The Hindu Business Line : Bonds firm as traders await RBI intervention to soak up liquidity

Bangalore June 17 Bonds firmed last week as traders continued to anticipate the Reserve Bank of India's intervention to soak up liquidity in the coming weeks.

Traders said that the inflation retreat failed to ignite bonds. Instead, traders now expect that Government borrowing requirements for purchase of the RBI's stake in State Bank of India would soak up the liquidity. A trader said: "Any RBI intervention can be expected only after this mammoth transaction is completed." Besides, they also said that advance tax outflows amounting to Rs 25,000 crore would also help contain the liquidity overhang.

But inflows, mostly through the capital account route and foreign equity flows, continued to pour into the country. The flows were mainly portfolio and foreign direct investment, external commercial borrowings and non-resident investments. Besides, bankers said that investors also targeted public offerings of the ICICI Bank.

Inundated by the capital inflows, forward premia dipped to below 3 per cent for up to 12 months. In fact, premia would have dropped further, but for the RBI's intervention in the forward markets. Traders said that RBI has been active in the swap markets. As a result of this intervention, spot rupee-dollar exchange rate remained close to 40.95.

The interventions prompted simultaneous liquidity containment efforts. The RBI mopped up Rs 11,000 crore through placement of 7.49 per cent 2017 security twice during the week. The security was placed at a yield-to-maturity (YTM) of 8.44 per cent in the first auction at the beginning of last week, when Rs 5,000 crore was mopped up. During the second auction at the end of the week, the security was placed at 8.35 per cent and another Rs 6,000 crore was mopped up.

During the week, the stepped up mopping efforts through Treasury bill add-on market stabilisation scheme (MSS) also continued. At the 91 day T-bill auction, the cut-off yield was fixed at the 7.77 per cent, up 54 basis points from the previous week's 7.23 per cent.

The weighted yield also moved to 7.73 per cent, up 60 basis points over the previous week. The total mop-up through this route was Rs 5,100 crore as against the notified amount of Rs 3,500 crore. Another Rs 2,500 crore was sucked out through the 182 T-bill route. The mop-up notwithstanding, at the weekend liquidity adjustment facility (LAF) auction, the bids amounted to Rs 69,000 crore, though only Rs 3,000 crore was accepted.

Little impact on yields

The high liquidity, however, had little impact on bond yields. The weighted average yield-to-maturity firmed to 8.28 per cent, up from the previous week's 8.16 per cent. This trend was largely driven by sentiments as traders stayed alert for a 25-50 basis hike in the cash reserve ratio.

Sentiments were weak resulting from the vigil. Daily trade volumes during the week stayed under Rs 500 crore. Traders showed little interest. This was evident from the high buy-sell spreads, which in some cases was as high as 20 basis points. Besides, yield spreads — between one year and 29 years was just 55 basis points, indicating a flat yield curve.

Absence of LIC

The low interest in dated securities was also due to the absence of the Life Insurance Corporation of India.

The outlook also remained weak. This is despite the fact that the inflation numbers are below 5 per cent for the second straight week. As a result, the one-year real yield remained high at close to 3 per cent and a correction now appears long overdue. There are only two ways a correction could take place — nominal yield fall or an inflation advance.

The latter now appears likely in view of the high international oil prices at $65 a barrel translating into a weighted average price of $63 barrel. Refinery margins are already under severe pressure and there is little alternative to an up tick in domestic prices. But worse, bankers said that there was difference of at least 50 basis points between the final figures and provisional figures.

The subtleties notwithstanding, banks investment-deposit ratios continued to rise. On an incremental basis, investment-deposit ratios were close to 100 per cent. This, bankers said, was largely on account of subscription to Treasury bills. Most of them preferred to stick to short-dated papers anticipating a reversal in the liquidity situation when the peak season begins.

Slow credit off-take

The focus, as a result, was only building up resources for deposits. Credit off-take has slowed down, as rebalancing has taken effect. Yet only the public sector banks were rebalancing their portfolios. For the large private sector, the focus was on ensuring asset health and maintaining a health average yield. As a result, the private sector banks still remain focused on retail assets.