The Hindu Business Line : Bond trade wary of hardening rates, rising crude prices

Most oil companies remained in the spot markets. This was also partly on account of large inflows into the country particularly through non-debt, quasi-debt (foreign currency convertible bonds) on the capital and strong invisibles flows on the current account.

This prompted intervention by the Reserve Bank of India with the consequent impact on domestic liquidity. But the intervention ensured exchange rate stability and helped oil companies save on forward cover costs.

However, bankers said one reason for the weakening of bonds was the hike in the US Federal Funds rate to 5 per cent. The hike has raised the possibility of exit by some foreign institutional, pension and insurance funds.

After the hike the differential in short-term yields between Indian and US yields has narrowed to less than one per cent. This is the first time since the 80s that differential is falling to this level since the 80s. The 3-month U S treasury yield is currently 4.82 per cent.

Awash with liquidity

Despite the possibility of a slowdown in the FII flows, markets continued to be awash with liquidity. This was evident from the large mop-up through the three-day weekend liquidity adjustment facility auctions.

At the auctions, the RBI mopped up a little over Rs 48,000 crore through the reverse repo auctions.

At the 364 day T-bill auction, the RBI accepted bids only for the normal auction of Rs 1,000 crore at an yield of 6.25 per cent. The MSS bids were not accepted. Traders said that this conveyed the signal that short-term yields were preferred within this band well within the repo/reverse rates (5.5 and 6.5 per cent).

State loans

In fact, this signal also led to a hardening of yields to the issue of state government loans during the week.

Almost all the loans were fully subscribed, with the exception of the UP State Government that devolved partially on to the primary dealers. The cut-off yields were fixed in a band of 7.8 and 8 per cent.

As a result, the 10-year yield-to-maturity moved further northwards on a weighted average basis to 7.58 per cent last week, up from the previous week's 7.55 per cent.

That the undertone was weak was evident from low trade volumes of barely Rs 800 crore per day. The weakness was partly on account of the loss of trading interest among the banks and the absence of insurance companies. But rates could harden further in the coming weeks. Signs of this were evident from the high real yields.

Real yields were 2.7 per cent, despite the slight rise in inflation. Cost of fund raising as a result was also on the ascent, with more banks offering high interest rates for deposit mobilisation.

Farm sector loans

Banks are increasingly deploying the funds in the farm sector. Loan coverage to the farm sector is currently barely about 20 per cent of the GDP.

The shift to the farm sector was also on account of protection to the net interest margin even in a regime of high interest rates. For housing loans, the margin is wafer thin.

For this big push to the farm sector, deposit mobilisation efforts have intensified. Bankers said that they would need more long-term funds for farm sector lending and infrastructure funding. This is triggering a push to raise more long-term funds and rely less on short-term resources.