The Hindu Business Line : Floater ruled out for next auction

Given the past market response to floating rate issues and its subsequent illiquidity, I think the central bank will wait for the committee's report before issuing fresh floaters.

THE Reserve Bank of India surprised the market by announcing an auction on the first day of the year.

Looking at the government's cash surplus, one would have thought that the auction might get delayed, if not cancelled.

One doesn't know the reason behind this promptness, but the only thing that comes to mind is the central bank's discomfort with so much liquidity sloshing around.

There is no doubt that the system is flush with money and both the Finance Ministry and the RBI are unanimous in their view that the key driver of inflation has been liquidity.

So, may be, that is why they decided to push through the auction inspite of a very comfortable cash situation of the government.

If liquidity was the reason behind a prompt first auction, then it is unlikely that even the second auction will get cancelled. A floater is also ruled out for the next auction for two reasons.

One, the issue of pricing and liquidity of floaters is pending with an expert committee of the central bank, which is yet to make its recommendations public.

Given the past market response to floating rate issues and its subsequent illiquidity, I think the central bank will wait for the committee's report before issuing fresh floaters.

Two, the floaters issued earlier were priced off the average of last three 364-day T-bill cut-off yields reset annually but paid semi-annually.

In its effort to correct this anomaly, I believe the central bank has started the 182-day T-bill issuance again from this year. From now on, the floaters will most likely be priced off the average of the last three 182-day T-Bill auction cut-off yields reset and paid semi-annually.

We have seen only one 182-day T-bill auction this year, so the central bank will have to wait for at least two more fortnights before it can auction a floater priced off the 182-day T-bill curve.

Not so much the auction cut-off but the market behaviour post the first auction tells you that inspite of huge liquidity, there is limited appetite for bonds as of now. Banks continue to see healthy credit growth and are unwilling to bet large sums on government bonds at this point. If the sentiment continues to be like this, there is no doubt that another fixed rate auction in the 10-year segment will surely push up the 10-year rate to 7.25 per cent.

It is unlikely that the RBI will hike rates in its forthcoming monetary policy.

Although the economy continues to grow at a healthy pace, inflation has been benign. The headline WPI inflation for March-end at 5.05 per cent is much lower than the central bank's forecast of 6.50 per cent.

With inflation so much lower than what the central bank was comfortable with (or else they would have hiked the rates earlier), it's unlikely that it will hike rates now. But the risk of a hike in the coming months cannot be ruled out.

A closer look at the break-up will tell you that the manufacturing inflation has started creeping up again.

With the long impending fuel price hike and its secondary pass through, we could see inflation climb over the next few months.

A large current account deficit for the third quarter, after a reasonable deficit in the second, makes one believe that the country will have to continue to depend on capital flows to manage its balance of payments till such time as crude prices come down.

The US economy seems to be on a healthy growth path and the Fed will most likely end up pushing its rate to around 4 per cent. In a current account deficit scenario where capital flows become very important, the RBI will have to be more sensitive to the Fed hikes, as it will have a direct bearing on capital inflows.

With the possibility of future rate hikes not ruled out completely and a large government borrowing requirement, the market was not willing to buy large quantity of bonds at rates less that 7 per cent for 10 years. And that is why we saw this correction.

With limited supply in the last three months, the market could manage to move in a 6.50-6.70 per cent range, but a fresh borrowing calendar and bunched-up supply is a different ball game altogether.

Then, in the current circumstances, the market should stabilise in the 7.15-7.40 per cent range for 10 years. At that level, you should see reasonable market interest to buy bonds.

(The author is senior trader, Interest Rates at HSBC Mumbai. The views expressed herein are his own and not necessarily those of his employer.)

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