Gilts mart braves fiscal's jolts

The despondency with which the bond market lumbered into the financial year in April is proving to be unwarranted as yields are set to complete a full circle by June-end, the first quarter.

A sigh of relief is evident with the 10-year gilt yield climbing down to 6.80 per cent, having scaled 7.36 per cent after beginning the year at 6.70 per cent.

Investors were bracing for yet another year of losses as most negatives - rising interest rates, simmering crude prices, large government borrowing, surging bank credit, and firm inflation - had converged.

The relief now is that the market has endured most of these jolts and the near-term outlook seems bright with inflation firmly under the toe.

The June 4 inflation was at a 21-month low of 4.22 per cent and expectations are that it will stay within the Reserve Bank of India's 5.0-5.5 per cent projection by the year-end.

A big comfort came from RBI governor Y V Reddy earlier this month, when he said there were no "unexpected circumstances" to review policy interest rates.

Market consensus is that Reddy will leave interest rates unchanged at the quarterly review of the year's monetary measures on July 24. Worries that surging crude oil prices could fuel inflationary pressures are easing following the modest hikes in the domestic petrol and diesel prices announced by the government this week.

A litre of petrol was made dearer by Rs 2.50 and diesel by Rs 2 from Monday, which Petroleum and Natural Gas Minister Mani Shankar Aiyar said, was only a "one-time increase."

Since June, crude prices resumed their rise and, earlier this week, were a handshake away from $60 per barrel. They are now near $58 a barrel.

However, though confidence of growth across the globe has been shaken, there were contrary responses.

While the US central bank is set to hike rates for the eighth successive time at its meeting next week, there are expectations that the European Central Bank and the Bank of England would cut interest rates. This, in any case, gives space to the central bank to take a more conceited view and, possibly, defer an upward revision in rates.

The US Federal Reserve's monetary stance comforted the bond market sentiment here, even as the US central bank continued to hike rates.

On May 4, the US Fed hiked its funds rate for the eighth successive time by 25 basis points to 3 per cent.

Nevertheless, the comfort did not get converted into a fall in yields here because dealers pointed out that US and Indian rates weren't directly related.

"There is a correlation between the rates here and in the US but not a direct, one-to-one relation," said S P Prabhu, head of fixed income research at IDBI Capital Market Services. He pointed out at the time US yields were falling, the market rates were rising.

Big state-owned banks are likely to return to the secondary market with the tone gradually turning bullish if the trend in the last few days is taken as an indicator.

According to some market analysts, state-owned banks have increased their exposure in bonds this quarter ending June, in comparison to last few quarters, particularly in the primary market.

With half of the lean season remaining - which means lesser farm credit - and an improving debt market, the participation by these banks may only get increased.

Also, bond market players are seemingly learning to take in their stride the high market borrowing of the government this year and they aren't complaining anymore.

However, to ensure that they don't burn their fingers again like they did a couple of years ago, bonds dealers are expected to be cautiously positive.