation. This, in turn, will enhance the rupee liquidity with the banks.

The central bank's intervention in the domestic money market continues to remain a source of liquidity. The RBI has been infusing liquidity through purchase of government securities, which is otherwise referred to as repo.

Treasury bills Moderate cut-off likely

The RBI will issue 91-day and 182-day t-bills for auction to raise an aggregate Rs 3,500 crore.

According to dealers, the cut-off yield on the papers may moderate as opposed to weeks. This is because the outlook on interest rates in the short term has been modest after the monetary policy announcement, since the RBI did not hike the reverse repo rate. Reverse repo is regarded as the short-term interest rate signalling tool for the RBI.

The secondary market trading is also likely to pick up this week. This is because most of the banks want to trim their SLR portfolio but prefer to stock up enough papers for entering into the repo transactions. Since the liquidity has been tight, it is desirable for the banks to enter into repo with the RBI whereby the central bank infuses liquidity in return for government securities or treasury bills, as reiterated by the RBI in its policy review . Stocking up t-bills is advantageous for banks since they do not have to mark-to-market the valuation for the t-bills like they do for gilts, dealers said.

Recap

At the last week's auction, the RBI accepted a total of Rs 1,700 crore in the treasury bill auctions as against a notified amount of Rs 4,000 crore. While the cut-off yield in the 91-day t-bill was raised from 7.40 per cent to 7.56 per cent, the yield on 364-day t-bill moved up from 7.27 per cent to 7.75 per cent.

Government securities Rally to stay

The government securities market is likely to remain bullish. This is because there is no uncertainty over the RBI's rate stance since the policy review is over. In order to guard the spiralling credit growth and inflation, the RBI has only hiked the repo rate and has left the reverse repo which is perceived to be the main indicator for interest rates unchanged. This has triggered a rally in the market. The market participants feel the rally will continue this week too, albeit in the second half. The government securities auction will be held on February 9 as per the schedule. This has dampened the market sentiment to a certain extent. However, market players feel that once the auction is over, the market will be ready for a kill since most of the uncertainties till the next monetary policy review are over. The market also has to start building up the gilts portfolio for the year-end valuation purpose.

Another trigger has been the RBI's decision not to bring down the statutory liquidity requirement (SLR) which otherwise could have brought down the banks' gilt requirement. Inflation, according to market players, has been as per the market expectation. They are of the view that if the base effect is knocked off, the inflation may cease to be a problem.

Globally, the dollar has been gaining and so is the yield on the US treasury bonds. This could also affect the market sentiment but not this time. Players maintained that the domestic factors this week outweigh overseas factors.

In this backdrop, the yield on the ten-year paper is expected to rule in a wide range of 7.65-7.75 per cent.

Repo and reverse repo are the daily liquidity adjustment tools of the RBI for infusing and absorbing liquidity, respectively.

Recap

The trading in the government securities was brisk after the RBI in its monetary policy review did not tinker with the reverse repo rate. The yield on the ten-year benchmark security came down from a high of 7.90 per cent to 7.69 per cent on Friday. The annual wholesale price index-based rate of inflation rose to a near two-year high of 6.11 per cent for the week ended January 20.

Corporate bonds Wait may continue

This week may not see much activity from primary issuers as most of the companies and banks will wait for some sort of stability in the interest rate scenario.

Some of the issuers who may queue up for quotes, nevertheless, include the State Bank of India and Power Grid Corporation. According to market information, while SBI is likely to raise around Rs 2,000 crore, PowerGrid is yet to finalise the borrowing plan, said sources. Infrastructure Development and Finance Corporation (IDFC) is in the process of raising Rs 500 crore through a bilateral deal with the Life Insurance Corporation.

The secondary market, however, will remain lacklustre since there is hardly any interbank trades. Most of the demand for the bonds is accruing out of the need-based buying of provident funds and insurance companies. While banks are shying away due to concern on market valuation of the investment portfolio, mutual funds are getting huge subscription to fixed maturity plans which offer higher returns of 9/9.5 per cent. MFs, in turn, are preferring to invest in the non-banking finance companies to earn higher returns.

In the medium term, however, the corporate debt market may witness demand from the public and private sector companies for raising funds. This is because rising forward premiums have made the cost of swapping foreign funds into Indian rupee expensive which incidentally was the advantage for borrowing overseas funds.

Recap

The corporate debt market witnessed bilateral deals between provident funds and banks. There were not many issuers in the market except a few oil companies to sell their oil bonds to raise money. The banks or traders, like primary dealers, are shy of investing in bonds since they have to mark to market the investments.

Rupee May get a boost

The spot rupee is likely to rule with a bias towards appreciation. After long 16 years, global rating agency Standard and Poor's has raised India's sovereign credit rating to investment grade. This is likely to spur an inflow of foreign exchange from portfolio investors since the upgrade has added to the bullish sentiment in the domestic markets.

Besides, companies may be seen selling dollar receivables out of their depository receipts and overseas borrowings fearing sharp appreciation of the spot rupee. The equity market also has been on a roll.

Globally, the dollar is likely to remain well balanced between forces of appreciation and depreciation. According to dealers, the US consumer confidence data, otherwise referred to as University of Michigan's final index of sentiment, rose to 97 per cent from 91.7 per cent in December. Reportedly, the confidence among the US consumers rose to the highest in two years last month as gasoline prices eased and job market expanded.

On the other hand, ISM manufacturing data from the US has come weaker than expected. While markets had forecast index at 51.9 per cent, the actual data came around 49.3 per cent, the lowest in almost four years. Therefore, while one set of data could propel an acceleration in the value of dollar against major currencies, another set may prove to be a laggard.

Tight liquidity, over the weeks, has kept the forward premiums higher following rising cost of rupee funds. However, with the RBI opting to keep the reverse repo rate unchanged, the forward premiums may ease a bit. This is in line with the general bullishness in the gilts market where the dealers feel that the RBI does not want to tinker with the interest rates.

Cost of the rupee funds affect premiums since booking forward dollars require the banks to pay premium in the form of rupees which has become expensive following tightness in the liquidity in the money market.

In this backdrop, the spot rupee is expected to rule in a wide range of 43.95-44.15 against the dollar.

Recap

The spot rupee appreciated fast last week, following foreign exchange inflows. While inflows were robust, the market was active only for few days due to large number of holidays.

Therefore, the spot rupee spiked during the end of the week occasionally. Besides foreign exchange inflows into the equity market, corporates were also seen selling dollars fearing high appreciation of the rupee. The RBI also bought dollars as part of its intervention to stem the rupee appreciation. However, liquidity concerns and apprehension over the outcome of the monetary policy review played an active role in the forwards market. The annualised premiums for forward dollars continued to remain high, both on account of high cost of rupees and demand from oil companies.

Post Script

The RBI left the reverse repo rate unchanged contrary to the market expectation, while the S&P upgraded India to investment grade.