The Hindu Business Line : Rising inflation, Budget numbers worry market

BONDS remained listless as traders disappointed by the Budget numbers and worried over the accelerating inflation preferred to retreat from the markets.

Traders said that the Finance Minister's budgetary numbers for borrowing this year were likely to be breached, way beyond the Rs 1,55,365 crore estimated for the current fiscal. The disappointment was particularly because accretion estimated to the internal debt was far higher than the previous year's Rs 1,13,331.56 crore. The figure for the current year included the market stabilisation scheme, which nonetheless accounts for part of the Government's liability.

The scepticism over the Finance Ministry's figures was also over the revenue estimates made for the current financial year and the fiscal deficit. Traders said that the revenue deficit estimates were not sustainable.

This was especially since the Government's plan involved increasing revenue expenditure. Revenue deficit for the year has been pegged at 2.5 per cent of the gross domestic product despite the increase in revenue expenditure by at least Rs 2,26,000 crore.

One reason for the fear was that interest costs were likely to mount for the Government. In the last two years, domestic interest rate slide stemmed from current and non-debt capital account inflows.

This year however, the trends so far were not encouraging for the Government, bankers said. This was already evident from the rising cost of borrowing in the markets. Moreover, the Finance Minister has resorted to the formula of cutting back capital expenditure to accommodate the increased revenue expenditure, to ensure the fiscal target of 4.4 per cent of the GDP was complied.

Unlike last year, the Government does not have the flexibility of making more non-tax receipts, with the Left front completely opposed to any divestment in the public sector. Consequently, bankers fear that the Government was now likely to resort to another formulae identical to the one adopted in 1994.

In the 1994 Budget, the Finance Minister had merged the oil pool account into the general Budget to keep the fiscal deficit down. This year, there are fears that the earmarked funds would be taken into the Consolidated Fund to show fiscal compliance.

Traders said that investors' fears were already evident from dwindling interest in the T-bill auctions. In last week's auctions for instance, the 364-day T-bill hardly received any bids from non-competitive bidders.

The low interest was evident from the level of cut-off yields and weighted average yields at 4.62 per cent. Similarly, the 91-day T-bill also remained close to the repo rate of 4.5 per cent.

In the past, the cut-off yields have remained higher than the weighted average yields pushed by the non-competitive bids. Last week, what ensured full subscription to the bills were the large coupon flows amounting to Rs 4,000 crore.

The large coupon flows, including some of the maturing T-bills and repos, pushed up the liquidity mop-up over Rs 10,000 crore for the first time in about six weeks.

As a result, the 10-year yield to maturity dropped slightly to 5.77 per cent last Friday, down from the previous week's 5.81 per cent. But this drop was also due to the sudden shut down of trading terminals over the turnover tax issue. On Saturday, after the intervention of the RBI, 10-year yields were back to 5.81 per cent.

However, the undertone in the markets remained weak. This was evident from the low trading volumes during last week. The average daily trading volume was barely Rs 3,500 crore.

Moreover, the outlook for yields remained weak, evident from the wide spreads between one year and 24 years. These spreads continued to hover around the 185-200 basis points spread. Most of the buyers during the week were life insurance companies of some of the high-coupon bonds that returned to the markets.

The entrant included the 10.03 per cent 2019 security, which had disappeared into the held for trading list last year. The return of some of these high-coupon bonds indicated that another yield spike is likely.

Besides, inflation worries also continued to dog the market. Inflation was now over 6 per cent. At this level, real yields up to 12 years continued to be in the negative zone. This implied that there was a considerable upside risk for yields.

Traders said one of the major reasons for this negative yield was the large-scale support extended by some of the new life insurance companies, who remained buyers to take advantage of the high yields.

The buyers in the markets, besides, LIC, include, SBI Life, ICICI Prudential and HDFC Standard Life.

What also worried traders was the spike in oil prices. Oil prices are now once again close to about $41.5 a barrel or over $305 per tonne.

This had the potential to push up yields further in the coming months. Besides, the falling rupee also pushed some of the oil companies to begin taking forward cover.

This resulted in the rupee-$ forward premia to overshoot one per cent mark to about 1.3 per cent. Besides, some of the private sector refineries have also begun advancing their requirements, leading to some of them to source foreign currency in the markets, triggering a rise in yields.

What has also prompted the oil companies to take forward cover was the fact that foreign exchange inflows have now virtually stopped on the current account.

Most exporters continued to wait delaying their inward remittances so as to push up forward premiums further up. In fact, net inflows since May have mostly been negative on the current account. Only small flows have taken place on the non-debt capital account, which included foreign institutional investors.

But FIIs have also opted to take forward cover, unlike in the past when they left their positions open.

Moreover, foreign direct investments are virtually on hold, as these investors preferred to wait for some more time.

Last week, foreign exchange reserves breached the $120 billion barrier, on the back of a $671 million inflow.

However, traders said that these inflows were mostly due to the RBI's profits earned in trading foreign Government securities, in particular US Government securities, where about $14.6 billion were invested. Part of the rise was also due to changes in valuation, especially since the dollar has fallen sharply against most international currencies.

But bank credit offtake also appeared to have picked up. If credit offtake continues to pick up, bankers expect yields to harden further in the coming months. But the major fear for yields hardening stemmed from competitive pressures for credit, from Government, public sector and the private sector. Some corporates anticipating a surge in rates have already shifted to holding liquidity, after liquidating some of their large investments. This in turn led to a surge in deposits in the banking system by about Rs 11,000 crore, almost Rs 9,000 crore was in the form short-term deposits, where the returns were higher than Treasury bills.