The Hindu Business Line : Bond yields harden on rising credit demand

Some banks attempted to sell their securities' holdings and source foreign exchange for meeting the oil companies' demand. This resulted in a tightening of liquidity in the markets.

BONDS yields hardened on mounting credit demand and rising foreign exchange requirement from oil companies.

Traders said that much of the oil companies' demand was for importing liquid petroleum gas for overcoming a looming shortage. As a result, the dollar rose to over Rs 44 to reach a 10-month high.

Despite rupee's slide, the RBI did not intervene in the forex markets.As a result, some banks attempted to sell their securities holdings and source foreign exchange for meeting the oil companies' demand.

This resulted in a tightening of liquidity in the markets. Consequently, the government's twin auctions were only a partial success.

Bids for the 11.83 per cent 2014 security for a notified amount of Rs 6,000 crore were rejected, since the yields quoted were way above RBI's acceptable limit.

The 7.4 per cent 2035 security for a notified amount of Rs 3,000 crore went through successfully. Both these papers are reissues.

Insurers' limited interest: Bankers said that this situation in the bond markets was on account of limited interest by life insurance companies in the 9-year paper.

Life insurers are interested only in long-dated papers - 10 years and above.

The success of the 29-year paper was precisely on account of this reason.

Banks stayed away from both the papers because they already had a surfeit of government securities in their respective kitties.

Besides, few were interested in long-dated papers especially at a time when they had managed to derisk their respective investment books.

MSS quantum: The tightening liquidity situation also resulted in the RBI reducing the MSS quantum last week in the 91-day treasury bill auction to Rs 1,500 crore, which brought down notified amount to Rs 2,000 crore from Rs 4,000 crore (Rs 3,500 crore).

The lower amount notified brought down the yields to 5.42 per cent against previous week's 5.49 per cent. But in the case of the 182 day T-bill, the yield was 5.58 per cent, which is very close to the one-year yield.

Yet, despite the tightening liquidity at the weekend reverse repo, the RBI mopped up Rs 21,000 crore.

Traders said that this was particularly because of large accretions in demand deposits from the initial public offerings that have hit the market during the last few weeks.

In fact, more than liquidity, traders said that it was the low interest in securities that dominated market sentiments. This disinterest was particularly so for long-dated securities, evident from the movement of the 10-year yield to maturity (YTM).

The 10-year YTM rose to 7.22 per cent on a weighted average basis, up from previous week's 7.14 per cent.

Low volumes: The depressed interest in securities was evident from the low trade volumes, which were just above Rs 1,500 crore. Besides, the spreads also widened.

The spread between one and 23 years was 190 basis points last week, up from the previous week's level of 171 basis points.

High inflation expectations fuelled by escalating oil prices also aided bearish sentiment. Inflation numbers showed that the year-on-year increase in the wholesale price index was 3.97 per cent.

The real yields were accordingly at 1.8 per cent.

Traders said that the nominal yields were in fact tracking inflation numbers since the real yields have remained constant for the last few weeks.

Further hardening: Traders said that yields could harden further in the coming weeks.

This was in view of the government auction calendar and possible exit of the some of the foreign institutional investors for year-end covering.

FIIs typically begin to unwind towards the last quarter of the year and book profits.

Anticipating this, oil companies have already started taking forward cover for up to three months.

As a result, one month to three month forward premia went up. One month forward premium was upwards of 1.25 per cent.

Long forwards, however, six months and one year, remained below one per cent.

Foreign exchange reserves went up for the last week by $42 million.

A large part of the reduced accretion was also on account of the exchange rate corrections.

Credit continued to grow at 33 per cent and incremental credit-deposit ratios were upwards of 100 per cent.

Deposit accretions were just 17 per cent and mostly short-term deposits.

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