The Hindu Business Line : Bonds rally, yields soften ahead of Budget

The rally was largely triggered by the belief that the Government's borrowings for the current year are unlikely to exceed Rs 3.62 lakh crore as estimated in the interim Budget. The rally also came despite hints of an expansionary budget. Besides, oil companies also appeared to have slowed down their foreign currency purchases, as demand for petroleum products slowed down. As a result, despite net foreign institutional investors-led outflows of $193 million last week, the rupee actually vaulted against the dollar to Rs 47.99, from Rs 48.51. FIIs offloaded $498 million of their debt holdings (Rs 2,431 crore) of mostly government securities /public sector bonds. Yet the sell- out had little effect.

Traders said that one of the major factors was the large current and capital account inflows into the country. Current account inflows were mostly from exporter repatriation of receipts. Invisible inflows included software and insurance inflows. Capital flows were particularly from non-resident remittances. According to the Reserve Bank of India's Balance of Payments data, for the last quarter of the financial year 2008-09, NRI remittances topped $2 billion, double the inflows over the corresponding period of the previous year. The inflows continued unabated into the banking system, officials said. The difference was that this time some deposits flowed into the non-resident ordinary accounts.

As a result, despite dollar outflows by FIIs, foreign exchange markets remained fluid. Low import demand sustained the fluidity. The only importers present were oil refiners. PSU refiners such as Indian Oil Corporation sold some of their subsidy bonds and took advantage of the current situation. IOC sold the 8 per cent 2026 oil bonds at a Yield to Maturity (YTM) of 7.94 per cent to raise Rs 1,000 crore (about $207 million). Oil companies are under pressure, in view of rising global crude prices. India's import parity last week averaged $70 a barrel or about $513 a tonne.

Forward premia

Refinery demand though had little impact on the foreign exchange forward markets. Forward premia for one, three, six and 12 months settled the weekend at 2.69 per cent (3.13 per cent), 2.57 per cent 2.94 per cent), 2.43 per cent (2.94 per cent) and 2.27 per cent (2.45 per cent) respectively. The low long-term forward premia was despite the $11 billion of corporate debt servicing outflows this year. But bankers said that much of the exposure was already fully hedged. Consequently, there was little major forward demand for dollar immediately unless imports are expected to dramatically increase, traders said.

Short forward, cash to spot, also narrowed to 2.21 per cent (2.32 per cent) in view of thin interest differential between the rupee and the dollar. In fact, traders said that there were few takers for foreign banks buy-sell swaps during the weekend in view of the comfortable domestic liquidity conditions. That exchange rates are likely to remain stable, with an upside bias, was evident from the Non-Deliverable Forward (NDF - offshore rupee trading where settlement is done in foreign currency, mostly in dollars) markets that ended the week at Rs 48.20 (Rs 48.54).

Exporter inflows however, led to markets being inundated with liquidity. At the weekend Liquidity Adjustment Facility (LAF), recourse to the reverse repurchase window topped Rs 1.57 lakh crore. Part of the high liquidity, was also on account of the absence of government borrowings during the week. The Government completed about 45 per cent of its gross borrowing target for the current year or Rs 1.69 lakh crore.

Few traders expect this target to change. A report by Kotak Mahindra Bank on market said, " The additional borrowing is expected to be restricted to only Rs 17,000 crore to Rs 20,000 crore, mainly on account of more revenues from non-tax sources of 3G auctions and disinvestments. In case this view is correct, a short-term dip in bond yields could be expected, post announcement of Union Budget."

But traders already appeared to have discounted a short-term yield dip. This was apparent at the weekly Treasury Bill auctions. At the auctions, the yield on the 91-day T-Bill was 3.11 per cent, 21 basis points lower than the previous week. The weighted yield dropped even more sharply, 25 basis points to 3.07 per cent. The 364-day T-bill ended the week at 3.81 per cent.

The ten-year YTM followed an identical trajectory and softened to 6.79 per cent on a weighted average basis, last weekend, down 19 basis points over the previous weekend.

Trade volumes

The positive sentiment was also reflected in a big increase in daily trade volumes. The average per day trade volume last week jumped Rs 5,500 crore to Rs 18,200 crore. But equity trade volumes continued to contract and trade volumes dropped another Rs 1,300 crore to Rs 17,500 crore over the previous week.

Although the outlook for bonds remained buoyant, the bias was mostly in favour of short-term securities. Traders preferred to remain liquid.

A Yield Movement

The liquidity preference was evident from the high yield spreads. The spread between the one-year and ten-year yields were 298 basis points.

Besides, there were banks raising short-term liquidity through certificate of deposits issuances, including the British bank Barclays Bank. Barclays is in the domestic CD market, for the first time since it commenced operations in the country, with a Rs 1,500-crore 3-month issue priced at 3.3 per cent. But PSU banks were marshalling even larger resources. Last week alone, Rs 6,500 crore was mopped up through CD issuances, subscribed by mutual funds, insurance companies and large corporates. Funds and insurance companies remained wary of the equity markets and once again retreated to the safe haven of bank deposits.

But bank officials said that they expected credit offtake to pick up in the coming weeks when the peak season kicks in. Top rung corporates though preferred the primary bond markets through private placements. Corporates like SAIL are already tapping the commercial paper market for working capital funds, at rates as low as 5 per cent. Even longer term funds were sourced from the bond markets. Last week, for instance, Tata Chemical raised 10-year funds through bond float at 10 per cent.

High risk weight

But even for such highly rated corporates, the risk weighting remained high. The high risk weight was evident from the spread between Triple A rated corporate bonds and sovereign securities, that is currently 320 basis points. The risk weights remained high even for public sector corporates, where the spreads were 215 basis points. Bankers said the high spreads reflected risk aversion among banks. However, even at these spreads, Tata Chem's pricing was at least 175 basis points below the new benchmark prime lending rate of 11.75 per cent.

Yields are likely to see further dips in the coming weeks, if the credit offtake does not pick up. Already banks are operating at incremental credit deposit ratio of minus 0.04 per cent, implying redemptions. Food credit off-take though appeared to have begun this on the back of procurement operations. Moreover, inflation in the negative zone at 1.30 per cent, translated to a real yield of slightly over five per cent, implying some more flexibility for a further softening

With deposits surging in the banking system at the rate of Rs 2,200 crore per day there were few alternatives to park funds. A further pruning of deposit rates appears imminent, though it is likely to take place only at the RBI's signal after the review of the Credit Policy this month end.

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