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Rupee to stay vulnerable to market
July, 13th 2009

Call rates were little changed amid low volumes, as surplus cash conditions helped banks to comfortably meet their reserve
requirements, preventing rates from rising sharply. Amidst the current liquidity surplus, there seemed no pressure on liquidity while the availability of funds at cheaper rates from CBLO, an alternative to the inter-bank cash market, also added support to call money rates. At the liquidity adjustment facility (LAF) window, the average amount accepted by RBI through the reverse-repo window, rose to Rs 141,764 crore, Rs 30,663 crore above the previous weeks average of Rs 111,101 crore.

Outlook: Call rates could linger in the current range, with comfortable liquidity prevailing in the banking system and lower demand from banks in the second half of the reporting fortnight, preventing any sharp moves. With banks still wary of non-performing loans and slack credit growth, cash conditions would continue in the surplus mode, enabling rates to stay glued near RBIs reverse-repo rate.

Gilts: The yield on the 10-year benchmark (6.05% 2019) bond ended at 6.97% from 6.83% in a volatile week. Aversion for long-tenor bonds increased after the Budget. The security also faced selling, as traders made space for the new 10-year bond that was auctioned on Friday. Bond yields rose sharply at the beginning of the week as the government announced a higher-than-expected market borrowing for the remainder of FY10 that stoked supply fears, and a bloating fiscal deficit estimate pushed the 10-year yield above 7%.

The short-dated securities, however, garnered buying interest, largely owing to regulatory-based factors. Also, overseas cues like lower US yields and softer global oil prices backed sentiment locally. RBIs open market operations (OMO), however, disappointed traders with the central bank buying back only 1/5th of the total amount and traders eyed the government auction for further cues.

Outlook: Weakness and uncertainty will continue to exist, especially impacting the longer end of the curve. The yield curve has steepened to record levels so that could bring in some respite in the form of a correction. Another source of support can be the overseas leads, which remain bullish for bonds, though domestic factors are negative. The next auction results on July 17 would be watched.

Corporate Bonds: Corporate bonds slumped in response to FM Pranab Mukherjees admission that federal supplies would elbow out private borrowers. The AAA benchmark 5-year yield rose to 8.08% from 7.84%.

Outlook: The market awaits firm cues to emerge even as surplus cash conditions lend support, prompting some buying interest at lower level of prices, while factors such as WPI inflation and industrial output are barely affecting trade.

Forex: The rupee fell over the week, initially weighed by negative sentiment following the Budget, and later on sharp volatility in overseas currency markets. The rupee ended the week at 49.00/$ and over 2% weaker than the previous weeks 47.90/$. The local currency fell to a low of 49.06/$ before receiving support from exporters, and possibly also state-run banks. Weakness permeated through risk aversion witnessed in the Asian emerging nation markets, adding to the selling pressure.

Softer oil prices and modest FII flows failed to provide direction to the rupee as overseas markets witnessed sharp volatility with the dollar ending firm against majors. However, the rupee showed notable resilience by recovering into sub-49.00 territory and slipping through the level twice. Forward markets eased and continued to witness receiving interest, aiding premia to broadly end lower. The six-month premium ended lower at 2.44% from 2.55% the previous week.

Outlook: The rupee remains vulnerable to risk sentiment in regional markets and dollar movement overseas. For the medium term, the fact that India can still grow at a robust pace, despite the lack of reform measures announced in the Budget, is expected to hold the rupee in good stead. However, the monsoon has emerged as the joker in the pack and could shave off the upside of Indias growth potential.

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