Rupee holds steady: The rupee remained stable, ending the week at 42.52/5. The finance minister has once again mentioned thatbudget estimates of the fiscal deficit are under pressure, primarily owing to the expected shortfall in indirect tax collections totalling Rs 10,000-12,000 crore. The PSU share buyback scheme is another measure to plug the yawning disinvestment gap. Thus, while macro-indicators continue to exert pressure on the rupee, low oil prices and depressed industrial demand are expected to provide immediate support.

Treasury bill cut-offs reflect tightness: The 14-day cut-off increased from 8.63 per cent to 9.16 per cent, as call rates averaged above 9.3 per cent during the week. An amount of Rs 42 crore devolved. The 91-day auction cut-off was 13 basis points higher at 9.61 per cent, with Rs 52 crore devolving on primary dealers and the RBI (even after the notified amount was reduced from Rs 400 crore to Rs 100 crore).

Liquidity conditions are expected to improve: The market has experienced close to two weeks of tight call rates, beginning from mid-December which coincided with advance tax outflows(expected to be about Rs 5,000 crore). Low inflows from coupons and redemptions in the following two weeks impacted short-term liquidity in the banking sector. However over this period, security prices have not reacted in any significant manner, at the most suffering a loss of 3-4 paise for two- and three-year maturities. This would indicate that the market expects the tightness to be temporary.

We expect inflows to be about Rs 2,400 crore during the next reporting fortnight (January 2-15), assuming an approximate credit of Rs 1,000 crore on account of interest on CRR balances. Subsequently on January 18, Rs 3,000 crore accrues from the redemption of zero 1999. In sum, beyond this week, we expect the liquidity situation to be relatively balanced while the large redemption should generate market interest in short-term paper with maturities up to three years.

If we believe that over the next 15-20 days there are no further dated auction announcements, the short-term liquidity outlook turns positive.We donot expect any significant pressure on yields this week, though a tight call money market would impinge on market volumes. We continue to recommend a short-end bias, with relative concentration in the two and three year maturity buckets. At the medium to long end, the RBI OMO window would determine the yield curve.

Corporate paper: With tighter call rates, the short-term corporate yield curve flattened. Three month P1+ CPs traded in the 10.75-11 per cent range. One-month paper traded in the 10-10.25 per cent range while the two-month paper traded at 10.40-10.60 per cent.

In this market too, the short-term tightness is being regarded as temporary. Only if call rates persist above 9.5 per cent, there would be a hike in yields. Otherwise, there is negligible downslide in CPs this week.

With primary FI borrowing rates unchanged, there was no significant change in market yields. Further, as most market participants expected the tightness to be temporary, there were no desperate sellers. One-year rateswere at 12.5-12.75 per cent, two years at 13.25 per cent, three years at 13.5 per cent and five years at 14 per cent.

(For the week ended January 2)