The Hindu Business Line : Liquidity back as Asian funds fancy equity

Bankers said that oil companies stayed away as most of them again resorted to leaving some of their foreign exchange positions unhedged anticipating a further strengthening of the rupee.

Bankers said that oil companies took this risk following the large-scale entry of East Asian portfolio funds into the domestic equity markets. These included portfolio investors from Japan and Korea, who are emerging as big investors in the Indian equity markets.

Funds' entry: Bankers said the entry of these funds was beginning to impact domestic liquidity. This was in addition to the large interest payouts on special deposit schemes of the government.

As a result, during the week-end reverse repurchase operations, the Reserve Bank of India mopped up close to Rs 4,000 crore, contrary to the previous week when liquidity had to be pumped in to the market.

Improved liquidity: The improved liquidity also reflected in the Treasury bill auctions last week.

At the 91-day T-bill auction, the cut-off yield dropped sharply to 5.94 per cent, down from the previous week's 6.11 per cent.

However, in the 364-day T-bill auction, the yields, both the cut-off and the weighted average, remained above the bank rate and close to the repo rate at 6.13 per cent.

Similarly, the 10-year yield to maturity (YTM) was 7.16 per cent on a weighted average basis, almost on the same level as previous week's 7.17 per cent.

Sentiments, however, remained weak despite the slight firming up of yields. In a thin market, even small volumes impact yields.

The daily trading volumes continued to remain at Rs 1,000 crore.

Widening spreads: The outlook was flat, evident from the slight widening of spreads to 129 basis points, from previous week's 120 basis points. Traders said that yields were not likely to harden in the immediate future and the outlook for interest rates remained benign.

In fact, some of the mutual funds are planning to make large purchases of long-tenor securities.

Mr D.S.R. Murthy, Executive Director of UTI Asset Management Company Private Ltd, said, "We expect interest rates to slightly soften before they begin hardening some time during the next financial year."

However, funds' assessment are also partly stemmed from the fact that during the last quarter of the financial year most banks preferred to go easy on credit, especially risk weighted assets.

This was to conform to the capital to risk weighted asset ratio of 9 per cent prescribed by the banking regulator.

Rush for papers: Consequently, this period is likely to see a rush for government securities, in turn pushing up the prices and leading to a softening of yields.

As a result, bankers and traders have stopped speculating on any further hikes in the reverse repo or the bank rates.

Besides, yields are also unlikely to show any big rise during the next few weeks as more liquidity is expected to pour in from life insurers, especially Life Insurance Corporation of India.

The life insurer has during the first nine months of the current financial year recorded a 247 per cent increase in premiums across all its schemes.

This accretion is likely to help the government borrowing of Rs 10,000 crore, slated for the week , through the issue of the 29-year 7.40 per cent 2035 and the five-year 9.39 per cent 2011.

Both these securities are expected to go down well among the funds and the insurers.

Funds preferring the high yields and the short-tenor of five-year security and insurers have an appetite for high YTM long-term securities.

The RBI's optimism of full subscription of the securities was evident by the low underwriting fees of three paise and five paise, respectively, fixed for the securities.

Inflation outlook: Besides, what would likely help yields was the low inflation outlook.

Inflation for the week ended December 24 was 4.4 per cent, translating into a real yield of 1.75 per cent for one year.

This means there was some limited flexibility for yields to soften, traders said.

Moreover, the likely large inflows during the next few weeks are also expected to support yields.

In anticipation of these flows, forward premia across all tenors are beginning to ease.

Bankers said that not many were keen to push deposit rates too high despite the recent round of increases.

Even at existing rates, deposit flows are buoyant. At the current deposit rates, the weighted average cost of working funds have slightly increased, though higher NPA recoveries have helped banks to keep the rates in check.

Banks are likely to show good results on the back of good spreads.

The spreads, the difference between the average return on assets and the weighted average cost of funds, are now close to about 6 per cent, traders said.

This partly explains why banking stocks are the equity markets' favourites.