Bond likely to remain firm

B. Venkatesh

BONDS are likely to remain firm in the coming fortnight. Consider the factors that point towards such a conclusion.

First, the market is pricing a possible rate cut by the Reserve Bank of India (RBI). The industry has been prodding the government to call for a rate cut for quite some time now to spur economic growth. The recent 50 basis points (bps) cut by the Federal Reserve has only made the industry gain more voice. The market consensus is that the RBI may cut rates sometime soon.

Second, the market appears to be comfortable with the oil price ruling around $25-27 a barrel. With oil prices likely to remain at those levels in the near-term, the market may not be overly concerned with inflation either.

Third, the rupee is likely to remain stable against the dollar in the near term. Consider the factors that suggests as much: For one, the central bank's coffers are now bulging with forex reserves of over $40 billion. For another, the RBI recently removed the 50 per cent surcharge on import finance _ a signal that the central bank expects the rupee to remain stable against the greenback.

Four, the economic growth in the second quarter has been better than expected. And if the RBI affects a rate cut, the economy is likely to do even better as more projects will go on stream. Besides, software exports have been cantering up. In short, the economic variables are beginning to look up, a positive factor for the bond market.

Fifth, liquidity is still comfortable, despite the temporary tightness in the overnight market. Consider this. It is true that banks have racked up Tier I refinance of over Rs 10,000 crore. But the fact is that the RBI is willing to inject liquidity into the system through reverse repos. That probably explains for the central bank receiving bids worth over Rs 5,000 crore in the auction for the 16-year bond held on January 15, 2001. The liquidity position is likely to have a positive impact on bonds.

Finally, banks need to mark-to-market their bond portfolio for their year-end financial statement. There is every reason for banks to support the bond prices at the current level, lest they end up marking down their portfolio and taking a loss in their financial books. In all, bonds are likely to remain firm in the coming fortnight.