The Hindu Business Line : Bonds rally; inflation fears weigh on bankers

Traders said that foreign currency inflows into the country also powered the rally. In fact, during last week, several foreign institutional investors and external commercial borrowings by domestic corporates contributed to the expansion of liquidity.

The FII entry was triggered by the absence of any hike in rates by the US Federal Reserve Board. Besides, bankers said, the buoyancy was also caused by the absence of oil companies from the foreign exchange markets. Bankers said that the liquidity was also on account of the big-ticket equity floats during the week.

Surge in deposits

This caused a surge in bank deposits. Bankers said much of the bulk deposits were short term in nature and therefore parked in reverse repos. In addition, this accretion to the deposits also resulted in pushing up reserve ratio requirements, both SLR (statutory liquidity ratio) and CRR (cash reserve ratio). At the weekend Liquidity Adjustment Facility (LAF) auctions, banks parked Rs 30,990 crore in three-day reverse repos. Bankers said, since most of the funds were short-term in nature, the parking was done only in short-term instruments to prevent liquidity mismatches. But the liquidity surge resulted in pushing down yields at the Treasury bill auctions.

The yield on the 91-day T-Bill dropped to 6.36 per cent. The weighted average yield was 4 basis points lower indicating that some of the bids, including the non-competitive bids were actually lower than the cut-off yields. The non-competitive bids also included those by some State Governments that have taken to parking central transfers temporarily in T-Bills as part of their treasury management activities till such time the funds were required.

The preference by those categories of investors was only for the 91-day T-bill. The 182-day T-bill auctions saw cut-off and weighted yield at 6.69 and 6.68 per cent respectively.

Term deposits

But bankers said that there was also a build-up of term deposits, particularly one-year deposits. This was in view of high rates being offered by private sector banks such as the ICICI Bank for mopping up funds. As a result, the 10-year yield to maturity (YTM) plunged to 8.17 per cent on a weighted average basis, down from last week's 8.34 per cent. But the spread between the benchmark 10-year yield and the weighted average was wide. This implied that trades in non-benchmark securities were far higher than in benchmark papers, bankers said. Particularly sought after was the 12.30 per cent 2016, which was sold by some private sector banks at 8.33 per cent and picked up the Life Insurance Corporation of India.

The undertone was firm during the week and was evident from the pick-up in volumes. Daily trade volumes averaged Rs 1,000 crore. This was the first time this year that daily volumes reached this figure. The rise in trade volumes was largely on account of purchases by insurance companies, both life and non-life. Besides, provident funds were also active in picking up government securities.

Bankers said that this rally was likely to be sustained. This was apparent from the narrowing bid-offer spreads. These spreads continued to be between 5 and 10 basis points, between the short and long ends. Besides, the yield spreads between one year and 29 years narrowed to 160 basis points. Bankers said that this was largely on account of purchases by provident funds.Besides, banks are likely to remain active, if the current pace of insurance accretions continues, traders said. Life insurers, for instance, have seen 120 per cent increase in premium collections on a year-on-year basis.

Besides, real yields remained high. With inflation at 4.61 per cent one-year real yield was 2.34 per cent. This was at least 130-basis points above internationally acceptable levels. Traders said that accordingly there was scope for some more corrections in real yields, either through a fall in yields or a rise in inflation.

A retreat in nominal yields was likely since dated securities issues are slotted for the next week. Expectations are that government borrowings are likely to be far less than what is budgeted for the current year. This is in view of buoyant revenue receipts. Consequently, traders said that the fiscal deficit was likely to be reined within the budgetary targets.

But inflation fears weighed on bankers. They said that the current inflation numbers failed to reflect the high oil prices.

On the basis of the fiscal estimates for the current year, the nominal GDP growth is estimated at a conservative figure of 9.75 per cent. Money supply has expanded at double that estimate, triggering the inflation fears.

The high credit-deposit ratios also fuelled the fears. Nominal ratio was 71 per cent on the basis of a year-on-year credit growth of 31 per cent.

The incremental ratio, however, was just 51 per cent. This was driven by the chase for deposits. This chase is likely to intensify in the coming days as more banks begin upping deposit rates ahead of the peak season.