The Hindu Business Line : Bonds firm on liquidity, inflows to bank deposits

Corporates have increasingly begun parking their funds in time deposits of banks as part of their treasury management. Some oil companies were also parking their funds with the banks.

Demand for foreign currency remained comparatively subdued. This was partly due to the fact that foreign currency inflows have overwhelmed demand.

Forex inflows: Foreign currency inflows were upwards of $100 million per day. The outstanding amount on the three-day reverse repo auctions was about Rs 25,000 crore. This was the highest level since January.

Besides, at the Treasury bill auctions during the week, the yields remained steady. At the 91-day T-bill auction, yields were 5.28 per cent; whereas at the 364-day auctions, the yields were 5.65 per cent.

This trend reflected in the 10-year yield to maturity (YTM) as well. The 10-year YTM on a weighted average basis was 6.63 per cent last week, almost unchanged from previous week's 6.64 per cent.

Firm undertone: The undertone was firm, evident from the improved trading volumes. Daily average trading volumes in the market was about Rs 4,500 crore.

Besides, the outlook also appeared firm. This was partly evident from the shrinking spreads between the long and short ends of the market.

The spread between one year and 23 years was about 125 basis points. Traders said that one of the major factors driving the markets was the presence of life insurance companies and mutual funds.

Life insurers' interest: Life insurers were at the longer end of the market, switching some of the shorter end securities for longer dated high-coupon securities.

The favoured securities by the life insurers, particularly the Life Insurance Corporation of India, were the 11.50 per cent 2015 per cent and the 9.85 per cent 2015. Large volumes of these securities were switched between banks and insurers.

Banks picked up the shorter dated securities for the longer dated ones. That insurers were prepared to pay higher prices for shorter yields was evident from the high spreads at the short end.

The spread for the first five years was close to about 70 basis points. Moreover, spreads between the weighted average 10-year YTM and the 10-year benchmark narrowed. The spread was down to 12 basis points.

The reason, traders said, was life insurers' purchase of about Rs 15 crore worth of 11.50 per cent 2015 at an YTM of 6.59 per cent.

But, the 9.85 per cent 2015 was picked at an average YTM of 6.67 per cent.

The reason for this higher pricing was the multiplicity of smaller lots increasing the transaction costs.

Banks preferred to switch securities during the last few weeks, since more of their high-coupon securities were in the `available for sale' and the `held for trading' categories.

Shifting portfolios: This shift has allowed them to book some profits on sales of the high coupons to neutralise some of the losses incurred in shifting portfolios to the held-to-maturity category.

Besides, traders said, more of the banks were shrinking the maturities below the five years in a bid to derisk their portfolios and remain liquid.

Traditionally, short maturity securities are seen as liquid securities as opposed to long-dated ones.

As a result, traders said, the average maturity of the investment portfolios of most banks in the country were already below five years.

Inflation: What also appeared to make the current level sustainable was the retreating inflation. Inflation as measured by the wholesale price index was 5.01 per cent. This level made real yields even for 91-day positive by at least 22 basis points.

Yet, traders said that the real yields were likely to widen further in the coming weeks. This was because inflation was retreating at a faster rate than yields.

Yields were also partly pushed down by the absence of Government borrowings.

Besides, foreign exchange inflows also ensured that liquidity was surfeit.

But imports, both oil and capital goods, were on the rise and so was credit expansion. In fact, non-food credit has grown by at least Rs 8,800 crore last week.

Yet, few traders were worried with these trends.

Most of them said despite this increase, there was unlikely to be any big jump in yields during this fiscal.

Any change, they said, was likely only towards the beginning of the next fiscal, when the US Federal Reserve could carry out its next round of increases.

Meanwhile, domestic banks have already begun pushing up some of the deposit rates to meet the rising credit demand, though this is not likely to immediately translate into lending rates.

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