The Hindu Business Line : Bond yields stable amid tight liquidity, rising oil prices

Traders said that liquidity remained tight partly due to large mop up through Government borrowings and fertiliser companies’ draw-down of bank credit lines. The credit line draw-downs were ahead of the issue of subsidy bonds by the Government.

The tight liquidity was also compounded by the exit of foreign institutional investors from the markets. Last week, FII liquidation of investments amounted to $421.7 million. The effect was a spike in the exchange rates.

The rupee shed 1.4 per cent on a week-on-week basis against the dollar, ending the week at Rs 43.38. The HDFC Bank’s treasury bulletin said, “Rise in global oil prices and weaker global equities could put further pressure on the rupee”.

Reflecting this sentiment, forward premia moved up at the short end. One month and three month forward premia moved up to 5.26 per cent (2.58 per cent) and 4.66 per cent (4.58 per cent). At the long ends, six month and 12 month, premia remained soft at 3.73 per cent (3.95 per cent) and 3.11 per cent (3.23 per cent ) respectively. The weakening at the long ends was on account on off hedging by exporters and by some software companies.

Traders said that the hardening at the short end was also partly as a result of the inflation numbers. The head line inflation, as measured by the whole sale price index, was 12.63 per cent, keeping traders, who speculated more hikes in policy rates and cash reserve ratio, on tenterhooks. The tight liquidity kept the short forward premia high at 8.99 per cent as some foreign banks swapped their cash for spot, to capitalise on the high call rates which were close to 10 per cent.

What also kept liquidity tight was the anticipated outflow when the CRR hike of July 29 comes into effect. This is expected to remove close to about Rs 9,000 crore from the banking system. The tight liquidity prompted recourse to the Reserve Bank of India’s repurchase window. At the weekend liquidity adjustment facility auction, the recourse to the repo window was Rs 32,675 crore, from 27 bidders.

T-Bill auctions

The tight situation was also evident from the weekly Treasury bill auctions. The cut-off and weighted yield at the 91 day T-Bill auction were 9.15 per cent. The mop-up through the 91-day T-bill auctions amounted to Rs 5,000 crore including the Rs 2,000 crore, through a single non-competitive bid of Rs 2,000 crore. The levelling of the cut-off and weighted yield signalled that short-term yields were poised to harden further in the coming weeks. Normally, the weighted yield is about 4-5 basis points lower than the cut-off yield. The cut-off yield at the 182 day T-bill auction was 9.32 per cent. This auction also saw non-competitive bids of Rs 1,000 crore. Most of the non-competitive bids came from mutual funds and insurance companies that are increasingly moving out of equities and parking funds in T-bills for liquidity purposes. The T-bill yields remained above the repo rate of 9 per cent.

The tight liquidity notwithstanding, the 10-year yield to maturity on a weighted average basis closed the week at 9.15, almost unchanged from the previous week’s level of 9.17 per cent.

The undertone was stable with average trade volumes at Rs 6,000 crore per day during the week. But the bulk of the trade volume was contributed largely by trade in the 8.24 per cent 2018 paper. There were more banks and funds chasing this paper in view of high liquidity. Over 60 per cent of the trade volume was in this particular paper.

Besides, what also kept the volumes high was the RBI’s intervention through special market operations. Last week, the purchase focussed on the 6.96 per cent 2009 oil bond. The securities were picked by the RBI through the SMO route at YTM of around 9.81 per cent. The SMOs window opened, as oil import prices moved up and raised the import basket price to $115 a barrel up from a low of $107.93 this month. The reopening of the SMO window was largely on fears that Russo-Georgian conflict would lead to choking of oil supplies to Europe. European refiners were in the forward markets tying up purchases ahead of the winter months.

Subsidy bonds

In addition to the RBI’s special market operations, banks, funds and insurers also chased subsidy bonds. This category included bonds placed with refineries, fertiliser companies and the Food Corporation of India. Interest in the bonds was largely on account of the high current yields. The current yield on the FCI bond of 8.03 per cent 2024 was about 9.45 per cent.

Despite the trade interest, outlook for bonds remained uncertain. The uncertainty was apparent from the high short-term yields and low-long term yields, implying an inverted curve. Inverted yield curve forebodes a recession. The one-year yield is 9.69 per cent and the 10 year is 9.15 per cent. Besides, the yield spreads between one and 27 years remained barely 18 basis points. Nominal yields up to 27 years remained lower than inflation by at least 300 basis points.

The uncertainty in the bond markets also stemmed from Government policy directions and the surge in credit off- take. Credit off-take this year so far was Rs 65,678 crore that translated into incremental credit deposit ratio of 44 per cent. The high credit off take was also partly triggered by fears that rates were likely to move up further in the coming weeks with the RBI remaining inflation focused.

Corporates, as a result, drew on the credit lines and parked the same in bulk deposits as rates on certificates of deposits moved close to 12 per cent. Some foreign banks also resorted to parking swap resources in short-term CDs giving an arbitrage advantage of at least 5 per cent.

The low credit deposit ratio was, however, partly on account of the intense resource mobilisation efforts as banks chased bulk deposits, anticipating a liquidity squeeze. Besides, growth of non-resident deposits for periods about 6 months was beginning to pick up. Traders said that NRI deposit inflows in money were partly for investing in the initial public offerings of the Bharat Sanchar Nigam Limited and the National Hydro Power Corporation Ltd. As a result of the large deposit accretions, incremental investment deposit ratios dipped to 17 per cent as against the nominal ID ratio of about 34 per cent.

Some bankers expect a short rally for meeting the shortfalls in the statutory liquidity ratio. Most purchases though are expected to be confined to the short ends, particularly T-Bills, traders said.

Besides, traders said if the Government decides to go ahead with the big ticket IPOs bond markets are likely to benefit. This is because government borrowing requirement would shrink. Cross border inflows are expected to drive down yields. All eyes are now on Government signals in this direction.