Mumbai: The Reserve Bank of India’s (RBI) interest rate hike earlier this week did not deter investors from buying government securities on Friday, the first auction after the monetary policy review, as they bet that a sharp fall in crude prices overnight would help slow inflation.
The central bank’s half-a-percentage point hike in its key policy rate to contain inflation on Tuesday had prompted fears that it would not be able to attract buyers for all of the Rs 12,000 crore bonds up for auction because investors may become risk averse.
Bond traders expected yields in the auction to reflect RBI’s hike, with investors avoiding bids fearing a fall in prices. Bond prices are more likely to fall when the interest rate rises as yields start to match the higher rates. Prices and yields move in opposite direction.
RBI received 35 bids totalling Rs 9,691.98 crore for the Rs 4,000 crore 7.59% bond due in 2016. It got 189 bids worth Rs 13,350.55 crore for the Rs 5,000 crore 8.13% bond due in 2022.
However, the fall in oil prices forced dealers to cover their short positions on expectations that inflation may cool more rapidly going forward.
Piyush Wadhwa, a senior vice-president at ICICI Securities Primary Dealership, said a $10 (Rs 446) fall in crude oil prices on Thursday changed the market view. “Before this fall, people might have even expected the auction to get devolved, but such a sharp fall made traders believe that inflation will cool off faster than earlier expected,” he said.
Wholesale price inflation was at 8.98% in March, higher than RBI’s twice-revised year-end projection of 8%, and the central bank said it expects inflation to remain at around 8% till September before coming down to around 6% by March 2012.
But the fall in crude oil prices has raised hopes that an inflation pullback may start earlier than September, allowing RBI to halt its interest rate hikes.
Crude oil prices have fallen all through this week. Brent crude futures for delivery in June have fallen to $109 a barrel after ending last week at $125.89 a barrel. On Thursday, it plunged $10.39, or 8.57%, to $110.80 a barrel.
A trader in Mumbai working for a Swiss bank said the fall in oil prices was the main reason for the better-than-expected demand for bonds. “Even the equity market has rallied and that enthusiasm seems to have spilled into bonds as well,” he said. “Traders covered their short positions after oil fell sharply, but the situation is very fluid. If oil rises again on Monday, we could see a sell-off in bonds.”
Oil prices fell on Thursday after reports indicated economic weakness in the US and Europe. Crude slid in New York on expectations that the US labour department may show that fewer were jobs generated in April than in March, after jobless benefit applications in the US showed a surprise increase and German factory orders unexpectedly slowed, Bloomberg reported.
In India, expectations are that interest rates are on their way up and government borrowing is likely to become more expensive.
“Markets are doing well so far because the 50 basis points (bps) hike on Tuesday was factored in. But there is still possibility that rates may go up by another 25 bps,” said P. Mukherjee, treasurer at Axis Bank Ltd. A basis point is one-hundredth of a percentage point.
Wadhwa of ICICI Securities said higher oil prices are already hurting government finances since the 2011-12 budget had estimated oil at $85-90 a barrel.
“Oil (is) already averaging $120 per barrel, and the government already borrowed about Rs 36,000 crore extra in the first month itself. Going forward, there is going to be pressure on the short-term yields, but if the government can’t keep a lid on spending, then even long-term yields may rise,” he said.
Short-term yields are likely to rise following the interest rate hike by RBI. The government plans to sell Rs 2.5 trillion of securities between? April and September, which is 60% of the total borrowing of Rs 4.17 trillion.