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C. Shivkumar

BOND markets plunged on the back of institutional sales, from both domestic and foreign, as most of them booked profits.

Traders said the selling was triggered by the RBI's moves to go ahead with 28-day repurchase operations in the markets in a bid to suck out the liquidity. Traders said that these long-term repos were happening for the first time in the domestic financial markets.

As such these operations conveyed the signal that there were unlikely to be any major reductions in the interest rates as anticipated by them in the Credit Policy to be announced next week. This conviction was reinforced in the high cut-off yields fixed at the 91-day Treasury bill auctions. Yields at the T-bill auction last week jumped to 4.78 per cent, up from the previous week's 4.42 per cent.

Traders said that during the week there was a large-scale sale by insurance companies, mutual funds and foreign institutional investors. This selling wave was triggered by the RBI's intentions, traders said, to convey to the markets that it was not prepared to accept any further softening in yields or strengthening of the exchange rates. This is especially at a time when dollar yields were also rising. As a result of these moves, the ten-year yield to maturity (YTM) on a weighted average basis hardened to 5.13 per cent last week, up from the previous weekend's 4.97 per cent.

The markets' favourite securities ended similarly and the undertone of the market was weak. The 11.40 per cent 2008 hardened to 4.83 per cent, the 11.50 per cent 2011 to 5.14 per cent, the 11.03 per cent 2012 to 5.18 per cent, the 7.40 per cent 2012 to 5.12 per cent, the 9.81 per cent 2013 to 5.14 per cent, the 7.27 per cent 2013 at 5.13, the 6.72 per cent 2014 at 5.18 per cent, the 9.85 per cent 2015 at 5.30 per cent, the 10.71 per cent 2016 at 5.55 per cent, the 8.07 per cent 2017 at 5.49 per cent, the 7.46 per cent 5.49 per cent, the 6.25 per cent 2018 at 5.55 per cent, the 6.05 per cent 2019 at 5.59 per cent, the 6.35 per cent 2020 at 5.67 per cent, the 8.35 per cent 2022 at 5.85 per cent and the 10.18 per cent 2026 at 5.98 per cent.

The previous week, these securities had ended at 4.61 per cent, 4.94 per cent, 4.98 per cent, 4.93 per cent, 4.99 per cent, 4.96 per cent, 5 per cent, 5.12 per cent, 5.26 per cent, 5.40 per cent, 5.26 per cent, 5.30 per cent, 5.34 per cent, 5.38 per cent, 5.58 per cent and 5.73 per cent respectively.

Traders said that the bulk of selling was driven by technical reasons alone and there were no anxiety on the economy.

This trend was evident from the slope of the yield curve which remained upward sloping at the long end. Normally if there are recessionary expectations, yields at the short end harden and soften at the long ends, leading to inversions. There was no such evidence.

Selling was also partly influenced by the equity markets, they added. Some hedge funds had decided to strike when both the exchange rate and equity prices were at the peak. The concomitant demand for foreign currency impacted the debt markets, leading to a hardening of yields, they added. Besides, life insurance companies also sold large volumes of securities.

Selling was also driven by the fact that the real yields are negative for up to 20 years. With the last week's hardening, yields from beyond seven years have already become positive by about 15 basis points per year. Consequently, traders now believe that yields are likely to stabilise at the current levels till such time the peak season Credit Policy is announced. Traders said that all expectations of any cut in interest rates were now off. They also expect that the reduction in the Cash Reserve Ratio also to be deferred for some time until all the liquidity in the markets is soaked up.

Traders also said that the RBI's moves were also aimed at partially reducing problems relating to open market operations. The OMOs had become difficult, since RBI is low on stock of the government special securities. Traders believe that the focus is on stability rather than softening further. This signal to the markets have been conveyed effectively and forward premiums have begun rising. Six months forward are already close to about 0.75 per cent.

However, this is not expected to impact inflows into the market. In fact, for the week ended October 17, the reserves had already overshot $91 billion on the back of $962 million flow. This week, however, the figures are expected to show slight drop in view of the prepayments that have been made by the some large public sector undertakings and moves by the oil companies to lock into the current exchange rates and forward premiums for oil imports.

Traders said that if the rise in yields had not taken place, dollar yields would have become higher than domestic yields, leading to the rupee going into a premium against dollar, instead of the reverse. Such a situation was expected to hurt exporters' earnings. This stability is to ensure that credit off take takes off in a big way.

In fact, credit deposit ratios of the banks have already begun rising; CD ratios are now about 56 per cent, with the last fortnights' non-food credit increasing by over Rs 16,000 crore.

The rise in credit off take is big booster for the banks, whose earnings are now likely to rise for the year. Banks have been under earnings pressure during the year, since the bulk of their profits have been driven by investments.

For corporates, the rising yields implied that spreads are likely to widen. Corporate spreads, especially `AAA' and `AA' rated companies have been widening and they are now about 75 to 100 basis points over sovereign yields.

The companies expected to benefit are mainly small and medium enterprises, where despite the high spreads, the effective borrowing costs are actually down to about 11 to 12 per cent, almost half the rates at which they were raising funds 5 years ago. Some bankers expect that more of these SMEs to go for credit rating and begin tapping the bond market route for raising resources.

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