Range-bound movements likely

B. Venkatesh

BONDS are likely to remain range-bound during the coming fortnight. The following factors lead to such a conclusion.

First, the term spread between the one-year and five-year bonds is less than 50 basis points. That leaves limited scope for rally in the medium-term bucket. With the yield curve steepening beyond five-years, there may be some rally left in long-term bonds. But the moot point is whether the term spreads will be arbitrage away, considering the market's lack of appetite for long-term paper. As for the short-end, the ample liquidity in the system may drive down yields just a wee bit. But in all, the scope for a bond rally appears limited.

Second, the Reserve Bank of India (RBI) may not allow excess liquidity in the system for long. The reason? The government needs to complete another 20 per cent of its borrowing programme for the current fiscal. Then, the fact remains that the government is pushing its now reduced limits under the Ways and Means (WMA) Advances. Besides, the market may need to absorb more government bond offers, considering that the fiscal deficit may overshoot the budgeted estimate. The central bank is, thus, likely to hold a series of bond auctions in the next two months and drain liquidity from the system. The likelihood of such auctions may cap any bond rally for the present.

Third, there are no positive factors to drive bond prices up except for the ample liquidity in the system on account of the proceeds from India Millennium Deposits. Consider this. The government's fiscal deficit still seems far from control. If anything, the deficit is only likely to increase for two reasons _ the inability to raise the targeted Rs 10,000 crore from disinvestments and the rising crude oil prices. If crude prices were to sustain above $32 a barrel, there may be a drain on the forex reserves, pushing the rupee further down. Then, the rising inflation is another factor to reckon with; inflation for the week-ended November 11, 2000 rose to 7.55 per cent and may rise further if firm trends persist in crude oil prices.

Of course, the RBI may bid up bond prices to reduce the government's borrowing cost. But, that apart, the above factors may weigh on the bond market, capping any rally driven by the present liquidity in the system.