The Hindu Business Line : Bond traders look to Credit Policy for cues

Traders said that what also ensured firm yields was the absence of insurance companies, mutual funds and provident funds. Insurance companies and mutual funds, traders said, had pitched for purchases in the primary markets. Along with primary dealers, insurers were the biggest buyers for the RBI's auction of the 10-year and 28-year securities last week.

Insurers' bids were also one of the major factors that ensured that the yields on both these securities overshot expectations by a huge margin, traders said.

Last week, the 10-year security was placed at 7.59 per cent and the 28-year 2034-7.5 per cent security at 7.97 per cent. Both these placements had stunned the markets that expected the pricing to be far lower, given the sudden influx of liquidity.

LAF auctions

That there was a liquidity overflow was evident from the two week-end liquidity adjustment facility auctions. The RBI's mop-up through the four-day reverse repurchase operations was the highest, Rs 57,000 crore, in two years, . Besides, at the weekly Treasury bill auctions, the yield on the 91-day security plunged. This was despite the high cut-off yield fixed for the dated securities. The cut-off and weighted yields on the 91-day Treasury bill were 5.49 per cent, down 29 basis points from the previous week. This is the first time in two years that the 91-day T-bill yield has declined below the reverse repo rate of 5.50 per cent. Similarly, the 364-day T-bill also fell to 6.06 per cent and the weighted yield to 6.04 per cent.

Yields harden

However, despite the liquidity overhang, the 10-year yields hardened. The 10-year yield to maturity (YTM) was at 7.56 per cent on a weighted average basis, up from the previous week's 7.45 per cent. The hardening was entirely due to the high cut-off yield fixed on the 10-year security, traders said.

Traders made money last week, especially primary dealers. This was because many of them were able to liquidate the new 10-year security at 7.54 per cent, though banks by and large remained at the lower end of the yield spectrum.

Crude rates

Bankers are still wary of a liquidity tightening. This was on account of high international oil prices, which are again on the verge of breaching $70 a barrel. This fear reflected in firm real yields at 2.55 per cent, up from the previous week's 2.36 per cent, despite the lower inflation of 3.51 per cent.

This trend also reflected some underlying concerns among bankers. Bankers said they do not expect any major changes in either the Cash Reserve Ratios or the hikes in the repo rates since there were fears that it would retard growth in industrial and farm sectors.

Minor changes

However, some changes are expected in risk weighting and provisioning. This was especially since real estate loans were becoming a problem area for banks.

This kind of banking regulation was likely to squeeze credit to the sector that is feared to damage the asset books of the banking sector. But the undertone in the market was firm, evident from the improving volumes. Daily trade volumes were Rs 2,000 crore and more improvement was expected. But bankers said most of the trade was focussed at the short-end of the yield curve.

This was evident from the steep yield curve.

The steep curve was apparent from high spreads between one year and 29 years. This spread was 185 basis points, up from the previous week's 151 basis points. The steep curve was also on account of the large inflow of foreign institutional investors' funds.

Since most of them tend to be short-term players, bankers preferred to remain at the short-end of the yield curve, so as to avert any liquidity problems and associated losses in the event of the sudden withdrawals.

Bankers' preference

Besides, bankers said that the preference was to remain liquid at all times. This was especially since credit growth was buoyant. Nominal credit-deposit ratios were 72 per cent and incremental continued to be above 100 per cent, though this is likely to see some changes in the weeks ahead, as deposit growth begins to pick up and soak up the high investment-deposit ratios.