This is the first time that the spreads have begun to narrow after the US imposed sanctions on India and Moody's downgraded India to speculative grade.

The spreads on Indian paper had risen by 50-60 basis points after the nuclear tests and had increased by 500 basis points. While yields on Indian paper decreased, the spreads on Thai and Chinese paper have increased by 25-30 basis points during the fortnight. This is primarily because of the turmoil in Japan where yen had lost considerable ground to the dollar and China was all set to follow suit.

In its latest debt market update, I-Sec has said that there will be a continuous upward pressure on inflation.

"The main upward pressure on inflation would be on account of the introduction of the four per cent special additionalduty as well as rupee depreciation (which would also affect domestic diesel prices as these are priced on import parity) and reduction of modvatable portion to 95 per cent.

An economic upturn could aggravate the situation," the I-Sec commentary said.

The commentary further said that the low inflation during the last year was primarily due to the economic slowdown and the consequent lack of demand growth coupled with overcapacity in a number of commodity and manufacturing goods. "This scenario has seen much change, and the present burst of inflation has been mainly due to a spurt in the prices of primary articles including food items," the debt report said.

However, primary articles inflation would be ruled by the crop output this year, and is likely to come down if the monsoon is as good as predicted by the Indian meteorological department.

"The fuel group had a significant price rise last September when administered prices were raised and the pricing of a number of items was linked to the landedcost of imports. With global oil prices softening, the fuel group WPI has shown a declining trend over the last quarter, and could further weaken in September as the base gets inflated," the commentary said.

The I-Sec report further pointed out that liquidity should ease further during the fortnight on account of inflows to the tune of Rs 6,189 crore and proceeds of Resurgent India Bonds which are slated to hit the global market on August 5.