FII inflows cause for concern

Dollar movement and uncertainty over reverse repo rate hike will be key market drivers; The spot rupee is likely to rule in the 44.80-90 range; The 10-year gilt is expected to trade in a range of 7.15-20.

MONEY MARKETS
FII funds hold key

Liquidity in the banking system continues to be comfortable. The market is, however, jittery about receding inflows of foreign institutional investors (FIIs) as most booked profits in the equity market last week.

Inflation is expected to remain moderate following relatively stable oil prices. There is, however, worry on account of the base effect, used to pull down inflation impact, which is gradually ceasing. According to dealers, liquidity will remain rangebound till FII money starts flowing in again.

The week will witness an inflow of around Rs 4,600 crore and an outflow of Rs 3,500 crore.

Overnight rates to stay soft
Call rates are likely to remain easy at 5-5.05 per cent. In addition to calls, collateral lending and borrowing obligation has become very popular with corporates too availing of the facility.

Thus far, non-banking players such as mutual funds, insurers and brokers used to participate in the CBLO market. Banks, however, will remain a bit cautious on lending heavily in wake of the upcoming credit policy.

Cut-offs may rise
Auctions of 91-day treasury bill for Rs 2,000 crore and 182-day t- bill for Rs 1,500 crore is scheduled this week, both for government borrowing and market stabilisation scheme.

There will be brisk trading in treasury bills in the secondary market as the market is cautious about taking positions in long-term bonds. Cut-off yields on t-bill auctions may remain high as the market has discounted a reverse repo rate hike.

FIIs, which earlier dumped t-bills from their portfolio, may re-enter the market to cash in on the yield differential following a hike in t-bill rates.

Recap: Inflation for the week ended October 1 rose to 4.24 per cent from 3.97 per cent the week before. This was due to a rise in prices of essential food and non-food items, fuel and manufactured products.

The cut-off yield for the 91-day t- bill rose to 5.48 per cent from 5.39 per cent. Even as call rates figured at 5 per cent, the reverse repo bids came down to around Rs 9,000 crore as banks became cautious and kept holding on to liquidity.

GOVERNMENT SECURITIES
Contrarian view on reverse repo hike

The gilts market will remain jittery awaiting the mid-term policy review. The market is divided on the issue of reverse repo rate hike in the policy review.

While supporters of reverse repo rate hike view rising oil prices, upward trend in interest rates globally and rising trade deficit as potential issues triggering a hike, others do not seem to be quite convinced.

Moreover, there is one more dilemma this time. The spread between repo and reverse repo is at the optimum level of 100 basis points. One basis point is one hundredth of a percentage point.

If the reverse repo rate is hiked, then the repo rate will also have to be increased so as to maintain the spread. This, in turn, will impact the bank rate which is the rate at which RBI lends money to the banks as repo also performs the same function.

With such uncertainty, the 10-year benchmark is expected to rule in the range of 7.15-20 per cent.

Recap: The gilts market ruled ranged with lacklustre trading during the entire week. The sentiment towards the end of the week, however, became bullish with the government cancelling the auction scheduled to be held between October 18 and 25.

The lack of liquidity outflow from the market, however, led to rates crashing to 1 per cent in the CBLO market even as reverse repo bids came down to around Rs 9,000 crore.

CORPORATE BONDS
Fresh issues await policy cue

The corporate bond market is tracking government securities. With issuers sitting on the fence watching the unfolding interest rate scenario, fresh issues have become few.

Once the credit policy is announced and the market gets a clear signal on interest rates, there will, however, be a slew of issues. Most corporates are firming up their capital expenditure plans and banks are preparing for coping up with capital requirement under the Basel-II regime.

Both the secondary and primary markets appear brisk for commercial papers. According to dealers, short-term instruments gain popularity at times of uncertainty.

Oil companies have been frequent users of commercial papers so that it helps them skirt the exposure norms with banks. Being short-term in nature, CPs can be rolled over. In addition to CPs, Mibor-linked non-convertible debentures also are in vogue.

Recap: The spread between the 5-year AAA corporate bonds and government security remained at 45 basis points. There were hardly any fresh issues in the market.

CURRENCY
Dollar moves to steer Rupee

Data from the US has been moderate, which is likely to check euro's appreciation against the dollar. Oil prices too have been ruling moderate. But with the equity market on a slide, FII inflows remain uncertain. With expectations of a reverse repo rate hike, foreign investors would wait for a while before they start profit-booking at the year end.

With the rupee gradually rebounding back from 44.97 levels, importers would rush for cover, exporters will equally panic to book their receivables so as not to miss the bus.

The downside to the rupee will be dollar's movement globally. If the dollar moves up further and there is no support coming from the central bank, the rupee may depreciate further breaching even the 45 level. Therefore, the rupee is expected to rule in the 44.70-90 band to a dollar.

With a bullish outlook on the rupee, forward premiums should ease further. Despite a depreciating rupee, forwards have been easing owing to the cancellation of currency options, struck by banks with their corporate clients when the rupee was around 43.15/20 to a dollar after the revaluation of the Chinese yuan.

Moreover, banks, taking the contrarian view of a rupee appreciation, have also been selling dollars. However, if the rupee further depreciates, panic among importers may lead to firming up of dollar-rupee forwards.

Recap: The spot rupee touched a low of 44.97 to a dollar during the week as FII inflows subsided and dollar demand on the other hand peaked.

Both oil companies and corporates were busy covering their imports as the market never expected the rupee to breach 44.50.