The Hindu Business Line : Bond yields steady despite liquidity surge

Bangalore, Oct. 7 Bond yields remained steady despite the liquidity surge as nervous traders opted to keep a low profile in uncertain market conditions.

Traders said that oil companies were active in the spot foreign exchange markets. Many oil companies reversed their hedges, in view of the appreciating rupee. The Reserve Bank of India’s interventions at best slowed the appreciation, traders said. But the RBI’s interventions were mostly in the forward markets, traders said. The interventions prevented the dollar from slipping into a discount.

Instead, they ensured that forward premia from one month to 12 months moved up slightly. Forward premia for one month was 0.7 per cent, six months was 1.01 per cent and 12 months 1.10 per cent last week-end, up from the previous week-end’s level of 0.45 per cent, 0.73 per cent and 0.94 per cent respectively.

Besides, traders said the current firm rupee also prompted some corporates that have external debt service commitments over the next 12 months to take forward cover, taking advantage of the current low premia and favourable exchange rates. Traders said that the corporates had taken cover in view of the RBI’s interventions. What also prompted the spike in the forward premia was the change in the ceiling on the market stabilisation scheme (MSS) to Rs 2 lakh crore. The revision was prompted on account of the liquidity surge. The surge was evident from the week-end liquidity adjustment facility auctions.

LAF auctions

At the three-day LAF auctions, the mop-up through the reverse repo auctions was Rs 54,370 crore. That the liquidity was prompted by large flows through foreign hedge funds was apparent from the data available with the securities market regulator SEBI. Between October 1 and October 5 alone, the net inflow was in excess of $2.3 billion or the equivalent of about $600 million per day.

The liquidity impact of the flows resulted in pushing down yields at the weekly Treasury bill auctions. At the T-Bill auctions, the cut-off yield on the 91-day security softened to 7.14 per cent last week, from 7.19 per cent. The weighted yield was 7.02 per cent, down 7.10 per cent. Bids at the auctions amounted to Rs 9,383 crore (Rs 5,383 competitive and Rs 4,000 non-competitive) reflecting the liquidity accretion.

The actual retention was Rs 7,500 crore, inclusive of the two non-competitive bids of Rs 4,000 crore. The yield on the 182 day T-bill was 7.32 per cent, and bids were Rs 4,990 crore as against a notified amount of Rs 2,500 crore. The high bids were despite the mop-up through reissue of MSS securities 5.87 per cent 2010 and 11.30 per cent 2010, that sucked out Rs 7,000 crore. But the high liquidity, driven by foreign flows was beginning to cause concern in the government.

More interventions?

The Finance Minister’s economic advisor, Dr Parthasarathy Shome, speaking at a CII sponsored conclave on sub- prime impact, said: “Managing hot capital inflow is of concern to the monetary authorities. We should be prepared.”

Dr Shome said: “We are prepared to use all the tools at our disposal, to ensure that inflation target and growth are not compromised.” This implied that the government and the RBI were prepared for further interventions, including tweaking the reserve ratios. The comments had a tempering effect on bonds. Ten-year yields remained steady at 7.97 per cent last week, almost unchanged from the previous week’s 7.98 per cent.

The undertone was weak. Daily average trade volume last week was Rs 4,000 crore at the CCIL trading platform. The bid-offer spreads were as high as 20 basis points at the long-end of the yield spectrum. At the short-end however, spreads were level, indicative of traders’ preference for short-dated securities.

In fact, insurers and provident funds that traditionally pick up long-dated securities were restrained in their purchases. Bankers said that they would prefer to wait and watch for some more time before moving into the longer end of the yield spectrum. Currently, the requirement was low, since most of them were already compliant with the statutory liquidity ratio of 25 per cent.

Banks’ government securities to deposits ratio was close to 30 per cent, though most of them were short-dated securities and Treasury bills.

The average tenure of securities with the banks is currently only 2 years. A technical correction, however, could be under way. One sign of this possibility was available from the inflation numbers. Inflation as measured by the wholesale price index is currently 3.42 per cent.

One-year real yield translated to 4.08 per cent as a result. ICICI Bank’s chief economist, Dr Samiran Chakraborty, said: “Even factoring in an oil price increase at current import prices, inflation will rise only by another 40 basis points.”

Besides, pressure is already building up for an interest rate reduction. Credit off-take so far this fiscal year is only Rs 54,908 crore or half of what it was last year. Though the incremental credit-deposit ratio is over 300 per cent, it was largely on account of large redemptions of bulk deposits and oil companies drawdown on credit lines.

Since the beginning of this fiscal about Rs 33,206 crore of demand deposits have been redeemed.

Besides, the incremental investment-deposit ratio is about 52 per cent, clearly indicative that the average yield on assets of banks is under pressure, though at the same time cost of deposits has escalated. This is the major factor behind narrowing net interest margins of banks, which for the last quarter is estimated at around 2.4 per cent or a huge 75 basis points down over the corresponding period of last year. This is a worry that is dogging bankers.