The Hindu Business Line : Bond yields may harden further

Traders said that inflation was the biggest worry in the markets. For the latest reporting week, it was 6.2 per cent. The concern was driven by high oil prices that remained in the $41 per barrel zone.

In the past, some of the escalation in oil prices was absorbed by the appreciating exchange rates.

However, this time, a weak dollar appreciated by about one per cent against the rupee during the last week. The fear is that the combined effect of these two elements could have a cost-push effect. India currently imports about 1.6 million barrels per day.

In the last one week , the country's oil bill has moved up by at least $5 million per day.

Traders said that the current impasse over some of the key Budget proposals also alarmed them. One of the major reasons for alarm is that some key non-debt capital account flows would halt. The Government is yet to convince some of the key allies over the relaxation in the foreign direct investment norms to 49 per cent in insurance, telecom and aviation sectors.

As a result, some Budget proposals are now expected to face some setbacks, traders said. This in turn has also resulted in ensuring a further deferral of current account inflows. Exporters in particular deferred their inflows, anticipating a further weakening of the rupee in the coming months.

What also rattled traders were the high cut-off yields in Thursday's auction on market stabilisation scheme bonds of 4.83 per cent 2005. The cut-off yields at the auction were fixed at 5.05 per cent.

This was at least 35 basis points above market expectation. At the last auction of the MSS securities, 6.18 per cent 2005, the yield to maturity remained close to the repo rate of 4.5 per cent.

The present hike in the MSS yield in turn has triggered speculation that an upward revision in the repo rate was imminent. That the market expectations were way off the market was also evident from the 91-day T-bill yields weighted average yield, which was 4.51 per cent.

Despite this high cut-off yield at the weekend seven-day repurchase operations, the mop-up amount was close to about Rs 10,000 crore, implying that any revision in the repo rate was unlikely during the next seven days. Traders also said that some of the large buyers like insurance companies stayed away from the markets waiting for the Government decision over the FDI cap hike. Besides, public sector insurance companies, both life and general insurance companies, stayed away anticipating yields to rise further.

The undertone in the markets remained weak. This was apparent from the low trading volumes and the erratic yield movements.

Trading volumes were barely Rs 2,500 crore. Signalling a further hardening of yields were the continuing wide yield spreads between one-year and 24 years. This spread continued to remain close to about 200 basis points.

Further, real yields continued to remain in the negative zone with the rising inflation. With inflation at 6.16 per cent, real yields up to 12 years were negative. Consequently, traders said that yields were likely to move northwards in the coming week as well.

Traders said that as a result of the low forex inflows, reserve money expansion had substantially reduced. One-month forward premia was close to about 3 per cent.

Long forward premia, six months and one year were lower at 1.75 per cent and 1.5 per cent respectively.

The advancing forward premia were also due to oil companies taking forward cover. In the long-term, however, the outlook on both oil prices and the exchange rate was positive, which was one of the factors leading to an inversion in the forward premia.

Yet, these trends notwithstanding, the RBI has reported an accretion of $700 million to the foreign exchange reserves.

Bulk of accretions were profits contributed by RBI's aggressive treasury management of the external reserves.

What also pushed up yields was the rising credit demand. Credit offtake for latest reporting was close to Rs 11,000 crore.

Almost the entire offtake was in the form of non-food credit, including farm credit. Substantial increase in non-food credit was in the form of rescheduling of farm loans. But credit-deposit ratios remained about 55 per cent.

This was partly on account of the large accretion to term deposits in the banking system. Incremental credit-deposit ratios though were over 100 per cent. The high incremental credit-deposit ratio was also due to largescale selling of securities by the banks, which have now aggressively pitched for farm credit, in view of the good monsoon

However, investment deposit ratios continued to be on the high side at 46 per cent. Traders said that this partly on account of the large deployment of funds in the MSS.

Besides, banks were parking some of the deposit accretions in short-term securities, especially highly liquidity securities. These included the 8.07 per cent 2017, where trading volumes averaged upwards of Rs 200 crore.

For corporates, rising yields was beginning to cause concern. One of the major concerns was that interest rates were beginning to mount as evident from the rising spreads between sovereign and sub-sovereign papers.

These spreads are in the region of about 140 basis points. In fact, there were few takers for corporate securities even at these spreads.

Buyers for such securities preferred to wait for some more time since the low coupons resulted in current yields falling far short of expectations.