The Hindu Business Line : Pressure on RBI eases as cos prepay forex debts

Traders said that some of major banks, especially private sector and foreign banks, which operate the bulk of the foreign institutional investor business had put out a sell on some of the securities in the market. This in turn was triggered by fears of a crackdown by the securities market regulator, Securities Exchange Board of India, over the issue of banned entities participating in the domestic equity markets through issuance of participatory notes. This issue has not abated, and as investigations continue, traders said that there could be some more corrections.

Further, oil companies had also begun sourcing foreign currency in the markets fearing a steep spike in oil prices. Oil prices are already high at close to about $34 a barrel. As a result, some of the oil companies have entered the markets to tie up their forward contracts and source foreign currencies at the current levels. This also acted as a sell trigger in the bond markets.

However, some traders said that some of the selling wave was nipped due to the liquidity inflow in the market. Participation in the four-day repo (on account Republic Day on Monday) was slightly down to about Rs 24,000 crore. Three-day repos during the month have averaged around Rs 30,000 crore plus.

Instead, some of the bankers have preferred parking funds in short-ended debts or in mutual funds, where the yields are slightly higher. Moreover, traders said that insurance arms of ICICI, HDFC and SBI had also begun tapping the debt funds, in view of the insurance regulators' directions on investments.

As a result, any steep rise in yields was arrested. But at the treasury bills auctions, the 364-day bill ended at 4.4 per cent, down from the previous rate of 4.35 per cent. The 91-day T-bill, however, remained steady at 4.25 per cent. But the 10-year yield to maturity hardened to 5.15 per cent on a weighted average basis as against the previous week's 5.13 per cent.

The hardening was reflected in the markets' favourite securities. The 11.40 per cent 2008 ended the week at 4.80 per cent, 11.50 per cent 2011 at 5.13 per cent, 7.40 per cent 2012 at 5.11 per cent, 7.27 per cent 2013 at 5.13 per cent, 9.81 per cent 2013 at 5.15 per cent, 7.37 per cent 2014 at 5.14 per cent, 7.38 per cent 2015 at 5.23 per cent, 7.46 per cent 2017 at 5.49 per cent, 8.07 per cent 2017 at 5.49 per cent and the 6.25 per cent 2018 at 5.59 per cent.

The steady trend among some of the securities at the long end was partly due to the fact that some of the banks had moved into them for the weekend, instead of parking in the 4-day repo window. Traders said that this allowed them a slight advantage when the markets open on Tuesday, when they expect to exit at slightly higher prices or even level. "This is certainly better than parking at 4.5 per cent," one trader said. These securities were preferred in view of the large floating stock and their high liquidity

Yet, despite this slight purchasing activity, volumes remained low. In fact, the volumes have been falling. Daily average trading volumes during last week was in the region of about Rs 2,750 crore. The lack of trading interest was also evident from the high spreads between one-year and 24 years, which were currently in the region of about 165 basis points.

Expectations are that yields are likely to be range-bound till the elections, despite the markets being awash with liquidity.

"We can see yields moving within these levels till the budget 2004-05," Mr Cherian Varghese, Chairman and Managing Director of Corporation Bank, has said.

One of the major factors for debts market to lose sheen was said to be the rising inflation. Inflation is currently in the region of 6.21 per cent as measured by the wholesale price index. This means that 10-year real yields are negative by more than 100 basis points. This is the first time in more than two decades that such a trend was becoming evident. These trends existed only when debt markets were administered and free play frowned up on. In fact, this is also one of the reasons for traders to pick securities as opposed to repos. In the event of the liquidity hitting the market, yields are expected to slide, giving traders a good opportunity to book profits. In fact, on most Monday mornings yields tend to slide in view of the sudden influx of liquidity due to the maturing of repos.

But for the RBI, liquidity management is now becoming slightly easier. This is in view of the accelerated rate at which prepayments are being made on foreign currency loans by some of the domestic borrowers. These borrowers have finally begun taking advantage of the strong exchange rates to pre-pay some of their foreign debts. Among those readying to prepay include almost all the public sector companies. Prepayments and large purchases by oil companies and other infrastructure companies have driven up forward premiums to close to 0.75 per cent for six months and about 0.8 per cent for 12 months.

Till last week, even 12-month premium had dropped to as low as 0.2 per cent. In fact, for last week, the RBI's figures indicate that the foreign exchange reserves have dropped by at least $698 million. This drop is happening for the first time in many weeks. Reserves have been rising at the rate of over $1 billion during the last one month, driven partly by current account flows.

But there are also major worries on the dollar's fiscal front. Among the worries is that some of the maturing US Treasuries are likely to be rolled over instead of being redeemed. Some securities like the 9 1/8 per cent US Treasury issued in 1979 was being compulsorily replaced with low coupons. This would mean a further weakening of the dollar in the coming months, leading to further accretions in the foreign exchange reserves.