The Hindu Business Line : Bonds firm up on technical correction

Traders said that the slight reversal was also triggered by the remarks of the Union Finance Minister, Mr P. Chidambaram, of a benign interest rate regime, an opinion echoed by the Reserve Bank of India.

During the week, most traders had discounted a 50 basis points increase in the key signal rates - the reverse repo - of the RBI.

The RBI hiked the rates by only 25 basis points belying market expectations leading to a technical correction.

But other factors that contributed to the softening of yields were the absence of oil companies.

In fact, panic among oil companies appeared to have considerably abated with the drop in international prices to about $61 a barrel. For India, this would mean that the weighted average import prices would be about $57 a barrel.

Less forex demand: This would mean a reduction in foreign currency demand. As a result, the foreign institutional investors' rush out of domestic markets triggered little panic.

Yet, bankers said that a rise in interest rates was inevitable given the pace of credit growth.

Mr Y. Vijayanand, Managing Director of State Bank of Mysore, said, "Some firming of rates is inevitable if credit growth is sustained at current levels."

These concerns were evident from the cut-off yields at the weekly Treasury bill auctions, immediately after the announcement of the peak season Credit Policy. The yield on the 91-day T-bill was 5.57 per cent, up from the previous week's figure of 5.53 per cent. The rise in the weighted average yields was even steeper. The weighted yield last week was 5.57 per cent, up from the previous week's figure of 5.49 per cent. The yield on the 364-day T-bill was 5.84 per cent, both cut-off and weighted average.

No liquidity tightening: Yet, the firming of the yields hardly implied any liquidity tightening,evident from the weekend 3-day reverse repo auction mop-up when the RBI sucked out Rs 20,840 crore.

Even the 10-year yield to maturity (YTM) softened slightly towards last weekend to 7.15 per cent, down 11 basis points from the previous week.

Low volumes: Bankers do not expect this trend to sustain in the coming weeks, evident from the low trading volumes and the continuing high spreads.

Daily trading volumes remained under Rs 2,000 crore. The weak outlook was manifest in the high spreads between one and 23 years. This spread was 180 basis points.

Traders anticipate another mid term change in interest rates, indicative from the fact that only the repo and reverse repo rates were hiked.

The repo rate or the repurchase of government securities, through which the RBI provides liquidity support to the market participants is 6.25 per cent.

The Bank Rate, which is a clean lending, is 6 per cent. The Bank Rate also provides liquidity support to commercial banks as lender of the last resort.

More hikes likely: In any ideal situation secured lending rates are lower than clean rates, though in this case it is the reverse. Given this situation and also the inflation upswing, bankers said another round of hikes looked inevitable.

Moreover, bankers said that the low interest in government securities was driving up yields. With the investment-deposit ratio continuing at 42 per cent not many banks are interested in picking up securities.

Instead, most of them see an opportunity in arbitraging between the RBI's reverse repo rates.

For instance, through the Collateralised Borrowing and Lending Obligations (CBLO), banks are in a position to raise short-term funds at rates as low as 4.5 per cent.

Expecting big inflows: Bankers were also expecting big inflows into the domestic market through foreign currency earningsDespite the volatility in the rupee-dollar exchange rate at the spot, forward premia remained under one per cent.

FII exodus: The FII exodus failed to impact the rupee-dollar forward premia.

Consequently, most traders now expect the rupee to begin firming up against the dollar from January, especially as some of the export inflows would begin.

But the critical element was credit growth.

Most banks were already operating at all-time high credit- deposit ratios. These ratios are now 67 per cent. .

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