Price rally in gilts likely to follow profit sales

OUTLOOK/Money markets

Liquidity does not seem to be a crucial factor for the bonds market any longer. Despite abundant liquidity in the banking system, the markets rallied last week as players built up positions in view of the dip in the inflation rate to 4.91 per cent.

There will be a further addition to liquidity this week with the redemption of the 12.50 per cent 2004 government paper.

The indications are for a possible rise in prices which, dealers say, will take time but will surely happen.

While repo has become a handy instrument for the Reserve Bank of India for market management, the subscriptions signal an abundance of liquidity in the system.

Along with repo, the collateralised lending and borrowing obligation, an indigenous product of the Clearing Corporation of India Ltd (CCIL), has picked up in volumes.

Meanwhile, RBI deputy governor, Rakesh Mohan said in Dubai on Saturday that he had not ruled out the use of open market sales to mop up surplus cash from the system.

Mohan also reiterated the central bank would continue to intervene in the currency market to avoid volatility. Traders said that was likely to lead to the infusion of more rupee funds into the system, supporting support bond prices.

The tightly policed rupee has appreciated nearly one per cent against the dollar this year, and could have gained more but for the central bank's intervention.

This week there is a liquidity inflow of Rs 12,943 crore into the system while outflows will be to the tune of Rs 500 crore towards a treasury bill auction.

However in the coming months, liquidity is likely to abundant as forex inflows are set to increase on many accounts.

Corporates are set to bring in their overseas borrowing proceeds raised through the external commercial borrowing route.

Moreover, FII inflows are likely to go up manifold as they have been major investors in ongoing public disinvestment.

Call rates seen staying soft
Interbank call rates are expected to continue to rule soft this week as there is a liquidity overhang in the system. Forex inflows are expected to pick up on account of foreign institutional investor inflows.

While liquidity is getting added for sterilising the forex inflows, besides repos, there are not enough securities with RBI to absorb liquidity.

Structurally, the call rate is ceasing to be the only tool for managing day-to-day liquidity in the system as the entire market is looking forward to the repo system.

Treasury bill cut-off seen lower
There is one treasury bill auction slated for this week "" for the 91-day bill for Rs 500 crore. The cut off rates are expected to be extremely competitive, going by the market yield of the treasury bills.

Last week, rates came down marginally and, going by the current rates, the RBI is likely to announce a lower cut-off rate for the 91-day paper.

Treasury bills have emerged as one of the attractive options from the arbitrage point of view, with forward premiums ruling below one per cent for the one year period.

Dealers seem to be enthusiastic about trading in bills as they feel there is still some scope for a fall in interest rates in the short end of the maturity.