The Hindu Business Line : `Further softening of yields unlikely'

BOND markets weakened last week after the Reserve Bank of India (RBI) sent out strong signals and resorted to subsequent interventions to buttress those signals that a further softening was unlikely.

The signals emanated from last week's cut-off yields during the 91-day and the 364-day Treasury bill auctions. At these auctions, the cut-off yields were fixed at 4.42 per cent and 4.99 per cent. While the 91-day was unchanged from the previous week's levels, the 364-day had moved up by at least 25 basis points from the previous auctions.

In fact, the 364 T-bill yield has been steadily rising from July this year when it had gone down to as low as 4.36 per cent.

Besides, the RBI's interventions in the forex markets and open market operations are also intended to prevent any further softening of yields, traders said. However, interventions are also being pushed at the policy levels. These include curbs on raising external commercial borrowings. Traders said that upward shift in the yield curve was a direct result of these moves by the Government.

The upward shift in the auction yields, they said, clearly conveyed the message that further softening was not possible.

This was in line with the peak season Credit Policy announcement, where the plug was for interest rate stability. Besides, several bankers have been complaining that any further downward shift in the yield curve on the back of external flows was not likely to be very comfortable for most of them. This is especially since over 45 per cent of their funds are parked in government and public sector securities, against the mandated 25 per cent SLR.

Considerable volumes of export earnings used to emanate from forward premiums. However, with forward premiums at rock bottom lows, their earnings have also dropped.

Besides, there are also inflationary concerns over the rising liquidity in the system. Inflation is currently over 5 per cent.

Traders said these concerns had pushed for renewed aggression by the regulator to check liquidity build-up in the markets.

As a result , the 10-year yield to maturity (YTM) on a weighted average basis hardened to 5.10 per cent last week, up from the previous week's 5.08 per cent.

The shift in the yield curve was distinct, though rise was more pronounced at the long ends.

Traders said that this was partly because there was greater selling at the long-end, particularly by the banking institutions. Bankers have taken cue from the RBI.

Besides, insurance companies have also been selling their holdings partly in a bid to fund some of their potential liabilities, especially for VRS programme.

The selling has resulted in pushing up the yield spreads at the long-end.

The yield movement has lead to peculiar situation. The 364-day T-bill yield is higher than the five-year yield, by at least 19 basis points.

Bankers said that this was partly because the RBI's open market operations had resulted in tightening the markets. The resulting liquidity tightness pushed some of the bankers to sell securities, particularly at the short-end.

Trading is beginning to become less attractive as is evident from the falling volumes.

Trading volumes are only about Rs 4,500 crore per day or less than half of what it was about three months ago.

Insurance companies, in particular life are increasingly resorting to switches in a bid to replace some of their low coupons with high coupons even at premiums.

As a result, the 11.03 per cent 2012 has also begun to vanish from the market. Another security being targeted by the life insurers include the 9.85 per cent 2015 to ensure greater investment income flows through current yields. The 9.85 per cent in fact is being switched for another security of the same maturity, the 7.38 per cent 2015.

Besides, bankers said that some of them were selling to meet the credit demand. Corporate credit offtake has improved with the ban on private placement of securities. This ban has pushed up the yield spreads on corporate securities by over 100 basis points over sovereigns.

Bankers said that despite the forcible reduction in the demand for ECBs, external flows are likely to take place well into the next year, especially from current account flows.

These signals are evident from the fact that none of the foreign institutional investors faced with approaching year-end redemptions have taken any forward cover. Forward premiums in fact fell again last week to 0.28 per cent, despite the interventions by the RBI to suck out dollars. Traders said that even if redemptions do take place, the impact on the markets was unlikely to be very significant. This was in view of the inward remittances taking place both from merchandise trade account receipts and from invisibles and non-debt capital account receipts. The fores reserves for the latest reporting week was at $93.211 billion.

The forex accretion is now pushing the Government to go for more prepayments of external debts. The benefit of these prepayments has multiple benefits for the economy. However, bankers say that there was some urgency in making the prepayments in view of the rising yields in the international markets. US dollar rates have been on the rise and prepayments now would obviate the servicing burden on some these debts at high interest rates.

Moreover, domestic yields are also expected to creep up during the current calendar year, partly due to the sterilisation efforts and the increased requirement for funding credit.

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`Further softening of yields unlikely'