The Hindu Business Line : Life insurers' buying supports bonds

Traders said life insurance companies extended support to bonds, beingbuyers of government securities during the whole of last week. Besides, with deposit accretions in banks, particularly short-term deposits, bonds remained the most attractive destination for parking funds, they said.

Traders said that there was a rush byoil companies for covering their import exposures. Oil companies since late last month had left some of their exposures uncovered, anticipating oil prices to fall below $40 a barrel and the dollar to weaken further. With both these expectations belied oil companies rushed to the markets, traders said. Oil prices towards the week-end breached $48 a barrel.

The country, as on December, imported an average 2.1 million barrels per day. Although Indian imports were a mixture of both heavy and light crudes, traders said increase in prices would still substantially impact the oil bill.

Strong liquidity: These trends failed to impact the markets immediately in view of the strong liquidity induced by deposit inflows from both corporate and retail sources. This was evident from the three-day reverse repo auctions on Friday.

The outstandings on the reverse repo auctions was upwards of Rs 14,000 crore.

However, at the 91-day T-bill auctions, yields hardened 12 basis points to 9.32 per cent last week, up from 9.20 per cent. Moreover, there were also no large non-competitive bids in the auctions unlike in the past

One reason for this trend was that short-term deposits in banks presently offer rates close to 5 per cent.

Non-competitive bids: Unless 91-day T-bill rates cross this threshold, not many corporates were expected to make non-competitive bids, bankers said.

Traders said that non-competitive bids were also unlikely to take place in the near future, since, despite short-term trends, liquidity was expected to remain somewhat tight. This was evident from the weighted average 10-year yield to maturity (YTM). The 10-year YTM was 6.73 per cent last week, up from the previous week's 6.65 per cent.

Positive inflation: The hardening of bond yields took place despite the positive inflation numbers. Inflation last week dropped to 5.78 per cent.

At this inflation level, the one-year YTM at 5.77 per cent is virtually on a par with inflation. Real yields are becoming positive after a gap of almost seven months.

However, the positive real yields did not imply that nominal yields would begin sliding, traders said. The signs were evident from the drop in trading volumes. Average daily trading volumes were barely Rs 2,200 crore during the week.

Weak outlook: That the outlook was weak was also reinforced by wide spreads. Spreads between one year and 23 years continued to remain wide at 125 basis points. Further, the yield difference between the 91-day T-bill and one-year government securities at 45 basis points indicated that the long-term outlook for bonds remained uncertain.

Turbulent forex: Traders said that one of the major factors for this expectation was the turbulence in the foreign exchange markets. Traders were expecting another hike in the US Fed funds by 25 basis points. Traders said that this would set the stage for a dollar rally and hence a weak rupee which could drive more oil importers into the markets giving a further impetus for yields to harden. Already, yields at the short-end were hardening whereas the long ends, upwards of 15 years, were more or less stable.

Besides, traders also said that more hedge funds, which had gone overweight on India during the last few months were likely to exit if the US hike materialised. the foreign exchange The forex reserves dropped by over $2 billion last week, the highest drop in a week since two years. Traders said that the drop in reserves were also partly because the RBI had sold dollars to ensure stability in the foreign exchange markets.

Forward premia: Further hardening of yields appeared imminent, especially since the forward premia for one month was over 5 per centOil cos' charge for forward cover coincided with the FII rush. This was also particularly because few exporters have opted to repatriate their earnings. Most exporters continued to defer their receipts leading to a hardening of forward premia.

Moreover, bankers said, there was also fear that more Government borrowings would start during the course of this month. There was already a big shortfall in direct tax revenues and this was expected to translate into a higher fiscal deficit during the year.

Fiscal deficit: Banks estimate the fiscal deficit to be in the region of at least 5.8 per cent of the gross domestic product, way above the targets.

Credit demand also remained buoyant. Offtake was about Rs 67,000 crore for the latest reporting week, powered by non-food credit and a credit-deposit ratio of 63 per cent.

Bankers said that yields would rise further to sustain this kind of credit growth. Corporate borrowings currently cost at least 300 basis points over sovereigns.

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