The Hindu Business Line : IMD redemption pressures liquidity

One major factor that influenced liquidity in the markets was the redemption of the India Millennium Deposits on December 29. Besides, normal non-bank participants stayed away from the markets. These included life insurance companies and mutual funds as they preferred to wait for cues from the Reserve Bank of India.

What also contributed to the uncertain market situation was the presence of oil companies for sourcing dollars for meeting their current and future oil payment requirements.

The redemption of over $7 billion of the IMD went off smoothly, as the RBI met the full requirements of State Bank of India. But the RBI also intervened in the money markets during the week. At the weekend three-day repo auction, the RBI pumped in liquidity to the tune of Rs 30,000 crore.

In fact, during most of last week, banks were seen taking recourse to the RBI's repurchase window at 6.25 per cent.

Traders said that some of the more market savvy banks also raised funds to lend in the call markets where rates were over 6.75 per cent, booking spreads of a minimum of 50 basis points.

The tight liquidity situation also had its impact on the Treasury bill auctions.

Last week, both the cut-off and the weighted average yields of the 91-day were at 6.11 per cent and 6.07 per cent respectively.

The previous week, the yields were 6.02 per cent and 5.94 per cent respectively. During the corresponding period of 2004, the 91-day T-bill yield was 5.41 per cent.

In the 182 T-bill auctions, the yields were 6.14 per cent and 6.12 per cent respectively.

Bankers speculated that if this situation continued for some more time, the RBI was likely to hike repo rates at the next credit review meeting.

At present, the reverse repo/ repo rates are 5.25 per cent and 6.25 per cent respectively.

The tightening of liquidity, however, failed to impact the 10-year yield to maturity (YTM). On a weighted average basis, it remained steady at previous week's level of 7.17 per cent.

Last year, in the same period, the weighted average 10-year YTM was 6.77 per cent.

The 10-year benchmarks are also changing. Among the new and emerging benchmarks for the 10-year yields was the 10.71 per cent 2016 per cent security.

At present, this is the most frequently traded one.

Bankers said that sentiment remained weak, evident from the low trading volumes.

Average daily trading volumes remained under Rs 1,000 crore during most part of the week. However, spreads continued to thin out between one year and 23 years. The spread between one-year and 23 years was only 120 basis points.

Thinning spreads during a tight liquidity situation, however, was not a very good sign, traders said. This was because the low spreads were signs of a slowdown in the economy.

Bankers said the thin spreads were also partly driven by the high appetite for credit. Credit since the beginning of this fiscal year has averaged 30 per cent growth rate on a year-on-year basis. Besides, bankers are already operating at very high investment-deposit ratios.

Investments as a component of working funds for most banks still continued to be 38 per cent, or way above the prescribed statutory liquidity ratio (SLR) of 25 per cent.

Bankers said that that most of them preferred to align closer to the SLR.

Faced with difficulties in selling securities, bankers have switched to deposit mobilisation to meet credit demand.

In fact, barring the CRR, bankers were holding back fresh investments in government securities.

This was now likely to create difficulties for government borrowings in the coming weeks.

Bankers said that yield expectations for most of them have already increased.

Bankers added that none of them preferred hiking lending rates at this juncture. Besides, the RBI was also not in favour of hiking the benchmark prime lending rates for fear of jeopardising the GDP growth targets. Consequently, bankers have now put on hold any lending rate hike proposals and pushed for protecting their spreads, by holding back investments.

The key factor that could determine yields in the coming weeks would likely be reserve money, bankers said.

Some corporates were also preparing for making large prepayments of external commercial borrowings. This, along with the oil payments, drove up forward premia for the dollar above one per cent across tenors up to 9 months.

Inflows are likely to accelerate in the coming weeks from portfolio investors and exporters.

Consequently, liquidity pressures are likely to rise. In fact, it was in anticipation of this situation that the RBI has left the option of the market stabilisation scheme open for the fourth quarter.

But the January 6 weekly statistical supplement would likely show a sharp drop in foreign exchange reserves, on account of the IMD redemption. But reserve accretions are not likely to be allowed to exceed the current threshold. This was on account of the need to maintain the real effective exchange rate and keep inflation under control.

Real yield for one year is currently at 1.4 per cent and is likely to be defended at this range, bankers said.