The Hindu Business Line : Bonds firm up on buying interest

Traders said that most of the banks were also buyers during the week for meeting the statutory liquidity ratio requirements, due to large deposit inflows. What also helped bonds was the reduced presence of oil companies in the foreign exchange markets, anticipating a further weakening of international crude prices.

Last week, oil prices fell $73 a barrel, pushing the basket import prices to under $70 a barrel.

Little impact of hike

Traders said that last week's hike in reverse repo/repo rates by 25 basis points had little impact. The markets largely discounted the hikes. In fact, despite the hikes in the reverse repo and repo rates to 6 and 7 per cent respectively, the cut-off yield and the weighted yield on the 91-day Treasury bill remained at 6.44 per cent, at the same level as in the previous week.

Similarly, the 182 Treasury bill yields were also fixed at 6.75 per cent. Both these rates were within the new repo-reverse repo band.

At the three-day liquidity adjustment facility auctions, the Reserve Bank of India mopped up over Rs 44,000 crore through its reverse repo window. This was despite the RBI signalling a tightening of liquidity at the quarterly credit review. But the increase in the reverse repo rates increased banks' spreads from arbitraging between accretions into the short tenure deposits of about 90 days and the reverse repo window to about one per cent.

The 10-year yield to maturity also softened slightly to 8.34 per cent last week on a weighted average basis, down from the previous week's 8.41 per cent. However, the 7.59 per cent 2016 security dropped 8.25 per cent last weekend. Bankers said that the 12.30 per cent 2016 security was placed by some of them with the life insurance companies at 8.55 per cent. At least Rs 10 crore of this particular security was bought by the insurance companies on the last trading day of the week.

Trade volumes low

Despite the slight firming up of bond prices, volumes remained depressed. Daily trade volumes last week were barely Rs 600 crore. Bankers said that volumes were limited by competing demand for insurers' funds from the equity markets. But for the presence of insurance companies, provident funds and mutual funds, volumes would have been lower. In many cases where the Life Insurance Corporation was shuffling portfolios, switching short tenure securities for long tenure, yields were kept high for the latter category. Bankers said that this was because insurers took full advantage of the banks' appetite for short-dated securities. This allowed insurers to push for high redemption yields on their purchases. The preference for short-dated securities allowed the RBI to place the 7.55 per cent 2010 per cent at YTM of 7.69 per cent last week.

Despite purchases by insurers, bankers said interest in debt trading continued to be low-key. But bankers said insurers were parking accretions in short-term bank deposits. This was also one of the major factors driving the interest in short-term securities and reverse repos. This was because accretions to the unit-linked funds of life insurance companies were mostly or entirely in growth schemes. Clearly this indicated the preference for equity markets. This was evident from the continuing high buy-low spreads. The spreads varied from 15 basis points at the short end to as high as 25 basis points at the long end. Besides, yield spreads between one year and 29 years remained at 190 basis points, indicative of bear domination. Moreover, traders said this outlook was evident from the high real yields for one year. This was 2.5 per cent for one year, based on the WPI (wholesale price index) inflation of 4.52 per cent.

Policy trends

The bearish outlook was largely driven by some policy trends initiated by the RBI. This included raising the ceiling on investments by mutual funds in the international markets to $2 billion. Traders said that this move would have the double impact of containing expansion of liquidity through reserve money accretions and at the same time reduce the cost of intervention. In fact, intervention costs have been on the ascent for the RBI since the last hike in the Fed funds rate to 5.25 per cent. The yield on one-year US treasury is 5.01 per cent and the mop-up costs 6 per cent, indicative of a deficit of 0.99 per cent.

Similarly, the options for cutting losses through treasury operation have also shrunk. But this kind of policy decision was likely to be beneficial for aligning the nominal exchange rate with the REER (Real Effective Exchange Rate). Currently the nominal exchange rate is overvalued by at least 7 per cent, bankers said.

In addition, bankers said that credit off-take was continuing unabated. Nominal credit deposit ratios were 71 per cent last week. Credit off-take was 31 per cent over the previous year and deposits have grown only by 21 per cent. Some banks are already faced with large mismatches, prompting them to hike deposit rates. Private sector banks are already offering 8 per cent for maturities up to a year. Public sector banks are pushing for hikes in the savings bank rates, which is currently their low cost pool of long-term funds. But some have begun offering higher rates for long-term funds to avoid mismatches, though only for bulk deposits. This is expected to be extended to retail depositors as well in the coming weeks.