Bonds plunge on rate hike fears

MARKET ROUND-UP

Bonds fell this week on speculation the central bank is planning an interest-rate increase after it raised yields at a Treasury Bill sale.

Yields on 10-year debt rose to near the highest in almost five months after government three-month Bills yesterday sold at the highest yield since June 2001. Bonds also fell after the government today sold debt at higher-than-expected yields.

Inflation rate held above the central bank's forecast for a third straight week, a report showed today.

"There's now so much talk about controlling inflation, and with that kind of talk, it is only reasonable to expect the central bank will raise the reverse-repurchase rate,'' said Pradeep Madhav, chief operating officer at Securities Trading Corporation of India, a Mumbai-based primary dealer. The reverse-repurchase rate is the Reserve Bank of India's borrowing rate.

The yield on the benchmark 8.07 per cent note due January 2017 rose 8 basis points, or 0.08 per cen, to 7.88 per cent this week as of the 5:30 pm close in Mumbai, according to the central bank's trading system. The price, which moves inversely to the yield, fell 0.5, or 50 paise per Rs 100 face value, to 101.32.

Indian markets are closed tomorrow for Republic Day.

The government yesterday sold 91-day Bills at a yield of 7.4 per cent, compared with 7.14 per cent at the previous auction on January 17. The government also sold six-month bills at a yield of 7.75 per cent, from 7.14 per cent at the previous sale.

The RBI, which increased its overnight lending rate four times in 2006 to slow price rises, is scheduled to review its policy on January 31. Ten out of 16 economists in a Bloomberg News survey expect the central bank to raise the rate by a quarter per cent to 7.5 per cent.

The key wholesale price index was 5.95 per cent in the week ended January 13, the ministry of commerce and industry said in a weekly report in New Delhi.

Bonds may pare losses on speculation banks will buy debt to meet reserve requirements as their deposits rise. Under the nation's banking law, lenders are required to invest at least 25 per cent of their deposits in the government debt or other low-risk securities approved by the central bank.

"Banks have no choice but to maintain the 25 per cent bond reserve level, even if the market doesn't look good,'' said S K Sharma, chief bond trader at the New Delhi-based PNB Gilts, a primary dealer that underwrites government debt sales.

Indian banks' deposits expanded 23 per cent in the 12 months through January 5, beating a 17 per cent increase in the previous year, central bank data showed.

Bonds also dropped as yields rose at a gilt auction today. The government sold Rs 5,000 crore of 14-year debt today at 8.2 per cent yield, as part of its borrowing plan for the fiscal year ending March 31.

"Higher yields at the auction would indicate expectations of a rate increase by the central bank,'' said Vineet Malik, head of interest-rate trading at HSBC Holdings in Mumbai.

The cost of the country's interest rate swaps, derivative contracts used to guard against the risk of an increase in rupee-based rates, increased this week on speculation the central bank will raise its 7.25 per cent benchmark rate next week.

The five-year swap rate declined 3 basis points to 7.69 per cent this week.