The Hindu Business Line : Foreign exchange inflows, weak credit offtake trigger rally in bonds

Traders said that credit off-take was slowing in consonant with the Reserve Bank of India whip to the banks to tighten up on certain categories of loan, in a bid to rein in money supply growth. At the same time, banks were aggressively mobilising tail deposits, offering high rates of interest. In addition, bankers said that there were large inflows from the external sector, powered by capital account flows – both debt and non-debt. Inflows currently are estimated at over $200 million per day.

FIIs

According to data from Securities and Exchange Board of India, FII gross purchases in the equity markets amounted Rs 3,788 crore, equivalent to $987 million on the last day of the week. But FII’s sales were equivalent of about $780 million on the last part of the week, though this failed to dent the foreign exchange markets. The reason: Corporates were repatriating external commercial borrowings for funding their capacity expansions and working capital requirements.

Besides a slew of initial public offerings slated to take place during the next few days, including that of the public sector Central Bank of India, there was a little respite from rupee appreciation.

Forward premia

Besides, interventions from the RBI remained muted and were entirely in the foreign exchange markets. The restraint allowed the rupee to remain firm at Rs 40.50, though there are indications that there could be further appreciations in the coming weeks. This was evident from the shrinking forward premia, both at the short and long ends. Forward premia for one month dropped below 0.5 per cent (zero point five per cent).

At the middle and long ends, 3, 6 and 12 months, forward premia dropped below two per cent, implying that there was little respite likely from the surging inflows. Forward premia would have dropped further but for hedging by oil companies, traders said.

The inflows and muted interventions pushed down call and the collaterallised borrowing and obligations market rates down to as low as 0.4 per cent.

Similarly, the liquidity overhang was also evident from the large bids at the reverse repurchase (reverse repo) window at the liquidity adjustment facility auctions.

Bids for reverse repos at both LAF1 and LAF2 totalled Rs 1.05 lakh crore. Of this only Rs 3,000 crore was siphoned out through the reverse repos leading to a humongous liquidity overhang.

Treasury bills

The cap in the reverse repo pushed more banks into the treasury bills markets. The rush for the 91-day T-bills resulted in a steep drop of 127 basis points in the cut off yields to 5.12 per cent last week. The cut off yield was also at least 88 basis points below the RBI’s reverse repo rate of six per cent. The weighted average yield was just a tad above five per cent at 5.03 per cent. The bids for the 91-day bills were Rs 7,553 crore, both competitive and non-competitive. The final amount accepted was only Rs 2,250 crore. The trend in the 182 T-bill auction was identical, where the cut off and weighted yields dropped to 6.05 per cent and 5.99 per cent respectively.

The high liquidity also resulted in pushing down weighted average 10-year yield to maturity down to 7.90 per cent last week, down from the previous week’s 7.98 per cent. The undertone remained firm. This was evident from steep increase in the trade volumes. Daily trade in the National Stock Exchange was Rs 1200 crore, a 100 per cent increase over the last week. In the Clearing Corporation of India, on line trade, the daily trade volume was Rs 5,500 crore. Bid-offer spreads for short and middle ends have shrunk to about 5-10 basis points.

Yield spreads have become a little more linear. Clearly the sentiment was positive, and the current rally appeared moving into full throttle. The fundamentals also favoured the situation. Inflation is currently at 4.27 per cent and the one-year real yield was 3 per cent, double internationally acceptable levels. Clearly debt now appeared to be the flavour of the season.

Speculations

Changes though could still take place. Current trends have triggered speculation that there could be a mid term intervention by the RBI. “With this kind of liquidity build up, we could see some proactive action by the RBI,” a trader with a large private sector bank said. Few expect changes in the CRR in view of interest rate implications. The options, however, are limited.

1: Remove the cap on the reverse repo. 2: Increase the reverse repo band, by reducing only the reverse repo rate and finally. 3: Hike the MSS components in the T-Bills or increase the MSS securities variety with longer dated securities, the traders said.

Any intervention, the traders said was likely to come only after the Government completed its next borrowing programme of Rs 9,000 crore through a twin auction of 7 year and 32 year securities through reissuance of the 7.27 per cent 2013 and 7.32 per cent 2032 per cent.

Through this it would have completed about 73 per cent of the borrowing target of Rs 92,000 crore for the first half of the current financial year. In addition another Rs 9,000 crore is expected to siphoned out through T-Bills and issue of 6.65 per cent of 2009 MSS security.

Yet even these interventions bankers said would have only limited impact in view of the credit slowdown. Credit during the last week has grown 23 per cent. But deposits have also grown by the same amount. The telling story of a credit offtake slow down is in the incremental credit deposit ratio. This ratio is down to 29 per cent. The incremental investment deposit ratio retreated to 32 per cent, though it was still above incremental CD ratio. Banks are now sitting on idle cash, with nowhere to deploy.

Deposit chasing is now expected to see a temporary pause.

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