The Hindu Business Line : Bond traders focussed on year-end valuations

Oil companies maintained a large presence in the markets. With international oil prices above $57 a barrel, they were large buyers for foreign exchange.

In addition, foreign institutional investors were also large sellers in the markets, sourcing foreign exchange for repatriation. Despite this bear pressure, banks held on to yields towards the year-end. Bankers' concerns were mostly on bottomlines.

If bond prices were allowed to drop sharply, valuations of investments would also be affected adversely, leading to increased depreciation charges and consequently weak bottomlines.

Life insurers presence: Bonds were also supported by the presence of life insurance companies, who were large buyers. Life insurers have had large premium accretions towards to the fiscal year-end. This was particularly so in some of the unit-linked policies.

As a result, the yield on the 91-day T-bill at the auction dropped slightly by four basis points last week to 5.32 per cent, from previous week's 5.36 per cent. What also helped the drop was the liquidity overhang due to deposit accretions and coupons/redemption flows. The mop-up in the reverse repo was close to about Rs 38,000 crore.

Despite the liquidity, the 10-year yield to maturity rose marginally to 6.73 per cent on a weighted average basis, up from last week's 6.71 per cent.

Weak sentiment: The overall sentiment remained weak, evident from thin trading volumes. Trading volumes were barely Rs 2,500 crore throughout the week, though on the last day of the last fiscal year, it rose to over Rs 4,000 crore,

on account of the switch deals by some banks and life insurers and also on account of some ready forward deals by banks. These kinds of deals allowed banks and funds to dress up their books for the year-end and shrink the depreciation incidence.

Bankers said the outlook for the next few weeks remained bearish. This was partly driven by the possibility of high government borrowings.

Government borrowings for the year ahead is expected to be close to Rs 1,10,291 crore, up from the revised estimates of last fiscal's Rs 46,034 crore.

Along with this liquidity mop-up the Reserve Bank of India's reintroduction of 182-day T-bills was expected to deplete the markets.

The first of the 182-day T-bill auction of Rs 1,500 crore (Rs 1,000 crore under the market stabilisation scheme and Rs 500 crore for the normal scheme) is to begin this week. This would mean that the first round short-term borrowings during the fiscal would siphon out Rs 3,500 crore from the markets. The issue of Rs 8,000 crore of securities was also planned during the week. This included the 6.85 per cent 2012 and the 7.95 per cent 2032. Both these securities are reissues of securities privately placed with the RBI.

Long-dated papers: But, these issues of securities are likely to face hard times, bankers said. This was because few bankers were interested in long-dated securities. The only possible bailout was likely from life insurers, who have a large appetite for long- dated securities. That there was a strong risk of a high pricing was evident from high spreads between one year and 23 years. This spread, last weekend, was 155 basis points, clearly indicating that banks, the largest subscribers to government securities, were disinclined. This disinclination of banks partly stems from the high investment-deposit ratio of 44 per cent, as against the prescribed statutory liquidity ratio of 25 per cent. Moreover, bankers said that at a time when credit growth was maintaining an annual growth of over 30 per cent, few were inclined to pick up low yielding government securities.

Forex inflows: What also led to rough weather expectations for government borrowings were the reverse flows in foreign exchange.

In fact, last week, foreign exchange accretion was actually negative. Reserves dropped by $1.2 billion to $140 billion, despite dollar's continuing slide worldwide. Bankers said that this implied that liquidity overhang was not likely to last long. These forecasts also partly stemmed from the possibility of further hikes in the US interest rates.

The US Fed funds, the rate at which banking institutions borrow/lend overnight funds, was expected to be hiked further even before the meeting of the Federal Open Market Committee in May.

As a result, some hedge funds, which had entered the Indian markets through the participatory note mechanism (FIIs issue of participatory certificates to ineligible investors), have already begun exiting. This was evident from the widening forward premia for one month.

This premia is now close to 2.5 per cent. Only the long forward premia, three, six and 12 months, remain below 2 per cent, on account of anticipated current account and non-debt capital account remittances.

Inflation worries: Further, inflation expectations are on the rise due to oil price changes worldwide.

Even at the current inflation rates of 5.11 per cent, the nominal yields for one year was only 50 basis points higher, way below international levels of 1-1.5 per cent. With credit offering greater returns, there is little interest for government securities other than for maintaining statutory ratios.

Incremental credit-deposit rates for most banks are over 100 per cent.

In fact, bankers said that to sustain the current pace of non-food credit growth of 30 per cent, deposit rates would need to be revised upwards, a trend that is expected to begin soon.

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