According to the report, the greatest threat to bond markets stems from a steep slide of the rupee. "However, there is a remote possibilty that the RBI will defend the currency by hiking domestic interest rate as was done in January and August 1998," it said.

"Markets are expected to be rangebound over the next couple of weeks and government bond prices are unlikely to move by more than 15-20 paise on either side from current levels," it said. Early part of last fortnight saw a sharp rally in bond prices aided by strong foreign inflows and aggressive dollar purchase by RBI. "The conflicting news flowing in on the Kashmir situation has led to a fair degree of confusionabout the market strategy to be followed in such a situation," the report said.

According to the report, most market participants would be happy maintaining a status quo till the picture gets clearer which might take a month. "We are unlikely to see players enlarging commitments while at the same time large scale selling is also not expected," it said.

The price action since the news of air-strike in Kashmir broke out has been fairly measured compared to the similar situation in May 1998 after the nuclear blast. "While the drop has not been alarming, the recovery has been quite fast with prices nearly back to the original levels," it said.

"The ability of the fixed income markets to absorb external as well as internal shocks has been demonstrated once again with bond prices nearly back to the pre air strike levels," the report pointed out.

According to the report, much of this has come from market's confidence in the Reserve Bank of India. "The conviction of the market participants that the RBI wouldmaintain a comfortable liquidity situation and keep interest rates stable has ensured that the price auction in the government bonds after the recent `crisis' has not been exaggerated," it said.

According to the report, while the air strikes are likely to continue for a few weeks, the market response to adverse news on the Kashmir issue will get progessively lower over times.

Noting that secondary market trading activity in treasury bills has declined significantly in the past few months, the report said the average daily volumes in treasury bills for April-May 1999 have dropped to Rs 123 crore from Rs 145 crore in 1997-98 and Rs 154 crore in 1998-99 which clearly shows that interet in treasury bills is waning.