The Hindu Business Line : Traders cautious on RBI warning

Traders said that top RBI officials have been cautioning banks against unbridled trading and warned that external developments were bound to have an impact on the domestic bond markets. The key external development identified to have an impact on the domestic markets were the large fiscal and trade deficits of the US.

Traders said that both these developments were likely to lead to large US sovereign borrowings, leading to higher dollar interest rates. Traders said that adding to these developments were also the firm international oil prices. What had so far kept the rates down were the repeated interventions by Asian central banks, both in the foreign exchange and US bond markets. The accretion in the reserves were in turn invested in the US treasuries. This ensured that the US treasury yields remain low.

As a result of the cautions by the RBI, the ten-year yield maturity remained steady at 5.08 per cent, almost unchanged from last week's level. The steady trend in the markets was also on account of the large mop-up through repo operations, which has checked the build-up of liquidity.

The repo rate has remained at 4.5 per cent, despite speculation that it could fall further. However, bankers said, that some of them have already discounted a 25 basis point (0.25 per cent) drop in the repo rate, though few were certain on the timing of the drop.

But interventions in the markets through the 91-day T-bill route, under the market stabilisation scheme continued unabated, in view of the liquidity flows. There were also interventions through the 7-day repos all at 4.5 per cent.

As a result, the repo rate was now acting as a floor for all interest rates. Insurance companies, banks and mutual funds continued to be largest buyers. Purchases by insurers were mostly at the long end of the yield curve.

Buyers were mostly life insurers, in particular for some of the high-coupon securities such as the 8.07 per 2017 and 8.35 per cent 2022.Consequently, profits of all the insurers this year are likely to see slight difference in figures. Unlike in the past when investment income shored up the bottom lines, trading income was expected to help their profits for the last financial year.

Traders said that some of the banks have also been selling their holdings of securities. But despite the profit-taking, the undertone in the markets remained bullish. This was because the lean credit season for most of the banks has begun.

Besides, food credit offtake has become negative. In fact, the Food Corporation of India is now preparing to prepay some of its outstanding dues to the banks by refinancing the same through bond issues.

Yet one of the critical factors that were driving liquidity in the markets was external flows. Presently, inflows are mostly in the form of current account and non-debt capital account flows.

But a new trend has now begun taking place. Foreign currency accounts by non-resident Indians have begun changing profile. In fact, NRIs are shifting their dollar accounts into domestic non-repatriable deposits.

Bankers also said that some of the NRIs were transferring their dollar accounts in the US due to fear of restrictions on repatriation of earnings.

In fact, the fear was that some of the non-banking statutes, like the US Patriot Act would likely be invoked to prevent outflows from dollar accounts in the US.

Traders said that it was this emerging trend that was driving down forward premiums, which have become negative up to 12 months.

In fact, external reserves rose by $1.5 billion during the week to $117 billion. Besides, there was little demand from importers for foreign currency.

This was also one of the major factors that were keeping yields down. Yields normally tend to rise in a situation when foreign currency demand escalates.

However, what could push up yields in the coming weeks was the rising credit demand. Non-food credit has been rising, consistently.

The credit deposit ratios are now about 57 per cent, the highest in almost two years.

On an incremental basis however, the ratio is over 75 per cent. On the other hand, the investment deposit ratios have been falling. The chase for risk-weighted assets by banks has been pushing down spreads on high quality papers.

The spread between high-rated corporate papers and sovereigns are now down to about 55-75 basis points.

Similarly, for small and medium enterprises, the rates are closer to the prime lending rates, unlike the past and for small agriculture loans it is even lower than the PLR.