The Hindu Business Line : Yields firm on tight liquidity, mounting inflation worries

Traders said that capital flows into the country resumed their forward momentum, after weeks of reverse flows. Last week, foreign institutional investors brought about $876 million, into both equity and debt.

However, the flows failed to cool the markets, roiled by high international prices and fears that the Reserve Bank of India may bring in more measures to contain the inflationary impact.

Global oil prices topped $100 a barrel, though they backed off towards the week-end to settle at $98 a barrel. Public sector refinery demand, as a result, for foreign exchange pushed up the dollar to about Rs 40.10, though it finally settled at Rs 39.90 towards the week-end.

In fact, with the dollar moving down, exporters who hedged at Rs 39.70, cancelled and rebooked their hedges. The Vijaya Bank Chairman and Managing Director, Mr Prakash P. Mallya, said: “Many exporters are resorting to cancelling their hedges.” But after cancelling the hedges, exporters, including software majors, rebooked their covers. As a result, forward dollars remained at a discount for up to six months. The discount implied that forward dollars were cheaper than spot. Bankers said that this situation was also largely because the exporters preferred to capitalise at the sudden turn of events. The situation resulted in continued shortage of spot dollars, as oil demand overwhelmed capital flows.

Besides, the draw down of credit lines by refiners also resulted in liquidity tightening. The tightness reflected at the weekly Treasury bill auctions. At the 91-day Treasury bill auctions last week, the cut-off yield was 7.39 per cent, up from the previous week’s level of 7.27 per cent. The weighted yield was 7.35 per cent, up from 7.27 per cent. As liquidity was tight, the market stabilisation scheme auctions were discontinued. Despite the notified amount being just Rs 500 crore, the actual mop up was Rs 1,850 crore at the 91-day T-bill auctions. This was on account of the State Governments’ participating in the auctions through the non-competitive bid route.

High CD rates

The tight situation prompted banks to raise resources through certificates of deposits (CD). In fact, CD rates this year crossed 10 per cent. Leading the charge into the CD markets were the SBI associate banks that sparked off a virtual rate war, quoting rates as high as 9.8 per cent. Other banks responded by quoting even higher rates. Banks like ING Vysya pushed up CD rates to 10.2 per cent also. Bankers said that the situation was largely on account of the banks preference to retain maturing bulk deposits with themselves or add to their deposit base. At least Rs 50,000 crore of bulk deposits are expected to mature over the next three weeks. The tightness prompted banks to take recourse to the repurchase window at the Liquidity Adjustment Facility (LAF) auctions for Rs 17,240 crore towards the week-end.

The 10-year yield to maturity slumped to 7.57 per cent on a weighted average basis towards the week-end, down from the previous week’s 7.50 per cent, reflecting the liquidity situation.

The undertone was weak. Daily trade volumes were down to Rs 5,700 crore from last week’s average of Rs 8,100 crore. Buy-sell spreads widened to 10 basis points. Besides, with short-term liquidity at a premium, the inter yield spreads narrowed. The spread between the 91-day yield and 10 years was just 18 basis points. This situation also reflected the reduced interest in short-term papers. Most banks are stuck with long-term papers after three years of derisking and prefer to move up to longer tenures to improve coupon flows.

The outlook appears positive. This is largely on account of close to Rs 6,000 crore inflows for subscription to the Rural Electrification Corporation’s initial public offering. In addition, coupon flows estimated next week is about Rs 3,500 crore and equivalent amount of T-Bill redemptions — both 91-day and 364-day.

Yet inflation worries dogged the market. One-year real yields remained at 3.3 per cent. This was largely on account of the absence of insurance companies that are moving back in the equity markets. Bankers said that despite the high real yields, nominal yields are unlikely to reverse.

In fact, yields are expected to remain stable at the current levels. This is because few anticipate major policy interventions from the RBI. Some anticipate a reduction in the cash reserve ratio to relieve the liquidity in the markets. That anticipation has evaporated, traders said, given the inflation focus of the RBI. The RBI’s liquidity target is yet to be met. Money supply growth is in excess of 23 per cent, as against the target of 17 per cent.

Borrowing target

Besides, expectations of stability are also largely due to the completion of government borrowing target. The Government borrowing target for the current year is Rs 1.55 lakh crore. Actual borrowing for the fiscal year so far is Rs 1.56 lakh crore.

However, next month advance tax payments are slated to begin. Yet major liquidity problems during the period are not foreseen. This is because most banks already have made excess provisions for tax liabilities for the entire year. Instead the focus is to improve the asset books, especially, risk weighted assets. Rate reductions made during the week to stimulate credit-off take is yet to generate results. Credit demand remained low. This is evident from the credit-deposit ratio, which since the beginning of this financial year, is just 57 per cent as against 69 per cent during the corresponding period of the last financial year.

Investments therefore are slipping out of the banks’ radar. This is especially since most on them are already in excess of the prescribed statutory liquidity ratio of 25 per cent. G-Sec investment ratios are currently at about 34 per cent. Further increase in investments would imply shrinking the net interest margin below 2.5 per cent. Few banks are interested in such a situation.