Business Standard

Will The Iraq War Impact The Debt Market?

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BUSINESS STANDARD

Hostilities discounted

SANDESH KIRKIRE

Head debt funds, Kotak Mahindra MF

The sentiment in the bond market has been subdued since mid-January. The rally went bust in February owing mainly to Iraq war fears.

The finance minister pleasantly surprised Bond Street with the one percentage point cut in the small savings rate. This was followed up with a 50 basis points repo rate cut by the Reserve Bank of India.

The benchmark 10-year government paper rallied on the Budget day to 5.90 per cent from a low of 6.48 per cent during the day registering a gain of about Rs 5.

 

The market continued to drift down after the Budget tracking the geopolitical scenario.

The labour minister followed the Budget rate cuts by indicating that the rate of return on the employee provident fund (EPF) could become floating in the future depending on the returns generated on the corpus.

This is a very significant step. This was followed up with cuts in the government provident fund rate and the rates on special deposit scheme.

In spite of all these positive developments, the market continues to be in ho-hum mode and traders not building positions.

The world seems to be clearly divided on its stand on Iraq. The US has also indicated that if it is unable to pass the UN resolution, it would go alone.

A war seems inevitable. What we need to analyse is the impact of war on us. It is difficult to gauge as to what happens if the war gets prolonged. However, in all probability, it should be over very fast.

The large foreign exchange reserves built up by the Reserve Bank of India (RBI) should act as buffer for any foreign exchange volatility.

We believe that a significant discounting of the war is right now into the current prices.

After the initial knee-jerk reaction following the outbreak of hostilities, the market, in fact, can go up significantly.

Apart from the war risk, the other market fundamentals look good. The government had a credit balance of Rs 12,000 crore with the RBI on March 28. This excess liquidity, together with the advance tax outflows, could enter into the system before the end of the month.

The system would thus be flush with liquidity when the borrowing programme for the next financial year commences.

Global oil prices could plunge after the Iraq issue is resolved and the domestic inflation, therefore, could fall in the near term.

In fact, the rise in inflation to close to 5 per cent level is on account of a lower base of February 2002. Over the last six months, the wholesale price index (WPI) inflation index has moved by less than 2.50 per cent and this was a period when the domestic fuel pries were hiked three times as also there was a surge in the edible oil prices.

The overnight funding cost could hover around the repo levels of 5 per cent with the beginning of the next year.

The market is aware of it. Which is why the market participants are funding their 10-year gilts holding at above 6 per cent.

A drop of half a percentage point in the benchmark 10-year yield from this level could give a capital gain of above 3 per cent. We believe this are good entry times for income/ gilt fund investors.

There

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First Published: Mar 17 2003 | 12:00 AM IST

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