The Hindu Business Line : Bond yields seen soft for few more weeks

Traders said one of the major reasons for the failure of the liquidity to manifest in bond prices was the Reserve Bank of India's aggressive interventions.

The interventions were two-pronged — aggressive liquidity mop-up operations and reissue of the Central government papers with the banks.

The reissued securities - the 7.37 per cent 2014 paper and the 7.5 per cent 2034 paper were fully subscribed and the targeted amount of Rs 8,000 crore was mopped up with ease, evident from the large over-subscriptions to the issue.

The securities were placed at yield to maturities of 7.05 per cent and 7.55 per cent respectively. The treasury bill auctions also saw similar responses.

As a result, the cut-off yield on the 91-day T-bill last week was 5.20 per cent against 5.24 per cent the previous week.

For the 364-day T-bill, the cut-off yield was 5.61 per cent against 5.65 per cent at the previous auctions. But the weighted average yield on the 91-day and 364-day was lower than the cut-off yields at 5.16 per cent and 5.60 per cent respectively.

The issues were fully subscribed at these auctions. As a result, the mop-up at the reverse repo auction was lower last weekend.

Stability: At the three-day reverse repo auction, liquidity mopped up was Rs 25,500 crore.

Interventions of these sorts ensured stability in the markets.

The 10-year yield to maturity (YTM) was at 7.08 per cent on a weighted average basis against the previous week's 7.12 per cent.

But for the intervention, the drop in yields would have been sharper, traders said.

In fact, expectation in the markets was that yields would remain soft for the next few weeks as well.

"We expect interest rates to remain at this level for another five-six months, given the high liquidity," said Mr Keki M. Mistry, Managing Director, HDFC.

Even the Finance Minister had echoed a similar view on Friday.

Shrinking spreads: That yields could soften was evident from shrinking spreads. The spread between one year and 23 years was down to 158 basis points as against 175 basis points the previous weekend.

One reason for the shrinking spread and a soft yield environment was the benign inflation regime. Inflation last weekend was at 3.35 per cent.

At this level, the one-year real yield was 2.25 per cent, implying that there was little scope for any sharp rise in yields. In fact, at these levels, real yields were consonant with international levels.

"Pushing up investments will not help in increasing the average return on assets," said Mr N. Kanta Kumar, Chairman and Managing Director, Syndicate Bank.

In fact, bankers' focus was on improving the average return on assets. They were gradually reducing the investment-deposit ratios to statutorily acceptable levels and pushing up credit offtake.

Low trading volumes: This was also one of the major factors behind the low trading volumes in the markets. Daily trading volumes were barely Rs 2,000 crore.

One major reason for this shift in focus was the credit that presently returned a spread of 5-6 per cent over the weighted average cost of working funds. In the case of investments, the spread was about 1.5 per cent.

This is clearly an opportunity for insurance companies, particularly life insurers. They are picking up high-coupon securities, especially 10 years and above.

For instance, the 10.47 per cent 2015 was picked up at 7.17 per cent and the 11.43 per cent 2015 at 7.18 per cent. However, this did not push up the weighted average 10-year yield since volumes in these securities were low.

Moreover, bankers said that most life insurers were resorting to switches - selling short-dated securities and replacing them with long-dated high coupon ones.

For meeting the credit demand, bankers said they were also resorting to repurchase operations among themselves in excess G-Secs or referredto collateralised borrowings. This allowed them sufficient time to raise deposits for meeting the escalating credit demand.

Despite these sale by bankers, yields were expected to remain at current levels in the coming weeks as well. This was partly on account of large foreign currency inflows taking place.

Forex inflows: Accretion to the foreign exchange deposits for the last week was $1.7 billion, pushing up the reserves to $144.375 billion.

Anticipation on the yields is supported by the soft forward premia, which is below 0.75 per cent across all maturities.

For one month, forward premia used to be above one per cent, but now it was below 0.5 per cent and likely to go down further, indicating more inflows are in the pipeline. Inflows are already in the region of about $150 million per day. Bulk of the inflows was non-debt capital account including non-repatriable non-resident deposits and current account receipts.

Even oil companies' demand has failed to soak up the inflows despite the high crude prices.

As a result, traders anticipate some relaxations on prepayments of foreign debt.

In fact, some more prepayments of multilateral borrowings are expected. This would be to ensure exporters are helped by stable exchange rates and at the same time interest rate volatility is kept in check.

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