The Hindu Business Line : Bonds remain subdued in thin trading

Bonds remained subdued in thin and nervous trading as liquidity tightened with inflation and fears of rising oil prices gripping the markets. Traders said that sellers outnumbered buyers in view of the liquidity pressure build up.

The tight liquidity was also triggered by large scale annual sell-off of equities by foreign institutional investors, hedge funds and foreign trust funds, ahead of their accounting year end. In addition, traders said that the incipient signs of a oil price ease off had vanished and oil companies were once again drawing down on their credit lines.

Premia Rise

This tightening was also evident in the foreign exchange markets where one month forward premium moved close to 5 per cent, and 12 months at 4 per cent. Forwards were at a four-year high. But traders said that the premia rise was also partly triggered by large corporate buyouts being planned by domestic companies including the Corus steel bids, which is a leveraged buyout.

This was major propelling element of forward premia, bankers said. The combined effects led to a liquidity squeeze leading to sharp spikes in the call rates. Week-end call rates ended at 9 per cent. But many banks anticipating call rate spikes took recourse to the RBI's repo window at 7.25 per cent. This allowed them to arbitrage between call and the repo window earning a spread of 1.75 per cent. At the week-end liquidity adjustment facility auction, banks took recourse to Rs 23,090 crore of liquidity from the RBI window.

T-bill auctions

Yet, despite this liquidity tightening manifested at the weekly T-bill auctions, for 91-day T-bill auctions the cut-off yields were at 7.10 per cent — the same level as the previous week.

But the weighted yields were also at the same level as the cut-off yield, unlike the previous week when there was a difference of 15 basis points. The bids accepted were just Rs 1,256 crore last week, although the bids made — both competitive and non-competitive — were close to Rs 3,000 crore.

The spread between the 91-day and the 364-day T-bills, however, remained narrow at 14 basis points. The cut-off yield on the 364 day T-bill was 7.24 per cent and the weighted yield was 7.21 per cent. But the ten-year yield to maturity (YTM) dropped to 7.60 per cent last week on a weighted average basis, down marginally from the 7.61 per cent.

Borrowing Targets

However, the outlook for bonds was stable. This was especially in view of statements from the RBI's Deputy Governor, Dr Rakesh Mohan, that the inflation target was 5-5.5 per cent, discounting any possibility of interest rate hikes for the moment.

The Syndicate Bank Chairman and Managing Director, Mr C.P. Swarnkar, said: "Yields will remain range-bound for the rest of the financial year." This possibility was largely due to the reduction in Government borrowing targets for the current year in view of buoyant tax inflows and fiscal deficit remaining well under the targeted 3.5 per cent of the GDP for the current financial year.

Yield Spread

But yield spreads remained narrow supporting the view of soft yields. The yield spread between one and thirty years was 55 basis points. But this narrowing of the yield spread was largely on account of the absence of life insurance companies from the markets during the week. Moreover, the one-year real yield was 190 basis points. This situation implied that there was scope for a yield correction in the coming week, traders said

The flip side risk was the credit growth. Credit off take last fortnight was over Rs 25,000 crore. But the incremental CD ratio was well off the 100 per cent plus figure recorded since the beginning of the last fiscal year at 82 per cent. The easing of the incremental CD ratios was largely on account of a pick-up in deposits in the banking system, mostly from the rural areas partly offsetting the impact of disintermediation of bank deposits. Term deposit rates for 18 months and above are already 8 per cent plus. As deposits are tweaked once more, bankers said the disintermediation process would further decelerate.