The Hindu Business Line : Bonds remain weak ahead of Credit Policy

Bangalore April 15 Bonds remained weak through last week as nervous traders preferred to wait for a cue from the Reserve Bank of India lean season credit policy announcement.

Traders said that the nervousness also stemmed from the situation in the Iran-US stand off in the Persian Gulf. Oil prices are currently firm at $64 a barrel. This effectively means a weighted average import basket price of approximately $60 barrel. But few oil companies expected prices to come down in the near future.

Most of them continued to hedge their imports, evident from the continuing high forward premia for the greenback. Premia for one month to six months remained above 5 per centdespite the fact that some foreign banks reversed their swaps taken during the tight liquidity periods of the last three-four weeks.

Bankers said that there were also large inflows from non-resident depositors. While most of the banks expected the deposits/remittances to be converted into rupee account deposits, in view of the high rates, few were taking chances. Instead most of them preferred to hedge them for eventualities, leading to the current high forward premia.

This situation was also leading to firm spot rates, where the rupee breached the Rs 43 to a dollar mark. This has also resulted in an unusual situation of high foreign exchange accretions and high forward premia.

While theimport demand continued to remain high, exporters were slow to repatriate their earnings into the country, bankers said. Consequently, most of the inflows currently taking place were on the capital account.

This was mostly in the form of debt creating components of the capital account, including foreign currency borrowings by corporate houses and financial institutions, without any sovereign guarantee support.

The inflows have pushed the Reserve Bank of India to intervene aggressively in the money and foreign exchange markets, to ensure that the liquidity generated did not jeopardise the inflation target of 5 per cent.

In fact, last week the liquidity generated was mopped up through the week-end MSS (market stabilisation scheme) bond issues. The MSS issues — the 7.38 per cent 2015 and the 8.33 per cent 2036 mopped up Rs 12,000 crore. They were placed at yield to maturities (YTM) of 8.16 per cent and 8.58 per cent respectively.

MSS securities

fact, the normal tools of sterilisation, the reverse repos have now been replaced by longer-term MSS securities. Bankers said that the advantage with MSS was that it ensured that the liquidity siphoned out was for a long-term, consonant with the objectives of containing money supply growth.

Reverse repos, on the other hand, were only overnight instruments.

Besides, many banks have used reverse repos for arbitraging purposes — borrowing low from call and deploying the same in overnight repos. That opportunity ceased to exist now for the banking sector in thelast few weeks.

The RBI's reverse repo interventions have seldom exceeded Rs 3,000 crore. This was despite bids in excess of Rs 30,000 crore. But this has now shifted to the tre

asury bill and MSS auctions. At the 91-day T-bill auctions, the cut-off yields dropped for the third straight week to 7.35 per cent. This time the drop was 40 basis points over the previous week. The fall in the weighted yields to 7.27 per cent was even more sharp, 62 basis points over the previous week.

T-bills

The competitive bids for the 91-day t-bills were Rs 7,215 crore as against the notified amount of Rs 2,000 crore. The actual retentions inclusive of the non-competitive bids was Rs 2,500 crore. In the case of the 364-day T-bill auctions, the bids accepted, both competitive and non-competitive was Rs 2,130 crore, as against a notified amount of Rs 2,000 crore. The bids made for the 364-day T-bill auction amounted to Rs 8,010 crore.

Yet , few were speculating on any possible repo rate changes. In fact, traders said, that the only possibility of a rate change at the RBI's credit policy was through an increase in the repo-reverse repo band. This band is currently 175 basis points.

A further increase in the band would completely eliminate any arbitrage opportunities out of short-term foreign exchange inflows, traders said.

Anticipating such a situation the ten-year YTM remained firm at 8.14 per cent last week on a weighted average basis, though it was down two basis points from the previous week.

Traders said that the firm yields were also driven by the absence of insurance companies in the bond markets. Insurers had not yet begun their switches for churning their investment portfolios.

Daily trade volumes last week were barely Rs 500 crore.

Neutral outlook

The neutral outlook for the bonds was also evident from the narrow inter yield spreads. Spreads were just 74 basis points. Traders saidthe reversal in inflation was likely to fuel a short rally in the coming weeks, if the trend remained.

Last week, inflation as measured by the wholesale price index dropped to 5.74 per cent indicating a one-year real yield of 2.14 per cent last week, up from the previous week's 1.6 per cent.

The sharp increase in the real yield, traders said, was indicative that a short rally in the markets was likely to take place. This would, however, depend on the Credit Policy, bankers said.

However, bankers said that such a rally was unlikely to lead to any increase in the investment-deposit ratios. Currently, ID ratios are 34 per cent, after excluding non-government securities. Clearly, bankers said that this position would change, once redemptions of bulk deposits start in the coming weeks.

Deposit growth rates are currently 22 per cent and excluding bulk deposits, the growth was under 20 per cent.

A change in the saving bank deposit rate could help banks accelerate this rate, and at the same time ensure that credit demand was sustained, bankers said.

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