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Monday, Mar 22, 2004

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Bonds get a boost from inflation figures

C. Shivkumar

BOND markets continued to remain buoyant last week propped up by expanding liquidity and renewed optimism that inflation would remain under control.

Traders said refunds on the recent public issues and tax refunds somewhat alleviated the pressure on liquidity in the markets. At the three-day repurchase auction, the RBI's mop-up was under Rs 40,000 crore. Throughout last week, the daily repos were in the range of Rs 42,000 crore plus. But this was considerably lower than the previous week's repo mop-up of Rs 50,000 crore.

The 364-day bill yield was 4.32 per cent, down from the previous week's 4.43 per cent.

The yield on the 91-day t-bill, however, remained steady at 4.26 per cent. The 10-year yield to maturity dropped to 5.17 per cent, down from last week's 5.21 per cent on a weighted average basis. However, traders said that the rally was unlikely to sustain in the coming weeks. This was evident from the falling trade volumes. Daily trade volumes have fallen to about Rs 3,400 crore last week as against the previous week's Rs 5,500-6,000 crore. Similarly the bid-offer spreads also appear to have widened implying reduced trading interest. Bid-offer spreads were in the region of 40-50 basis points. In peak trading, spreads had fallen to as low as five basis points. The widening spreads are also due to the large number of non-bank sellers. Non-bank sellers include mutual funds, which are now faced with large redemption pressures, especially on their fixed income funds.

With the year-end approaching, reconciliation was the priority. Besides, traders also said that some churning of portfolios was also taken up by moving some of the high-coupon securities into the permanent categories. Traders said that the deceleration in the inflation was already expected and much of it had been discounted. Inflation decelerated to 4.91 per cent from last week's 5.32 per cent. As a result of the sharp fall in inflation, real yields became positive beyond 2010 onwards.

Traders also said that yields could come under pressure as oil companies resort to purchases and forward covering of some of the future contracts . This was particularly because import demand would most likely exceed supply. This was likely to lead to some yield stabilisation at the short-term. In fact, the presence of the oil companies and mopping up efforts by the RBI in the spot and forward markets tempered the rise of the rupee and at the same time allowed for a slight widening of the forward premiums.

Forward premia for 12 months was 0.6 per cent and for six months at 0.5 per cent. Consequently, traders said that some of the exporters were likely to take advantage of the rising forward premiums and resort to selling their forward receipts. Net accretion to the foreign exchange reserves continued unabated. For the latest reporting week, foreign exchange reserves have increased by $464 million to $109.556 billion.But remarks by the RBI's top management, that even these reserves were insufficient have triggered some liquidity worries in the markets.

The RBI's statements meant, that aggressive interventions would continue, said traders.

This was despite the increased cost of interventions. The cost of the interventions was bringing down the spreads.

Traders said that it was the aggressive purchases of US government treasuries by foreign central banks that was preventing any interest rate increase in the US markets, despite the high twin deficits there - fiscal and balance of payments.

But unlike most Asian central banks, the RBI however, has preferred keeping only a small amount in long-term bonds.

The bulk of the funds were deployed in US government treasury bills and bank deposits with commercial banks in both Europe and the US. This was to ensure that weighted average returns remained positive, above the current repo rate. The prepayment of external lines of credit, domestic credit had also increased, in line with encouragements provided by the government.

For the latest reporting week, credit offtake increased by close to Rs 9,000 crore. This despite the lean season. Besides, some of the banks are also resorting to external borrowings, especially for short-term purposes.

Such ECBs obviated the need to maintain any CRR or SLR balances and allowed banks to fund domestic credit at high spreads.

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