Bonds fall on cash worries, Re blocked near 9-yr high

Mumbai, May 23 | Updated: May 24 2007, 05:30am hrs
Government bond prices fell for the second day on Wednesday, amid rising worries that the Reserve Bank of India (RBI) may sell bonds next week and drain out cash from the banking system.

The yield on the 10-year bond ended at 8.13%, up from Tuesday's close of 8.11 percent. The market is slightly worried the RBI may sell a bigger chunk of market stabilization scheme (MSS) bonds as the cash situation has improved a lot, said Vikas Anand Naik, senior manager of fixed income at Dena Bank. Traders estimate the central bank may announce a sale of Rs 7000-8000 crore worth of MSS bonds next week. Weekly Treasury bill auction came in line with market expectations, triggering traders to take profits. RBI sold 91-day treasury bills for Rs 2000 crore at a cutoff price of Rs 98.13, unchanged from the last auction. If the cutoffs were a bit more bullish, then there would have been a minor rally, said a local trader.

Overnight rates were quoted around 7.50-7.70%, a tad lower than 7.50-7.75% on Tuesday, indicating easier cash. The RBI through its liquidity adjustment facility injected Rs 5775 crore into the financial system through repo window on Wednesday.

The rupee came within striking distance of a recent nine-year high on Wednesday, buoyed by capital inflows, but its path was blocked by suspected RBI intervention, traders said. The rupee ended at 40.550/565 per dollar, a shade higher than Tuesdays close of 40.560/570, and just off Mondays peak of 40.50 -- its highest since May 1998. The RBI was selling rupees around 40.53, but the question is for how long they can sustain this blocking, said a dealer with a private bank. The flows are too strong, and there is a cost attached to intervention. The market is expecting $4 billion to $5 billion of foreign money to flow into Indian capital market and equities by the end of June, which should add to the rupee's strength.

Accepting that currency appreciation was used as a tool to contain inflation, RBI could come back into the market to prevent sharp appreciation in the Indian unit once inflation cools, Kotak said on Wednesday, forecasting the rupee will weaken to around 41.10 by the middle of July. In the forward market, the six month forward premium ended higher at 4.41% from its previous close at 4.13% while the twelve month premium also inched up to 3.80% from 3.66% earlier.