The Hindu Business Line : Bonds remain flat as inflation worry looms

Traders feared possibilities of further tightening. Besides, there were concerns on the fiscal fallout of the wage hikes to Central Government employees.

Foreign institutional investors also remained major sellers. FIIs sold about $134 million of equities during the week. More selling appeared likely with the dollar strengthening in the international markets, as FIIs repatriated earnings home to beef up the capital of their respective troubled parents.

As a result, the dollar firmed against the rupee during the week, reversing a week-long trend.

The dollar ended the week at Rs 42.82. The rupee drop would have been far sharper but for the Reserve Bank of India’s intervention through sale of dollar.

The chase for dollar and the consequent liquidity demand was from recourse to the repurchase window even on the reporting Friday. The recourse to the repo window at both the liquidity adjustment facility auctions was Rs 31,635 crore. Recourse to the reverse repo window was only Rs 1,300 crore.

Forward premia also firmed slightly at the near ends due to corporate covering of debt service obligations. At the middle and long end, exporter covering and importer unwinding pulled down forward premia. Forward premia for one, three, six and 12 months ended the week at 4.48 per cent (4.27 per cent), 4.58 per cent (5.12 per cent) 3.95 per cent (4.14 per cent) and 3.23 per cent (3.65 per cent).

Traders said that the retreat was also in anticipation of inflows for big ticket Government divestments such as the Bharat Sanchar Nigam Ltd. Besides, refineries were no longer in the market since most of them were armed with cash equivalent of about $5 billion after the RBI’s special market operations.

However, cash-spot forward premia widened as global banks took advantage of the tight cash situation in the domestic markets. Traders said that some foreign bank swapped their cash dollar for rupees and reversed the spot for Monday, which is the spot date. But foreign banks also raised short-term resources for complying with the reporting Friday’s reserve requirements.

As a result, cash spot forward premia remained wide at over 8 per cent, though down from last week’s 9.38 per cent.

The tight short-term liquidity situation notwithstanding, yields at the weekly Treasury bill auctions remained steady. The cut-off yield at the 91-day T- Bill auctions was 9.15 per cent, down from the previous week’s level of 9.24 per cent.

The weighted yield was 9.11 per cent from 9.19 per cent.

The accepted bids amounted to Rs 5,150 crore, as against the notified amount of Rs 3,000 crore. But traders said that the non-competitive bids amounting to Rs 2,150 crore were mostly from refineries, mutual funds and general insurance companies.

Insurers were more circumspect of the equity markets after having burnt their fingers in the last few months. Some FIIs also picked up T-bills. FIIs were only fringe players in the debt securities markets. Despite these, buying interest in the 91-day T-bill yield remained well above the repo rate of 9 per cent.

Undertone bullish

The undertone remained bullish. This was apparent from the high trade volumes. Trade volumes during the week averaged about Rs 7,800 crore. During the week, trade volume had topped the Rs 10,000-crore mark, for the first time since 2004.

But traders said the increased volumes were partly triggered by the unit-linked funds switching over to debt papers, particularly short-term debt.

Leading the insurers’ chase for Government debt was the Life Insurance Corporation of India. LIC picked up high coupon securities, mostly oil and fertiliser bonds. The securities included the 8.23 per cent 2023 and the 8.20 per cent 2024 oil bonds. Both these securities were lifted at YTMs of 9.59 and 9.51 per cent.

As a result, the spreads between subsidy bonds and government securities levelled, implying complete disappearance of the risk premia.

Mutual funds’ interest in short-term papers was driven by anticipation of bargain valuations in the coming weeks. This was particularly after the Economic Advisory Council to the Prime Minister admitted to a slowdown. The EAC, in its report released on Thursday, scaled down the country’s growth to 7.8 per cent.

A scaled down growth implied a slow down in credit off-take, bankers said. The situation, however, augured well for bond markets.

Traders said investment-deposit ratios could rise in the coming weeks. Incremental investment deposit ratios were already well over the prescribed statutory liquidity ratio of 25 per cent at 30 per cent.

Besides, incremental credit deposit ratios remained low at 43 per cent.

As a result, the spread between nominal yields and the whole sale price index widened. Nominal yields on gilts up to 27 years were lower than the WPI-based inflation by at least 300 basis points.

Bankers anticipated a further liquidity squeeze. This was evident from the continued market stabilisation scheme issues. For the coming week, the MSS issuances through the T-Bill route are expected to remove another Rs 1,000 crore through the 182-day bill route.

Besides, another Rs 3,000 crore would be removed through the 91-day t-bill route, under the Government’s regular borrowing route. This would be in addition to the Rs 6,000 crore of borrowings targeted next week. Accordingly, a total of about Rs 10,000 crore of liquidity would be removed from the banking system.

Slowdown in money supply

Already the tightening impact was evident from the slowdown in money supply growth to under 20 per cent for the first time. Despite the deceleration, money supply growth remained well above the RBI’s targeted band of 15-17 per cent. This was partly on account of bank credit to the commercial sector.

Bank credit to the commercial sector grew by 24 per cent this year, according to the weekly statistical supplement of the RBI’s weekly bulletin. In the coming weeks, if inflation control remains the focus, one more round of cash reserve ratio hike appears imminent.