The Hindu Business Line : Securities rally powered by bank purchase

The key factor that helped drive the markets were the RBI's new accounting norms, which allowed banks to categorise more securities under Held to Maturity.

BONDS rallied last week powered by bank purchase as traders preferred to ignore the high inflation numbers and rising international oil prices.

Traders said that the key factor that helped drive the markets were the RBI's new accounting norms, which allowed banks to categorise more securities under Held to Maturity (HTM). This was accomplished by a change in technical definition. The original definition was that 25 per cent of investments would have to be valued on the basis of HTM or acquisition value. The changed definition allowed banks to hold 25 per cent of their demand and time liabilities as HTM. In effect, for banks it implied that the entire portfolio of securities held under the Statutory Liquidity Ratio (SLR) could be valued on the basis of HTM. The prescribed SLR is currently 25 per cent.

Traders said that this changed definition gave a reprieve and was consistent with what the banks had sought. This triggered a stampede among banks, especially, some of them who were short for SLR securities. In fact, many of the foreign banks were SLR deficit. The resulting rush pushed down yields drastically.

Traders had anticipated the RBI decision last Wednesday itself. This was evident from the low cut-off and the weighted average yields at the 91-day and the 364-day Treasury Bill auctions. In both these auctions, the cut-off yields dropped to 4.63 per cent and 5.06 per cent respectively. At the previous 364-day auctions, this was 5.40 per cent and 4.71 per cent respectively.

Once the full details of the valuation guidelines were announced, traders went into frenzy. As a result, yields on the ten-year YTM dropped below 6 per cent mark to end at 5.99 per cent on a weighted average basis, down from previous week's 6.16 per cent.

Mixed yield trends

But the question among bankers was on the sustainability of the rally. Yield trends were mixed. Some bankers have already indicated that this was only a temporary phase. Banks would have to take a hit in the investment books. This was particularly because of the rider that any transfer from the `Available for Sale' or the `Held for Trading' into the `HTM' category could be done only at market prices. Losses in such transfers would have to be amortised over the remaining period of the security's maturity. Therefore, bankers said, they would still have to take a hit.

As a result, some of the prudent banks are moving most of the low coupon securities into the HTM category to stave of losses.

High-coupon securities

This has resulted in some more of high coupon securities coming into the markets. Among the high coupons that have come back include the 12 per cent 2008, which ended the week at 6.65 per cent.

Others included the 11.50 per cent 2011 and 12.32 per cent 2011. These high coupons traded between 6.60 per cent and 6.81 per cent respectively. In fact, trading volumes were high on these categories of securities.

Trading volumes

Daily average trading volumes went up to over Rs 4,500 crore, it was mostly accounted by some of the high coupon securities.

Besides, some of the banks in the past had also kept some of the non-SLR securities in the HTM category. These securities were also likely to be substituted with SLR securities.

Bankers said that the shift in portfolios would allow them to absorb the coming shocks. These shocks refer to the possibility of yields hardening. High inflation rate is a pointer to this.

As a result of the high inflation, the negative real yields widened further across all maturities.

Negative real yields was 3.1 per cent. Besides, the inter-tenor spreads remained on the higher side. The spread between one-year and 24 years was 153 basis points.

Borrowing schedule

Moreover, sudden spike in bond prices (fall in yields), is likely to prompt the Government to advance its borrowing schedule so as to avoid bunching of borrowings during the peak credit season.

Besides, raising resources at this juncture would also help the Government to keep its borrowing costs down, bankers said. Oil prices were once again beginning to harden. Oil prices towards the weekend rose to $44 a barrel.

Forex reserves

It was the high oil prices that contributed to depletion in foreign exchange reserves by almost $1.370 billion to $117.522 billion. This was also one of the factors that led to the liquidity tightening during the previous weeks.

Expectations are that oil companies would move into the markets during the week, which could result in pushing up yields.

"We can expect a further softening in yields in the coming weeks," said Mr V. Ravi Kumar, Executive Vice-President, ING Vysya Bank Ltd. The reason for this optimism stems from the possibility of an expansion in foreign exchange reserve driven reserve money expansion.

This was also evident from the fact that the forward premiums were beginning to soften. Six months forward fell below 2 per cent.

This was partly driven by exporters beginning to make their inward remittances. Moreover, in the non-deliverable forward markets, the dollar was quoting at a discount to the domestic spot rate. Normally, such a trend indicate major inflows into the market. As a result, some of the traders anticipate the flows to translate into lower yields.

Redemption flows

Besides, this week, around Rs 9,200 crore of coupon and redemption flows are expected to take place, which was likely to push down yields.

Yet, despite this anticipation, corporate spreads spread continue to remain wide. Corporate spreads were in the range of about 150-200 basis points over the sovereign papers, indicating that markets could harden for some of them in the coming weeks.