The Hindu Business Line : US-Iran stand-off, credit demand impact liquidity

International oil prices are already at $64 a barrel and there are fears that the events in West Asia could impact the country's balance of payments position despite surging exports.

Fears are that oil imports would likely to continue at the current high prices with the US-Iran standoff beginning to escalate.

Besides, traders were concerned that if the current situation continued, domestic liquidity could tighten further, driven by the oil companies' demand for foreign currency.

In fact, last week again the liquidity was tight. At the three-day weekly auction, banks were borrowers from the RBI's repo window, drawing almost Rs 20,000 crore.

At this level, most banks appeared to have reached their limits.

In fact, some of the banks have also begun to make a beeline for the RBI's Bank Rate window for support.

Tight liquidity: That liquidity was tight was also evident from the high Treasury bill rate at the weekly auctions.

Last week, the cut-off yield was 6.19 per cent, close to the repo rate of 6.25 per cent and well above the Bank Rate of 6 per cent.

The yield was 5.94 per cent the previous week. The 182-day T-bill yield also rose to 6.22 per cent, though the weighted yields were lower than the cut-off yields.

The 91-day weighted yield was 6.11 per cent and the 182- weighted yield was 6.18 per cent.

The surge in the cut-off yields once again triggered speculation among traders that the repo rates and the Bank Rate were likely to undergo an upward revision. This fear was also evident from the movement of the weighted average 10-year yield, which firmed slightly to 7.19 per cent last week, up from the previous week's 7.17 per cent.

Trading volumes: The tight liquidity situation led to a disinterest in trading, evident from the low volumes.

Daily trade volumes continued to be less than Rs 1,000 crore. But spreads remained narrow at 125 basis points for up to 29 years, implying yields at the long-end were flat, conveying that there was virtually no interest in long-term papers.

The reality was that there were no sellers since some of the insurance companies were quoting higher yields, traders said.

Bankers said that some of the insurance companies were quoting yields upwards of 7.50 per cent for the 29-year 7.40 per cent 2035 paper.

Opting for CBLO: At this yield, not many banks or funds were prepared to sell. Instead, the banks preferred to resort to collateralised borrowing and lending obligations (CBLO), for raising the liquidity. Institutions operating in the CBLO markets were mostly funds and insurers, especially unit-linked funds.

These funds have been taking advantage of the surge in the money markets, through the CBLO route advancing liquidity to some of the banks.

The outlook on yields also remained benign, bankers said. This was despite the slight rise in real yields to 1.8 per cent.

The real yield was well within accepted levels, bankers said.

But yields were likely to be driven by two factors - forex markets and the rising credit demand.

Foreign exchange demand was driven by oil companies.

Forex demand: The demand for foreign exchange, especially dollars, was clearly on the higher side, more than what was already available through current account and non-debt capital account inflows.

The non-debt capital account flows were from institutional funds out of East Asia, bankers said.

The rising demand for foreign exchange kept the forward premia at above 2 per cent up to three months, though beyond that it remained less than 2 per cent.

Moreover, credit demand continued to surge.

The surge in credit demand last week ensured that the nominal credit-deposit ratio was close to 70 per cent. The incremental ratio remained above 100 per cent.

Clearly banks are now preparing to push for a higher deposit rates, though lending rates are likely to remain constant till the end of the fiscal year.