The Hindu Business Line : Govt may have to pay more for borrowings

Traders said that oil companies were present in the markets, as international crude prices remained firm over supply uncertainties. Crude futures were close to about $65 a barrel. Futures price is driving oil companies scurrying for cover.

Besides, during the week, insurance companies, normally the largest buyers, stayed away. The reason for abstention was the large liquidity inflows, mostly on account of unwinding of market stabilisation scheme securities. This resulted in pushing down the yields at the weekly Treasury Bill auctions. The 91-day T-Bill yield was 6.60 per cent, down from the previous week's 6.65 per cent. The 364-day T-Bill was 6.75 per cent.

Global liquidity situation

However, by the end of the week, the liquidity had evaporated. This was despite the large foreign currency inflows from East Asian funds.

The tightening was also partly related to the global liquidity situation. In fact, the RBI was beginning to unwind some of its dollar security holdings ahead of a crucial Federal Reserve Board meeting and parking funds in the form of international balances.

Besides, oil demand exceeded forex inflows, traders said, leading to the tight liquidity.

This was evident from the banks' return to the RBI's repo window. At the week-end three-day LAF auction, banks drew support to the extent of about Rs 4,100 crore through the repo window.

The tightness towards the end of the week was entirely on account of oil companies' demand and credit offtake.

As a result, towards the weekend, the 10-year yield to maturity (YTM) ended at 7.42 per cent on a weighted average basis, up from 7.38 per cent the previous week.

Weak undertone

The undertone was weak, evident from the low trading volumes. Barring a brief spike, daily trade volumes remained below Rs 500 crore.

The outlook also remained confusing, with yield spreads widening. The spread between one year and 29 years was 100 basis points.

The widening was due to the presence of a large number of sellers.

More banks were offering their recapitalisation securities for repurchase operations for meeting their liquidity requirements.

But there are fears that the conversion of the recap bonds into SLR securities would likely raise the cost of government borrowings in the next financial year.

This was because the conversion had resulted in the banks' SLR requirements moving very close to the investment-deposit ratio of 38 per cent.

This now implied that for most of banks' incremental deposits, there was little requirement for SLR, traders added.

Yield expectations

Therefore, fresh placements of G-Secs would have to be done at higher yields to match up to banker's yield expectations. Bankers' yield expectations are currently driven by the need to protect interest margins.

Average yield on investments are already below the weighted average cost of working funds, for most banks, after the series of hikes in deposit rates.

As a result, there are fears that yields are likely to harden further in the coming weeks. This trend was evident from the one-year real yield.

The one-year real yield was 2.75 per cent.

Credit-deposit ratios

Hardening real yields, traders said, were also driven by the high credit-deposit (CD) ratios.

Nominal CD ratios were 71 per cent, but incremental CD ratios were upwards of 100 per cent.

Most of the incremental liquidity demand was met through repurchase operations or through the CBLO (collateralised borrowing and lending obligation) by some of the banks with insurance companies and mutual funds.

Farm assets

The chase this time is more for farm assets, driven by the high return on assets. Average farm lending rate by most of the banks is currently about 10 per cent.

Consequently, a high farm asset portfolio tends to dress up balance sheets of the banks by raising their average yield on assets.