How will the RBI react to the benign

Inflation for the week ended 9 June was at 4.28 per cent v/s 4.80 per cent. The market estimate was at 4.43 per cent. The inflation on food prices is at its lowest in 57 weeks. Last week, inflation for the week ended 2 June, was at 4.8 per cent as against 4.85 per cent for the previous week ended 26 May.

It is clearly a base effect, which has brought year-on-year inflation down to below 4.5-per cent mark. But there is a contribution of softer prices week-on-week and that is clearly not lost on the bond market, reports CNBC-TV18.

The primary articles and food article prices have come down and that is having a sobering effect on the bond markets. There is good liquidity into the system, which too is helping as the liquidity is at Rs40,000 crore or thereabouts; keeping the bond market well bid.

Indranil Pan, chief economist, Kotak Mahindra Bank, thinks that this softening of inflation numbers is sustainable. "It is definitely not a flash in the pan; wheat production has been better, therefore the cereal's prices are coming down, there is some restriction that is therefore happened on the wheat prices. The inputs are also quite strong and they are going ahead also with the inputs.

"What I would be looking at for inflation is that it would be sustaining the downward momentum, both, on the base effect as well softening in the primary articles prices during most part of the first half of the year and till about September. Post-September, we can have some amount of uptake again in the inflation," he adds.

But the crucial factor, which is not allowing a rally in the bond markets, is what the RBI might do later. The market is more or less clear that it can be a CRR hike; it cannot be a rate hike any time soon.

Pan says, "Immediately I do not think there is anything much that the RBI can do in terms of the policy its liquidity. If you are looking at a hike, definitely not a hike, the liquidity is comfortable and inflation is down. If you are looking at a cut immediately, I do not think that also comes immediately because your manufactured article prices still above 5 per cent and 5.25 is the current range, though it has come down from around 6 per cent at the start of April.

"Globally your inflation concerns are still there, so we really do not know what is the type of implication that we will have for the Indian economy. Globally central banks are still talking about firming up rates. So I do not think we will be looking at a cut immediately just on the basis of the inflation numbers."

The expectations are that the Reserve Bank is more likely to make some announcements about bond and bill sales next week.
Bills, or treasury bills are a government borrowing below one year. Last week, the government had borrowed approximately Rs22,000 crore and much of it was through the sell of treasury bills. It is possible that it will make a similar huge announcement of treasury bill sales this week as well; and that will be done next week.

A bond sale also cannot be ruled out though it is likely that they will do a treasury bill sale and why would the government do so much of treasury bill sales and take money for itself? The suspicion is that it will want to take a little more money to pay for the State Bank of India share stake sell.

The Reserve Bank of India, which currently owns 59.7 per cent in the State Bank of India will transfer its stake to the government of India. The government of India will pay for this and for that, it needs an estimated Rs40,000 crore. It is understood from the Reserve Bank data that the government is already running a surplus of about Rs21,000 crore with the Reserve Bank; it has to borrow the balance. So it is quite possible that today evening, the Reserve Bank could announce a lot of treasury bill sales next week.

There is ample liquidity in the system; so that will mean that the government will be able to borrow that money and this probably will be the last big tranche of treasury bills sales by the government of India.

So next week, this will mean that liquidity will be squeezed out; also next week we will see the genuine impact of the advance tax outflow, people will have to start keeping their CRR requirements and that will mean that there will be pressure on liquidity. So we will probably see call rates going up to 8 per cent and that could have a con-competent impact of dollar sales.

So we will see pressure in the bond market, some liquidity moving out; therefore higher call rates and if the call rates move to 8 per cent, you probably will see more dollar selling and we could therefore see dollar weakness next week.