The Hindu Business Line : Yields firm on surging oil prices, tightening liquidity

Traders said that there were renewed inflation worries, as the whole sale price index grew 7.83 per cent on a year-on- year basis. The rise comes just as the third phase of the cash reserve ratio (CRR) kicks in on May 24.

The hike is expected to remove Rs 10,000 crore of liquidity from the banking system. Despite the tightening, there is mounting concern on the impact of global oil prices. Global oil prices are currently about $124 a barrel. For India, this means that the weighted import basket prices remain above $120 a barrel or about $880 a tonne. This translates into a daily foreign exchange requirement in excess of $295 million a day for crude imports alone. Besides, there are other product imports. The fear is that high import bills would translate into an escalation on the current account deficits this year.

Drop in exchange rate

The fears are evident from the sharp drop in the exchange rates. The rupee dropped to Rs 42.64 against the dollar or a fall of 3.5 per cent on a year-on-year basis and 6.6 per cent since the beginning of this financial year.

Forward premium though remained softened at the short end on covering by exporters and inward remittances. However, in the case of three months, there was a distinct firming trend, in view of covering by corporates with foreign currency liabilities. Premia for one month, three, six and 12 months were 1.83 per cent (2.32 percent), 1.97 per cent (1.84 per cent) 1.45 per cent (1.55per cent) and 1.15 per cent (1.38 per cent) respectively. Short forwards though surged with the hardening of call rates. Call rates were at 7.85 per cent, as refineries’ credit lines were reworked. Consequently, some foreign banks took advantage of the firm overnight call rates swapping cash dollar for spot. As a result, four-day forward premia hardened to a little over 6 per cent.

The tight liquidity situation manifested at the weekend liquidity adjustment facility (LAF) auction. At the weekend auctions recourse to the repurchase window (liquidity support for the banking system) was Rs 20,345 crore. Part of the liquidity demand was refinery driven.

Refineries also continued off-loading their oil bond holdings for meeting their fund raising requirements. This year, they have been allotted another Rs 35,000 crore of bonds. The bond allotment is expected to be done over the next few weeks to partly gap their under recoveries for the last financial year, estimated at a little over Rs 77,000 crore.

But appetite for oil bonds appeared to have waned. Consequently, spreads were on the ascent. Spreads for oil bonds over comparative sovereigns were over 100 basis points. Spreads of state development loans over sovereigns was just 55 basis points.

With increasing recourse to issue of oil bonds or deferring subsidy liabilities, interest liabilities are likely to rise. A slippage in the fiscal deficit target of 2.7 per cent now appears realistic. That left little room for any tax/duty reductions.

A preview of the impact on interest rates showed at the weekly Treasury bill auctions. At the weekly auctions, the cut off yield rose to 7.39 per cent and the weighted yield to 7.35 per cent, up 9 basis points from the corresponding period of the previous week. But the competitive bids remained high at Rs 8,527 crore as against a notified amount of Rs 3,500 crore, largely on account of low credit demand.

However, the tightening situation was apparent in the ten-year yield to maturity (YTM) movement. The ten-year YTM on a weighted basis firmed to 7.98 basis points, up from the previous week’s 7.91 per cent.

Trade volume

Average daily trade volume during the week shrank to about Rs 6,000 crore implying a weakening undertone. In the previous week, the trade volume was about Rs 7,000 crore. Traders said that insurance companies abstained from making purchases, anticipating a further hardening of the ten-year YTM.

The weak outlook was also evident from the wide bid-offer spreads.

The spreads widened to about 10 basis points. This was despite low credit off take. Bankers said that with most of them beginning to hold back on deposit growth, there was little need for further investments. Already, the government security investment to deposits ratio was over 32 per cent, as against the prescribed statutory liquidity ratio of 25 per cent. Moreover, the pause in the debt market rally was also partly due to inflation effect. The one-year negative real yield, widened to 0.2 per cent slightly up over the previous week’s 0.16 per cent.

All focus was on the Reserve Bank of India as traders waited for possible cues. Traders said that with the tightening of liquidity, the RBI would hold back on the market stabilisation scheme auctions. MSS outstanding are currently about Rs 1.75 lakh crore. During the week, Government borrowings of Rs 10,000 crore are expected through placement of the 8.24 per cent 2018 and the 8.28 percent 2032 securities. The auctions are expected to throw up cues on rates.

To accommodate the borrowings, the RBI had already pared the MSS components. The notified amount at the 364-day Treasury bill was just Rs 1,000 crore. For the 91 day T-bill it was at Rs 3,000 crore.

Next week about Rs 12,000 crore of cash flows are expected through a combination of redemptions and coupon flows.

The liquidity was insufficient to satiate demand from the markets especially in view of soaring oil prices. Besides, there was little flow from foreign institutional investors, who have maintained a low profile in view of cross border losses and large provisioning. Since the beginning of this month, net FII flows were just about $69 million.

As a result, yields are now expected to remain firm, a trend that does not augur well for Government borrowings. Consequently, yields with the cut off YTMs on next week’s dated security auctions are likely to be closer to the coupon rates or above it.