The Hindu Business Line : Bonds outlook remains bearish, say bankers

Traders said that what also helped buoy the markets was the cancellation of auctions amounting to Rs 6,000 crore scheduled for next week. This was in view of the Government's large credit balance with the Reserve Bank of India, mostly tax receipts, valued at around Rs 35,000 crore. Besides, a fall in international oil prices also helped reduce the bear pressure on the bond markets.

For domestic markets, a fall in international oil prices below $48 (Rs 2,160) a barrel implied that oil companies would need to spend less. Indian imports are equivalent to at least 2.1 million barrels daily.

Less demand:The fall in prices implied that the demand for foreign currencies from oil companies was substantially down. In fact, most oil companies have already stopped taking forward cover. Forward premia last week dropped to less than 2 per cent for up to 12 months.

However, despite these trends, liquidity remained tight, evident from the outstanding amount in the repurchase window of the RBI. The outstanding amount on three-day repos was Rs 16,500 crore. Unlike the last two years, there were no outstanding on the reverse repo window.

RBI support: The repo implied that the RBI was providing liquidity to banks against their holdings of Government securities as collateral.

The reverse repo implied the RBI's liquidity mop up operations by placing G-Secs with the banks and other money market participants.

The tightness pushed up the 91-day Treasury bill yields last week to 5.62 per cent as against previous week's 5.58 per cent. This prompted the RBI to quietly discontinue the market stabilisation scheme auctions, reinforcing beliefs that liquidity was likely to remain tight for some more.

In fact, this was also one of the reasons for the ten-year yield to maturity (YTM) remaine steady at current levels on a weighted average basis. The ten-year YTM was 7.19 per cent last week, unchanged from the previous week.

Life insurers' interest: Traders said private sector life insurance companies prevented any hardening of rates. These private sector insurance companies have seen growths in excess of 75 per cent in their unit-linked policies.

Most of the accretions were into balanced funds, where at least 60 per cent was invested in debt and the remaining in equity. For these funds, the companies have been buying into Government securities, targeting current yields, to sustain high returns to policyholders.

The insurers focussed on the 11.83 per cent 2014 paper. In fact, this security was picked up at yields of 6.33 per cent, way above the 10-year benchmark security - 7.37 per cent 2014.

Six months ago such purchases would not have made any impact on the markets. But, traders said, in a market with thin trading volumes, even small lots impacted yields.

Trading volumes: Daily trading volumes were barely Rs 3,000 crore, indicating weak undertone.

The outlook also remained bearish, bankers said. This was evident from the high spreads between one year and 24 years, which was 151 basis points. There were also other reasons for the bearish outlook. The negative real yields have widened once again, due to rise in inflation to 7.76 per cent. The negative real yields now extend up to 24 years.

FIIs selling: Further, traders said that some of the foreign institutional investors were likely to begin selling ahead of their year-end. The selling was expected since FIIs have the twin advantage of both the exchange rate and a high equity prices with the Sensex breaching the 6,000 mark.

When the selling starts, yields would resume the hardening trend, traders said.

During the last few months, accretions to the reserves were mostly in the volatile components. Given this quality of reserves, none of the banks are keen to utilise them for funding infrastructure as recommended by the Government. Bankers warn that such a trend was likely to trigger a huge mismatch leading to severe instability in the domestic banking system. This opinion was also shared by the top brass of the RBI, bankers said.

Forex reserves: For the last reporting week, forex reserves were $123.53 billion. The accretions came from revaluation of the reserves due to a depreciating dollar and rise in gold prices, and accretions from FIIs. Besides with at least 20 per cent of the reserves in the form of other currencies, mainly the euro and pound sterling, the appreciation was substantial. This was because since April and now, the euro advanced by at least 10 per cent against the dollar.

Moreover, traders said that credit balances were partly due to the fact, that some plan and non-plan expenditure were deferred by the UPA Government.

Govt borrowings: Once the drawdown starts, bankers said that the fiscal deficit targets were likely to be breached, in view of the escalating revenue deficits.

The planned fiscal correction would still be a distant dream, they said, since the tax to GDP ratios in the country was still on the lower side, comparable to African levels. The tax to GDP ratio in Europe is currently about 50 per cent, in Korea it is 25 per cent, in Vietnam it is 22 per cent and in China it is 17 per cent. India's tax to GDP ratio is currently only about 8 per cent. The low ratio implied that the public sector borrowings would remain high in the long term. This in turn meant that yields were expected to remain on the high side, with short-term blips.