The Hindu Business Line : Higher borrowings loom large over bond market

Traders said that Finance Minister's partial rollback of transaction tax failed to assuage them. One trader said, "Transaction tax is only a minor issue. The Finance Minister has not conveyed how the resulting revenue shortfalls are going to be met." In fact, most traders indicate that revenue shortfalls were likely to be met through additional borrowings.

Besides, the drought has also triggered concerns. Borrowings targeted this year were around Rs 1,55,000 crore. But if drought relief works were to be carried out, there could be additional borrowings in the coming months. This, along with the slowdown in reserve money expansion, is likely to push up the interest costs of the Government, way beyond the Budget estimates.

Even at the existing levels, there were fears that the Budget estimates on interests would be overshot. These estimates were made when 10-year yields were in the region of about 5.6 per cent.

Rising T-bill yields

These fears reflected in the rising T-bill auction yields. Last week's auctions saw the 91-day Treasury yield remain at 4.51 per cent, above the repo rate of 4.50 per cent. Similarly, at the 364-day T-bill auction, the cut-off yields and the weighted average yields were level at 4.62 per cent. In both these auctions, participation by non-competitive bidders was limited. The rise in yields was despite the increased liquidity in the market, evident from the rise in seven-day weekend repo auction, where the mop-up was about Rs 12,000 crore.

Inflows into the banking systemamounted to over Rs 10,000 crore, by way of coupon payments, redemptions of some G-Secs and Treasury bills. In addition, there were also coupon flows from corporate securities. These factors contributed to the large mop-up, traders said. However, despite this one-time increase, the outstanding amounts have actually progressively decreased. Outstanding amount on the seven-day repo auctions are now only about Rs 55,000 crore. This was partly on account of the contraction in some of the sources of reserve money expansion, especially foreign exchange reserves.

As a result, 10-year yields was 5.97 per cent last week-end on a weighted average basis, almost unchanged from the previous week's 5.98 per cent.

The undertone also remained weak with volumes remaining low, under Rs 3,000 crore. More high-coupon securities have re-entered the market. Some of them included the 9.85 per cent 2015 per cent, which had gone into the `held to maturity' category of some of the banks. The outlook remained weak, which was evident from the continuing high yield spreads between one and twenty four years. These spreads continued to remain in the range of 195-200 basis points.

What prevented a technical correction was the inflation numbers. Inflation last week was 6.52 per cent. Consequently, real yields continued to remain in the negative zone up to 24 years. Traders said, unless inflation was corrected any retreat in yields was therefore unlikely. Yields are likely to rise till they become positive or above the inflation numbers.

Forex demand impact

Demand for foreign exchange has also had a cascading effect with oil companies sourcing the dollars from the markets, they have driven up the dollar and the forward premiums. A weakening rupee has therefore led to further pressure on inflation, bankers said. The inflationary impact was compounded by some of the exporters deferring their remittances, further weakening the rupee.

This anticipation was evident from the rising forward premia. Forward premia for six months was now upwards of 2 per cent, the highest in almost a year. There were some foreign exchange inflows for the week-ended July 16 of about $328 million. But this accretion was mostly on account of the RBI's aggressive treasury operations. But these flows were not sufficient to meet the demands from markets, traders said. This was because, even some of the foreign investment flows have also tapered off in recent weeks, they said. Consequently, some banks sold their securities to source the foreign exchange requirement for oil companies.

Traders also said that credit demand also helped yields to harden. Credit demand is expected to pick up in coming months, with the beginning of the peak season. Some were attempting to reduce their investment deposit ratios from the current level of 46 per cent to accommodate the possibility of an increase in the credit-deposit ratios. Bankers expect deposit rates may slowly be allowed to rise to meet the large credit demand.

The hardening yields had their repercussions on the corporate bond markets. Some corporate borrowers have now begun reversing their floating rate borrowing and shifting to fixed interest rate loans. Some of the banks were resisting such shifts, especially the new private sector banks, traders said.

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