The Hindu Business Line : Bond yields soften on renewed interest in G-Secs

Bangalore, Nov. 22 Bond yields softened as traders shrugged off the impact of the hardening global oil prices and resumed chasing of government securities anticipating a liquidity surge.

Traders also said that fears of a breach in government borrowing target abated with the line-up of a disinvest roadmap for the rest of the fiscal year. Consequently, they said borrowings were expected to considerably slow down in the coming weeks. Last week, 79 per cent of the government borrowings target was completed.

Besides, there was a deluge in inflows through non-resident deposits into the banking system, especially the NRO deposits. NRO deposits are technically non-repatriable and form part of the core deposits of the banking system. The NRI inflows, traders said, were partly for subscribing to public offerings in the planned big ticket divestments of some of the PSU behemoths.

NRI inflows

The inflows also offset the slowdown in foreign institutional investor flows. Net FII inflows into the banking system were only $601 million (Rs 2,780 crore) last week. But the flows into the bank deposits averaged Rs 3,000 crore since the beginning of this year. Traders said that the NRI inflows were also triggered by the low dollar interest rates. In addition, FIIs and foreign banks were beginning to show renewed interest in government securities using the dollar as a carry currency.

The carry currency status was in view of the low cost of dollar liquidity that is currently barely one per cent. Domestic NRO deposits offered interest of 6 per cent for one year. With the possibility of currency appreciation the effective returns were nearer to about 7 per cent per annum. The currency carry trade status of the dollar also sparked fears in the financial markets that a ‘Tobin Tax’ was likely to be levied to prevent excessive exchange rate volatility. That currency volatility risks had considerably escalated was evident from the sharp swings in the rupee-dollar exchange rates.

Last week, the rupee ended at Rs 46.58 against the dollar. Since September, the rupee appreciated by over 4 per cent against the dollar.This was despite the presence of the oil companies for purchase of the dollar. Besides, the RBI also intervened in the markets for preventing any major exchange rate appreciation. This is the first RBI intervention in the foreign exchange markets this fiscal year to moderate exchange rate volatility.

The RBI intervention, traders said, was mostly in the swap markets, through buy-sell swaps. The forward market intervention and oil companies’ purchases pushed up forward premia at the short and middle end.

One, three and six month as a result firmed to 2.22 per cent (1.87 per cent), 2.51 per cent (2.35 per cent) and 2.73 per cent (2.74 per cent). However, one year premium softened to 2.64 per cent (2.73 per cent) as exporters hedged anticipating a rupee appreciation at the long end. Near end forward premiums remained steady in view of arbitrage by foreign banks. Cash to spot premium was 2.35 per cent (2.33 per cent).

But exchange rates are largely expected to remain ranged, with a slight upside bias. This was apparent from the trend in the non-deliverable forward (NDF — offshore rupee trading where settlement is done in foreign currency, mostly in US dollars) market, where the exchange rate ended at Rs 46.52, or above the domestic spot rate.

Despite the inflows and the RBI intervention in the foreign exchange markets, liquidity tightened slightly. The tightening was triggered by the oil companies drawing down on their credit lines. The drawing down was triggered by the import basket price at around $80 a barrel. The tightening was evident from a fall in the recourse to the weekend reverse repurchase window of the RBI’s liquidity adjustment facility auction.

Govt auctions

At the auction, the recourse amounted to Rs 94,160 crore (Rs 96,930 crore). The slight tightening of liquidity though had little impact on the government borrowing auctions for Rs 10,000 crore. At the auctions, the cut-off yield on the reissued securities — 7.32 per cent 2014, 6.35 per cent 2020 and the 7.50 per cent 2034 — were 6.90 per cent, 7.56 per cent and 8.28 per cent respectively. The average ‘bid to cover’ ratio also improved to 3.2 times. Traders said that the high bids were largely on account of sluggish credit offtake and the large deposit inflows. The large inflows indicated a demand for SLR (Statutory Liquidity Ratio) securities. Banks are expected to park a minimum of 25 per cent of their demand and time liabilities in government securities.

Besides, there was also a distinct shift to long-end securities. This was evident from declining interest in short-end securities. At the weekly Treasury bill auctions, the cut-off and the weighted yields on the 91-day T-Bill was 3.28 per cent. The cut off yield on the 364-day T-bill yield was 4.45 per cent. The low interest in T-bills was also apparent from the ‘bid to cover’ ratios. The ‘bid to cover’ ratio for the 91-day T-bill for instance was 3.6 times.

The same ratio was 4.33 times for the 7.32 per cent 2014 security at the government borrowing auctions.

The shift to long dated security also resulted in pulling down the 10-year weighted average yield to maturity(YTM) to 7.21 per cent, down 14 basis points over the previous week.

Surge in trade volumes

Trade volumes jumped last week. Average daily trade volume during the week surged to Rs 18,900 crore (Rs 10,700 crore).

The jump in trade volumes was partly helped by the deposit surge. The increased volumes also narrowed bid-offer spreads, down to barely 5 basis points.

The sluggish credit offtake also prompted a shift to bonds. The weak credit offtake was apparent from the low incremental credit deposit ratio. The incremental CD ratio this year, so far, was still 34 per cent or about a third of what it was during the corresponding period of the last financial year. Incremental investment deposit ratio remained at close to 60 per cent.

Traders’ shift to the longer end of the yield spectrum also implied a focus on improving coupon earnings. Long dated securities for instance earn high current yields at present prices. The 10-year benchmark security currently generates a current yield of over 7 per cent.

Besides, the turn to long dated securities, was also driven by a belief that no major policy intervention was likely in the immediate future. This was despite the high food price inflation. Food price inflation is currently 14.55 per cent. Some foreign banks preferred caution. HSBC’s Asia Economic Research Senior Economist, Mr Robert Prior-Wandesforde, in the India Economic Watch though said, “We are sticking to the view that the first CRR move will come in January however, with the repo and reverse repo rate being hiked in March.”

For the time being, flooded with retail and NRI deposits, banks are now focusing on reducing deposit rates. Last week, for instance, barely Rs 1,000 crore of CDs were floated by the banks. Discouraging CDs is mostly done through reduction in rates. One year CDs, for instance, are about 5.3 per cent or about 70 basis points below one year retail deposits. Other NRI deposit rates are also likely to follow suit in the coming weeks.

Tobin Tax: The Tobin Tax is a levy that is meant to curb fluctuations in short-term cross border capital flows, typically of the overnight variety. The currency fluctuations caused by such inflows can have a serious macroeconomic impact, complicating the task of currency management for monetary authorities.

The tax derives its name from Nobel Prize-winning economist James Tobin, who proposed it with a view to “throwing some sand in the wheels of international finance”. Brazil has imposed a 2 per cent tax on portfolio flows, leaving out foreign direct investment. India had, till recently, levied a nominal ’securities transaction tax’, which was nothing but a Tobin Tax.

At that time, the RBI was hard pressed trying to cope with inflows, given its impact on money supply and the exchange rate. A similar situation is building up at present. A levy of, say, 0.25 per cent, is expected not to discourage long-term flows, while acting as a disincentive to short-term transactions which are high on volumes but thin on margins.

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