The Hindu Business Line : Bonds steady; trading listless ahead of Budget

Business Daily from THE HINDU group of publications Monday, Feb 26, 2007 ePaper

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Money & Banking - Debt Market
Bonds steady; trading listless ahead of Budget

C. Shivkumar

Liquidity improves; more securities in market on `recap' conversion

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Bangalore Feb. 25 Bonds remained stable in thin and listless trading during the week as anxious traders waited for the Union budget.

Expectations were that inflation control measures could be tightened at the fiscal level, as the Reserve Bank of India appeared to have called a pause in monetary measures. Few traders are, however, expecting any harsh measures. This was especially since the Government was well within the fiscal deficit target of 3.8 per cent of the GDP (Gross Domestic Product). As a result, fiscal measures widely expected included reduction in duties to neutralise the impact of high international oil prices. International oil prices are currently ruling at around $58 a barrel, belying forecasts of a fall below $50 a barrel.

forward premiums

Oil companies continued to hedge their payments. As a result, forward premiums remained above 3 per cent between one and 12 months. Along with oil companies, corporates that had raised funds in the international financial markets have also taken forward cover, bankers said.

Liquidity improves

But liquidity situation in the markets has improved. The improvement, bankers said, was largely on account of deposit inflows and inward remittances by exporters taking advantage of the favourable forward premia. Besides, the premature redemption of Rs 400 crore of securities by Rajasthan and Orissa also contributed to the improved liquidity.

The high liquidity was evident from the three-day weekend liquidity adjustment facility auctions. The RBI mopped up Rs 6,940 crore through the reverse repo window. At the weekly T-Bill auctions, the cut-off yield for the 91-day T-bill was fixed at 7.77 per cent, down from 8.10 per cent the previous week. Moreover, the weighted yield was about 10 basis points lower than the cut-off yield, indicating that many bids were actually made way below the cut-off yields.

The auctions saw high retentions by the RBI during the week. The bids for 91-day T-Bills were in excess of Rs 7,000 crore by competitive bidders and Rs 1,900 crore by non-competitive bidders as against the notified amount of Rs 2,000 crore (Rs 500 crore as normal amount and Rs 1,500 crore as part of the market stabilisation scheme). The RBI retained a total of Rs 3,900 crore in the auctions. Similarly at the 182-day T-bill, bids made were Rs 3,903 crore though only Rs 1,500 crore was accepted at a cut-off yield of 7.73 per cent.

As a result the ten-year yield to maturity (YTM) retreated to 7.95 per cent last weekend on a weighted average basis, as against 8.05 per cent the previous week.

Daily trade volumes, however, remained low at Rs 300 crore. This was largely on account of low demand for debt papers from insurance companies.

Moreover, availability of G-Secs has increased after conversion of recapitalisation bonds to SLR securities. Consequently, bankers said, most of them were expected to see SLR securities holdings in excess of 30 per cent, as against the mandated 25 per cent.

Two weeks ago, the Government had converted outstanding recapitalisation bonds of about Rs 8,800 crore into 15 year, 20 years and 25-year SLR securities. The conversion has made the banks' investment portfolios more liquid. This was because recap bonds were not eligible for repurchase operations or for ready forward transactions. The conversion has now made the securities eligible for ready forward transactions and making banks investment portfolios more liquid.

Bankers unhappy

But few banks are happy at the conversion. In fact, most of the banks had preferred redemption to conversion, since this would have improved their liquidity. Besides, conversion has escalated the average maturity of their investments at a time when they had derisked them. Bankers had brought down their average maturity profile to about three years. The conversion has raised it to five years.

As a result, some of the securities would be offered for sale to the life insurance companies, bankers said. Life insurers are hungry for long-term securities and constantly on the look out for high coupon securities for switching their short-dated papers.

low-yield spreads

Yet despite increased volume in quantum of securities, the outlook remained dim. This was evident from the low-yield spreads. The spread between one and 29 years was just about 50 basis points. One reason for this was largely due to the high investment deposit ratios of banks currently at about 34 per cent, bankers said. Besides, most of the inflows that life insurers have seen were mostly in unit-linked policies.

This implied that the equities would be favoured over government securities, though there was likely to be focus on short-dated papers for maintaining liquidity. In fact, this was also one of the major reasons for the high level of non-competitive bids for T-Bills during the last few auctions.

Besides, traders were concerned over the inflation numbers. Inflation was 6.63 per cent translating into a one-year real yield of 1.17 per cent.

Accordingly, there was little room for further softening of nominal yields. Moreover, with credit demand unabated and deposit growth still lagging, bankers were expected to push for selling their securities.

Incremental credit-deposit ratios continued to be close to 100 per cent for most of the banks, raising liquidity risks. As a result, it was these banks that were aggressive in the short-term deposit markets, offering high rates.