The Hindu Business Line : Yields slide; outlook for bonds positive on low credit off-take

The slide in bond yields came despite inflation hitting a three-year high of 7.57 per cent. The retreat was partly from the tough messages conveyed by the Reserve Bank of India at the lean season Credit Policy. The RBI hiked the Cash Reserve Ratio (CRR) by another 25 basis points. As a result, the total liquidity impounded is likely to be about Rs 28,000 crore. CRR is a reserve maintained by banks with the RBI against their deposits. This mop-up is more than the redemptions coming up till May, which amount to about Rs 20,000 crore.

The RBI though stopped short of further tough measures, preferring to reserve them for another day. There were no hikes in the repo/reverse repurchase rates. Bankers said that hikes in signal rates would have pushed up lending rates. But the low credit off-take from the productive sectors deterred the RBI from such a move. Instead, the RBI conveyed its intentions to begin supervisory inspections of banks’ books on advances to commodity traders, a signal that the credit control measures are further options of inflation control.

Besides, what helped the slide in yields was the reduction by another 25 basis points in the Fed funds rate. Fed funds is the overnight borrowing and lending of reserve funds between US banks. With last Tuesday’s reduction, the Fed funds rate fell to 2 per cent.

But carry costs remained high, despite the Fed funds’ reduction. Cash spot forward premia currently is 3.54 per cent and after factoring in the fund-raising costs, there was little room for arbitrage. Besides, oil demand also put pressure on the rupee.

Oil companies such as IOC sold their bond holdings to fund their crude oil purchases. IOC, last week, sold about Rs 2,300 crore worth of bonds at a discount to face value that translated into a yield to maturity (YTM) of 9.22 per cent. With oil prices rising at a record $120 a barrel, import prices are likely to be $115 a barrel. India’s current requirement is about 2.9 million barrels per day (mbd) of which about 2.2 mbd are imported. This translated into foreign currency requirement of about $250 million per day. As a result of the purchases, the rupee fell to Rs 40.65.

Forward premia also firmed as more corporates took cover. Besides, refineries began taking advantage of the RBI’s permission to take forward cover. Under the RBI guidelines of October 2007, oil companies are permitted to take forward cover of up to 50 per cent of their inventories. Many refineries took advantage of the liberalised regime, driving up forward premia for up to six months. One, three and six months firmed to 1.33 per cent (0.6per cent), 2.56 per cent (2.29 per cent) and 1.92 per cent (1.89 per cent).

The refinery demand notwithstanding, liquidity remained high. At the weekend liquidity adjustment facility auction (LAF), the recourse to the reverse repurchase window was Rs 20,250 crore from 20 banks. During the previous week-end it was over Rs 32,675 crore from 33 banks. Part of the reduction to the reverse repo window was on account of subdued non-debt capital account flows, mainly foreign institutional investors during the last few weeks.

The liquidity overhang had its impact on the Treasury Bill auctions. The cut-off yield on the 91-day T-bill auctions was set at 7.35 per cent, down from the previous week’s 7.44 per cent. The weighted average yield dropped to 7.31 per cent, 9 basis point down from the previous week. Competitive bids at the auctions amounted to Rs 7,695 crore as against a notified amount of Rs 3,000 crore. At the 182-day T-bill auctions, the cut-off yield was set at 7.45 per cent. Interestingly non-competitive bidders began moving to the longer end of the yield spectrum. Non-competitive bidders included insurance companies, mutual funds, State Governments and corporate entities. Non-competitive bids for the 182 day T-bill was Rs 750 crore.

The liquidity overhang in the markets, as a result, yanked the 10-year yield to maturity (YTM), on a weighted average basis below the 8 per cent threshold to 7.85 per cent, down a sharp 30 basis points from the previous week’s 8.15 per cent.

Trade volumes picked up, indicative of the positive market undertone. Average daily trade volume was upwards of Rs 6,500 crore. The bid offer spreads also narrowed to just about 5 basis points. Kick-starting of Treasury desks implied that most banks have discounted further changes in interest rate, with a southwards bias, becoming apparent. In fact, at last week’s meeting between bankers and the Union Finance Minister, this bias was evident. The Finance Minister asked bankers to desist from hiking lending rates.

The outlook consequently remained positive, bankers said. This was despite one-year real rate becoming negative by about three basis points. But the slip to the negative zone implied that outlook for inflation expectations are low, bankers said. The outlook was endorsed by the Finance Minister, Mr P. Chidambaram, at a meeting with reporters in Bangalore. He said, “Inflation will come down sooner than later.”

The positive outlook for bonds was also largely on account of low credit off-take. Credit off-take since the beginning of this financial year remained low. Credit-deposit ratio for the current financial year so far was minus 169 per cent. This implied that banks had more liabilities than loan assets. For the financial year so far, the deposits in the banking system was Rs 4,425 crore. Loan assets were a negative Rs 7,464 crore, implying more redemptions than new loan assets.

The situation pushed more banks to investments. Investment-deposit ratio this year so far was about 63 per cent, as against the mandated 25 per cent statutory liquidity ratio.

This is clearly not a happy situation for banks, since the interest margins suffer. So the option left, especially after last week’s CRR hike to 8.25 per cent was to contain liabilities – deposits. Accordingly, the next thrust is likely to be in the form of aggressive reductions in deposit rates.