The Hindu Business Line : Bonds limp over oil prices, FII exit

BONDS remained listless in a seller-dominated market, as most traders remained concerned over oil price spikes and foreign institutional investor exits.

Traders said the selling was partly driven by banks, who for sometime have been switching over to credit assets to improve their returns. Average yield on assets is now about 7.5-8 per cent.

Currently, bankers are holding government securities in excess of 44 per cent, though the mandated statutory liquidity ratio is only 25 per cent.

Besides, traders said, most banks were also beginning to shrink the average maturities of their investment portfolios in a bid to remain liquid. Some private banks, in fact, have shrunk the average maturities to less than five years.

FII-driven selling was also exerting pressure both in the bond and the equity markets. FII selling, traders said, was driven in anticipation of further hikes in the US interest rates in the coming weeks. Traders said the selling wave was also driven by the oil companies' demand for foreign exchange, anticipating further international price spikes. Oil futures for March delivery were already at $49.75 a barrelSince the beginning of this fiscal year, oil imports have gone up from an average of about 1.8 million barrels (2.45 lakh tonnes) per day (mbd) to about 2.1 mbd (2.87 lakh tonnes) in December. There was mounting concern about the possibility of an escalation in the West Asia conflict.

Strong liquidity: These concerns ensured that the 91-day treasury bill yields remained at 5.32 per cent at last week's auctions, unchanged from the previous week, despite strong liquidity situation. The high liquidity was evident from the large non-competitive bids at the auctions.

Even after factoring in the non-competitive bids, the weighted average yields remained at 5.32 per cent, implying that some non-competitive bids were much higher than the cut- off yields. Besides, a liquidity hangover was also evident from the reverse repo auctions. At the week-end auctions, the outstanding was Rs 14,780 crore.

Even with such strong liquidity, there was little interest in bonds, traders said. This was apparent from the trend in the ten-year yield to maturity. The ten-year yield to maturity (YTM) was 6.86 per cent on a weighted average basis last week, up from the previous week's figure of 6.79 per cent.

Moreover, another peculiar trend emerged. The difference between the 10-year benchmark, 7.38 per cent 2015 and the weighted average 10-year YTM was wide. Last weekend, the difference was about 14 basis points. Traders said this was partly because few banks were interested in pushing down the value of the benchmark, since it would imply that the depreciation provisions would rise for the next quarter.

Low volumes: The overall sentiment in the market was weak, evident from the low trading volumes. Daily trading volumes were less than Rs 2,000 crore during the week.

Moreover, the outlook was also bearish - reflected by the wide spreads between one year and 23 years. The spread was 142 basis points. Most insurers preferred higher coupon, long dated securities, traders said. Alternatively, some of them preferred to wait for some more time before making large purchases, so as to get pricing advantages. from banks' moves to shrink maturities of marked to market investment portfolios.

Life insurers are looking for high prices for their short-dated coupons and high yields for their longer-dated purchases.

The hardening yields pushed up real yields further. With inflation at 5.42 per cent, real yields were up 0.3 per cent for one year. But despite the positive real yields, traders said nominal yields would continue to harden in the coming weeks. This was partly because domestic real yields were still way below internationally accepted levels of between 1.5 and 2 per cent.

Besides, traders said foreign exchange flows, both volatile and non-volatile, were considerably down. In fact, the flows were only about $51 million last week, with little accretion to the reserves. Traders said the RBI was not to too keen to raise the level of its reserves. This was in view of the high cost of sterilisation. Consequently, for more than a month, exchange reserves held steady at $129 billion. Traders said credit expansion, led by non-food credit, maintained a healthy growth. For the last week, credit growth was in excess of Rs 10,000 crore. Despite the credit growth, credit-deposit ratios for most banks actually dropped slightly to 62.6 per cent.However, they said if credit growth continued at the current pace, corporate-deposit ratios were expected to resume the same levels as before.

But this does not augur well for government borrowings, bankers said. Already saddled with high investment deposit ratios and faced with depreciation risks, few bankers were interested in G-Secs unless the coupons were high. Bankers said unless the yields were close to at least the average yield on assets (investments, cash balances with RBI and credit), G-Sec placements would face rough weather.

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