The Hindu Business Line : Bonds rally on CRR cut; daily trade volumes increase

Bangalore, Oct. 12 Bonds continued their rally as risk averse investors turned to bank deposits and foreign funds liquidated their domestic assets. Traders said the rally was also largely driven by domestic institutional investors chasing Government securities. Towards the weekend, the booster for the bond market rally came from the Reserve Bank of India’s intervention through a record cut in the Cash Reserve Ratio (CRR).

The RBI had last Monday announced a CRR cut of 50 basis points.The CRR is the minimum cash balance that banks maintain with the RBI against their net demand and time liabilities. But, despite a reporting Friday, markets were strapped for liquidity. The liquidity crunch became apparent from the high recourse to the RBI’s repurchase window at the weekend Liquidity Adjustment Facility auction. At the LAF auction, 95 banks and primary dealers borrowed a total of Rs 91,500 crore through the repo window.

Yet, call rates remained over 20 per cent prompting the RBI to act. The liquidity crunch was largely driven by panic from foreign institutional investors and hedge funds rapidly unwinding from the domestic markets to shore up the capital of their beleaguered parents.

FIIs, during the week, sold a total of $906 million of both equities and bonds. With the RBI limiting its interventions in the foreign exchange markets FIIs were mostly dollar buyers. The purchases drove down exchange rates to Rs 48.72 against the dollar. Bankers said that the fall would have been far more steep but for the RBI’s intervention, both in the foreign exchange and the money markets. The RBI sold dollar and at the same time pushed in rupee liquidity to offset the compression in reserve money, the bankers said.

Forward premia low

However, the forward premia across all maturities remained low during the week as some exporters hedged to take advantage of the current situation. Forward premia for 30, 90, 180 and 360 days were 0.74 per cent (0.26 per cent), 0.16 per cent (0.6 per cent), 0.08 per cent (0.73 per cent) and 0.14 per cent (0.64 per cent).

Traders said that the slight widening of one-month forward premia was partly on account of hedging by oil importers and anticipation of redemption by foreign currency convertible bonds. Besides, traders said that the three-day forward premia also remained narrow despite the high call rates. Three-day premia was 7.4 per cent as against the previous week’s level of 4 per cent, as some West Asian banks swapped dollar for meeting their reserve ratio requirements.

But RBI’s interventions are far from complete. The Bank of Baroda’s chief economist, Dr Rupa Rege Nitsure, said: “We will see more such action in the coming weeks and perhaps some redemption of market stabilisation scheme securities”. This expectation was on account of the fact that M3 (broad money supply) expansion, this year, so far, has remained muted. Between April and September this year, M3 expansion was just 6.6 per cent. For the corresponding period of the last financial year the expansion was 8.2 per cent. The outstanding MSS securities with the RBI is currently about Rs 1.74 lakh crore as against Rs 1.44 lakh crore during the corresponding period of last year. Consequently, with little non-debt capital inflows MSS relaxations were now expected to be deployed for pumping in liquidity into panic-stricken markets. The panic in the markets also prompted the RBI to defer auctions of securities worth Rs 10,000 crore, through issue of 6-year securities and reissue of the 7.95 per cent 2032 paper.

The reason for the deferral was largely because few banks were prepared to lend in call markets. Instead, most preferred to park funds in Government securities. The preference for Government securities was evident from the weekly Treasury bill auctions. For a notified amount of Rs 5,000 crore, bids amounted to Rs 10,020 crore. The rush pulled down the cut-off yield to 8.48 per cent or down 38 basis points over the previous week. But the difference between the cut-off and the weighted yields widened to 34 basis points. The wide differential was driven by some bidders chasing Government securities. The trend extended into the 364-day T-bill auction that saw the cut-off yields falling to 8.45 per cent. The chase for Government securities also pulled down the 10-year yield to maturity to 7.96 per cent or down 38 basis points over the previous week.

Undertone bullish

The undertone in the markets remained bullish. The bull run was evident from the rising daily trade volumes. Average daily trade volume was in excess of Rs 9,000 crore. In fact, trade volumes were very close to equity market volumes. Traders said that the increased trade volume were largely on account of institutional flight from equities to safer investments, particularly Government securities. At the retail level, investors flocked to bank deposits that have surged.

Bank deposits are currently benefiting from the reversal in the disintermediation process. Typically a reverse takes place, when confidence in equities and mutual fund slip. A trader said that such a situation was already beginning to happen with funds facing redemption pressures. Mutual funds sold a net of Rs 2,500 crore of investments in the beginning of this month. The outlook for bonds consequently remained positive.

This was despite inflation remaining in double digits at 11.80 per cent, higher than nominal yields up to 28 years. Besides, nominal yields showed an inversion, high at the short-end and low at the long-end. For instance, the 91-day cut-off yield was 8.48 per cent, whereas 28-year-yield was 8.46 per cent. Normally inversions indicate a slowdown. This was also supported by the index of industrial production that grew only by 1.3 per cent. However, there was little evidence of a slowdown in bank credit off-take. Incremental credit deposit ratio for the latest fortnight was 140 per cent. Credit grew 25 per cent on a year-on-year basis. Deposits continued to surge with the banks. Time deposits with the banks have surged Rs 2.73 lakh crore this financial year so far. The surge in deposits was leading to a shortage of SLR securities, driving up prices and pulling down yields. Bankers are now pushing for including more securities eligible for reserve ratios and also for repurchase operations. This is one option for increasing the liquidity with the banks holding special Government securities.

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