The Hindu Business Line : Rising crude, changed outlook on rates pull down bonds

Traders were worried about the deteriorating situation in West Asia and the impact on the oil import bill. Bankers said the weighted average import prices were already above $60 per barrel.

India imports the equivalent of two million barrels per day (2.73 lakh tonnes).

This translated to an equivalent of about $124 million per day. About two months ago, the pricing was an equivalent of just under $105 million.

Faced with under recoveries, several oil companies resorted to short-term borrowings in the form of revolving credits for funding their foreign exchange purchases.

This, bankers said, in turn drove up short-term interest rates and also forward premia, as demand for dollars remained on the higher side.

Credit growth: What also kept up the pressure on the interest rates were the high credit growth.

In addition, most traders were caught off guard by the 25 basis points hike in the repo rates.

Most of them had in fact expected a reduction in the cash reserve ratio by at least another one per cent, to cool the markets and release liquidity.

The combined effect was felt on the domestic liquidity. At the weekly Treasury Bill auctions, the cut-off yield on the 91-day T-Bill jumped to 6.69 per cent, up 50 basis points from the previous week.

The weighted average yields were about 13 basis points lower. But the bids for the 182-day T-Bill were rejected, since all of them were on the higher side.

Traders said some of the bids made last week for T-Bills were at yields of 6.80 per cent. Accordingly, all the bids amounting close to about Rs 670 crore were rejected.

Liquidity during the week remained tight.

Tapping repo window: Most banks resorted to the RBI's repo window for liquidity. At the three-day LAF (liquidity Adjustment Facility) auctions, banks drew Rs 20,100 crore through the repo window, clearly implying that the markets have shifted from a surplus to a deficit situation.

However, the tightness failed to reflect on the 10-year yield to maturity (YTM). The 10-year YTM ended flat at 7.2 per cent.

Few bankers were interested in long bonds. In fact, most of the interest was confined to the short-end. Volatility in the markets was entirely at the short-end of the yield curve, where yields crashed.

But, despite the fall in yields, there were few buyers for short-end securities. Life insurance companies were also absent from the markets. Life insurance companies are mostly buyers of securities with tenors upwards of 10 years. This is the major reason for the yields at the long-end to remain stable.

There were also fears that the equity markets were now overheated. Any reversal in the stock markets could reverberate on the bond markets as well.

The reason for this fear was the virtually flat yield curve, evident from the spreads between one and 22 years.

This spread was 62 basis points. The falling spread was entirely driven by rising short-term yields.

Inflation: Besides, traders said inflation on the upswing at 4.4 per cent reflected in a hardening of one-year real yields, which were at 2.5 per cent.

A correction in real yields could however be under way, according to traders.

This correction was unlikely to be driven by a fall in interest rates; instead it could also come in the form a rise in inflation.

This was because oil price increases are yet to be passed on to end-users.

Weak outlook: As a result, the outlook remains bearish for bond markets, evident from the high forward premia. One-month forward premium was close to 4 per cent and the 12-month was 2 per cent.

The high premia was driven by oil companies taking forward cover, fearing a spike in exchange rates, in the event of crude prices rising further.

Besides, the rising oil prices are beginning to impact the current account.

In fact, during the last three years it was the large inflows from the current account and non-debt capital account that had contributed to creation of domestic liquidity, with a concomitant impact on interest rates.

Besides the external factors, bankers said that high credit-deposit ratios were also becoming a major issue.

Currently, most banks are operating on a nominal credit-deposit ratio of 69 per cent and an incremental ratio in excess of 100 per cent.

With liquidity now drying up and the focus shifting to mopping up deposits, a rise in lending rates now appears imminent.

Lenders are ready for hikes though it could be scheduled only for beginning of the next fiscal.