The Hindu Business Line : Bonds pause ahead of year-end; traders await policy intervention

Bangalore, Dec. 28 Bonds paused even as traders prepared to book profits ahead of the year-end and most of them took a break for a holiday after facing a tumultuous year.

Inflation, which retreated to 6.61 per cent, had little impact. Much of the inflate-onary impact was already discounted last week itself, traders said, in view of the weakening commodity prices. Oil import basket, for instance, is down to a five-year low of $34 a barrel.

Besides, FIIs appear to have halted their exodus from the domestic equity markets. Last week, FIIs actually made net investments of about $104.9 million, though mostly in debt securities. Equity investments, however, remain a low priority for the FIIs at the current juncture, traders said.

The rupee slid though against the dollar, despite the net inflow. Traders said that FII investors were holding to the government debt securities for treasury gains, hoping to book profits, when the key policy rates — the Reserve Bank of India’s reverse repurchase rate (an instrument for removing liquidity from the markets through sale and buyback of securities) and the repurchase rates (injection of liquidity through purchase of securities) are effected over the next few days. Traders expect a 50 basis points reduction in the rates. At present, the reverse repo is 5 per cent and the repo is 6.5 per cent.

However, the expectation notwithstanding, oil companies remained net buyers of foreign exchange, fearing further volatility in exchange rates. The purchases were also partly on account of the RBI’s special market operations for oil companies. Traders said that at least Rs 2,800 crore of bonds were purchased from the PSU refiners. Simultaneously, the refiners were advanced foreign currency from the RBI for meeting their crude import payments. Refiners also made purchases from the open market driving down the exchange rate to Rs 47.89 last week from the previous week’s level of Rs 47.08. In addition, importers and corporates, with external debt service payments falling due, took forward cover, leading to a spike in forward premia. One, three, six and twelve month premia firmed to 6.26 per cent (5.73 per cent), 5.01 per cent (4.59 per cent), 3.42 per cent (3.19 per cent) and 2.39 per cent (2.28 per cent).

Three month forward premia widened to 5.19 per cent from 3.9 per cent in view of the high differential between the Federal Funds and the domestic call money rates. Traders said the widening trend was also on account of window dressing by some private sector banks, ahead of the third quarterly results. But foreign banks continued to arbitrage between the liquidity support programme under the Treasury Securities Lending Facility (This is a lending facility whereby the US Fed offered a loan of treasury securities against a basket of eligible securities that include mortgage- backed securitised papers). At the Fed auctions on December 23, liquidity support to the extent of $22 billion was advanced to US banks at a stop-out rate (cut-off rate in domestic parlance) of 0.1 per cent, offering arbitrage opportunities for US banks operating in India.

LAF auction

But the demand for foreign exchange notwithstanding, liquidity remained comfortable. At the weekend Liquidity Adjustment Facility auction, recourse to the reverse repo window amounted to Rs 24,105 crore from 14 bidders.

Recourse to the repo window was only Rs 3,400 crore. Traders said that a key driver of the liquidity overhang was the slight slowdown in credit offtake, ahead of the yearend. For the last fortnight, incremental credit deposit ratio was down to 26 per cent. Besides, banks were still being inundated with deposits at the rate of about Rs 3,000 crore per day.

The high liquidity also manifested in the weekly Treasury bill (T-Bill) auction. At the weekly auction, the notified amounts were pared to Rs 500 crore each for the 91-day T-bill and the 182 day T-Bill. Till December 19, the notified amount for the 91-day bill was Rs 5,000 crore. Traders said that the move was to increase the liquidity through redemption of market stabilisation scheme securities. The cut-off yield on the 91-day bill eased to 5.04 per cent, down 41 basis points from the previous week’s 5.45 per cent. The weighted yield though dropped below the reverse repo rate to 4.96 per cent, indicating that a cut was imminent. The cut-off yield on the 182-day yield though was set at 5.10 per cent.

But the ten year yield to maturity (YTM) however firmed slightly to 5.62 per cent up from the previous week’s 5.53 per cent. Traders said that this was largely in view of profit booking by some of the foreign banks that had largely bought dated securities during the last few weeks with arbitrage funds. But some public sector banks were also sellers for beefing up their balance sheet bottom lines through treasury profits.

Under tone positive

The under tone remained positive. Trade volume averaged about Rs 1,1200 crore during the week or about Rs 2,000 crore more than equity turnover in the National Stock Exchange. The positive sentiment was also apparent from the thin bid offer spreads of barely 5-10 basis points.

The Chief Investment Officer of IDBI Fortis Insurance Company Ltd, Mr Aneesh Srivastava, said, “Ten year yields will test 5 per cent soon.”

However, this optimism notwithstanding, the outlook remained mixed. This was largely in view of the high incremental investment deposit ratio of 37 per cent, way above the statutory requirements of 24 per cent. Consequently, requirement of government securities were mostly for trading requirements. Besides, the gap between inflation and nominal yields was beginning to narrow indicating an imminent short run correction. Last week, inflation was in level with the 10-year YTM.

Besides, credit offtake increases could temper the yield falls, bankers said. The RBI move to increase liquidity in the markets point in that direction, traders said. Credit offtake is expected to pick up from the beginning of the first quarter. Signs of this were available from the RBI’s moves to increase liquidity availability. With foreign borrowings still not available to corporates, the offtake from domestic credit lines is likely to remain high. The fiscal credit-deposit ratio remained at 78 per cent. But, there are expectations of acceleration in credit demand, bankers said. The Government and RBI steps to increase liquidity, through paring T-bill notified amounts and premature redemptions were intended for meeting the corporate credit demand. The third quarter, despite the global meltdown, has not been bad for banks that have seen both interest and treasury incomes remain buoyant, bucking global trends. Sustaining the offtake though is likely to remain bottlenecked by capital constraints. Bonds are likely to benefit from this trend.