Bonds at 7-month high, yields fall to 1-year low

MONEY MARKET ROUND-UP

India's benchmark bonds advanced the most in more than seven months, pushing yields to a one-year low, on speculation the government aims to lower borrowing costs from a five-year high.

The notes due 2017 extended a rally following their best month since July after the yield on the six-month treasury bills fell to a five-month low at an auction yesterday. Finance Minister Palaniappan Chidambaram said Jan. 4 he would like a ``moderation'' in interest rates to stimulate investment and consumption in Asia's third-largest economy.

"The central bank has held rates as part of monetary management but the finance minister seems to be thinking of the economy as a whole,'' said Rajesh Babu, a trader with state-owned Andhra Bank in Mumbai. ``Bonds are rallying as the market thinks the government may take fiscal measures to reduce borrowing costs if the RBI keeps rates steady.''

The yield on the frequently traded 7.99 percent note due July 2017 fell 8 basis points to 7.57 percent at the 5:30 p.m. close in Mumbai, according to the central bank's trading system. That is the biggest decline since May 28 and the lowest yield since January 2007. The price rose 0.55, or 55 paise per 100 rupee face amount, to 102.83.

The benchmark yield may fall to 7.5 percent before the current fiscal year ends on March 31, Babu said.

Central bank Governor Yaga Venugopal Reddy increased the key repurchase rate, or the rate at which the monetary authority injects funds for a short period, twice in 2007 to 7.75 percent to curb inflation that accelerated to a two-year high last January. It also told lenders four times to set aside more cash.

The Reserve Bank of India expects economic growth to slow to 8.5 percent in the fiscal year ending March 31, following a 9.4 percent gain, the fastest since 1989.

Overnight rates
Bonds also advanced on speculation the falling cost of overnight funds spurred investors to buy debt with borrowed money. The overnight borrowing rate in the money market has averaged 5.7 percent since Jan. 1, compared with 7.4 percent in December, suggesting banks have more cash.

Surplus funds in the banking system may have increased because of rupee sales in the foreign-exchange market by the central bank aimed at preventing a stronger currency from hurting exports. The central bank's reserves rose to a record $275.6 billion at the end of December, suggesting the bank sold rupees to raise dollars.

"Banking system liquidity is very comfortable, with forex intervention continuing,'' Andhra Bank's Babu said. ``That is additional fuel for the rally in bonds.''

The central bank yesterday sold 182-day debt at 7.23 percent, the least since July.

Rupee flat
The rupee traded in a narrow band to end little changed on Thursday, with the central bank suspected of mopping up dollar inflows, dealers said.

The partially convertible rupee ended at 39.285/295 a dollar, a shade softer than the previous finish of 39.28/29.

"The fact that the rupee held steady despite the Sensex falling nearly 300 points shows that the market believes we're going to see some strong inflows," said a dealer with a foreign bank, referring to India's benchamark share index.

The rupee hit a peak of 39.16 in November, its highest in almost 10 years. Suspected central bank intervention has blocked attempts to test that level this week, and dealers said the central bank has bought around $3 billion so far this year.

Dealers paid scant attention to the decline in the local equity market that fell sharply after hitting its fifth record high in as many days in early deals, focusing instead on a slew of IPOs that should generate strong overseas interest.

Reliance Power is set to raise up to $3 billion in an initial public offer next week, which would be India's biggest-ever IPO, and currency dealers expect a net of about $1 billion to flow in from foreign funds.

Sentiment was slightly cautious after Asian markets eased despite a Wall Street rally, on worries about global growth after Goldman Sachs forecast a US recession this year, helping gold hold near record highs.