The Hindu Business Line : Bonds rally on liquidity inflow

Traders said the redemptions left banks flush with cash. The redemptions of the 4.88 per cent 2008 and the 11.40 per cent 2008 last week alone were about Rs 15,000 crore, leaving the banking system with a surplus of at least Rs 7,000 crore, after conforming to the new Cash Reserve Ratio. In addition, the 12.25 per cent 2008 is also coming up for redemption on September 9, leaving another Rs 6,000 crore of cash with the banks.

The redemptions left many banks with shortfalls in the Statutory Liquidity Ratio (SLR). Under the SLR guidelines, banks are expected to park at least 25 per cent of their net demand and time liabilities in designated Government securities. The shortfalls led to a buying frenzy for Government securities towards the weekend.

However, oil companies returned scrambling for dollar, for meeting their respective payment liabilities. This scramble was largely for oil companies wanting to lock into future contracts, as permitted by the RBI earlier this year. The oil companies shifted to the markets for sourcing the foreign currency, since they preferred holding on to their subsidy bonds. Many of them now preferred to keep the bonds as reserves.

The dollar purchases by refiners and foreign institutional investors pulled down the rupee to 43.79 against the dollar last weekend, down from the previous week’s 43.38. FIIs’ net exit last week was $10 million. But gross investments during the week were also neutral. About $2.31 billion came into the country during the week and $2.32 billion went out. Clearly there are no portfolio investments flows.

Forward premia

Forward premia at the short end, however, softened. Cash spot forward premia was just 2.19 per cent last weekend against the previous weekend’s level of 8.99 per cent. The softening was largely on account of the liquidity in the markets. Consequently, there was little opportunity for foreign banks to arbitrage using the cash spot arbitrage. Traders said the RBI also sold spot dollars through some of the State-owned banks for meeting refinery demand.

Forward premium for 30 days bucked the trend, on the back of refinery covers and firmed to 6.58 per cent (5.26 per cent). Premia for 90, 180 and 360 days remained stable at 4.48 per cent (4.66 per cent), 3.93 per cent (3.73 per cent) and 2.67 per cent (3.11 per cent) respectively.

Last week was also a reporting Friday. Therefore, there was little demand for funds. The low demand reflected in a drop in recourse to the repurchase window at Rs 8,700 crore, at the liquidity adjustment facility auctions. However, the recourse to the reverse repurchase window was Rs 1,100 crore as some of the banks parked their surpluses with the RBI.

The surfeit of short-term liquidity also reflected in the Treasury bill (T-Bill) auctions. At the weekly auctions, the cut- off yield and weighted yield on the 91-day T-bill was 9.06 per cent. The amount mopped up was Rs 3,608 crore as against the notified amount of Rs 2,000 crore. The non-competitive bids almost entirely came from mutual funds looking for avenues to park their cash surpluses.

The ten-year yield to maturity (YTM), as a result, dropped to 8.7 per cent on a weighted average basis, down sharply from the previous week’s level of 9.15 per cent.

The undertone was stable with average trade volumes at Rs 6,000 crore per day during the week. Again, insurers chased the high coupon papers. The preferred paper was the 8.24 per cent 2027 security. The security ended the week at 9.63 per cent. Daily trade in this paper was upwards of Rs 2,000 crore.

The rally was partly driven by the slight retreat in inflationto 12.4 per cent last week, down from the previous week’s level of 12.63 per cent.

Yet the rally is unlikely to remain sustained. This is especially since inflation despite the retreat remained in the danger zone. Average import basket price for oil was $115 a barrel during the month.

The HSBC Bank’s chief economist, Asian Economics Team, Mr Robert Prior Wandesforde, says, “It is tempting to conclude that with the economy slowing more sharply and the WPI inflation rate dropping (to 12.4 per cent from 12.6 per cent) the central bank has finished raising rates. We remain sceptical, although the peak is probably not too far away now — our own forecast, envisages 50 bps of repo rate hikes over the next couple of months, with the CRR increasing by 50-75 bps.”

Outlook uncertain

The outlook for bonds, therefore, remained uncertain. The uncertainty stemmed from fear that the tight liquidity conditions are likely to revisit. Oil and fertiliser companies are still in the markets for raising funds. Oil companies have approached banks for three to five-year borrowings at anywhere between 10.5 per cent and 11 per cent.

Besides, credit off take from the farm sector was also beginning to pick up. The offtake was evident from the numbers released by the RBI’s weekly statistical bulletin. Incremental credit deposit ratio was 55 per cent this financial year so far and was still picking up.

But investment deposit ratios (ID) were down. Incremental ID ratios were down to 15 per cent. With one more redemption in the offing, a further yield retreat is likely. But that could be the last rally for the year, if the current pace of credit growth continues. This is because some of the bulk deposits taken in during the early half of this financial year are expected to come up for redemption.

A Government decision on the mega initial public offerings of the telecom behemoth Bharat Sanchar Nigam Ltd and the National Hydro Electric Corporation would, however, filibuster any downturn in bond markets.