The Hindu Business Line : Life insurers keep low profile in bond market

Traders were also cautious on account of the Union Cabinet's decision to allow 74 per cent foreign equity participation in the telecom sector and the move to hike the EPF rates to 9.5 per cent.

Moreover, traders said that the upgrade of India's sovereign rating to one notch below investment grade failed to have any big impact on the bond markets. This was because many international banks and financial institutions already treat India as investment grade.

Oil prices: Instead, markets were concerned about the direction of oil prices. Oil prices are currently at $48 a barrel. However, according to International Energy Agency data in real terms, oil prices were still low though nominal prices were high.

Oil cos quiet: Lower nominal oil prices though would have had a greater positive impact on the bond markets, traders said.

Normally, oil companies' take forward cover at signs of volatility in the exchange markets. Last week, however, oil companies remained quiet, preferring to watch the rupee trend, before moving in.Further, what also helped the markets was the Government's announcement of only Rs 5,000 crore of borrowing for the current fiscal year.

This was despite the shortfall in tax receipts. But, there are no bonds coming up for redemption during this fiscal. This announcement helped the RBI to push down yields at the 91-day and the 364-day Treasury bill auctions.

The yield on the 91-day T-bill was 5.20 per cent last week, down from 5.32 per cent the previous week.

The yield on the 364-day T-bill was 5.76 per cent, as against 5.74 per cent the previous week.

In both these T-bill auctions, there were no non-competitive bids from mutual funds, insurance companies or corporates.

Ten-year yields remained steady on a weighted average basis. The weighted average ten-year yield to maturity (YTM) last week was 6.81 per cent, almost unchanged from the previous week.

Weak undertone: The undertone in the markets was weak. This was evident from the low volumes, wide spreads between the 91-day and 364-day T-bills and the wide spreads between one year and 23 years.

Daily average trading volumes were just about Rs 2,000 crore during the week. But spreads between one year and 23 years remained high at 144 basis points.

No impact: Moreover, traders said the receding inflation also failed to have any impact on real yields.

Inflation hit a 34-week low of 5.34 per cent. Real yields across all maturities were positive though well below comparable international figures.

Internationally acceptable one-year real yields are at least 1.5 per cent. Domestic one-year yield is only 35 basis points above the inflation.

But this was not the only signal of the possibility of yields hardening in the coming weeks.

Hardening trend? Signs of this hardening trend were evident from the rush for certificates of deposits (CDs).

In fact, this was an instrument that banks had discouraged for quite sometime.

Any issue of the CDs were well below the reverse repo rate. But the last issue of the CDs, by the private sector ING Bank virtually set the markets on fire, since the pricing was at least 10 basis points over the Bank Rate. More banks are now planning to enter the CD market in the coming weeks to fund their expanding non-food credit growth.

Besides, bankers said that reduced accretions to the foreign exchange reserves contributed to a deceleration in the reserve money expansion. Accretions to external reserves were just $291 million and reserves have hovered around $129-130 billion for the last few months.

Bankers said that this appeared to be a deliberate policy doctrine of the RBI.

Forex reserves: This was partly because accretion to the reserves was increasingly imposing costs. The costs were partly evident from the difference between the purchases of foreign currency, the interest realised by parking it abroad and the low reverse repo rate.

The RBI preferred parking dollars only in liquid treasury bills, instead of dollar-denominated Government securities as a derisking strategy.

This was partly on account of the four hikes in US interest rates, which have led to depreciation of the investments.

Reducing holdings: In anticipation of further such hikes, the RBI has been quietly reducing its holdings of US Government securities and shifting more to short term treasury bills and bank deposits, to partly offset the possible depreciation in investments.

China and Japan, however, have incurred large depreciation of their investments in view of the large holdings. This was beginning to trigger fears among traders that the China was likely to hit the stop loss trigger leading to further depreciation, traders said.

But the hike in the US interest rates would also likely drive up the dollar, as more foreign institutional investors begin shifting to US Government securities.

Widening forwards: Some institutional investors were already in the process of doing so, leading to widening of the forward premia at the short end.

Widening of forward premia at the short end, traders said, indicate that liquidity is likely to tighten in the short term.

Further, what also led to the tightening was the high offtake of term credit from the domestic banks and FIs.

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