The Hindu Business Line : Traders expect bond yields to rise further

Traders said that with expectations of an oil price reversal completely belied, almost all the major petroleum companies were in the market to raise foreign currency resources. Oil prices topped $53 a barrel. This was expected to severely pressure the country's import bill. At this level, bankers estimate the oil bill to be at close to about $96 million.

In fact, some of the companies have already begun selling their oil pool bonds issued by the Government in the 1990s against the outstanding subsidy payments due to them.

Tax collections: Besides, bankers said,the fall in tax revenue collections was also beginning to be a point of concern. Revenue deficit for the first five months was 82.6 per cent of the Budget estimates as against 54.1 per cent during the corresponding period of the last fiscal. If the trend in revenue receipts continued at the current pace, the fiscal targets would be hard to meet, bankers said.

These fears reflected at the 91-day Treasury bill auctions. The cut-off yield at the auctions last week was 5.08 per cent, the highest level in a year. The previous week, the cut-off yield was 5.04 per cent.

Traders said that the Reserve Bank of India had the option of rejecting the bids. However, that RBI chose to accept the bids at the high yields reinforced expectations of a possible hike in the reverse repo rate, which is currently at 4.5 per cent.

This rate has been held steady for the more than a year. This is despite interest rates ascent worldwide.

Repo rate The repo rate of the RBI is 25 basis points more than the Bank of England's rate. Bankers are now expecting that the rate hikes are likely to be announced well before the Credit Policy season. The rate hike anticipated is anywhere between 25 and 50 basis points.

The expectations also pushed up the ten-year yield to maturity (YTM) last week to 6.85 per cent on a weighted average basis. The previous week, the 10-year YTM was 6.47 per cent.

Inflows of close to about Rs 9,000 crore by way of subscriptions to the initial public offering of National Thermal Power Corporation failed to cool the bond markets.

Traders said that the hardening was also triggered by some of the private sector mutual funds, and insurance companies liquidating their holdings of long-dated Government securities for subscribing to the IPO.

The papers that were on offer included the 10.50 per cent 2014 at YTMs as high as 7.04 per cent towards the weekend. Even at these high yields, there were few takers.

Low volumes: The undertone in the markets remained weak, which was evident from thin trading volumes. The average daily trading was barely Rs 2,500 crore.

Besides, the spread between one year and twenty-four years remained wide, despite the large-scale inflow of funds. The spread last week was 160 basis points, slightly lower than the previous week's 175 basis points.

Traders said that the yields would continue to the rise in the coming weeks as well. This was partly because most traders expecte the RBI to revise its inflation target for the year.

With real yields negative, bankers said, bond prices would continue to fall till such time as nominal yields became positive to inflation in line with international trends.

Banks' strategy: Yields are also expected to harden in view of the banks refocusing on operational income. With few banks prepared to hike deposit rates, the focus has been to liquidate their securities holdings, even at the cost of making losses. This strategy is being adopted by banks since some of the farm and retail credits still offer returns in excess of the PLR.

Banks anticipate that such a strategy of switching investments with credit portfolios would increase their return on assets.

The investment-deposit ratios for banks were in the region of about 45 per cent. This was equivalent to the SLR ratios prevailing during the pre-deregulation period, when pre-emption ratios touched a high of 42 per cent.

With the SLR down to 25 per cent, most banks now want to bring down their securities holdings down to this level. Such a strategy, bankers said, would also help them bring down their weighted average cost of working funds to below 4 per cent.

This would allow them to sustain soft interest rates without compromising on spreads. This strategy was evident from the big increase in non-food credit during the week. Non-food credit went up by Rs 23,000 crore.

Forex inflows: The pick-up in the foreign exchange inflows also failed to influence the bearish trend. For the last reporting week, foreign currency inflows were about $515 million, closing in on the April figure of $120 billion of reserves.

Inflows on the current account have suddenly abated, with exporters again deferring their receipts anticipating forward premia to rise further, along with the hardening oil prices.

Forward premia at the short end was close to 3 per cent; whereas at the long end it was 1.8 per cent.

This was because most of the oil companies were taking cover only at the short end. As exporters begin deferring their inflows, or imports begin to rise, traders said, there was a possibility of a hardening forward premia at the long end as well.

The poor level of inflows and hardening yields meant that the Government's bond issue for Rs 6,000 crore slated for the next week was headed for some trouble.

The borrowings are more in the nature of a securities reissue of the 7.38 per cent 2015, held by the RBI. Traders said that YTM on this security was likely to be above 6.5 per cent.

In addition, bankers also expect the underwriting commissions to be kept similar to previous auction in order ensure a good response to the issue.

Higher costs: These trends, however, also meant that corporate borrowers face higher borrowing costs in the coming weeks.

Borrowing costs are already on the rise, as is evident from the widening spreads between corporate and sovereign papers.

The spreads between sovereign papers are about 150 basis points over sovereign papers.

These spreads are likely to widen further as more corporates rush to lock into current interest rates.