The Hindu Business Line : Insurers lend support to bond markets

Oil prices are currently about $55 a barrel, translating into a weighted average import price of near $50 a barrel. The sharp drop in prices over the last two weeks, bankers said, would benefit the balance of payments situation. But oil companies have taken forward cover on future purchases on all unhedged exposures to guard against any future exchange rate spikes.

Tightened liquidity: However, liquidity tightened, powered by high credit offtake. At the last weekend's repo auction, there were more banks/institutions drawing funds from the RBI's repo window at 6.25 per cent.

The repo window saw drawdown of liquidity of Rs 1,250 crore of support for the banks. On the other hand, at the reverse repo window, liquidity mop-up was only Rs 650 crore. This is the first time in three years that subscription to the reverse repo window has fallen below Rs 1,000 crore.

Bankers said that the tightening liquidity prompted the RBI to remove the market stabilisation scheme (MSS) component out of the Treasury bill auctions. Still, the cut-off yield on the 91-day T-bill was 5.82 per cent, unchanged from the previous week's level. Similarly, at the 182-day T-bill auction, the cut-off yield was 5.90 per cent (5.80 per cent).

More hikes seen: But traders said the firm short T-bill yields notwithstanding, few believed further hikes in the reverse repo/repo rates immediately were impending.

"If a signal is to be conveyed, it will be done through the bank rate," one trader said. This was because the bank rate is now out of synchrony with the repo rate.

Moreover, this anticipation of steady rates at current levels was also due to the fact that the weighted yields at the T-bill auction had dropped below the cut-off yields. The 91-day T-bill weighted average yield was five basis points lower than the cut-off yield.

Traders said that this implied that yields were unlikely to continue hardening in the short term due to resumption of foreign exchange inflows. This anticipation was also reflected in the softening of 10-year yield to maturity (YTM). The weighted 10-year YTM at the end of last week was 7.13 per cent, down from the previous week's 7.17 per cent.

Weak undertone: Despite these positive signals, the undertone remained weak.

Daily trading volumes were less than Rs 1,500 crore during the week, indicative of bankers/traders' disinterest in investments.

Mr V.K. Chopra, Chairman and Managing Director of Corporation Bank, said, "Our focus is only on improving return on assets." Clearly, investments in G-Secs do not appear to fit the strategy for bankers if return on assets is the consideration. Obviously it would be credit.

Restricting buys: As a result, bankers' preference was to restrict government securities purchases. The only large buyers in the markets were the life insurance companies, and in particular, the Life insurance Corporation of India. Life insurers' presence in the markets pushed down yields. The yield retreats were more pronounced in tenors between 10 years and 17 years.

The favoured 10-year papers included the 9.85 per cent 2015 which some of the banks pulled out of their permanent category and sold at yields as high as 7.38 per cent.

Similarly, the 10.71 per cent 2016 paper was picked up by LIC at yields as high as 7.33 per cent.

What also reinforced bankers' beliefs of steady yields were the thinning spreads between one and 23 years. This has remained narrow for two consecutive weeks at below 160 basis points, or about 7 basis points per year.

Inflation effect: Bankers said that the reason for the trend was the changed outlook on inflation, with falling international oil prices. Real yields were upwards of 1.8 per cent. Bankers said that there was little scope for real yields to rise beyond the current level, given the current trend of inflation and international oil prices.

In fact, bankers said that the possibility was of narrowing yields, if the foreign currency inflows were to pick up and power an expansion in the reserve money. Last week's RBI data showed a small drop in foreign currency reserves by $310 million, bringing down reserves to $142.31 billion.

Yet this drop was technical, more due to the rise in dollar's appreciation against other international currencies, particularly the pound sterling and euro. At least 20 per cent of the foreign currency reserves are held in these currencies as well. The drop in reserves failed to impact the markets as was evident from the low forward premia. Forward premia from one month to 12 months remained under one per cent.

Yet, not many traders expect a major liquidity build-up.

Prepayments: Traders said that what was now expected was more prepayments of external loans by some of corporates due to a possible hardening of foreign currency interest rates. This was one of the major factors leading to a rise in corporate credit demand from the domestic financial institutions. Besides oil companies, corporates were the ones hedging for possible prepayments of external loans.

In fact, few corporates were resorting to external borrowings despite the liberalised terms due to fears of exchange rate uncertainty and a further hardening of dollar interest rates.

Credit demand: As a result, bankers said that they continued to sustain credit demand through liquidation of investments. This was leading to a fall in the nominal investment-deposit ratios below 40 per cent and increase in the nominal credit-deposit ratios to 68 per cent.

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