The Hindu Business Line : Insurers turn cautious on inflation, keep to sidelines

Bangalore March 18 Bonds remained stable in thin and lacklustre trading during the week as nervous traders worried about surging inflation and high international oil prices.

Traders said that insurance companies stayed away largely on account of higher yield expectations. Insurerspreferred to wait for the Government's anti-inflation measures to start, before moving into the debt markets, traders said.

What also triggered the slide in the markets was the advance tax liabilities. This led to a tightening of liquidity, evident from the recourse to the repurchase window of the Reserve Bank of India (RBI). At the three-day liquidity adjustment facility auctions, banks borrowed up to Rs 19,705 crore through the repo window.

But bankers said the recourse was also driven by corporate recall of bulk deposits and reinvesting the same at higher interest rates. Bulk deposits of one-year maturity are commanding interest rates of up to 12 per cent.

The bulk deposit accretion was evident from the response to the Treasury bill auctions. The cut-off yield on the 91-day auctions was at 7.48 per cent and the weighted yield 7.43 per cent. Competitive bids for the T-bills amounted to Rs 4,035 crore and the non-competitive bids Rs 5,000 crore. The RBI accepted Rs 2,000 crore of the competitive bids and the entire non-competitive bids, about three-and-half times the notified amount. For the 364-day T-Bill, the cut-off yield was fixed at 7.83 and the weighted yield at 7.78 per cent. The competitive bids were close to Rs 5,000 crore, though the accepted bids were just Rs 2,000 crore, the notified amount. In addition, the RBI had also conducted auctions under the Market Stabilisation Scheme placing 6.65 per cent 2009 security. This also mopped up Rs 2,000 crore.

The combined effect of the auctions contributed partly to the liquidity tightening during the week, traders said. Despite the tight liquidity, the 10-year yield-to-maturity was down to 7.97 per cent on a weighted average basis as against the previous week's 8.01 per cent.

Bearish outlook

Trade volumes, however, remained low, at barely Rs 800 crore per day. The low volumes, bankers said, were largely on account of the uncertain environment. In fact, most of the securities placed in the weekly repos for overnight liquidity were long dated ones.

Similarly, it was the long dated securities that were also offered for inter bank repurchase through the CBLO (collateralised borrowing and lending obligation) windows. Traders said that few of the insurers were buying in the securities markets. As a result, the yield spreads widened to 70 basis points between one and 29 years. Also, the outlook remained bearish for bonds.

This trend was also apparent from the inflation numbers. Inflation, as measured by the wholesale price index, was 6.46 per cent translating into a one-year real yield of 1.14 per cent. While the real yield was in line with internationally expected norms, traders said the downside risk was high. This was largely on account of credit demand. Credit continued to grow at 30 per cent per annum. But the incremental credit deposit ratio was 77 per cent, very close to the nominal CD ratio of 74 per cent.

Bulk deposits

But Vijaya Bank's Chairman and Managing Director, Mr Prakash Mallya, said, "This is largely due to accretions in bulk deposit chasing by the banks." Besides, traders said, some of the public sector banks were also resorting to window dressing to show high business during the year, leading to an accretion of the bulk deposits. Consequently, as some of the bulk deposits are redeemed, the CD ratios would self correct, unless retail and long-term deposit growth also picked up, bankers said.

Moreover, the critical element was oil companies. Oil companies were still in the markets, chasing dollars for meeting their payments. The weighted average basket price for oil continues to be above $55 a barrel and if the Iran-US standoff worsens, oil prices could go over the roof. The US has prepared for such a contingency, so have some of the European nations, by building up large oil reserves. The US alone has a strategic petroleum reserve of about one billion barrels. India is yet to build up large reserves, though oil companies have hedged their exchange rate exposures. Forward cover, up to three months, was already close to five per cent, the highest in about four years. Besides, some of the ECB borrowers were also taking cover pushing up the premia. Between six and 12 months, the premia was over 3 per cent.

Fed move awaited

This was in anticipation of the meeting of the Federal Open Market Committee next week. If the Fed fund rates are hiked, then the repercussions are likely to be felt on the domestic markets, as foreign institutional investors move back into home turf to take advantage of the high yields.