The Hindu Business Line : Yields soften on fund inflows, low credit off-take

Bangalore, Jan. 6 Bond yields continued their southward roll for the second consecutive week, propelled by inward capital flows, as most traders preferred the international oil price spike.

Top bankers said the softening of yields was also largely on account of low credit off-take, as more banks plugged for investments. Investment-deposit ratios for almost all the banks for the current year are well above 50 per cent.

In fact, even last week’s tweak of deposit rates by State Bank of India that pushed up some short-term rates failed to impact bonds. The SBI had hiked short-term rates by as much 50 basis points. This was evident from the weekend liquidity adjustment facility auction. At the auction, there were 33 bids for the reverse repurchases of the RBI for Rs 32,275 crore.

Part of the increased liquidity, bankers said, was on account of inward remittances by institutional investors particularly East Asian FIIs, diversifying exposures into India. FIIs brought close to $423 million. Besides, non residents have also brought in funds ahead of some large equity floats by public sector undertakings. The rupee firmed as result. Though forward premia dropped, the retreat was tempered.

One month forward premia, for instance, dropped to 1.6 per cent from last weekend’s 2.43 per cent. Six month forward premia remained unchanged at 1.78 per cent, but 12 month premia dropped to 1.27 per cent from 1.39 per cent the previous week. Refineries were not present in large numbers, despite international oil prices nudging $100 a barrel. Instead, part of the forward premia moderation was attributed to capital exports by large Indian corporates — the latest one being Tata’s proposed cross border acquisition of Ford’s Land Rover and Jaguar divisions. This deal was estimated at a little over $2 billion.

Yet such trends, notwithstanding, the liquidity overhang appears to return to the financial markets. The overhang was evident from the sharp drop in yields at the weekly Treasury bill auctions. At the 91-day T-bill auction, the yield dropped last week sharply by as much as 33 basis points over the previous week to 7.02 per cent. As against the notified amount of Rs 500 crore, competitive bids amounted to Rs 3,411 crore and the non-competitive bids to Rs 1,000 crore. The RBI retained Rs 1,500 crore from the auctions. At the 364 day T-Bill auction, the yields dropped to 7.39 per cent. Reflecting the softening trend, the ten-year yield to maturity dropped to 7.76 per cent last week on a weighted average basis down from the previous week’s levels of 7.85 per cent.

Liquidity overhang

But ICICI Bank’s chief economist, Mr Samiran Chakraborty, said: “It is too early to see any liquidity overhang. But liquidity has come back into the banking system from redemptions.” Indeed redemptions for the remaining part of this year are expected to be close to Rs 39,000 crore, as against government borrowings of Rs 19,000 crore.

Consequently, banks and primary dealers bought more securities last week. The frenetic buying pushed up the average daily trade volumes to Rs 11,635 crore, the highest level since 2004. Besides, the Finance Minister’s comments, calling for a reduction in lending rates by as much as 50 basis points, also partly buffered the rally.

But yield spreads widened to 67 basis points. Normally, widening spreads implied demand for long-term credit. Bankers though suggested that credit off-take was yet to improve.

Although peak season credit off-take had begun, the growth was much lower than last year. Credit-deposit ratio for the current year so far was 57 per cent as against 97 per cent during the corresponding period of the last financial year. The slight pick-up instilled optimism among bankers and those who still preferred to remain at the short end of the yield curve (implying that the preference was for short dated securities). This was one of the major factors for the widening spreads, the bankers said. In fact, most trades during the week were entirely by banks, as insurance companies stayed away. Besides, redemptions of securities were also driving banks into the market for maintaining their respective reserve ratios.

MSS auctions

But the increased liquidity is expected to result in resumption of the market stabilisation scheme (MSS) auctions in the coming weeks. This is largely to mop-up liquidity created by cross border inflows. The RBI already has a limit of Rs 2.5 lakh crore and its current outstanding is only Rs 1.62 lakh crore. Bankers said that the resumption is also due to the pursuit of aggressive containment of inflation. Inflation currently is 3.5 translating into a one year real yield of 3.9 per cent, clearly way above the international levels. However, bankers said that this gap could narrow, if oil prices are hiked. Besides, broad money supply growth continues to remain above 22 per cent.

As a result, bankers are not willing to push non-productive sector credit. Instead, the focus remained defensive cutting back high cost liabilities and bringing down the average cost of working funds to push up interest margins above 3 per cent.