Last week began on a tight note on the back of advance tax outflows. Call rates tightened to near 9 per cent levels. However, liquidity eased towards the end of the week as banks had overcovered their requirements earlier. The total amount outstanding in repos climbed to Rs 3,764 crore. This week being the first week of the reporting fortnight and the overall liquidity for the fortnight being balanced, we expect call rates this week to stay in the 8.25-8.75 per cent band.

Rupee stays rangebound:

The rupee continues to be stable, ending the week at 42.54 a dollar. The US-UK air strikes on Iraq did not have any impact on the rupee. The US house of representatives has passed the impeachment motion against president Clinton. However, this has been discounted by the currency markets and is not likely to have any significant impact.

Global oil prices jumped up sharply on the news of the air strikes. However, the flow of oil from Iraq has continued, and pricesreverted near earlier levels. Brent dipped back to below $10 a barrel by the weekend.

Good response to 364-day treasury bills:

The 364-day treasury bills auction for a notified amount of Rs 500 crore attracted bids for Rs 1,528 crore. The cut-off at 10.53 per cent was 1 basis points lower than the previous auction. However, the response to the 14-day and 91-day treasury bill auctions was lacklustre. Thirty-nine per cent of the 14-day and 19 per cent of the 91-day treasury bills devolved on the RBI.

Short-term liquidity outlook positive:

With non-food credit offtake not picking up significantly, short-term liquidity outlook for banks appears positive. Barring dated auction announcements, post the advance tax outflow, there is no significant bulk outflow from the banking system expected over the next two months. With a lot of debate on the implications of fiscal deficit exceeding the budgeted figure, further dated auction announcements would be resorted to only under very adverseconditions. The next one and a half months should witness two significant inflows -- Rs 3,000 crore on January 18 from the redemption of zero 1999 and Rs 2,000 crore on February 7 from 13.65 per cent 1999. Both these securities are widely held and we expect banks to replace these largely with short-dated paper up to three years maturity.

For the medium-to-long end, the RBI OMO window would set the market yield curve. The RBI has been very active at the OMO counter this fiscal, and has sold over Rs 17,000 crore through this route. We expect the RBI to remain very active in its sale operations, and the target would be to suck out liquidity (negate monetisation) to the extent of Rs 3,000-5,000 crore over the next two months, if market conditions permit.

No significant change in yields expected this week:

The gross inflow this week is estimated to be about Rs 800 crore. We do not expect any significant change in the underlying liquidity or in the market sentiment this week, and expect prices totrade near current levels. With limited trading at the medium to long end, and the upside at the short end limited by call rates, we continue to recommend portfolio concentration in the two-three year bucket. Last week, we had stopped a barebell window in the four, five and six year maturities; the opportunity is still available.

Corporate paper:

With call rates tightening last week, short-term corporate yield curve tightened. Three month P1+ CPs traded in the 10.65-10.8 per cent range. One-month paper traded in the 9.90-10.10 per cent range while two-month paper traded at 10.25-10.40 per cent. With call rates already near the bank rate and unlikely to tighten further, there is negligible downside in CPs this week.

There has been no change in the primary FI yield curve. One year is at 13.5 per cent, five years at 14 per cent, while the 10 years is at 14.5 per cent.