Indian shares are seen rising this week as traders build positions in the run-up to the federal budget, while bonds may extend a fall fuelled by fears rates may rise amid global tightening and higher inflation.
The new Congress-led coalition government is set to unveil its maiden budget on July 8 and traders are betting that Finance Minister P. Chidambaram will announce measures to sustain momentum in one of the world's fastest growing economies.
"We expect a pre-budget rally," said Falguni Nayar, a director with Kotak Securities. "Indications are the government may give several tax breaks, reviving investor interest."
The Bombay share index has dipped 12 percent since mid-May after the pro-reform National Democratic Alliance was voted out in the general election, raising doubts about the future of some key economic reforms like sale of state-run firms.
India is Asia's worst performing market this year with the key index having dropped about 19 percent.
"Valuations are attractive and we recommend automobile and power sector stocks," Nayar said.
Traders also expect strong demand for technology issues, with a recent fall in the rupee's value against the dollar seen benefiting the export-driven sector. The rupee has weakened 4.7 percent since the fiscal year began in April as foreign capital and trade inflows have thinned amid reform-related concerns.
Cement and auto makers will also be in focus, with leading firms expected to release June shipments data later this week.
WILTING BONDS EYE FED: Indian bonds tumbled last week after a second straight week of higher-than-expected inflation fuelled concerns local interest rates may be headed up sooner than anticipated. The 10-year benchmark posted its lowest close in more than 13 months.
India's wholesale inflation rate jumped to a four-month high of 5.89 percent in the year to June 12 on a rise in food and manufactured product prices, well above an expected 5.55 percent.
Analysts said investors would keenly watch the US Federal Reserve's meeting on June 29-30 for clues after the Indian central bank chief said last week authorities would revisit the monetary policy stance if global rates rose faster than expected.
The yield on the 10-year bond soared nearly 40 basis points last week to a 5.8631 percent close on Saturday. It last closed higher at 5.8648 percent on May 17, 2003.
The spread between the two-year bond and the 10-year bond has widened 17 basis points in the past fortnight to 70 basis points. J.P. Morgan's Mathur said it could steepen more given that fresh bond supplies are also expected in early July.