Pakistan's withdrawal fuels markets

Pakistan's announcement that the infiltrators would withdraw during the week gave impetus to the markets. Gilt prices ran up sharply last Monday, and the high's gain was in the long-end.

Rupee recovers to 43.25 against the dollar

The rupee also ran up to 43.18 against the dollar before correcting to 43.25 levels. There appears to be little speculative activity and most of the movement is due to merchant transactions. Forwards were steady through the week with six-month premia trading between 4.6 per cent and 4.7per cent. We do not expect significant movement in either the spot or the forwards this week.

T-bills continue to devolve

The 14-day treasury bill cut-off at 8.63 per cent while the cut-off yield for the 91-day bill was maintained at 9.32 per cent with 38 per cent of the notified amount devolving on the Reserve Banking of India. Fifty-six per cent of the 364-day treasury bill devolved on RBI at 10.35 per cent cut-off yield.

Gilts run up on Kargil; Retrace on auction

Following the resolution of the Kargil conflict, prices of government securities rallied sharply. The entire yield curve moved down by 8-10 basis points from the levels at the beginning of the month, and the maximum prices appreciation was in the medium to long term securities. The 11.90 per cent 200 security (which was auctioned on July 1, at 100.80 with devolvement) ran up to 101.45 levels.However, the announcement of yet another auction at the long end (12.32 per cent 2011) security put a brake on the upward trend. Tightliquidity conditions also dampened the market. Following the auction announcement, security prices fell by about 10 paise at the short end and 20 paise at the long end. Participation at the auction was also subdued with 53 per cent of the auction devolving on primary dealers at the cut-off price of 102.14 (11.97 per cent yield). On Friday, Rs 2,500 crore of the 12.30 per cent 2016 security was privately placed with RBI. Liquidity continues to be tight and the borrowing programme would continue to set a cap on price appreciation, especially at the long end. However, if RBI injects liquidity into the system, market interest could shift towards the long end, resulting in a further flattening of the yield curve.Considering this possibility and keeping in mind the positive market sentiment post-Kargil, we recommend a slight increase in the weightage for long tenor securities.

The interest rate swap market

The current swap curve is broadly pegged to the sovereign T-bill yield curve. In the absence of aliquid inter-bank term money market, T-bill rates have emerged as term benchmarks, particularly for short tenure swaps.

The forward rate market is also pegged to T-bill yields. The initial market quotes for three months forwards, the floating leg benchmarked to the 91- day T-bill auction.The forward quotes are 10-30 basis points lower than the forwards implied by the T-bill yields. Adjusting for the credit risk, the swap curve should theoretically be slightly above the treasury bill curve. Current levels is probably due to the low number of participants and this is expected to correct as activity in the swap markets increases over the next few months.

(For the week ending July 24, 1999)