The Hindu Business Line : Life insurers keep off bond market ahead of Budget

Traders said life insurance companies stayed away from the markets. Life insurers, they said, preferred to wait for the Budget before making their next round of purchases. But insurers are quietly selling some of their equity portfolios by booking profits at the current high prices and preferred holding short-term bonds in treasury bills up to the Budget.

It was the large foreign exchange purchases by oil companies that kept the markets going. Oil companies made efforts to lock into the current low international prices. With oil prices below $60 a barrel for the first time in two months, it implied that the weighted average for imports was likely to be under $55 a barrel. However, there is still no reason for domestic oil companies to smile as they are still stuck with weighty bills.

Tight liquidity: As a result, bankers said liquidity in the markets remained tight. At the Liquidity Adjustment Facility auctions, bankers drew Rs 9,445 crore through the repo window. The tight liquidity conditions resulted in pushing up the yield on the 91-day T-bills to 6.69 per cent, up from the previous week's 6.56 per cent.

Similarly, the 364-day T-bill yields also moved up to 6.81 per cent. Non-competitive bids were also very close to the cut-off yields at 6.65 per cent and 6.79 per cent respectively

The tight conditions pushed up the 10-year yield to maturity (YTM) to 7.29 per cent on a weighted average basis, up from the previous week's 7.25 per cent.

Low volumes: The undertone continued to be weak, evident from the low trading volumes of about Rs 600 crore. Spreads also dropped. Inter-tenor spreads were down at 65 basis points between one-year and 29 years, driven more by a sharp rise in short-term yields.

A flattening yield curve was not a good sign of the economy, bankers said. More bankers and analysts are beginning to contest the government's prognosis of 8 per cent GDP growth during the current year.

Said Mr Ajit Dayal, Director of Quantum Mutual Fund, "The signs of a slowdown are all there."

Rising real rates: Besides, real rates were also rising. Real rates were driven by a combination of deceleration in inflation and a rise in short-term rates. One-year real yield based on the latest WPI derived inflation was 2.75 per cent.

An increase in real rates was an ominous sign that nominal yields were likely to harden further in the coming weeks.

What also prompted the hardening was slowdown in foreign exchange inflow induced reserve money expansion. This was partly due to hardening dollar yields and flight of foreign institutional investors to home turf. During the last few weeks, exporters have deferred inward remittances. This was in anticipation of a weakening of the rupee against the dollar. The high forward premium for up to three months was evidence of such a trend. Premia were upwards of 3 per cent for up to three months. Only the 12-month premium was below 2 per cent.

In fact, the current deceleration in inflation, traders said, was partly on account of an appreciation in the rupee, driven largely by foreign-debt driven inflows. The latest ECB data of the RBI showed that domestic corporates had raised close to about $12 billion through foreign borrowings till December last year.

Short-term hedges: Bankers said that most of the borrowers had taken only short-term hedges up to three months. As dollar interest rates rise, hedging costs are also likely to see spikes, bankers said.

This anticipation was also evident from the RBI's treasury operations. The RBI was actually liquidating its holdings of long-term treasuries contrary to the rest of Asia, as in Japan and China. The shift was intended to cut the costs of depreciation in the event of a hike in US interest rates.

Credit demand: Besides external factors, what was also driving domestic yields was credit demand. But credit demand was beginning to slow down, evident from converging incremental and nominal credit-deposit (CD) ratios.

Incremental CD ratios were 77 per cent and the nominal ratio was 70 per cent. Part of the reason was the pick-up in deposit mop-up by the banks.

Moreover, bankers have stopped selling securities for funding credit demand. But they are not buying either.

However, tinkering with interest rates stimulated this increase in deposits. More such tinkering is expected in the coming weeks, which is likely to translate into a reduced a net-interest margin unless lending rates are hiked from the current levels.