The Hindu Business Line : Bonds stable as traders take cue from RBI to expand credit

Traders said that the credit policy was in line with market expectations. Few had expected any significant reductions in the cash reserve ratio (CRR) after a drop of 250 basis points over a period of two weeks. Besides, the RBI had, at the beginning of week, pre-empted the policy and cut the repo rate 100 basis points to 8 per cent. This clearly was a signal that addressing the liquidity situation was top priority for the central bank.

That the RBI’s measures were beginning to impact was evident from the liquidity adjustment facility (LAF) auctions. The recourse was mostly to the reverse repurchase window. Reverse repurchase implies sale of securities by the RBI to banks and primary dealers for mopping up excess liquidity. At the two weekend LAF auctions, net recourse to the reverse repo window was Rs 19,605 crore.

The central bank’s measures though failed to make any dent in the foreign exchange market. This was because the dynamics were different. The forex market was dominated by a massive run off by foreign institutional investors. FII exit in October so far amounted to $3.4 billion and about $8.5 billion since the beginning of this financial year. The FII sell-out more than offset the impact of sagging oil prices. India’s oil import prices are down $61 a barrel or about $447.13 a tonne.

The simultaneous entry of oil companies and FIIs for purchase of dollars, pulled down exchange rates to Rs 49.95 per dollar or about 25 per cent down from the beginning of this financial year.

The exchange rates would have slipped below Rs 50, but for the RBI’s intervention in the foreign exchange markets, mostly through sell-buy swaps. In fact, throughout the week, the rupee remained highly volatile on the back of hedge fund and FII unwinding. Average volatility, was close to about 50 paise per day.

However, despite the dramatic movements in exchange rates, few non-oil importers resorted to any panic hedging. The absence of any panic hedging was despite the non-deliverable forwards shifting to Rs 52.20 per dollar for one month. NDF is a mechanism used by FIIs for hedging against currencies like the rupee, with settlements mostly in dollar. Upward movements in the forward premia were largely on account of refineries taking cover. Forward premia for one, three, six and 12 months were 2.4 per cent (1.48 per cent), 2.24 per cent (0.66 per cent), 2.32 per cent (0.49 per cent) and 2.32 per cent (0.45) respectively.

Moreover, traders said that the hardening of premia was largely on account of some exporters deferring their inward remittances in anticipation of a further slide in exchange rates. Only short-term forward premium softened. Cash to spot forward premia dropped to 0.72 per cent (7.40 per cent) as domestic call markets stabilised. Cash spot forward premia mostly tend to function in tandem with call rates, reflecting narrowing interest differentials.

But traders said that the differentials could shift further down in the coming weeks and forward premia correction was imminent. This was in view of the RBI’s steps that pushed up the foreign currency. Non-resident deposit rates were up to 100 basis points over the London Inter Bank offered rate (LIBOR). FCNR rates have remained below LIBOR since 2003 to contain liquidity expansion.

The FCNR flows are likely to have an immediate impact, especially from non-residents, battered by low rates and the market meltdowns in the US and Europe.

However, the relaxing of the foreign currency borrowings spread to 500 basis points, they said, was unlikely to have an immediate effect. This was in view of the high spread between the US Treasury Bill and euro-dollar spreads. The spread is over 300 basis points.

That liquidity flows were more likely through bank deposits reflected in the bids at the weekly Treasury bill auctions. The 91-day T-bill rate dropped sharply to 7.19 per cent, down 150 basis points. The weighted average rates were down to 7.06 per cent, down 129 basis points.

At the auctions, the mop-up through the T-bills was Rs 6,000 crore as against a notified amount of Rs 5,000 crore. Bids at the auctions amounted to Rs 14,426 crore. The cut-off yield on the 364 T-bill dropped to 7.40 per cent.

However, the drop in the ten-year yield to maturity (YTM) was tempered. The ten-year YTM remained stable at 7.68 per cent on a weighted average basis last week. Traders said that this was largely because traders slowed down bond purchases taking cue from the RBI to expand credit.

The undertone though remained upbeat last week with average daily trade volume at Rs 9,100 crore.

In fact, on most days of last week, debt trade volumes exceeded the NSE equity turnover.

However, debt is still not the flavour of the season. The SBI Life Insurance Company Ltd, Managing Director, Mr Uday Shanker Roy, said, “There is more money coming into growth funds now.” This implied that domestic investors remained focussed on equity, despite a market meltdown.

In the immediate term, however, more funds are parking in bank deposits and short-term papers. This was also one of the major factors leading to high non-competitive bids. In such a situation, a shortage of SLR securities is likely to intensify that could see further softening of yields or greater profits from bond trading. The falling yields also led to a further widening of the gap between nominal yields and the whole sale price inflation. Inflation last week was 11.07 per cent. The gap is close to 3 per cent.

But traders said that some more exchange management steps are likely to come from the bank. This was to moderate inflation to acceptable levels. Currently, the high exchange rate largely neutralised the impact of falling commodity prices, especially oil. Traders said that accordingly more steps were in the offing to step up foreign inflows into the country and accelerate export remittances back into the country.

Despite the anticipation of such moves, bankers said, the outlook for bonds remained tempered. This was largely in view of the continued credit off-take. The nominal credit deposit ratio is currently in excess of 75 per cent. The ratio for this year is currently 90 per cent. The high off-take was also largely due to choking of foreign debt flows.

Consequently, domestic credit off-take is likely to rise even higher in the coming weeks, mostly from infrastructure sectors. For banks, the reversal in disintermediation is becoming an opportunity. To sustain this growth, banks have begun bracing for selling some of their investments, especially after the reduction in the statutory ratios.

Related Stories:
Dull trading in bond markets
Liquidity influx sends bond market into a tizzy
Bond prices volatile

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