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C. Shivkumar

Bangalore, March 23 Bond yields sustained their northward momentum due to mounting inflation concerns and turmoil in the global financial markets.

Traders said that most of the foreign banks were sellers of Government securities to support their parents hit by the sub-prime meltdown.

The US Fed rate cut by a 75 basis points to 2.25 per cent and raising the discount tenure of support to 90 days from 30 days provided some succour.

In addition, the Federal Reserve, in an unprecedented move also allowed investment banks to borrow from the discount window against collateral.

The support was intended to increase liquidity in the markets. Yet the euphoria was short-lived. Foreign institutional investors remained sellers in the equity markets to support their parents.

FIIs sold the equivalent of $400 million during the three trading days of last week.

In fact, there were rumours that more investment banks were potential candidates for fire sale. Domestic banks remained worried about the fate of the world’s largest bank, Citibank.

The worry was mainly related to the fact that Citi is a correspondent banker to many of the domestic banks in the country. These worries and FII selling notwithstanding, the rupee remained firm. This was largely on the back of inward remittances by exporters and non-resident investors.

Besides, oil companies also dropped out, as prices headed south of $100 mark on fears of a US recession.

Besides, there was a shortage of rupee liquidity. The shortage was partly due to advance tax liabilities and some redemption of bulk deposits. The tight liquidity pulled down the forward premia at the short end. One month forward premia dropped to 0.89 per cent (1.78 per cent). However, three, six and 12 months firmed to 1.88 (1.48) per cent, 1.53 per cent (1.29 per cent) and 1.26 per cent (1.04 per cent) respectively.

The liquidity tightening pushed 29 banks/primary dealers to the RBI’s repurchase window at the five-day week-end liquidity adjustment facility (LAF) auction. The recourse to the repurchase window, through which the RBI provides liquidity support, was Rs 43,295 crore.

But the tight conditions failed to impact the weekly Treasury bill auctions. The cut-off yield at the 91-day T-bill auction was 7.31 per cent, down 8 basis points from the previous weekend’s level of 7.39 per cent. The weighted yield was down to 7.27 per cent from the previous week.

As against the notified amount of Rs 500 crore, the actual mop-up was Rs 1,200 crore, inclusive of Rs 700 crore through non-competitive bids. At the 182-day bill auction, the notified amount was brought down to Rs 500 crore, unlike in the past when it was Rs 1,000 crore.

Non-competitive bidders were active on this window as well. The bids were mostly from mutual funds that exited from equities and shifted to liquid short-term securities, especially T-bills.

The cut-off yield on the 182-day bill was 7.36 per cent and the weighted yield 7.34 per cent. The drop in both the 91-day and 182-day T-bill yields was also helped by redemptions of MSS securities. Redemption of the 91-day T-bill MSS amounted to Rs 6,000 crore and the 182 day T-bill MSS was Rs 2,000 crore. However, the 10-year yield to maturity (YTM) hardened to 7.66 per cent on a weighted average basis, last week down from the previous week’s 7.61 per cent.

The undertone remained depressed. Average daily trade volume fell to less than Rs 2,500 crore.

The low trade volume was largely on account of the year-end. But inter-yield spreads widened slightly as some of the funds sold their long-dated holdings for meeting redemption pressures.

Bankers said the Life Insurance Corporation’s presence also remained subdued. Yield spreads widened to 65 basis points as a result from the previous week’s 52 basis points.

But bankers said the hardening yields were also triggered by the uptick in inflation. Inflation at 5.92 per cent translated into a one year real yield of 1.6 per cent. This implied that there was little flexibility for yields to retreat.

Instead the focus was now on the liquidity aggregates, especially since the RBI has inflation control as its declared anchor. The liquidity overhang in the banking system is currently over Rs 3 lakh crore (outstanding MSS securities with the RBI were Rs 1.71 lakh crore, outstanding reverse repurchase amount of Rs 6,325 crore and Central Government cash surplus of Rs 1.61 lakh crore).

The liquidity overhang left very little upside risk for interest rates, bankers said.

Traders, instead, speculated the possibility of a reduction in the reverse repurchase rates from the current level of 6 per cent in a bid to contain arbitrage flows as a fall-out of the US Fed’s actions.

In fact, the repo rate and the cash reserve ratio were the only fiscally neutral tools to contain reserve money expansion. Few bankers expect hikes in CRR in view of the impact on interest rates.

Besides, MSS interventions are beginning to lose favour in view of the fiscal load, something the Finance Minister admitted finally.

Traders said that all eyes are now on the March 27 auction of the Fed’s Term Security Lending Facility, after which the RBI is expected to act. Credit off-take was seen picking up. Incremental credit-deposit ratio for the first 11 months of the year was now 68 per cent. It was less than 50 per cent during the first eight months of the year. Incremental investment- deposit ratio was down to 31 per cent, as some securities are redeemed to meet bank liquidity.

The trend is clear: Depositors can rest easy: Rates are unlikely to move down.

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