The Hindu Business Line : Bonds remain weak in thin trading

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Bangalore Jan. 21 Bond traded weak in thin trading last week as dealers braced for fresh inflation containment steps from the Reserve Bank of India.

Traders said that insurers stayed away from the markets for the second week. Life insurers normally step in to support when yields harden or when prices are soft. But their absence last week was in anticipation that the RBI may use the SLR as a tool to contain inflation.

The RBI is expected to make its review this month-end, when it is expected to take combative measures against inflation. Inflation as measured by the wholesale price index has hit a two-year high of 6.12 per cent.

Oil companies tying up their crude purchases also triggered the hardening of yields. Besides, traders said that with international crude prices sliding, some of the oil companies have unwound their crude oil futures and substituted them with fresh ones in a bid to defend/enhance their respective refinery margins. Some public sector refiners have shifted to the spot market, traders said.

However, public sector oil companies were also beginning to take forward cover against their future oil imports, anticipating a depreciation of the rupee and a fresh upswing in international prices.

Little intervention

Last week, there were little interventions from the RBI in the foreign exchange forward markets. In fact, forward premia was mostly driven by the oil companies' demand. But traders said that some of the foreign institutional investors and foreign banks were beginning to liquidate their holdings of equities and debt. This was in anticipation of a hike in the Federal Funds Rate, when the Federal Open Market Committee meets this month-end. This along with the bank credit demand continued to exert pressure on liquidity.

liquidity

As a result at the three-day liquidity adjustment facility auctions, banks continued to take recourse to the repurchase window and borrowed Rs 11,900 crore.

This was also partly to arbitrage in the call money markets, as corporates attempted to redeem maturing bulk deposits. Credit demand, however, continued to play a major role, despite a slight deceleration.

However, this tight liquidity failed to reflect at the weekly Treasury bill auctions. At the 91 day T-bill auction, cut-off yield was unchanged at 7.14 per cent. But the weighted yields moved up in line with the cut-off yield. However, given the tight liquidity situation, the amount retained was Rs 1,431 crore, well under the notified amount of Rs 2,000 crore. At the 364 day T-bill auction, the cut-off yield was 7.27 per cent. Even at this auction, the retained amount was lower than the notified amount of Rs 2,000 crore at Rs 1,557 crore.

The undertone was weak. This was apparent from the low trading volumes. Daily trade volume last week was barely Rs 150 crore. Yield spreads between one year and 29 years remained at 92 basis points. This was evident from the narrow real yields. The one-year real yield, the difference between inflation and the one-year nominal YTM, were 1.12 per cent. Traders said this trend indicated that yields were likely to remain flat in the coming week, till the RBI announces its inflation control measures.

Money supply growth

Bankers said that major worry continued over the high credit offtake and money supply growth. Money supply growth as measured by the M3, has accelerated to 20.3 per cent. Money supply should ideally be in line with the nominal growth rate of the economy.

Bankers said that given this kind of a situation, some drastic measures were expected to temper this growth, mostly some credit control measures. Tweaking the SLR may be difficult, since it would translate into increase in government borrowings. This was particularly at a time when government borrowings are estimated to be lower than the budget estimates of Rs 1,52,000 crore.

Some non-conventional measures are already taking place, by the restraint in interventions in the foreign exchange markets by the RBI. But bankers speculated that among the measures that were mostly likely was through changes in the administered deposit rate, the saving bank rate.

This rate is now 3.5 per cent. Bankers said that this was essential to step up the deposit growth rate, particularly for meeting long-term fund requirements of the economy. Deposit growth, despite the hikes and rationalisation in term rates, still continued to be lower than credit growth.

Deposit growth was about 23 per cent, and credit was growing at 29 per cent for most banks, driven by offtake in farm and SMEs