The Hindu Business Line : Bonds weak on concerns over oil prices, US rates

Traders said the weakness was also due to the equity market collapse, leading to large outflows. Foreign institutional investors, as a result, were large foreign exchange buyers, triggering large-scale G-Sec sales, traders said.

Besides, oil companies were also in the foreign exchange markets for meeting their crude oil import obligations. In fact, the oil companies continued to remain large borrowers for meeting their foreign currency requirements for oil purchases.

Consequently, the pressure exerted by the high prices was likely to ensure that the current account remained in deficit. Yet this deficit has failed to impact the forward premia in the markets. This was mostly on account of large. During the last few days, exporters, foreign currency borrowers and corporates that made FCCB issues took advantage of the sudden fall in the rupee and cancelled their forward cover at the current levels.

In addition, there was also a build-up of liquidity with State Governments drawing on their Centrally allocated funds. As a result, at the weekend three-day liquidity adjustment facility auctions, the Reserve Bank of India mopped up about Rs 57,000 crore from the market through the reverse repo window.

Yet, the Treasury Bill yields at last week's auctions rose. The 91-day T-bill yield rose to 5.70 per cent up slightly from 5.65 per cent the previous week. The yield on the 364-day T-Bill at 6.42 per cent, however, moved closer to the repo rate of 6.50 per cent. This was partly on account of the RBI interventions in the foreign exchange market midweek on account of oil and FII-driven purchases.

The weakness pushed the 10-year yield-to-maturity up further. On a weighted average basis, the 10-year YTM was 7.63 per cent last week, up slightly from the last week-end.

That the undertone was weak was evident from the low trade volumes. In fact, most trading was at the short tenor G-Secs. Normally, it is the Life Insurance Corporation, provident funds and public sector non-life insurers that have appetite for long duration securities. Insurers have restricted their purchases of government securities. Instead, traders said that LIC and the insurers were pushed to the equity market to prevent any sharp depreciation of their portfolios following FII sales.

High yield spreads

The outlook for the market was also weak. The weakness was evident from the high yield spreads. The yield spread between one year and 29 years was 175 basis points implying a steep yield curve. Moreover, buy-sell spread also remained high indicating low interest. The spreads were about 10 basis points at the short end, but as high as 25 basis points at the long end.

Despite the rise, nominal yields and real yields fell. Traders said that the drop in one-year real yields was largely on account of rising inflation as measured by the wholesale price index. The real yield accordingly was 2.13 per cent down from the previous week's 2.4 per cent.

Traders said that despite the softening of real yields, nominal yields were likely to remain stable at current levels. This was because FII exodus was expected to continue since US yields have become more attractive. But FII exit is likely to be offset by continued accretions to reserve money through foreign currency flows, particularly on the current account and from NRI deposits. Besides, bankers said insurers were likely to step in to support the markets since long- term yields appeared to have stabilised at current levels.

Moreover, with the RBI hiking the risk weightage on real estate sector to 150 per cent, advances to the sector are choked , bankers said. These resources are likely to be parked in short-term G-Secs, bankers said.

Impact of clampdown

The first stage of the clampdown on real estate lending was beginning to have its impact. For the first time, non-food credit showed a negative growth. However, despite the negative growth, non-food credit is expected to show a sharp pick-up. This was on account of the rush to farm lending by large banks. The focus to raise farm lending was driven by the possible positive impact on net interest margins.

For funding the advances, banks are now liquidating their non-SLR investments comprising debentures, preference shares and commercial papers.