Bonds likely to move up

B. Venkatesh

BONDS are likely to move up in the next fortnight. There are several factors leading to such a conclusion.

First, the liquidity in the system is comfortable. The Tier-I refinance at the bank rate, as on November 15, amounted to just Rs 9,160 crore. The outstandings under the Liquidity Adjustment Facility (LAF) is also low at Rs 1,480 crore.

Then, consider the results of the auction held on November 13 for the 12-year paper. For all claims that the uncertainty on interest rates had led bond investors to shift to the shorter end of the yield curve, the Reserve Bank of India (RBI) received bids for Rs 5,635.75 crore against a notified amount of Rs 4,000 crore. All these factors suggest that banks are, indeed, flush with funds. The liquidity may only improve in the coming days as proceeds from the India Millenium Deposit enters the system. This ample liquidity may drive more money into bonds pushing up their prices.

Second, with the rupee expected to remain range-bound in the near-term, banks may not need funds to buy dollars in large quantities. This, indeed, is a positive factor given that bonds dip in value when dollar demand increases.

Third, while inflation is still a cause for concern, it is unlikely to dampen sentiment in the bond market for the present. This is because oil prices have a lag-effect on inflation. True, the recent rise in crude prices may translate into higher inflation expectations. But the ample liquidity in the system may diffuse any rise in yields due to such higher inflation expectations.

The bond rally may, however, be capped by the likelihood of more frequent bond auctions and open market operations (OMOs). One reason for this is the fact that the government's Ways and Means Advances (WMA) has been to cut from Rs 11,000 crore to Rs 7,000 crore since this October. Another reason is, of course, the fact that the government needs to raise money fast lest its borrowing programme crowds out private sector from the credit market. It is small wonder then that the RBI called for bids under its sale-window for the five-year bond on November 16. Such aggressive OMOs by the RBI may check any sharp bond rally.

In all, bonds are likely to move up in the coming fortnight buoyed by the ample liquidity.