The Hindu Business Line : Trading in g-secs listless as fiscal year-end draws near

Bangalore March 25 Bonds remained listless in thin trading ahead of the year-end, as traders are on tenterhooks over tightening liquidity and deteriorating situation in the Gulf.

Traders said that advance tax payments were one of the key factors putting pressure on liquidity in the banking sector. Besides, oil companies were also present, as they hedged their import payment exposures.

The combined pressure drove up short-term forward premia to 9 per cent. The traders said many of the foreign banks were swapping their foreign exchange to generate rupee resources to meet the advance tax deadlines. The Federal Reserve's move to leave the Fed Funds rate unchanged last week at 5.25 per cent had little impact, as a result.

Profit boosters

Some public sector banks were clearly capitalising on the situation. The Canara Bank's Chairman and Managing Director, Mr M.B.N Rao, said, "We are lenders in the call money markets." Canara bank is flush with cash, faced with a surge of deposits, both retail and bulk.

For the PSBs, the tight liquidity situation has come as a profit booster for the year-end. The banks were arbitraging between bulk deposits and call money markets. With call rates ruling over 50 per cent during the last two days of the week, many of the banks were rushing for bulk deposits pushing up rates to over 12 per cent.

Moreover, some of the banks also took recourse to the RBI's repo window, after sensing windfall gains. As a result at the two week-end liquidity adjustment facility (LAF) auctions, funds raised through the RBI's repo window were Rs 42,195 crore. The tight liquidity also reflected in the weekly treasury bill auctions.

High bids

The cut-off yield on the 91-day T-Bill was 7.98 per cent last week, up 40 basis points over the previous week. The weighted yield though was 20 basis points lower.

Despite the tight liquidity situation, competitive bids for the 91-day T-bills remained high at Rs 5,035 crore though the RBI accepted only Rs 821 crore. The non-competitive bids made were Rs 1,800 crore, and the entire amount was accepted. The situation in the 182-day T-bill was also identical, where the cut-off yield was fixed at 8.02 per cent, just 4 basis points over the 91-day T-bill yield.

However, the ten-year yield to maturity did not reflect the tightness in the money market. On the contrary, the ten-year YTM softened to 7.94 per cent on a weighted average basis towards the weekend, despite all the feverish action in the money markets. The previous week, the year YTM was 7.97 per cent.

Bearish undertone

Despite the softening yields, the undertone remained bearish. This was evident from the low daily trade volumes that were barely Rs 500 crore.

Moreover the outlook also reflected the bear pressure build-up in the bond markets, evident from the narrow inter yield spreads. The spread between one and 29 years was under 50 basis points. In reality there were few trades and insurers also remained out of the markets, as they shopped for high yielding bank tier two bonds. LIC was aggressive in this market, where it has lifted Canara Bank's AAA rated bonds at 10 bonds.

What also ensured the bearish outlook was the inflation numbers. Inflation remained at 6.46 per cent, translating into a real yield of 1.44 per cent. In fact given this situation, expectations were that the belt would become further tight.

Limited effect

Besides, the broad money supply, M3 growth has accelerated, moving ahead of the Nominal Gross Domestic Product growth of under 20 per cent. Ideally money supply is expected to keep pace with nominal GDP growth. However, this growth was also largely on account of the accretion in foreign exchange reserves. The net foreign exchange assets of the RBI have grown by 34 per cent, on a year-on-year basis.

Given this situation, traders said, any inflation control measure with the RBI was very limited, other than allowing the rupee to appreciate. In fact, this was precisely what was happening. This was also largely because interventions in the markets have negative returns. With international yields at less than four per cent, intervention in the domestic markets at 6 per cent implies negative returns.

So the better options, bankers said, would be to utilise the reserves in sectors where the financial returns were higher. That is slowly beginning to happen. In fact, there are now expectations that the government would weigh the option of prepayments to sterilise the liquidity and at the same time have an inflation control tool.

Wooing farmers

For bankers, however, this would mean, such inflation control measures would allow rates to remain steady at current levels and sustain the credit flow to productive sectors. Farm sector remains the focus area and more banks are falling over each other to woo the farmer.

The chase for farmers, even by private sector banks, was also largely on account of the low risk of non-performing loans, which historically has barely crossed 1 per cent of the gross farm credit. As a result, bankers said, investments would remain at the current levels of 34 per cent of the deposits for some more time or may even be scaled down from next year.

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