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C. Shivkumar

BOND yields remained ranged during last week despite the big expansion in reserve money flows, as bankers were focussed on bottom lines.

Traders said that few of the big trading banks were keen to push up exposures in securities. This was because most of the banks already have G-Sec portfolios in excess of their SLR requirements of 25 per cent.

Banks' government security investment holding are in the range of about 44 per cent. Accordingly, traders said that any further increase in their exposure was likely to impact their earnings. The alternative was to push for credit offtake, which is what most of them were resorting to.

As a result of this credit push, there were more sellers for securities in the markets than buyers. This was evident from the thin trading volumes.

Daily trading volumes in the market were barely Rs 2,500-crore during the week. Besides, traders said that none of the insurance companies, both in the public and private sector, was present in the market for making purchases.

As a result, the 10-year yield to maturity (YTM) hardened further to 5.13 per cent on a weighted average basis, up from the previous week's 5.11 per cent. The banks' favourite securities also followed this trend.

The 11.40 per cent 2008 ended at 4.84 per cent, 11.50 per cent 2011 at 5.16 per cent, 11.03 per cent 2012 at 5.17 per cent, 7.40 per cent 2012 at 5.11 per cent, 9.81 per cent 2013 at 5.19 per cent, 7.27 per cent 2013 at 5.13 and 7.37 per cent 2014 at 5.17 per cent.

The 7.38 per cent 2015 closed at 5.33 per cent, 10.71 per cent 2016 at 5.65 per cent, 8.07 per cent 2017 at 5.57 per cent, 7.46 per cent 2017 at 5.57 per cent, 6.25 per cent 2018 at 5.67 per cent, 6.05 per cent 2019 at 5.77 per cent, 6.35 per cent 2020 at 5.89 per cent, 8.35 per cent 2022 at 6.02 per cent and 6.13 per cent 2028 at 6.42 per cent.

Yield movements were more pronounced at the long end. This was because most banks were interested in liquidating their holdings at the long end. Traditionally, in a liquidity preference situation, the preference is for securities holdings at the short end rather than the long end.

The undertone of the markets remained weak due to banks becoming large seller. But even in this selling wave, the preference is for high-coupon securities. The new security now to vanish from the market includes the 9.81 per cent 2013. Insurance companies mopped up this paper.

Besides, bankers said the new 10-year benchmark is expected to be the 7.37 per cent 2014, issued on April 19, 2002.

Despite weak sentiment in the market, daily trading volumes on this security has averaged over Rs 100 crore during the week.

With banks selling securities, spreads between one and twenty-five years are now about 200 basis points. These spreads were less than 100 basis points during the pre-peak season Credit Policy period. This effectively translates into an inter-tenor spread of about 8 basis points per year. However, it is at the long end of the yield curve that spreads were very high as a result of the banking sector's preference to liquidate long-dated securities.

The spreads at the long end are about 15-20 basis points per year, whereas at short-end, it was about 5-6 basis points per year.

The incremental weighted average costs of working funds are expected to come under pressure in the coming months partly driven by the government's demand for higher dividends. Bankers said that the weighted average cost of working funds are expected to move to the 5.5 per cent range, even assuming recoveries of non-performing assets of at least Rs 250 crore. So, there was little interest in pushing down yields further, they said.

Besides, there was the concern that real yields, which had remained positive, were also moving into the negative zone. Inflation is currently at 5.12 per cent, almost at the same level as 10-year YTM. Real yields below 10 years are all negative.

However, this situation did not imply that liquidity was likely to become tight. That liquidity was likely to be in surplus for some more time was evident from the fact that the T-bill auctions saw both the 91-day and the 364-day rates recording sharp falls.

The cut-off yield on the 91-day T-bill was 4.25 per cent, and the 364-day was 4.36 per cent. Both these yields were down sharply by at least 10 basis points each from the previous auction levels. Besides, at the repo auctions, the RBI has mopped close to about Rs 25,000 crore.

Clearly there is no problem for liquidity, a banker felt. "This will remain so for some more time," said Mr Michael Bastin, Chairman and the Managing Director of Syndicate Bank.

The forex inflows are driven by current account surpluses and build up of non-debt capital flows. That such flows were continuing was evident from the behaviour of forward premiums, which remain in the sub 0.5 per cent zone for up to one year.

This flatness is buttressed by the whopping inflow of about $1.71billion into the country, taking the foreign exchange reserves upwards of $95.37 billion. Some of these additions are also due to maturing of forward contracts done by the RBI, to temper the rupee's appreciation against the dollar and also ensure that forward premiums fall are moderated.

Despite large inflows, traders said there was little demand for foreign currency from importers.

Oil importers have preferred to leave their positions open, without taking forward cover and were accessing only the spot markets as and when their import contracts mature. Further, the sources said the demand for foreign currency-denominated loans had also disappeared in view of the rising yields in the international markets. Ten-year US treasury yields are already 100 basis points above last year levels.

With domestic banks insisting on forward cover for foreign currency denominated loans, more borrowers are into the domestic markets. As a result, despite the increase in deposits, the credit-deposit (CD) ratio has shown a rising trend. Current indications are that the ratio is about 57 per cent. Moreover, with the tightening of the private placements in markets, yield spreads have shown sharp increases during the last fortnight.

The spreads between top-rated corporate borrowers and sovereign securities are now in the region of about 150 basis points.

For sub-sovereign guaranteed securities, these spreads are above 500 basis points over comparable sovereigns. If issue costs are also factored, then the spreads rise by another 200 basis points.

As a result, the number of issues have dropped drastically in view of the tight due diligence. The inference is obvious — State-guaranteed loans are quietly being driven out of the markets.

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