States' spending spree to boost liquidity

Inflows of FCCB proceeds and fear of an auction will drive market this week; The spot rupee is likely to rule in the 44.25-40 range against the greenback; The ten-year paper is expected to trade in the 7.38-7.50 per cent band.

LIQUIDITY
May not meet credit demand

Liquidity is set to improve in the coming fortnight on account of increased spending by state governments before the end of the financial year.

The improvement, though, is likely to be far too less to match the growth in the non-food credit in the banking system. For the fortnight ended February 17, the non-food credit has grown by Rs 15,963 crore to Rs 13,58,511 crore.

Banks were even seen liquidating their investment in government securities to meet the demand. Investments fell by 1.2 per cent during the fortnight to Rs 7,15,540 crore.

Currency with the public stood at Rs 4,11,448 crore as on February 17, 2006, as against Rs 3,55,768 crore during the same period last year "� year-on-year growth of 17.7 per cent compared with 11.7 per cent in 2005.

An outflow of around Rs 1,000 crore towards the treasury bill auction is expected. Coupon redemptions and state government spending will supply liquidity to the system.

CALL RATES
To slip below 6.5%

Call rates (the rates at banks borrow and lend for daily fund requirement) are likely to further ease this week and rule below 6.50 per cent. It may settle in the range of 6.35-6.60 per cent, said players.

The market expects the RBI to continue infusing liquidity through purchase of securities under the daily liquidity management system, called repo. The central bank is also expected to buy dollars from the foreign exchange market to pump liquidity into the system.

TREASURY BILLS
Demand boost

The government will auction 91-day and 182-day t-bills for Rs 500 crore each as part of the regular government borrowing programme.

The demand for treasury bills in the secondary market is expected to improve with the increase in the investment limit of the foreign institutional investors in the debt market.

GILTS
Bearish trend to stay

The gilt market will continue to be bearish, though liquidity is expected to improve. Concern over an auction to be held before the end of the current financial year prevails.

The government is expected to raise around Rs 8,000-9,000 crore through the twin auction as part of the regular government borrowing.

In the meantime, the government is also expected to take a cue from the market to decide the interest rate for conversion of Rs 22,000 crore worth special securities issued to nationalised banks for recapitalisation. This huge supply is also likely to push the yield up due to lack of demand.

In this scenario, the 8.07 per cent 2017 paper, which is the top traded security and the proxy for the ten-year paper, is likely to rule in the range of 7.38-7.50 per cent.

CORPORATE BONDS
Hybrid floats likely

The corporate bond market is set to witness a slew of issuances from public sector undertakings and banks. Banks are expected to float Tier-II and hybrid Tier-III bonds to raise long-term money in order to meet Basel norms and also to stack up liquidity for meeting the year-end requirements.

Thus, the spread between the government securities and corporate bonds is likely to firm up. In fact, banks' rush to raise money at any given rate from their high networth clients, such as mutual funds, provident funds and insurance companies, has pushed the short-term corporate bond rates.

This has resulted in an inverted yield curve in the bond market where the short-term one-year funds are available at 8.75 per cent and 10-year funds could be mobilised at 8 per cent. Uco Bank that pioneered the issuance of hybrid upper Tier-II bond to raise long-term capital for 15 years will issue these bonds for trading this week.

Issuance of commercial papers continues to go up gradually as banks prefer lending the available funds for short term even as the liquidity position is challenging.

RUPEE
FII inflows key

Forex inflows from foreign institutional investors are likely to be a major booster for the rupee to appreciate. This will be supported by the proceeds of foreign currency convertible bonds raised by corporates in the international markets.

On the demand side, oil companies will continue to put pressure on the rupee. Moreover, in order to prevent a sharp appreciation of the local currency, the RBI is expected to continue buying dollars from the market.

The intervention will also help fund the market, which is short of liquidity, as the rupee available from dollar buying could be released into the market.

Premiums on forward dollars, on the other hand, will continue to remain on the higher side as the cost of rupee funds to book forward dollars has gone up. The reason for this is the paucity of rupee funds in the market.

However, a likely easiness in the liquidity situation in the week ahead may soften the premiums. In this scenario, the spot rupee is expected to rule in the 44.25-44.40 range against the dollar.

Recap: The spot rupee witnessed a rangebound movement during the week with a perfect match between supply from FIIs and dollar buying by the RBI.