REER talk to pull down rupee

OUTLOOK

Liquidity is expected to ease this week on the back of cancellation of treasury bill auctions under the market stabilisation scheme (MSS), dealers said.

The Reserve Bank of India (RBI) cancelled the auction last Wednesday and also the one scheduled this week "taking into account all relevant factors". The obvious reason is the shrinking liquidity.

"Liquidity is tight now, but we expect it to improve in the next few days, especially with the cancellation of auction. This will lift market sentiment," said a primary dealer.

RBI will auction only Rs 500 crore each of 91-day and 182-day treasury bills on November 16 as part of the government's regular market borrowing programme. Cash surpluses have dropped to about Rs 1,500 crore from more than Rs 20,000 crore at the end of October.

Liquidity has dwindled after companies withdrew money to pay annual Diwali bonuses and the Rs 8,000 crore government bond auction. If liquidity does not improve this week, then there could be a problem for the next government bond auction likely early next week.

The government is set to borrow Rs 5,000 crore through a bond of 15-19 years maturity between November 16 and 24 as part of its borrowing plan for the second half of financial year.

Calls seen easing
Call rates are expected to come off and trade between 5.25 per cent and 6 per cent this week taking a cue from liquidity. Hardening of call rates, which was a result of the tight liquidity situation, is temporary, say dealers.

"The market has been witnessing huge outflows on account of festival expenses and auctions. Liquidity will pick up this week as the festive season is over and RBI is going easy on auctions," a dealer said.

The rates may continue to be higher at 6.25-6.50 per cent on the first two trading days. As a reaction to the liquidity crunch, calls in the overnight call money market soared approximately by 135 basis points.

Calls ended at 6.80-7 per cent on Friday as against Monday's close of 5.65/5.75 per cent. They usually straddle around the reverse repo rate of 5.25 per cent when there is adequate liquidity is available.

Domestic inflation rose more than expected to 4.75 per cent at the end of October. The rise in inflation can be attributed to a combination of price pressures. Finance Minister P Chidambaram has said around 5 per cent inflation is "unavoidable" and the RBI governor said inflation remained as expected. This added to market expectations that the policy would be tightened at the next review on January 24.

CORPORATE BONDS
Fresh floats unlikely

The corporate bonds market is likely to be highly inactive this week. Corporates are refraining from raising resources through bonds because of the hardening of yields. The proposed coupon payment this week should help infuse liquidity. That rates are showing the tendency to harden is key.

Both primary and secondary markets are not likely to witness active trades. A debt market expert pointed out that there is a greater possibility that yields will rise.

Recap: The spread between the 10-year corporate bond and the government paper with similar maturity was 22 basis points last week and that between a five-year corporate bond and a five-year government bond was 40 basis points.

GOVERNMENT SECURITIES
Gilts to stay ranged

The gilt market is likely to be rangebound with prices moving in a range of 15-20 paise this week in the absence of triggers in the market. The market is not reacting to any factors, be it oil price movement, US treasury yields or inflation. The 7.35 per cent 2015 government paper is likely to remain illiquid even as the yield on the actively traded nine-year government stock is expected to trade in a band of 7.07-7.15 per cent cent.

The market would be lacklustre amid a decline in volumes as investors are shying away from holding long-tenure bonds on the back of hardening of rates at the long end. Only insurance companies like Life Insurance Corporation (LIC) of India are comfortable with long-tenure papers.

Banks have been active on short-term government papers, which can be directly shifted to the held-to-maturity category with some amortisation to meet their statutory liquidity ratio (SLR) requirements.

Recap: The government securities market remained largely rangebound through the week. The 10-year government stock was highly illiquid. The yield on the actively traded 7.37 per cent 2014 government paper softened by 2 basis points to end the week at 6.98 per cent as US treasury yields fell by 10 basis points to 4.53 per cent on Friday.

The government securities prices bounced back on Friday on RBI's announcement of the launch of a second daily liquidity adjustment facility auction to address temporary liquidity issues. The fall in oil prices to $57.70 per barrel also aided bonds to post some recovery.

CURRENCY
Rupee to fall further

The rupee is likely to come under pressure on the back of a strong dollar vis-a-vis the other global currencies. The local currency will stay in the 45.77-45.88 band this week. The rupee has been taking comfort from strong foreign institutional investment infows into the local equity market.

Even the stock indices have been reporting modest recovery, which has bolstered the sentiment of the local currency. At present, the rupee is overvalued by about eight per cent based on its real effective exchange rate (REER), which implies that the rupee is likely to witness a fall from Friday's closing level, dealers said.

A dealer with a foreign bank said, "Any currency is usually overavalued by 3-3.5 per cent, which is offset by routine/ volatile movements in the market. But the rupee being overvalued by eight per cent will require some correction," he added.

Forward premiums for near terms are expected to come under pressure. There will be heavy demand for dollars from importers to cover their positions and also for routine payments.

This will put pressure on near-term premiums, dealers said. The benchmark six-month premium should rise to 0.60 per cent and the 12-month to 0.50 per cent.

Recap: The rupee began the week by touching a new 13-month low at 45.81/92. However, it rose to 45.68 by the end of the week backed by fresh dollar supplies, strong capital infows and RBI's surrogate intervention in the foreign exchange market.

In the forwards segment, the six-month premium rose by 13 basis points to end the week at 0.54 per cent. Similarly, 12-month premium closed the week 7 basis points higher at 0.46 per cent, following heavy demand for dollars by exporters.