The Hindu Business Line : MSS bonds redemption powers market rally

Bankers said what also powered rally was the redemption of some of the market stabilisation scheme (MSS) securities issued in August, through the 91-day Treasury bills, estimated at Rs 8,000 crore. This was after netting for fresh mop-up through T-bill auctions.

Oil prices are now less than $55 a barrel, reflecting a sharp drop in import prices. At least 60 per cent of the imports are tied up at prices linked to the Dubai and Oman crude prices. The remaining 40 per cent is done through the spot markets. The fall would now mean that the weighted average import prices are less than $50 a barrel.

Yields decline: Optimism on the oil sector and the liquidity infusion resulted in pushing down yields at the week-end reverse repo auctions. The repo auctions resulted in bids amounting to Rs 3,685 crore, signalling a turnaround in tight liquidity situation. This also reflected in treasury bill auctions, where the cut-off yields on the 91-day T-bill dropped to 5.74 per cent, from the previous week's 5.82 per cent. Similarly, the yields on the 364-day T-bills also dropped to 5.94 per cent, from the previous auction's yield of 5.97 per cent.

The improved liquidity situation also helped the auction of the 8.35 per cent 2022 security. The yield on this paper was brought down to 7.43 per cent, though almost the entire subscription was from primary dealers and life insurance companies. Bids amounted to Rs 14,000 crore, though the retention was only Rs 5,000 crore.

Despite these mop-up, the 10-year yield to maturity (YTM) continued to retreat for the second straight week. The 10-year YTM on a weighted average basis was at 7.10 per cent, down from 7.13 per cent the previous week.

Volumes low:Despite slight improvement in liquidity, trading volumes continued to remain low. The daily average volumes were less than Rs 2,000 crore. Traders said the low interest in trading stemmed from bankers' disinterest in picking up securities.

Despite the improvement in liquidity, the largest buyers of securities were life insurance companies, both the public sector and the private sector.

Traders said that many banks realised huge profits on their sale and this is likely to help their third quarter results if the liquidity maintains the current trend.

Bankers' focus: Bankers were focussed on meeting credit demand that continued to grow at above 30 per cent.

However, spreads narrowed. The spread between one and 23 years moved to 155 basis points against 160 basis points. The falling spread was indicative that more liquidity was likely to flow into the markets as more securities from the MSS redemptions come in.

Bankers said other sources of liquidity expected were coupon flows and reserve money accretions from potential foreign exchange inflows. Anticipating this, the RBI had prepared for a second intervention through the liquidity adjustment facility. This would help mop up the excess liquidity created by interventions in the foreign exchange markets. Already, many bankers are expecting that the current account would return to black once again powered by a surplus on the trade account and invisible flows. Moreover, there were also expectations that the capital account would also continue to remain buoyant with non-debt inflows.

Forward premia trend: This optimism was evident from trends in the forward premia, which remained less than one per cent for up to one year.

If the outlook on any of the variables, current or capital account, were dim, the first sign would usually be on the forward premia.

Bankers said this has not happened since many of the exporters, companies planning to pump in capital to their domestic ventures, including insurance companies, were beginning to take forward cover.

As a result, forward premia between three and 12 months varied between 0.4 per cent and 0.5 per cent. Only the one-month forward premia was above one per cent. This was particularly because some of the bankers were taking forward cover, anticipating redemptions of millennium deposits.

Despite this optimism, foreign exchange reserves dropped by $127 million partly on account exchange rate corrections and due to drawdown for meeting external payment liabilities on sovereign obligations, traders said.

What also helped the markets was the inflation at 4.2 per cent. At this level, the real yield for one year was 1.75 per cent.

Buoyant credit: Traders said what could prevent yields from large falls was the buoyant credit demand, especially non-food credit. Bankers are operating at incremental credit-deposit ratios of over 100 per cent. If this credit demand were to be sustained, bankers said, deposit flows would have to start.

Moreover, many are beginning to look at long-term working fund accretions in the form of Tier II bonds, in view of the significant advantages.

Tier II bonds are long-term funds and are exempted from SLR and CRR till such time they become regular liabilities when the residual tenor drops below five years. As a result, more bankers are opting for this route of fund raising at coupons of 7 per cent.

Spreads to widen: As credit demand rises, bankers said corporate-sovereign spreads would widen as rates would begin to align closer to the prime lending rates. Currently, large corporates are raising funds at rates lower than the PLR.

These corporates would increasingly be pushed into the bond/debenture markets and the second entities would be extended funds, thereby cutting the cross subsidy of lending rates.

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