The Hindu Business Line : Yield keeps rising as oil prices, inflation soar

Traders said that they expected more intervention from the Reserve Bank of India (RBI) inflation advanced to 8.75 per cent. Last week, the RBI raised the repurchase rate by 25 basis points. Repurchase or repo is the rate at which the RBI buys securities from banks and primary dealers for providing liquidity support.

The hikes in the rates came even as liquidity tightened due to oil-driven demand and continuing exit by foreign institutional investors (FII). FIIs this month have so far pulled out about $1.3 billion. Besides, traders said, few corporates took advantage of the liberalised external commercial borrowing regime. One reason was the high cost of raising funds with spreads over the London Inter Bank Offered Rate (LIBOR) at close to about 375-400 basis points, as global liquidity remained tight.

Forex demand

Moreover, bankers said with oil prices remaining high, refiners were beginning to draw on their enhanced credit lines. Oil prices last week averaged about $131.26 a barrel. This translated into a foreign exchange demand of about $320 million per day for crude oil import payments alone. To support the funding requirements, last month the RBI had increased the exposure limit to refineries to 25 per cent, up from 20 per cent. Oil companies have subsequently approached the banks for more credit. These include the largest oil company, Indian Oil Corporation Ltd. One banker who declined to be identified said, “They want a credit line of about Rs 500 crore from all their empanelled bankers.”

Bankers also said that the RBI stepped in to support the refineries through special market operations that began about two weeks ago. With increased fund requirement, the RBI stepped up the support limit to Rs 1,500 crore, up from the originally fixed level of Rs 1,000 crore. The special market operations are liquidity support through purchase or repurchase of oil bonds from refiners. Traders said that the RBI purchased about Rs 955 crore worth of oil bonds from oil companies. The preferred security for the special market operations was the 8.40 per cent 2025 security at a yield to maturity (YTM) of 8.77 per cent. The resources provided were in the form of direct foreign exchange support to the oil companies.

Tight liquidity

Despite the special market operations, liquidity remained tight during the week. This was evident from the firm rupee-dollar exchange rate at Rs 42.87 to a dollar. Besides, forward premia also firmed, reflecting the tight situation and shrinking inflows. Premia for one, three, six and 12 months firmed to 6.16 per cent (4.21 per cent), 3.92 per cent (2.99 per cent), 2.75 per cent (2.15 per cent) and 2.73 per cent (1.78 per cent) respectively.

Some foreign banks also resorted to one-month swaps ahead of advance tax payments, which was one of the major reasons for the high one month premium.

The tightening situation was also evident at the week-end liquidity adjustment facility (LAF) auction, where recourse was to the repo window. There were 14 bids for Rs 12,290 crore. The weekly Treasury Bill auctions manifested the impending liquidity crunch. At the auctions, the 91 day T-Bill was placed at a cut-off yield of 7.69 per cent, up 13 basis points from the previous week’s 7.56 per cent. The weighted yield was 7.65 per cent or up 17 basis points over the previous week.

Credit pick-up

What made the situation worse was the pick-up in credit off take. The incremental credit deposit ratio for the month was close to about 70 per cent, according to the RBI’s Weekly Statistical Supplement. As a result, tight liquidity conditions pushed the ten year YTM on a weighted average basis to 8.35 per cent last week-end, up 8 basis points over the previous week.

Trade volumes picked up. Average trade volume during the week was about Rs 5,900 crore per day. The improved volume was largely on account of the impact of RBI’s special market operations. But banks were also picking up securities, largely short-dated securities. This was partly to replace maturing securities and maintain the investment-deposit ratios at the current level of 32 per cent. Banks remained sellers on a net basis. Purchase preferences of banks were mostly short-dated securities, a clear indicator of the bearish market outlook. Both public and private sector banks have shrunk the average maturity of their marked-to-market portfolios to about a year. Some of the public sector banks also moved part of their long-dated securities to the held-to-maturity category, to avert depreciation losses. The bearish outlook was partly on account of the inflation numbers that have pushed up the one year real yield to the negative zone by about 70 basis points. This was also an indicator that there were upside risks.

Insurers stay away

Besides, insurance companies also abstained. Life Insurance Corporation (LIC) preferred to wait for some more time before making purchases. But mutual funds were also faced with redemption pressure, leading to sale of securities.

Exit from mutual funds was one factor driving bank deposits, particularly time deposits. Time deposits of banks grew Rs 1.2 lakh crore since the beginning of this financial year, even without any change in interest rates. Lending rates are likely to see a slight mark-up in the coming weeks, when the RBI is expected to push through a cash reserve ratio hike.