The Hindu Business Line : Bond trade nervous over tightening liquidity

Bonds remained stable last week, but traders were nervous over the tightening liquidity and fears of further instability in West Asia after the execution of Saddam Hussein.

Traders said with the Reserve Bank of India limiting the intervention in the foreign exchange markets, liquidity had turned tightThey said that most of RBI's interventions were taking place only in the forward markets. This was evident from the inverted forward premium, with high rates at the short end and low rates at the long end. Three-day forward premia, cash to spot was 24 per cent, where as three, six and 12 months 4.5 per cent, 3.9 and 3.1 per cent respectively.

What was also contributing to the tight liquidity was the rush by the oil companies to draw on their credit lines and simultaneously take forward cover.

This was in anticipation of an increase in oil prices as instability increases in West Asia. Oil prices are currently about $61 a barrel. For domestic importers, this translates into a weighted average price of about $55 a barrel.

New CRR norms

Traders also said the tightening partly resulted from compliance to the new cash reserve ratio norms. The new CRR norms became effective from December 23. The second phase becomes effective from January 1. The effect on liquidity is estimated at Rs 12,000 crore. Short term liquidity squeeze, as a result. pushed up call money rates close to 20 per cent.

The combined effect of all these trends was reflected at the weekly Liquidity Adjustment Facility auctions. Banks drew down a record Rs 34,200 crore through the repurchase window of the RBI. 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 repo window, earning huge spreads.

The RBI continued to exercise restraint at the Treasury bill auctions. As against the notified amount of Rs 2,000 crore, and bids made of Rs 3,850 crore (both competitive and non competitive) at the 91-day Treasury bill auction, it accepted bids for just Rs 630 crore at a yield of 7.10 per cent. Similarly at the 182-day T-bill auction, the competitive and non-competitive bids received were Rs 2,120 crore, as against the notified amount of Rs 1,500 crore. If there were indeed a liquidity tightness, the bids made would have been far short of the notified amount, bankers said.

That the liquidity was a short-term problem was also evident from the week-end closing of the ten-year yield to maturity (YTM). The ten-year YTM ended at a weighted average of 7.61 per cent, almost unchanged from the previous week 7.60 per cent. Even the new benchmark security 7.46 per cent 2007 failed to reveal any trend of tightening liquidity. In fact, the YTM on this security was aligned with the weighted ten-year yield.

But, some bankers said, this was also largely because there was a shortage of securities with some banks. Consequently no trades could be made. Bulk of the securities, in the held for trading and the available for sale categories, had already been used in the collateralised borrowing and lending obligations market.

Outlook flat

The outlook for bonds remains flat. This was evident from the thin trade volumes. Daily trade volumes were under Rs 200 crore, the lowest in five years. But yield spread also narrowed further. The yield spread between one and thirty years has shrunk to under 50 basis points. Normally a flat yield is a pointer to an economic slowdown. But, bankers said that there was no cause for concern for a slowdown, in view of a high credit off take, particularly term credit.

Bankers now expect a further hardening of yields in the coming year. This was on account of redemptions of past MSS securities, reduced government borrowings and above all, maturing of RBI's interventions in the foreign exchange forward markets, during the last few weeks.

The fundamentals point as well to softening of yields. This was evident from the high one-year real yields of over two per cent. Normally, the preferred one year real yield is about one per cent, in line with international trends. Consequently, traders said that there was scope for a retreat in the coming weeks. The retreat was expected also on account of the acceleration in deposit mobilisation by banks. Deposit growth, bankers said, had accelerated to 24 per cent after the tweaking of interest rates.

But the focus was on raising the yield on assets. Consequently bankers said the focus was shifting to the longer end of the yield curve, where the yields were attractive currently as against the short end.

More Stories on : Debt Market | Financial Markets

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Chill in north as New Year dawns

Coffee Day, Coca-Cola top bids for kiosks at Railway stations

`Bad hire' costs zoom in tech sector

Hoping for better fund managers in 2007

Grasim Industries to launch new generation viscose fibre

ONGC voices concern over dual allotment of coal blocks

Year of strong growth for banking sector

Customised cover turns reality from today

Listless trade likely to mark New Year beginning

Bond trade nervous over tightening liquidity

The pain and the gain on celluloid