The Hindu Business Line : Market gears up for repo rate hike as yields harden

As yields rise further, there is increasing doubt about the ability of the Government to maintain fiscal estimates, according to traders. The fear is that Government borrowings are likely to overshoot the Rs 1,55,000 crore target, unless tax and non-tax revenues show a substantial increase.

The key driver for the three-year high inflation number continued to be international oil prices, commodity prices and exchange rates. Oil prices have topped $44 a barrel or about $330 a tonne. What worried the markets are not the spot prices, but crude oil futures, where prices have topped $45 a barrel. Clearly, hardening in oil futures pointed to higher petroleum prices in the domestic market, where at least 1.6-1.8 million barrels are imported to meet daily requirements.

As a result of these fears, the 10-year yield to maturity hardened sharply to 6.30 per cent last weekend on a weighted average basis, up from the previous weekend's 6.17 per cent.

Repo rate

The rise has now triggered fears that the RBI would step in to push up some of the short-term rates, the repurchase rate which is currently at 4.5 per cent. The markets have already been speculating a possible increase in the repo rate in view of the high T-bill yields. At the weekly auctions, the T-bill yields remained above the repo rate. The 91-day T-bill yield was 4.52 per cent, unchanged from the previous week and the 364-day T-bill yield was 4.63 per cent. In both these auctions, there was little interest from non-competitive bidders in the markets. Non-competitive bidders comprising corporates, mutual funds and insurers were staying away from the auctions.

Low volumes

The undertone remained weak, with low trading volumes of barely Rs 3,000 crore. The outlook also remained weak, traders said. Real yields up to 24 years were in the negative zone. Further, the spreads between one year and 24 years continued to remain upwards of 100 basis points, though beginning to narrow. The reason for this trend was that many of the banks were switching their long-dated securities with short-dated papers. Besides, more high coupons were back in the markets, as some of the funds and banks which had moved them into permanent investments, shifted them to the available for sale (AFS)/ held for trading (HFT). This was to partially offset the valuation blues. Traders said that in a bearish market, the ideal step would be to move the high coupons into the HFT/AFS categories to partially offset depreciation. The low coupons would move into the permanent category.

In fact, some banks have already done this in a bid to cut depreciation provisions. But funds also sold some of the high coupon securities faced with redemption pressures. This included the 10.71 per cent 2016, which has returned to the market. Buyers at these levels were life insurance companies, traders said.

11-year floater

The tightening market also spells trouble for the Government's 11-year floater planned next week. These floaters are linked to the 364-Treasury bill yields. Normally, if interest rates are expected to soften, the spread quoted over the benchmark T-bill yields would be low. However, this time bankers are expected to quote higher spreads. The spreads are likely to be closer to the 7.38 per cent 2015 security. This security was quoted last week at an YTM of 6.38 per cent.

The situation is likely to be worse for the Rs 2,000 crore 30-year borrowing. Traders expect that the yields quoted would indicate the direction of interest rates in the market. There are no 30-year securities in the market and this is going to be the first one. But yields are likely to be closer to 7 per cent, traders said, given the present conditions in the markets. Traders said that underwriting commissions would accordingly be used for pushing through these issues.

Moreover, traders said, with the RBI intervening in the markets to support foreign exchange markets, to prevent any large scale weakening of the rupee, liquidity was beginning to tighten.

Forex reserves

The intervention has resulted in the exchange reserves dipping by a large $1.2 billion during the week, to $118.319 billion.

Traders said that the weakening was likely to continue in the coming weeks as well, evident from the widening forward premia. One-month forward premium was 2.5 per cent and one-year was close to 2.05 per cent.

Part of the reason for the widening forward premia was the inflation and yield differentials. Inflation in the US continued to be about 2 per cent. The 10-year US treasury yield was 4.38 per cent.

Besides, exporters continued to abstain from bringing in their receipts into the country anticipating a further a weakening. On the other hand, oil driven demand with rising prices was pushing up the dollar and the forward premia, traders said. Traders expect further selling of securities for meeting the oil companies' appetite for foreign currency.

Credit demand

Credit demand appears to have reduced. Food credit still has not picked up partly because the Food Corporation of India has not yet begun its procurement operations in full swing. Last week, non-food credit expanded by only Rs 1,800 crore. Traders anticipate a pick-up in view of the revival of monsoon. The rising yields also portend a hike in corporate borrowing costs.

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