The Hindu Business Line : High credit offtake keeps yields firm despite easy oil

Bonds remained range-bound supported by the global crude oil price retreat, but high credit offtake prevented yields from softening in the current busy season.

Traders, however, remained tense over repeated statements from the Finance Ministry over the proposed thrust on lending to physical infrastructure sectors and fiscal tightening. In fact, the Finance Ministry is for greater bank finance availability to the physical infrastructure sector, especially power, roads, shipping and ports. This would cause a further acceleration in the credit growth from the current 30 per cent on a year-on- year basis. The proposal when it materialises is likely to choke off credit taps to housing /real estate sectors and open the same to the physical infrastructure sectors, they added.

Bankers also said oil companies' drawdown from their credit lines had reduced with the southward movement of oil prices. Oil prices remain at $58 a barrel. But expectations are that prices could move further southward in the coming weeks since the immediate possibility of a conflict involving Iran has receded. Forward premia, as a result, moved down.

Forward premiums down

Besides, large inflows are expected in the form of long-term external commercial borrowings by banking institutions. The latest is Canara Bank raising $300 million dollars and possibly State Bank of India and corporates such as the Reliance group. This pushed premiums down across all maturities to a range of 1.8 per cent for one month and 1.7 per cent for 12 months. The reduced forward premia was also due to some of the foreign banks swapping their dollar funds for rupees for meeting their domestic funding requirements.

Corporate disintermediation has ensured that liquidity is not an immediate problem. This was evident from the Rs 8,960-crore mop-up through reverse repurchase operations at the 3-day weekend liquidity adjustment facility auctions. This liquidity was also partly caused by the RBI's rejection of competitive bids at the 91-day T-bill auctions in favour of non-competitive bids. There were competitive bids for Rs 3,200 crore, though RBI accepted only about Rs 989 crore and another Rs 200 crore by way of non-competitive bids. The notified amount was Rs 2,000 crore including the market stabilisation Scheme. Similarly at the 364 day-T-bill auction, the bids were Rs 4,500 crore, though the actual bids accepted were to the tune of Rs 2,000 crore.

Bankers said that this high level of bids at the auctions indicated that liquidity clearly was not a problem. In fact, the non-competitive bidders for the 91-day T-bills were mostly corporates, life insurance companies and some state governments, as part of their treasury management. The cut-off and weighted average yield for the 91-day bill was 6.65 per cent. For 364-day bill it was 6.99 per cent.

As a result, the ten year yield to maturity retreated to 7.61 per cent last week on a weighted average basis, as against the previous week's 7.66 per cent.

Firm undertone

The firm undertone was evident from the high trade volumes, that averaged Rs 1,500 crore daily. The outlook also remained bullish, apparent from the continuing narrow yield spread. In fact, the yield spreads between one and 30 years dropped below 100 basis points for the first time since 2004. The fall in the spread, bankers said, was driven mostly by the large demand from insurance companies for long-dated papers, particularly from Life Insurance Corporation and other life insurers. Moreover, the bid offer spreads also remained narrow at the long ends on account of demand from the insurers at about 5 basis points.

The optimism also stemmed from the receding inflation, with the oil price effect kicking in. Inflation based on the wholesale price index was 5.01 per cent. This translated into a one-year real yield of 2 per cent. This implied that there was sufficient scope for a drop in yields.

The possibility of a further drop in yields was also largely on account of accretion in reserve money and deposit inflows. The reserve money was largely on account of the FDI flows and on the basis of the positive ratings for the Canara Bank issues. The Moody's have rated the $300 million medium term notes at Baa2, which is investment grade and one notch above sovereign rating. But the sovereign rating has not been altered, through the market is abuzz that the country is due for an upgrade investment grade. An investment grade rating would reduce the risk premiums payable. LIBOR spreads for investment grade borrowers are currently in the region of about 60-100 basis points bracket.

High intervention costs

In fact, currently there is no encouragement for inflows into the country in view of exchange rate, inflation risk and holding cost implications. For instance, the intervention costs are currently 6 per cent, evident from the reverse repo rate. But the maximum yield realised on RBI's investment in U S treasury bills is just about 4 per cent plus or a loss of 2 per cent. Besides, bankers said, deposit accretions were mostly at the short-end. Reserve money has expanded by 15.8 per cent on a year-on-year basis, but net foreign exchange assets have increased by 16.5 per cent.

Consequently, corporates are being encouraged for cross border acquisitions and end use of cross border resources are closely being monitored, bankers said. So with regulated expansion in reserve money, volatility in yields would be minimised, bankers said.

But bankers have indicated that yields could also firm up. This was in view of the possibility of a large scale redemption of bulk deposits, unless refinanced. In fact this was exactly what the banks were resorting to through an accelerated deposit mobilisation drive, particularly savings bank deposits.

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