The Hindu Business Line : Bonds rally on surging deposits, weak oil prices

Traders said the slide in yields was triggered by anticipation of policy interventions by the Reserve Bank of India. The anticipation stemmed from the inflation retreat. Inflation, as measured by the whole sale price index, dipped to 6.84 per cent .

NRIs, bankers said, flocked to public sector bank deposits after having incurred losses in the equity markets. Besides, after the Federal Reserve Open Market Committee dropped the Federal Funds (the overnight borrowing and lending of reserve funds between US banks and financial institutions) target to 0.25 per cent, dollar-deposit rates in the international markets were down. One-year dollar certificate of deposit (CD) rate is currently about 1.9 per cent and is expected to go down further in the coming weeks. The FCNR and the non-resident non-repatriable rupee deposits account offers far higher rates close to 4.5 per cent. As a result, inflows into the banking system since the hike in the rates from mid-October onwards were estimated to over $1 billion.

Besides, some US banks operating in the country resorted to cross border arbitrage operations. These banks, recipients of US Treasury support under the TARP invested in short-term treasury bills, particularly the high liquidity 91-day Treasury bills. Last week, at least 49 per cent of purchases of T-Bills were by foreign banks, mainly US banks.

The inflows resulted in the rupee appreciating to Rs 47.08 against the dollar, a 6 per cent appreciation since November 22, when the exchange rates had bottomed at Rs 50.03.The positive sentiment was also evident from the non-deliverable forward markets, where the rupee- dollar exchange ended the week at Rs 47.15.

Dollar demand

Moreover, refinery driven dollar demand weakened last week, traders said, with oil import basket prices falling to barely $40 a barrel. Part of the low refinery demand for dollar stemmed from the RBI’s special market operations. For the week ended December 12, the RBI purchased Rs 2,505 crore worth of oil bonds from the refiners, pumping an equivalent amount of dollar.

The intervention notwithstanding forward premia remained stable at firm levels. This was partly due to foreign banks covering against their TARP-driven arbitrage. Moreover, some refineries also took cover up to six months imports at the current levels. One, three, six and twelve month forward premia, as a result, ended the week at 5.73 per cent (5.30 per cent ), 4.59 per cent (4.61 per cent ), 3.19 per cent (3.26 per cent ) and 2.28 per cent (2.30 per cent). Three-day forward premia weakened, as the overnight arbitrage options weakened, with the narrowing domestic call money and Fed fund spreads. Overnight premia was 3.9 per cent last weekend, down from the previous week’s level of 5.20 per cent.

The comfortable liquidity position resulted in high recourse to the reverse repurchase window at the weekly Liquidity Adjustment Facility (LAF) auction. Recourse to the reverse repo was Rs 24,950 crore, though on a net basis, it was only Rs 10, 560 crore. The comfortable liquidity was also evident from the weekly T-Bill auctions. The cut-off yield on the 91-day T-bills was 5.45 per cent and the weighted average was 5.41 per cent or 20 and 12 basis points over the previous week.

However, the 364-day T-bill yield was even lower at 5.35 per cent or closer to the reverse repo rate of 5 per cent. But the bid to cover ratios for the 91 day T-bills dropped to 2.85 times, down from the previous week’s 4.1 to times. Part of the sale of the T-Bills was largely on account of conversion into regular government borrowings. The outstanding MSS securities, as a result, came down to about Rs 1.29 lakh crore from Rs 1.66 lakh crore.

Bankers said that one major reason for the drop in bid-to-call ratios was the shift of PSU banks from T-bills to dated securities, anticipating a further drop in yields. As a result, the 10-year yield to maturity (YTM) dropped to 5.53 per cent on a weighted average basis from the previous week’s level of 6.17 per cent. At this level, the ten-year YTM was just about 7 basis points above the 91 day T-bill.

Undertone positive

The undertone remained positive. The average trade volume during the week averaged Rs 15,000 crore or about Rs 3,500 crore more than the average NSE equity turnover per day during the week.

The outlook for debt remained positive. Rating agency CARE’s Chief Economist, Dr Saumendra K. Dash, said, “We can see yields falling to 5 per cent soon as more liquidity is released into the banking system.”

In fact, banks are currently expecting a further reduction in the cash reserve ratio by at least 100 basis points from the current level of 5.5 per cent that would release another Rs 1 lakh crore into the banking system.

In addition, reverse repo rates are also forecast to be cut by another 100 basis points to keep the GDP growth momentum on track.

But a key driver of yields was the demand for securities for meeting the statutory liquidity ratio (SLR). At present, banks are expected to maintain an SLR of 24 per cent. With deposits growing at an average of Rs 2,000 crore per day since the beginning of the financial year, demand for SLR securities remained high. Besides, bankers said, there was slight slowdown in credit offtake during the holiday season. Incremental non-food credit deposit ratio for the last reporting fortnight was just 21 per cent, a drastic reversal from the previous few fortnights when the ratio was close to 100 per cent. For the same period, incremental deposit ratio was 105 per cent.

Bankers said that despite high deposit growth, banks were unwilling to come below the threshold capital ratio of 12 per cent. In fact, some major banks were focused on raising capital to push up risk weighted assets.

During the last week alone, banks had raised about Rs 2,500 crore of Tier-II bonds, eagerly lapped up by life insurers and provident funds looking for high yields. The issuers included the State Bank of India with a Rs 2,000-crore 15-year-bond issue priced at 8.90 per cent. Insurer interest in the securities was shrinking the spreads. The spread on the SBI offering over the nearest sovereign security was just 270 basis points, down from the 600 basis points spread three weeks ago. Clearly, interest rates are poised to move only one way – down!