The Hindu Business Line : Bonds continue upward momentum

Traders said the sharp fall in global oil prices partially caused bond yields to soften. Oil prices are off their highs and headed downwards and ended the week at $101.18 a barrel. For India, this implied a sharp drop in the import basket prices. Import basket prices are already at the lowest level for this financial year at$96 a barrel.

Yet refineries continued to flock the foreign exchange markets. Traders said that oil demand was mainly driven by hedging requirements. Some refineries took advantage of the hedging window opened by the Reserve Bank of India for securing their future oil requirements, at the current low prices. In addition, large scale selling by foreign institutional investors (FII) also pushed down the rupee-dollar exchange rate to a low of $45.77. FIIs continued to repatriate home to shore up the weak capital of their parents. FII worries worsened in view of fears of an impending collapse of large investment bank Lehman Brothers.

During the week, FIIs sold about $401 million. Despite the sharp depreciation of the rupee by close to 15 per cent since the beginning of April, the RBI showed little inclination to intervene in the foreign exchange markets. This depreciation is unlikely to be sustained for long. HDFC Bank, in its monthly commentary, Eco-Talk, said, “Inflation remains well in double-digits and excessive depreciation could offset the gains from lower commodity prices.”

Moreover, the sharp fall in spot dollar not withstanding, forward premia stood on its own. Forward premia for three days and one month firmed to 7.87 per cent (0.27 per cent) per cent and 4.19 per cent (2.16 per cent).

The sharp firming of the three-day premia was partly driven by the Government auctions for Rs 8,000 crore. The firming of the 30-day forward premia was largely driven by the refinery demand and corporate debt service payments for cross border liabilities. However, at the long end, exporters took cover. Exporter cover restrained six and 12- month forward premia at 2.53 per cent (2.61 per cent) and 2.53 per cent (2.41) per cent.

The liquidity squeeze in the markets somewhat eased during the week stemming from large deposit mop-up from corporates through certificates of deposits. The easing was evident from the low recourse to the repurchase window at the weekend liquidity adjustment facility (LAF) auctions. The combined recourse to the repo window from five banks was Rs 12,215 crore. At least five banks took to the reverse repo window at the auctions.

T-bill auctions

Moreover, at the weekly Treasury bill auctions, yields continued their softening trend. The cut-off yield on the 91-day T-bill was 8.73 per cent and the weighted yield was 8.69 per cent, off sharply from the previous week’s levels of 9.02 per cent and 8.98 per cent respectively. At the T-bill auction, the quantum of bids, from both competitive bidders (banks and primary dealers) and non-competitive bidders (mutual funds and insurers) were on the rise. Total bids for the T-bills amounted to Rs 18,475 crore against a notified amount of Rs 5,000 crore. The bids accepted were Rs 9,836 crore. The trend in the 364 T- bill auction was identical, with yields falling below 9 per cent to 8.86 per cent. As a result, both the 91 and 364 yields were now below the repo rate of 9 per cent.

The softening yields benefited the Government borrowing programme, amounting to Rs 8,000 crore. The 8.24 per cent 2018 was placed at 8.30 per cent and the 7.95 per cent 2032 at 8.70 per cent. But even before the auctions had concluded, many of the foreign and primary dealers had short sold the papers, booking profits in the bargain. This was evident from the YTMs in the markets at the weekend’s close. PDs sold the papers, the 8.24 2018 at an YTM 8.27 and the 7.95 per cent 2032 at 8.65 per cent. The firm trend, however, pulled down the weighted average ten-year YTM to 8.36 per cent, down from the previous week’s 8.47 per cent.

Narrow spreads

Trade volumes remained high, averaging Rs 8,700 crore per day. Spreads remained narrow at just five basis points.

However, traders’ outlook remained uncertain. The uncertainty was evident from the almost flat yield curve. Between one year and 27 years, the yield spread was inverted. The 27-year was lower than the one-year by 8 basis points.

The uncertainty stemmed from two factors. Inflation remained a major cause of worry, with rates remaining in the double digit domain, at 12.1 per cent. This implied that nominal yields were lower than the WPI inflation up to 27 years by over 325 basis points, implying widening negative real yields. Besides, RBI’s purchases of dated securities confused the markets.

Traders said that unlike the special market operations (SMO) that were largely money supply neutral, purchase of dated Government securities tends to add liquidity into the banking system. The impact, however, was small. There were also sales from the RBI’s counter.

Yet, markets were troubled by a shortage of SLR securities. The shortage stemmed from large accretions to deposits.

This financial year alone, accretion to time deposits was in the region of about Rs 2.5 lakh crore.

The IDBI Gilts Treasury Head, Mr S. Srinivasa Raghavan, said, “The accretion in deposits was partly due to the shift from equities to debt.” Besides, domestic institutional investors preferred to park their funds in debt and bank CDs, given the current state of the equity markets. The accretions, in turn, created a rush for SLR securities, bankers said.

Besides, traders said the shortage partly stemmed from banks parking securities in the held-to-maturity category in droves early this year to avert depreciation losses. Public sector banks were unwilling to unwind from the HTM category. The reason: Profts from sale from the HTM category would have to be part of the capital, unlike in the case of the marked to market categories. In MTM holdings, profits are treated as part of the profit and loss account.

But credit also expanded during the period, triggering fears of another strong intervention from the central bank. Incremental credit deposit ratio is currently about 51 per cent during the period. Credit expanded by 25 per cent on a year on year basis. This was well above the RBI’s desired target of 18-20 per cent. The high credit had pushed up the money supply growth to 21 per cent. Clearly, another hike in the liquidity ratio now appears imminent ahead of the peak season credit policy announcement.