The Hindu Business Line : Insurers, mutual funds go for longs as oil prices dip

Bonds firmed last week with retreating international crude oil prices and reduction in inflation expectations. Traders said that large purchases from life insurance companies and mutual funds also helped keep bonds buoyant. Funds have taken the view that yields were likely to remain stable for some more time. Insurers have begun moving in droves into the long-dated securities, of maturities 10 years and above.

But international oil pricing remained as the dominant factor in the bond markets. Oil prices have dropped to $55 a barrel.

For India, this trend implied basket import prices could very well drop below $50 a barrel. With the price drop, oil companies have further reduced their drawdown on their credit lines from banks.

Credit Deposit Ratios

However, despite the reduced drawdown, liquidity in the banking system showed little signs of any major expansion. Bankers said that this was mainly on account of the high credit offtake in the economy, evident from the high credit deposit ratios. At the weekend liquidity adjustment facility auctions, the recourse to the three-day reverse repo window was just Rs 5,135 crore.

Bankers said softening yields and tight liquidity were was largely on account of demand from foreign banks. Foreign banks, bankers said, were resorting to swaps for meeting their rupee liquidity requirements. This resulted in the rupee remaining firm at 44.85 to a dollar. Forward premia hardened close to 2 per cent for up to three months in view of these swaps. The firming was also caused by a large rush of importers including corporates to cover their capital goods import payments. Besides at least Rs 2,500 crore was mopped up as state development loans during the week, leading to compression in the recourse to the reverse repo window. In fact, some of the insurers preferred redeeming their bulk deposits for investing in the State development loans.

Treasury Bill

The stability in the liquidity situation was also evident from the week Treasury bill auction, where the cut-off and the weighted average yields of the 91-day Treasury bill remained steady at 6.65 per cent for the fourth week in succession. As in the past, during the last week also it was the non-competitive bids that helped the RBI to mop up the notified amount that also included the market stabilisation scheme. Non-competitive bids accepted at the 91-day T-bill auctions were Rs 2,300 crore. The high level of non-competitive bids accepted, bankers said, was clear evidence that liquidity in the banking system would not pose any major problem in the foreseeable future. Similarly at the 182-day T-bill auctions the cut-off yields were 6.93 per cent and the weighted average yields were lower at 6.91 per cent.

This optimism was evident from the movement in the ten-year yield to maturity. The ten year YTM softened to 7.57 per cent on a weighted average basis last week end down from the previous week end's 7.61 per cent.

Firm undertone

The firm undertone was evident from trading volumes. Daily average trade remained at Rs 1,500 crore. The outlook also remained stable, evident from the flattening yield curve. A normal yield curve is low at the short end and high at the long end. But yield spreads between one and thirty years last week was 85 basis points. The shift at the long-end was related to large presence of insurance companies. In fact insurers have been chasing the 8.33 per cent 2036 per cent during the last few weeks.

This chase for long dated securities also pushed down the bid offer spreads. Bid offer spreads were about 5 basis points at the long ends implying large demand for the securities. This was largely on account of the sizeable life insurance premium accretions, particularly from the semi-urban and rural areas, where the preference was more in favour of conventional savings linked products. But banks preferred remaining at the short-end of the yield spectrum. This was in view of the continuing credit demand and possibility of redemption pressure build up on holdings of bulk deposits/ certificates of deposits.

Credit Demand

In fact, this bias towards the short end was also largely to avert any depreciation in the event of a hike in the reverse/repo rate. Mr Arpit Agarwal, Chief Executive Officer of Dawnay Day AV India Advisors Ltd, subsidiary of UK based international financial advisory firm, said: "We think that the reverse repo/repo rates will go up by another 25 basis points over the next few weeks."