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Monday, Jul 22, 2002

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Bond market volumes dip on liquidity fears

C. Shivkumar

Trading volumes dropped to about Rs 3,200 crore last week, down from Rs 4,000 crore plus during the previous week. The volumes declined despite the hefty $784 million increase in the foreign exchange reserves to $58.79 billion.

BOND markets thinned out last week after the initial surge prompted by fiscal fears and the possibility of a tightening of liquidity in the markets.

Traders said, that the combined effects of these fears resulted in trading volumes being pushed down in the markets.

Trading volumes dropped to about Rs 3,200 crore last week, down from Rs 4,000 crore plus during the previous week. Daily trade volumes in the SGL counter followed a similar pattern. The dip in volumes was despite the hefty $784 million increase in the foreign exchange reserves to $58.79 billion, which has resulted in expanding the reserve liquidity in the markets.

But the thinning of the market also reflected in the ten-year yield to maturity (YTM), which rose slightly last week on a weighted average basis at 7.40 per cent, compared to the previous week's 7.36 per cent. Traders said that the slight rise in the yield was also prompted by some profit-taking.

The markets favourite securities also moved in tandem. The 11.40 per cent 2008 closed last week at 6.85 per cent, the 11.50 2011 at 7.39 per cent, 11.03 per cent 2012 at 7.46 per cent, the 7.40 per cent 2012 at 7.32 per cent, 9.81 per cent 2013 at 7.44 per cent and the 9.85 per cent 2015 at 7.62 per cent.

Traders said that one of the main reasons for the weakening of the Government securities were the restrictions imposed by the Reserve Bank of India. In the past, banks have often resorted to arbitraging between the securities and the call money market.

However, such borrowings by the Primary Dealers (PDs) and the banks have been considerably tightened. In fact, PDs have restricted borrowings and lending in the call money market to their net worth.

In the last Credit Policy, banks have also been faced with similar restrictions. Such restrictions were brought about in a bid to avert any asset liquidity mismatch by arbitraging.

However, one of the major side effects of the restriction is a dampening of the securities market, traders said.

But in addition, the RBI has also been siphoning out liquidity from the markets. Dealers now find it more attractive to park in the RBI's repo markets than in the securities.

As a result of these repo operations and banks choosing to maintain higher cash balances with the RBI in excess of what is being, the balances of the banks with the RBI is in excess of Rs 9 lakh crore (nine lakh crore).

Banks now prefer to build up cash balances with the RBI also due to the build up of liabilities, particularly short-term time deposits. But there has been a pick-up in credit, though not in the same pace as liabilities are building up.

Given this trend, the anticipation is that yields are unlikely to show any big reversal in the near term.

In fact, this trend was clearly reflected in last week's auction, where only the 10-year security with the five-year call and put option. But even this security was priced well above the 5-year yield at 6.72 per cent. As a 8.07 per cent long 2017 bond auction, devolved on to the RBI and the primary dealers. This devolvement on to the RBI are bound to become treated as net RBI credit to the Government. Besides private placements, which are also part of the RBI credit to the Government, but likely to be reissued to the market by the RBI. The combined holding by the RBI of such privately placed debt and devolvements are currently in excess of Rs 22,000 crore, inclusive of last week devolvement.

But reissue of some these securities are not likely in the near future in view of the uncertain market conditions. Says Mr Darshan Mehta, Director of Anagram Securities Ltd, "Yields are not likely to fall any further in the current situation because spreads are thinning out." What could also prevent any further fall in yields are fears that the Government borrowing

requirements will overshoot the budget estimates. Borrowings estimated for the current year are in the region of about Rs 1.35 lakh crore.

The failure of the monsoons has triggered fears that the borrowing requirement would escalate and push up the fiscal deficit beyond the targeted 5.3 per cent of the gross domestic product (GDP).

What can rescue the Government is the disinvestment. The disinvestment during the next few weeks of the petroleum majors are expected to provide some reprieve for the Government. "If the disinvestment goes through successfully, then we can look forward to fall in interest rates," Mr Mehta said. Traders, however, cautioned such measures would only be "one time reprieves."

Yet, the liquidity fears have not prevented corporate borrowers from tapping the markets, especially cement and steel sectors, which are beginning to benefit from the push for infrastructure and housing.

In fact, the enthusiasm for corporate borrowers in the banking system is unprecedented since most banks are keen to push up the credit deposit ratios.

If these ratios go up substantially this year, bankers expect the average asset yields also to show big increases.

In fact, bankers during the last few months have been concerned over the decline in asset yields, which is now well below 10 per cent, essentially implying spreads are also becoming thinner.

But State Governments backed entities are beginning to tougher times in the markets, with yield expectations close to 600 basis points over identical sovereign yields.

Even at these figures, the covenants are far tighter than in the past. There are few other alternatives for them.

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