The Hindu Business Line : Caught in maelstrom of events, traders await Credit Policy

BONDS went into a tailspin as nervous traders, rattled by contradictory statements issued by various party heads of the Congress-led coalition, sold in a bid to cut losses.

Traders said they were no longer certain on the sustainability of the soft rate bias. This was particularly in view of the statements emanating from some of the economic policy authors in the coalition. The statements indicated there was a preference for higher interest rates. But the major fear is that the new Government is likely to let loose the purse strings. As a result, bankers fear that the momentum of fiscal consolidation so far undertaken would reverse.

Bankers said that such a reversal would directly translate into greater borrowings by the Government in the markets, driving up interest rates. "We are not taking chances and will prefer to wait for the Credit Policy and Budget on the intentions of the new dispensation at the Centre, before taking positions," traders said.

But along with the election results what also jolted the markets were international events. Oil prices have struck a record high of $41 barrel or in excess of $310 to a tonne over the worsening situation in West Asia.

However, oil companies have not yet started coming in to the markets. Foreign institutional funds have begun selling some of their investments here. In fact, they have been selling continuously throughout Asia including China in anticipation of an interest rate hike in the US. The US yields are already on the ascent with the 10-year yield currently close to five per cent, or about 115 basis points over the comparative level last year.

This situation has driven up dollar demand, particularly from the FIIs. The continuous selling by FIIs has led to some tightening of liquidity in the markets. The liquidity mop-up from the seven-day repo auctions have halved and was only about Rs 10,000 crore. Since the introduction of the seven-day repos, mop-ups have been in excess of Rs 20,000 crore.

Traders said that most of the mop-up last week was only from the maturing repos. "There are no incremental flows taking place," one banker said.

The trends were evident from the T-bill auctions as well. The cut-off yield on the 91-day T-bill auctions last week was 4.42 per cent, up six basis points over previous auctions. Similarly, at the 364-day auctions, the cut-off yield was 4.45 per cent, up four basis points. This indicated that rates were low, since both the yields remained below the repo rate of 4.5 per cent.

However, in the past, the weighted average yield has remained below the cut-off rate by at least five basis points in the case of the 364-day T-bill and at about 10-15 basis points in the case of 91-day T-bill. This difference has vanished, and both the cut-off and the weighted average yields were level. This conveyed that the participation from the non- competitive sectors had almost vanished. Non-competitive bids for the 91-day T-bill auction were barely Rs 150 crore. In the 364-day T-bill auction, it was nil.

In fact, one banker said that FIIs, insurance companies and corporates who had parked short-term funds in T-bills had completely pulled out.

As a result, the 10-year yield to maturity (YTM) plunged to 5.22 per cent, down 10 basis points from the previous week's 5.12 per cent on a weighted average basis.

Trading volumes or to be more precise, sale volumes remained high during last week, as panic driven traders pushed down yields on all the long-term securities. Sales were driven across all maturities. However, the bulk of the selling took place beyond 2015 years onwards, in particular the 7.46 per cent 2017, 7.49 per cent 2017 and the 8.07 per cent 2017. The overall trading volume during the week was under Rs 5,000 crore. The undertone in the markets was weak. This was evident from the high spreads between one-year and 24-year securities, which was about 149 basis points, up from the previous week's 125 basis points.

Market's nervousness also translated into foreign currency inflows. Traders reported that that some exporters deferred their realisation of their receipts. Exporters deferral of receipts was prompted by anticipation that the rupee was likely to retreat further against the dollar. It is already close to 46 to the dollar. Exporter deferrals and the slowdown in capital flows, especially from Non-resident Indians (NRI) in the form of non-repatriable deposits resulted in a shortage of spot dollars in the market, prompting banks to resort to swaps, selling forwards and buying spot. This was one of the key factors that has been keeping the forwards up to year at a discount.

Foreign exchange inflows last week were only $89 million taking the total reserves to $118.579 billion.

With the slowdown in inflows into the country, especially current account and non-debt capital account, reserve money expansion is likely to decelerate considerably during the next few weeks.

Traders said that reduction in the repo rate was unlikely in the forthcoming Credit Policy.

Traders expect the yields to harden in the coming months.

The RBI has already cautioned many banks on this possibility. The caution though was done in anticipation of external factors.

However, domestic factors are also expected to contribute to the hardening, especially if the Government borrowings are stepped up in the coming months to offset the shortfalls in revenue and non-debt capital receipts, public sector disinvestments, which the Congress-led coalition has indicated would be considerably reduced. Further, bankers said that most of them also intended slowing down the exposure to retail lending. Retail credit has been driving the credit-deposit ratios of most of the public sector banks. In fact, most of them want to keep credit expansion on hold for some time. Corporate borrowing costs are also expected to rise in view of the tightening liquidity.