Inflation takes bond yields to near 8% before falling to LIC gilt buys

MUMBAI: Yields on the 10-year government bonds threatened to touch the 8% level after government data showed that inflation as measured by the WPI rose 8.6% in January, higher than expectations. Bond yields, however, retreated after huge purchases, particularly from Life Insurance Corporation, which is understood to have bought over Rs 1,500 crore worth government securities.

The yield on the 6.35% bond maturing on January 2020 rose 2 basis points to 7.88%, after touching a 16-month high of 7.97% during the day. Bond yields improved following fresh buying as yields neared 8%. However, concern persists over possible RBI action on interest rates. If bonds yields continue to remain high until the end of the year, banks will end up having to make substantial provisions for depreciation in the value of their bond portfolio.

On Monday, yields soared ahead of publication of inflation data as there were early indications that the price rise would be higher than expected. Inflation numbers came close on the heels of industrial production data last weekend which showed that the index of industrial production surged 16.8% year on year as on December 2009. This has raised expectations of monetary action by RBI to cool the economy.

“The economy is now showing clear signs of a demand revival, as reflected in both macro and micro-level data with the latest data on, industrial production (16.8%), non-oil imports at (17.5%), bank credit (15%) and buoyant numbers in autos and cement dispatches. Moreover, with WPI inflation already breaching RBI’s March 10 estimates and CPI running in the 15-17% range, we are maintaining our view of a minimum 125bps rise in policy rates,” said Rohini Malkhani and Anushka Shah of Citi in a report.

While there was bearishness in bond markets, weak dollar demand led to the rupee firming up against the dollar in the foreign exchange market. The rupee closed at 46.32/33 against the dollar compared with its previous close of 46.50.51 on Thursday.

Most Asian markets are shut on Monday and Tuesday for Lunar New Year holidays while New York is closed on Monday for the President’s Day holiday. “We have had net inflows for the day, I guess. With New York holiday, there was not any dollar demand as such,” said RK Gurumurthy, head of treasury at ING Vysya Bank.

Dealers said there was exporter selling in late trade that also helped the rupee while a choppy sharemarket failed to provide any clear direction. Dealers are expected to watch the dollar’s moves versus other major currencies for direction on Tuesday in the absence of trading in most other regional markets. Concerns over Greece and Dubai pressured the euro on Monday, with data showing currency speculators had added further bets that the single European currency will fall against the dollar.

One-month offshore non-deliverable forward contracts were quoted at 46.30/40, little changed from the onshore spot rate. In the currency futures market, the most-traded near-month dollar-rupee contracts on the National Stock Exchange and MCX-SX closed at 46.3550 and 46.3525, respectively, with the total traded volume on the two exchanges at a low $3.8 billion.