However, statements by Indian army chief that the Cabinet may consider crossing the LoC if required and Pakistan's refusal to commit to "no first use" of nuclear weapons continued to cast a shadow over the possibility of a quick solution. It appears that the possibility of an escalation of the conflict cannot be ruled out. Consequently, currency and money markets remained jittery through last week.

Rupee continues to be volatile

The currency continued to be under pressure last week and touched an intra-day low of 43.42 against the dollar. On Friday, RBI Governor Bimal Jalan stated that "RBI is keeping a close watch... policy is to keep forex markets orderly and meet temporary demand supply gaps that emerge from time to time". Following the statement, the rupee recovered to endthe week at 43.32. Forward rates have also tightened and the curve inverted in the one to six month segment. At the end of the week, one-month forwards were at 5.89 per cent, three-month at 5.65 per cent and six-month at 5.56 per cent.

RBI has, over the past year, effectively scotched speculation in forex markets by requiring banks to report daily peak and end positions, as well as disallowing rebooking of cancelled forwards for imports. The current pressure on the rupee is believed to be due to increased demand from corporates covering unhedged positions. The market is likely to be fidgety this week too and track developments in Kashmir.

Call money trade between 8.5% and 9%

Tax outflows at the beginning of last week led to some tightness in money markets. Call rates tightened to nine per cent, but eased in the latter part of the week to near 8.5 per cent levels. The volatility in forex markets did not impact call rates in a significant manner, which leads us to believe that the activity in forexmarkets was not dominated by inter-bank speculation. Call rates are expected to track movements this week.

T-bill cut-offs higher

The 182-day treasury bill cut-off at 10 per cent, 24 basis points higher than the previous auction. The 91-day treasury bill cut-off yields also rose 25 basis points to 9.27 per cent with 6.5 per cent of the notified amount devolving on RBI. The 14-day treasury bill cut off remained at the previous week's level of 8.63 per cent.

Gilt yields tighten

There was a continued downward pressure on gilt prices as many market participants were reluctant to take increased exposure. The fall in the rupee towards the end of the week and RBI governor's statements further dampened market sentiment. Gilts fell across the yield curve with the highest price loss in the five- to ten-year segment.

Buying interest is unlikely to revive during this week. There is also a possibility of another government security issue. Security prices would come under further pressure if anauction is held. We believe that risk premia should be high under the current scenario of increased uncertainty. Our recommendation is to stay liquid to the extent possible and concentrate on the gilt portfolio in short tenor securities.

Corporate paper

Nervousness on the back of forex volatility resulted in bids vanishing in the commercial paper (CP) market. There were very few deals during the week in secondary CPs. The primary CP market saw a couple of 90 day issuances in the 9.9 per cent to 10 per cent range.

Bond market activity was also lacklustre during last week. Yields remained steady in this segment. Tata Chem three-year paper dealt at 12.75 per cent-about 15 basis points higher than the yield the previous week-before the paper was downgraded to double-A (AA). In the primary segment, state government-guaranteed issuances were attracting good response.