The Hindu Business Line : Bankers expect more mop-up under MSS

BONDS gained slightly last week buoyed by the more-than-expected foreign exchange inflows and despite Reserve Bank of India's aggressive liquidity mop-up operations.

Traders said inflows prompted RBI to intervene in the forex markets. The intervention was partly to support oil companies' foreign currency purchases which pushed up the dollar exchange rate.

However, towards the week-end, the intervention was more to mop up the inflows than to offset the outflows on the oil account.

The aggressive intervention and the level of foreign currency inward remittances were evident from the high level of weekly mop-up through reverse repurchase operations. The mop-up through three-day reverse repos was upwards of Rs 30,000 crore. Bankers said but for the high level of purchases through the T-bill auctions during the week, the mop-up amount would have been much higher.

Excess bids: During the week, at the 91-day T-bill auction, the RBI received bids in excess of Rs 10,000 crore for notified amount of Rs 4,000 crore, which included Rs 3,500 crore in the form of a market stabilisation scheme (MSS) and Rs 500 crore as the normal amount.

At the 364-day T-bill auction also, the response was similar. The bids were in excess of Rs 4,000 crore for a notified amount of Rs 2,000 crore (Rs 1,000 crore MSS and Rs 1,000 crore normal).

The phenomenal response to the auctions in turn led to a repeat of the previous week's situation. The weighted average yield was lower than the cut-off yields. The cut-off yield on the 91-day T-bills was 5.20 per cent and the weighted average yield was 5.16 per cent.

At the 364-day T-bill auction, the cut-off yield was 5.62 per cent and the weighted yield was 5.61 per cent. However, the RBI's signals pushed up both the cut-off and the weighted yields for the 91-day T-bills by 4 basis points each.

Yet, the signals failed to impact the 10-year yield to maturity (YTM). The 10-year YTM softened marginally to 7.10 per cent on a weighted average basis as against the previous week's 7.12 per cent.

MSS quantum: As a result, bankers expect the MSS quantum to be stepped up further in the coming weeks as well, if liquidity continued to inundate the markets.

The only alternative would be to allow yields to sink further, which the RBI is reluctant at this moment.

Bankers said that yields could be expected to remain flat for some more time, as was evident from the low trading volumes and the spreads. The spread between one and 23 years was 172 basis points as against the previous week's 180 basis points and trading volumes were about Rs 2,000 crore.

Clearly, this indicated that there was little interest in bonds trading for most of the banks.

Only insurers showed interest in bonds, with most of them opting for switches, replacing short-dated securities with long-dated ones.

Insurers' preference: In fact, only trade of these sorts gave some volumes to the market. It was this interest from life insurers that allowed yields at the long ends to soften. The securities sought by the insurers included the 12.30 per cent 2016, which was picked up at 7.24 per cent and the 8.07 per cent 2017 per cent at 7.17 per cent.

Despite the interest from insurers, real yields widened further with inflation retreating to 3.08 per cent. One-year real yields are at 2.5 per cent, implying that the upside risk, for any sharp yield spike in the near future, was clearly limited.

This was also borne out by the low forward premia across maturities. In fact, forward premia narrowed further. The forward premia up to 12 months was below 0.6 per cent, clearly implying that forex inflows were expected to swamp the markets. This was despite the fact that the India Millennium Deposits, floated by the SBI, were coming up for redemption. Inflows currently are upwards of $100 million per day. These inflows were taking place even after netting for high international oil prices.

Traders said that the oil prices at $70 a barrel had failed to impact the forex markets.

Forex inflows have forced the central bank to intervene more actively. One reason is that if the rupee were pushed down, the fear is that there would be strong inflationary impact, particularly in view of the high oil prices. On the other hand, if the rupee were allowed to appreciate, export earnings could likely be adversely hit.

Ensuring stability: Consequently, the pressure was to ensure stability in both foreign exchange markets and in the yield. In fact, this was also one of the reasons that traders were now expecting the MSS to be stepped up.

Credit demand, after weakening for two consecutive weeks, has begun picking up. Incremental credit-deposit ratio now is close to 100 per cent. This was partly on account of a negative accretion in demand deposits and the Rs 15,500 crore increase in credit offtake, almost entirely of non-food credit.

It this credit growth momentum continues, bankers are likely to hike deposit rates in the coming weeks. Some have already hiked the rates; others were focussing only on the investment-deposit ratio for raising resources. That option is likely to disappear and deposit mobilisation is now expected to be on bankers' agenda.

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