The Hindu Business Line : Bonds under pressure on forex outflows, inflation

Foreign exchange outflows continued to be a key driver, pushing up the yields. The foreign exchange demand was driven by foreign institutional investors liquidating some of their investments. Besides, oil companies were in the market leading the rush for dollars.

Traders said that oil companies were keen to lock into the current exchange rates and the prevailing oil prices. It was feared that the deteriorating situation in West Asia would likely drive up prices northwards.

As a result of these pressures, several banks sold bonds to meet the demand. This also resulted in pushing up forward premia since oil companies were mostly present in the forward markets and at the long end. FIIs were present at the near end.

FIIs have been taking forward covers at one-month levels, whereas oil companies were doing so at six and 12 months. Since FIIs' demand exceeded other importers requirements, short-end premia was higher than the long-end.

Traders said most mutual funds were also sellers, entirely to meet the redemption pressures from corporates. Several corporates in the last one-year had parked their surplus cash in mutual funds, particularly debt funds so as to take advantage of the high returns and as part of their new strategies in managing funds. But concerns of rise in interest rates prompted them to exit, triggering selling of securities by the funds.

Further, liquidity was also beginning to tighten. This was evident from the 364-day T-bill auctions last week. The T-bill issue was undersubscribed for the first time in almost three years. This was despite the high cut-off yields. The cut-off yields fixed for the 364-day T-Bills was 4.65 per cent. This was at least 15 basis points above the repo rate of 4.5 per cent. Yet the bids received were only Rs 1,771 crore and the bids accepted were for Rs 1,230 crore. This was against the Rs 2,000 crore mop-up fixed under both the normal and the market stabilisation scheme. Similarly, for the 91-day T-bills, yields were 4.46 per cent, slightly down from the previous auction figures of 4.51 per cent. Despite higher cut-off yields, there was little non-competitive interest in the auctions.

The tapering of liquidity was evident from the 7-day weekend auction. Also, the mop-up amounts remained under Rs 9,000 crore. The outstanding amounts dropped to about Rs 56,000 crore. These trends reflected in the 10-year yield movement. On a weighted average basis, the 10-year yield to maturity (YTM) dropped to 5.83 per cent as against 5.49 per cent the previous week.

In fact, the 10-year YTM dropped to almost 5.90 per cent, but the intervention of life insurance companies minimised the losses.

Even statements from the Finance Ministry failed to assuage the markets.

Besides funds, large sellers included banks, which were preparing their first quarter results. But traders said that some of PSU general insurers were sellers to meet large claims.

However, what buoyed yields at these levels were large-scale purchases by some of the life insurance companies, in particular Life Insurance Corporation, ICICI Prudential Life Insurance and HDFC-Standard Life and SBI Life. These companies saw bargain buys in some of the high-coupon securities such as 9.85 per cent 2015 and 10.71 per cent 2016.

The undertone remained weak and the bearish trend was likely to continue well into the next week, traders said.

Bankers were expecting the market stabilisation scheme to be pruned for the next quarter.

This was because this scheme was announced when foreign exchange inflows averaged upwards of $300 million per day. These inflows have considerably reduced since May. The Federal Reserve Board meet on June 29-30 regarding rate hike decision is likely to add pressure on yields.

Ten-year US treasury yields at 4.9 per cent have already signalled the possibility of an increase in interest rates.

Already in anticipation of this trend, some of the US government securities now being held by Indian institutions including the Reserve Bank of India have already been liquidated, to avoid losses in the event of any big hikes. This sale resulted in substantial profits.

Traders said that these profits were one of the major sources for the accretion to the foreign exchange reserves. Besides, some of the forward purchases made by the RBI as part of its sterilisation operations also matured resulting in the accretions. Other than these, there were little flows from either the current account or on the non-debt capital account. The non-debt capital accounts comprises FII and Foreign Direct Investment flows. These flows have completely halted during the last one-month as investors awaited the Budget on July 8.

Traders expect fiscal strings of the government to be loosened, leading to a further round pressures on bond yields.

This nervousness has pushed up the spread between sovereigns and sub-sovereigns to over 160 basis points. For instance, the 7.60 per cent 2008 Hudco bonds were traded at an YTM of 7 per cent last week. In the case of private sector corporates, there was a further 20 basis points difference.

As a result, some corporates were moving to advance their borrowings.

These include some of the public sector banks for Tier II bonds.