The Hindu Business Line : Yields set to rise further as market fears more rate hikes

Bangalore, July 6 Bond yields continued to soar on expectations of a further rise in inflation and high global oil prices. Traders said that there were also fears that the Government’s fiscal estimate would go haywire, as the battle against inflation takes precedence. The provisional estimates for inflation indicated an 11.63 per cent increase on a year-on-year basis. The final estimates that come with a six-week lag, are expected to be at least 100 basis points higher, implying the actual numbers are likely to be closer to 13 per cent.

Said Bharati AXA Investment Manager Ltd’s Income Head, Mr Sujoy Kumar Das, “We can see more interventions from the Reserve Bank of India. Perhaps a hike in both CRR and repo by at least 50 basis points is in order.” It was only two weeks ago that the RBI had hiked the CRR to 8.75 per cent and the repo rate to 8.50. The first phase of the CRR hike came into effect on July 5.

But there were fears that domestic interventions were being stretched in view of firm global oil prices. Global prices were close to $145 a barrel, and India’s import basket prices also moved upwards to $142.04 a barrel. With increased imports amounting to about 2.6 million barrels a day the refineries’ foreign exchange demand is currently estimated at $370 million per day.

Refineries’ funds demand was partly met through the RBI’s special market operations (SMO) through purchase of oil subsidy bonds. For the week ended June 20, the RBI had purchased Rs 4,670 crore of oil bonds for SMOs. Yet refineries’ costs were not cheap, despite the SMOs. At last week’s SMO, oil bonds were picked up at yield to maturities (YTM) of over 9.6 per cent. Since the beginning of the SMOs, the YTMs on oil bonds has steadily increased, reflecting the tightening conditions.

The tightening was also evident from the increased foreign exchange costs for the refineries. At present, refineries are purchasing foreign exchange at the RBI’s reference rate, that is Rs 43.21 to a dollar.

The tight conditions are also partly due to the fact that net foreign exchange flows into the country remained negative. Flows, through purchase of equities by foreign institutional investors, remained in the red line. Last week, the exit amounted to $188 million.

Forward premia softened slightly due to large inflows into non-resident Indian accounts. The tightening was reflected at the Government’s Rs 10,000 crore borrowings through placement of 8.24 per cent 2018 and the 8.32 per cent 2032.

The former was placed at a cut-off YTM of 9.13 per cent and a weighted YTM of 9.07 per cent. The latter security was placed at a cut-off YTM of 10.03 per cent and weighted YTM of 9.92 per cent. The hardening trend was also evident from the weekly Treasury bill auctions. The 91-day T-bill was placed at YTM of 8.81 per cent last week, up from the previous week’s 8.73 per cent. The weighted average yield remained steady at 8.73 per cent, with large non-competitive bids from mutual funds and corporates. The non-competitive bids accepted amounted to Rs 750 crore.

Despite the tight conditions, more banks took recourse to the reverse repurchase window of the RBI. The reverse repurchase implied mop-up of liquidity. The excess overnight liquidity, bankers said, was on account of the reporting Friday, when banks cut back on liabilities.The tightening trend was evident from the weighted average YTM movement. The 10-year YTM per cent ended the week at 9.06 per cent or up 35 basis points over the previous week.

Trade volumes

Trade volumes continued to sink. The average trade volume was a little over Rs 2,600 crore, down from the previous week’s level of Rs 3,500 crore. Even this volume was largely on account of oil bond purchases by the RBI through SMOs.

The undertone remained largely bearish, as banks preferred to sell and insurers abstained from making purchases. As a result, the bid-offer spreads, remained wide at about 25-30 basis points.

Moreover, the yield spread between one and 28 years remained narrow at 20 basis points. However, one year yields were higher than the 10-year YTM. Under normal conditions inverted yields portend a macro economic slowdown.

The outlook also remained bearish. Real yields up to 28 years remained in the negative zone.

Real yield is the difference between nominal yield and inflation. Traders said that this situation is not expected to continue for long. There are only two ways for real yields to become normal, higher than inflation. A deceleration in inflation or an increase in nominal yields.

Although the Government has so far not reacted, many traders believe that some more duty cuts are in the offing, for inflation-sensitive sectors. Tax revenues, as a result, are likely to come under pressure. To offset such revenue shortfalls, there are expectations of higher borrowings. Either way, it implied slippage in fiscal estimates.

The situation, in turn, escalated the upside risks for yields. Says Angel Broking’s banking analyst, Mr Vaibhav Agarwal, “We can see yields rising further in the coming weeks as RBI interventions gather pace.” The anticipation also showed up in the investment deposit ratios. Incremental investment deposit ratios were about 69 per cent. Most of the investments were in T-bills and short-term securities, in view of depreciation fears.

Moreover, reflecting the tightening liquidity conditions, banks resorted to a rash of interest rate hikes, of both lending and deposit rates. Besides, corporate borrowing spreads also increased. Corporate borrowings are currently at least 150 basis points over comparable sovereign yields. The rising spread was also reflective of the risk premium on credit. As a result, credit offtake was beginning to slow down.

Some of the corporates drew down on their sanctioned limits and parked the same in short-term T-bills and bank certificates of deposits.

Bank time deposit accretions as a result surged by Rs 1.29 lakh crore since the beginning of this financial year, as against Rs 97,000 crore during the corresponding period of last year. Corporates are now beginning to park funds in investments and earn short-term interest and holding back capital expenditure to a situation when interest rates stabilise.