The Hindu Business Line : Bond yields harden on liquidity, inflation worries

Traders said that the yield spike was also triggered by the Reserve Bank of India's restraint in interventions in the foreign exchange markets and insurers logging out of government securities. Most interventions were taking place only in the forward markets to support exporters worried over the rupee's appreciation against the dollar.

Interventions in the forward markets were also done to mitigate the impact on domestic liquidity and the consequent effect on inflation. Money supply growth is already at 20 per cent, way above the targets prescribed by the RBI. Moreover, traders said that this kind of policy doctrine blunted the market impact of the government's decision to extend greater flexibility to the RBI for fixing the statutory liquidity ratio. As a result, liquidity remained tight. At the liquidity adjustment facility auctions, the banks took recourse to the RBI's repurchase window for meeting the liquidity requirements of Rs 20,430 crore. However, the feeling was that the tight liquidity situation was temporary.

Temporary tightness

The temporary nature of the tight liquidity situation was evident from the trend at the weekly Treasury Bill auctions. At the weekly Treasury Bill auctions, the cut-off yield on the 91-day T-bill remained steady at last week's 7.14 per cent, and the weighted average yield 8 basis points lower, unchanged from the previous week. But at the auctions, the RBI accepted Rs 2,000 crore of the competitive bids and another Rs 2,000 crore of the non-competitive bids. Similarly, atthe 182-day T-bill auctions also, yields moved lower to 7.14 per cent and 7.12 per cent. But the amount mopped up was Rs 1,500 crore from competitive bidders and another Rs 400 crore from non-competitive bidders. In addition, during the week, was the placement of the 8.33 per cent 2036 security. The security was placed at 8.23 per cent and the entire amount of Rs 4,000 crore was mopped up. In both the T-bill auctions, the retained amounts were way above the notified amounts.

Traders said that the high fixing of the 30-year yield and the aggressive mop-ups in the Treasury Bill auctions signalled that the RBI was not prepared to accept any major softening of yields below current levels. The 10-year yield-to-maturity, as a result, dropped to 7.71 per cent on a weighted average basis, down from 7.57 per cent the previous week.

Low trading volumes

The undertone was weak. This was apparent from the low trading volumes. Daily trade volumes were barely Rs 500 crore. The yield spreads between one-year and 29 years also widened to 91 basis points inder strong selling pressure. In the previous week, the yield spread had dropped to under 50 basis points.

Traders said that this was largely on account of a large number of banks attempting to sell some of their holdings of long dated securities or resort to the collateralised borrowing and lending obligations for meeting their liquidity requirements. Insurers are normally the buyers, but last week the insurers restrained their purchases waiting for yields to harden. This was also partly driven by the surge in inflation.

Besides, the pressure on liquidity was driven by the strong credit off-take from the banking sector, particularly corporate credit. The incremental credit deposit ratio that was 144 per cent during the last week.

Bankers said that the high credit off-take was partly on account of some of the oil companies attempting to lock into the current low prices. . During the last quarter, some banks, including foreign and private sector banks, extended the maturity of their investments to over two years, anticipating a softening of rates.

Credit demand and restrained interventions have, however, resulted in some of them incurring losses. These banks are now attempting to cut losses due to depreciationin the event of yields hardening further. Besides, bankers also said that given the pace of credit growth, some more tweaks in deposit rates were likelyfor long maturities.