The Hindu Business Line : Bankers gearing up for sharp yield spikes

Traders said that oil companies were active picking up foreign currency for meeting their import payments since international prices were below $60 a barrel.

This translated into a weighted average price of less than $55 a barrel. Oil companies were also making purchases to contain losses due to exchange rate depreciation.

Bankers were selling securities to meet credit demand for the peak season.

During this season credit growth normally tends to pick up.

Liquidity tightening: The combined effects of foreign currency demand, and high credit growth resulted in a liquidity tightening during the week. Besides, the Government also mopped up Rs 8,000 crore from the markets through the twin auctions.

The 7.49 per cent 2017 security was placed at 7.33 per cent and the 30-year 7.40 per cent 2035 paper at 7.73 per cent.

The combined effects resulted in tightening of liquidity, which pushed up the yields at the Treasury bill auctions.

The cut-off yield on the 91-day T-bill was 5.82 per cent, up from the previous week's 5.70 per cent. The yield on the 364-day T-bill also moved up to 5.98 per cent, closer to the bank rate of 6 per cent.

This was up from the previous week's 364-day T-bill auction of 5.84 per cent. As a result, at the weekend reverse repo auctions, the mop-up amount dropped to a three-year low of Rs 1,500 crore.

Tapping repo window: Instead, some of the bankers took recourse to the repo window (banks' short term borrowing from RBI through placement of securities) for Rs 2,440 crore, indicating tightening of liquidity.

Yet, traders said that it was premature to expect any hike in the bank rate or the reverse repo rate. Such hikes could be expected only if the T-bill yields remain above the bank rate/ repo rate for a sustained period, they added.

The tightening liquidity was also evident from the movement in the 10-year yield to maturity (YTM).

The 10-year YTM firmed up to 7.17 per cent on a weighted average basis last week, up from 7.15 per cent.

This was partly on account of the high volumes traded in the coupon papers, particularly the 11.43 per cent 2015, 11.50 per cent 2015 and the 9.85 per cent 2015 at yields of about 7.19 per cent.

Yields harden: The preference for these papers by insurers resulted in hardening of yields for the benchmark 7.38 per cent 2015 per cent, where the yields firmed up to 7.13 per cent, from the previous week's 7.05 per cent.

Trading volumes: The undertone remained weak, evident from the low trading volumes which were at Rs 1,500 crore, indicative of bankers' low interest in bonds.

However, the spreads between one and 23 years narrowed slightly to 157 basis points from 170 basis points.

The narrowing was partly on account of the rise in short-tenor yields, where the bulk of the trade volumes were concentrated. The hardening of yields of these tenors indicated low demand for even these papers.

One reason being the banks' disinterest in these papers because most of them have completely derisked their investment book, implying an average tenor of just about one year.

In fact, few banks were interested in picking government securities, evident from the falling investment- deposit (ID) ratio.

The ID ratio has dropped for the first time in three years to below 40 per cent and on an incremental basis is already negative.

This implied that all the incremental deposits were increasingly being deployed entirely into credit.

Moreover, bankers said that the statements made by the Finance Minister on containing inflation also helped yields move up.

In fact, despite the rise in inflation to 4.75 per cent from last week's 4.4 per cent, real yields held steady at 1.2 per cent.

Bankers said that yields were poised to rise in the coming weeks. This was evident from the fact that the RBI has indicated the rupee was still overvalued on a real effective exchange rate basis.

RBI signal: Traders have interpreted this as a signal that the policy of restrained intervention would continue, indicating that the RBI would allow the rupee to drop further.

Bankers said that this would lead to further firming of yields as oil companies and importers start moving in to cover their exposures.

Delay in remittances by exporters and exchange rate fluctuation changes pushed down the foreign exchange reserves by $1.156 billion.

This move by exporters however has helped to neutralise the liquidity build up. .

But, bankers said that the most critical yield driver in the coming weeks would be credit offtake.

Credit offtake continues to be high, with most banks reporting credit-deposit ratios in excess of 66 per cent and incremental ratios of close to 100 per cent.

In addition, government borrowings are still not concluded which normally takes place before the end of the third quarter, when the Budget exercise starts.

As a result, bankers are now preparing for sharp yield spikes.

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