The Hindu Business Line : Bonds firm up on buying interest, forex flows

Traders said that bond buoyancy was also prompted by diminished inflation expectations and large tax flows into the Government kitty. This was expected to cut government borrowings this year, they added. What also supported bonds was the continuing soft oil price outlook. Oil prices, now about $58 a barrel, are forecast to drop as some nations complete their strategic oil reserve build-up. The soft prices were also expected to have beneficial impact on the current account balance. Till September, the merchandise trade account was in deficit by $24.601 billion as against the corresponding year's $20.908 billion, on account of high oil prices. Besides, there were large invisible flows from technology company earnings, cross-border dividend flows and remittances from non-resident Indians.

Good response

The combined effect saw the Reserve Bank of India's Liquidity Adjustment Facility auction getting large response. At the three-day week-end LAF auctions, the RBI mopped up Rs 15,995 crore through the reverse repurchase window. The flow was driven largely by reserve money accretions. Estimates are that over $100 million was flowing into the country on both the capital and current accounts on a net basis.

The liquidity build-up failed to manifest in the weekly treasury-bill auctions. The cut-off yields for the 91-day T-bill auctions held steady at 6.65 per cent. The was despite competitive bids of Rs 3,502 crore and non-competitive bids of Rs 2,750 crore received as against the notified amount of Rs 2,000 crore. This time, the RBI retained the entire non-competitive bids and retained only Rs 2,000 crore of the competitive bids.

Bankers said, "This is essentially a signal that there will be no major changes or reductions in interest rates in the immediate term." This trend was also evident at the 364-day bill auctions, where the cut-off and weighted average yields were 6.98 and 6.96 per cent respectively.

However, ten-year yield to maturity (YTM) dropped to a seven-month low. The ten-year YTM on a weighted average basis was 7.47 per cent last week, down from the previous week's 7.57 per cent. The softening helped the placement of the 8.07 per cent 2017 paper at an YTM of 7.43 per cent. This was indicative that yields could further move down.

Daily trade volumes

The firm undertone was evident from the pick-up in daily trade volumes which were close to Rs 2,000 crore. Besides, spreads have also shrunk as a result of the RBI's defence of the 91-day yield. The spread between 91 day and the ten years was just 80 basis points.

The spread between one year and 30 years was just about 70 basis points, clearly indicating a flat yield curve as against the previous week's 85 basis points. The flattening of the curve was driven by the chase for long-term papers by insurers, and surprisingly by foreign banks operating in the country.

Differing strategies

Foreign banks, bankers said, have increased the maturity of their investment portfolios to an average of about three years, whereas public sector banks were holding it down to about two years on their marked to market portfolios.

Bankers said that this was largely driven by anticipation of large inflows on the non-debt capital account, especially from non-resident Indians and overseas institutions, for the initial public offerings of Power Finance Corporation, Power Grid Corporation of India Ltd and Rural Electrification Corporation.

That inflows were expected was evident from non-deliverable forward market for rupees. (A cash-settled, short-term forward contract on non-convertible foreign currency, where the profit or loss at the time at the settlement date is calculated on the basis of a predetermined exchange rate for an agreed upon notional amount of funds).

Currently, the NDF market for the rupee is Rs 44.50 to a dollar for six months, well below the official rate. Besides, the forward premia for 12 months were well below 2 per cent. It was only at the short end for maturities up to one month that the forward premia was slightly above two per cent. But yields could retreat further, traders said as inflation expectations shrink. The one-year real yield is currently 1.75 per cent, as against the internationally accepted levels of one per cent.

On the flip side, credit growth is a major factor that could impact yields adversely. The credit- deposit ratios are currently 73 per cent for most banks.

Bankers said that the focus continued to be on short-term deposits, since there was very little retail interest for long-term deposits.

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