The Hindu Business Line : Bonds rally on fall in global oil prices

Bangalore, Aug. 10 Bond markets rallied as yields softened on the back of falling international oil prices. Yet, inflation remained a major worry as the whole sale price index breached the 12-per cent mark. However, the Chief Economic Advisor, Ministry of Finance, Dr Arvind Veermani, dismissed fears of inflation. He said, “Inflation is not a major worry. The GDP deflator is 6.5 per cent.” (Gross Domestic Product deflator is another measure of price change attained by dividing nominal GDP by real GDP).

Besides, even at the current WPI, inflation was lower than comparative US Producer Price Index (PPI). US PPI increased 14.1 per cent during a comparable period.

The changed inflation outlook notwithstanding, what favoured bond markets were international oil prices. Oil prices were on a clear down swing. India’s import basket price last week moved close to $112 a barrel, down about $30 a barrel from the July 3 peak of $142.04.

The lower oil prices also implied reduced dollar demand from refineries for meeting their import payment obligations. At the current prices, the foreign exchange requirement is about $270 million.

Lower oil prices also implied refineries were cash-rich after sale of subsidy bonds to the RBI through the special market operations. For the week ended August 1, refineries sold about Rs 277 crore of oil bonds under the SMO.

Since the beginning of the SMOs, the RBI’s cumulative purchase of oil bonds amounted to Rs 20,337 crore. The surplus cash also meant that refinery credit line drawdowns were low.

With oil prices down, exporters also resumed inward remittances of their earnings, pulling the rupee down to Rs 42.20 last weekend, from the previous weekend’s Rs 42.37. Succour for the rupee also came from the US Federal Reserve Board’s stance of continuing with the dollar liquidity expansion. The Fed, at last week’s meeting, kept the Federal funds rate at 2 per cent. Fed funds are the overnight borrowing of reserve funds among the US banks.

Forward premia down

The combined effect dragged the forward premia down. Forward premia for one, three, six and 12 months fell to 4.27 per cent (5.95 per cent), 5.12 per cent (5.66 per cent), 4.41 per cent (4.67 per cent) and 3.65 per cent (3.97 per cent). However, short forwards widened to 9.38 per cent last weekend from 7.65 the previous week, as foreign banks swapped cash for spot and took advantage of the tight conditions in the domestic money markets.

Call money rates in the weekend ended at 9.30 per cent.

The tight conditions, on account of credit demand, were evident from the weekend Liquidity Adjustment Facility (LAF) auctions.

There were 29 bids at the reverse repurchase window for Rs 32,720 crore. The tight conditions notwithstanding, at the Treasury bill auctions, yields retreated. At the 91 day T-bill auctions, the cut-off and weighted yields were 9.24 per cent and 9.19 per cent respectively, down from the previous week’s levels of 9.36 per cent and 9.32 per cent. The accepted bids amounted to Rs 5,638 crore that included five bids for Rs 2,638.10 crore.

The 10-year yield to maturity (YTM) also followed a similar trend. The ten-year YTM retreated to 9.15 per cent on a weighted average basis, down from the previous week’s level of 9.31 per cent. The Government’s Rs 10,000 crore of bond placements comprising the 8.24 per cent 2018 and the 7.95 per cent 2032 sailed through smoothly at YTMs of 9.14 per cent and 9.88 per cent respectively, benefiting from the soft YTM.

The undertone was bullish. This was evident from the increased daily trade volumes to over Rs 5,000 crore. Bid offer spreads also narrowed during the week to about 10 basis points. But interest was largely driven by foreign institutional investors and insurance company purchases. FIIs inflows during the week amounted to $215 million.

Outlook positive

The outlook remained positive despite the negative real yields. Nominal yields up to 27 years trailed the WPI-based inflation implying a real yield of 2.5 per cent.

Despite this situation, inflows are likely to continue, partly due to interest rate differentials between the dollar and the rupee deposit rates. Six-month dollar denominated Certificate of Deposits (CD) earn barely 3.1 per cent. Rupee CDs earn 11 per cent. Inflows mounted during the week as a result, as more non-resident Indians moved funds back home.

Inward remittances from exporters also mounted to benefit from the high domestic deposit rates, bankers said.

The inflows were evident from the reduced premia in the non-deliverable forward markets. NDF premium for 30 days is currently (a cash settled short term forward market) about 4 per cent. Traders said that the sharp fall in the 30-day forward premia by over 1.7 per cent was largely on account of some banks selling dollar in the NDF market anticipating a further upward momentum in the rupee.

Besides, the incremental investment deposit ratio was down to 13 per cent, well below the statutory liquidity ratio (SLR) of 25 per cent. Incremental credit deposit ratio, however, was 38 per cent, largely on account of the surge in deposits. Nominal credit demand was high at 73 per cent.

Deposits are, however, poised to grow even faster in the banking system after a series of rate hikes. Bond markets are likely to see some action in the coming weeks, as banks chase government securities for meeting SLR requirements, taking advantage of the high yields.