The Hindu Business Line : Bonds rally on dip in oil prices, deluge of deposits

But traders said anticipation of further Reserve Bank of India (RBI) policy interventions also kept the bonds on a high. On Saturday, the RBI carried out one more round of intervention through a 100 basis point reduction in the Cash Reserve Ratio, a reduction in the Statutory Liquidity Ratio to 24 per cent, a repo rate reduction to 7.5 per cent and a proposal to buy back securities issued under the Market Stabilisation Scheme. The immediate impact of the CRR reduction is likely to be Rs 40,000-crore liquidity infusion.

The RBI’s policy reflex stemmed from the tightening liquidity conditions. The tight liquidity was evident from the week-end liquidity adjustment facility (LAF) auctions. At the two week-end LAF auctions, the recourse to the repurchase window was Rs 65,385 crore. Besides, towards the week-end, call rates topped 20 per cent.

The tight liquidity also reflected at the weekly Treasury bill auctions. The cut-off yield on the 91-day T-bill yield was 7.44 per cent, up from the previous week’s level of 7.19 per cent. The weighted yield also rose to 7.26 per cent or 20 basis points over the previous week.

As a result, cash to spot forward premium rose to 19.5 per cent (0.72 per cent). The premium reflects interest rate differentials between the dollar and the rupee. This year, it was the highest level for the short forward premium. The reason for this steep rise was partly the Federal Reserve Board’s reduction in the key federal funds rate to just one per cent. The Federal funds rate is the overnight interest charged on reserve funds borrowing/lending between banks and savings institutions in the US. In addition, the US Federal Reserve also instituted swap lines with several central banks across the world as a liquidity support measure. A swap line allowed central banks to draw dollar denominated funds from the Fed against their respective currencies at a predetermined interest rate. These swap lines are valid up to April end next year.

Some foreign banks took the opportunity to effect overnight swaps to take advantage of the high call rates. This effectively implied swapping dollar for rupees and reversing the same on the settlement day — Tuesday. The dollar inflows, as a result, pulled up spot rupee to Rs 49.25 per dollar from the previous weekend’s level of Rs 49.95.

FII exit

Yet, liquidity continued to remain tight in the domestic markets. The tightness stemmed from the massive exodus by foreign institutional investors. FIIs exit in October alone was $4.27 billion, the highest in a single month. In addition, bankers said refineries and importers also stepped in to hedge their payment obligations anticipating further rupee gyrations in the coming weeks. As a result, forward premia for one and three months widened to 7.31 per cent (2.16 per cent) and 3.25 per cent (2.24 per cent). Refineries covered their payment obligations despite the drop in the import basket prices to $58 per barrel. But exporter covering shrank the longer forward premia, six and 12 months, to 1.79 per cent (2.32 per cent) and 1.32 per cent (2.32 per cent).

But traders believe that the rupee is unlikely to remain capped at Rs 50, with the possibility of an upside momentum. That this momentum was in the offing was evident from the trend in the non deliverable forward markets (NDF). NDF markets frequented mostly by institutional investors and hedge funds, is mostly for emerging market currencies, where settlement is in dollar. Last weekend, at the NDF market, the rupee-dollar closed at Rs 51, as against Rs 52.20, the previous week.

The trend was due to deposits flooding the banks, partly from non-resident Indians under Foreign Currency Non Resident (FCNR), in addition to domestic deposits. Syndicate Bank’s Executive Director, Mr V.K. Nagar, said: “We are having large deposit inflows particularly into time deposits”. Besides, the SBI was receiving deposit of almost Rs 1,000 crore per day. This, bankers said, continued to drive bankers’ hunger for Government securities. The chase for Government securities brought down the investment deposit ratio to 28 per cent, from over 33 per cent during the beginning of this year.

Bankers said that as a result the 10-year yield to maturity (YTM) dropped to 7.46 per cent on a weighted average basis, down 22 basis points from the previous weekend.

Trade volumes

The undertone remained positive. This was evident from the daily trade volumes that averaged about Rs 8,000 crore per day, though down from the previous week’s level of Rs 9,100 crore. Yet, traders said, debt continued to remain in favour. In fact, Government debt is likely to remain in favour. This was also evident from the thin bid offer spreads that were just about 5 basis points.

The fundamentals also favoured bonds, with inflation decelerating to 10.68 per cent. Nominal yields, however, remained at least 300 basis points over inflation.

Moreover, traders said, most banks had already discounted the SLR reduction. Most banks needed the securities for meeting their liquidity requirements for accessing the RBI’s repo window to support the future SLR requirements, as some securities, especially T-Bills, are redeemed.

Consequently, even the RBI’s buy back options are likely to find few takers. The IDBI Gilts Ltd, Vice-President and Head Treasury, Mr S. Srinivasa Ragavan, said, “It is only the private sector and foreign banks that may avail the buy back offer. Public sector banks will hold on to the securities in view of valuation issues”. This was because PSU banks have already transferred the bulk of low coupon securities to the Held-to-Maturity (HTM) category. Consequently, if sold to the RBI, valuation gains would have to be treated as part of the capital, instead of the revenue account.

Moreover, the effective impact of the buyback would be restricted to only about Rs 80,000 crore of Government securities that were used for the MSS operations during the last few years. These securities included the 6. 57 per cent 2011 and the 5.87 per cent 2010 papers.

Besides, bankers said that given the credit offtake situation, liquidity is likely to remain tight in the coming weeks. The current liquidity infusion is likely to be absorbed in about a week. That is also apparent from the high incremental credit-deposit ratio. For the fortnight ended October 24, the incremental credit-deposit ratio was over 200 per cent.

The offtake was mainly from corporates that had lined up external commercial borrowings. ECBs are not available, since spreads between US Treasuries and euro-dollars remained over 300 basis points. Consequently, ECB inflows appear unlikely in the near future. The only flows that now appear to be coming are FCNR deposits, where the effective yields were far more attractive than what are offered in the international markets.