The Hindu Business Line : Rising oil prices, inflation fears keep bonds steady

Bangalore April 29 Bonds remained steady during the week as international oil prices maintained the upward momentum and inflation fears returned to haunt the markets.

Traders said that the credit policy held out little hope for any softening of yields in the future. This was despite the RBI's pause in hikes in policy rates.

The repo-reverse and repo rates were kept unchanged at 7.75 and 6 per cent respectively. This was despite expectations that the band would be increased to facilitate interventions in the foreign exchange markets.

Traders said the unchanged situation conveyed the signal that the current regime of restrained interventions was likely to continue for some more time. As a result, the rupee rose to a nine-year high against the US dollar to Rs 40.60, driven by capital flows.

But bankers said that the firm exchange rate was prompting importers to take forward cover at current levels, including long forwards for up to a year. Forward premia for one month, as a result, was close to 10 per cent, six months was 8 per cent and 12 months at 5 per cent.

With the rush for forward cover from importers, the External Commercial Borrowings (ECB) borrowers and some corporates planning prepayments of ECB under automatic route, a correction was likely in the markets.

Liquidity Tightening

Besides, the long-term MSS (market stabilisation scheme) interventions by the RBI were leading to tightening of liquidity, the traders said. During the week, the RBI mopped up Rs 4,500 crore through the 91-day and 364-day T-bill auctions. The cut-off yields for the 91-day T-Bill was fixed at 7.35 per cent and the weighted yield at 7.31 per cent. During the week, the RBI also mopped up Rs 6,000 crore through auction of 8.07 2017 paper.

The tightening, as a result, was evident from the three-day weekend Liquidity Adjustment Facility auctions. Bankers, in fact, took recourse to the repurchase window to the extent of Rs 11,704 crore. The 10-year yield-to-maturity (YTM) as a result firmed to 8.14 per cent on a weighted average basis from the previous week's 8.08 per cent.

However, for long dated securities, the presence of Life Insurance Corporation helped the banks. In fact, many banks unloaded some of their long dated securities that were part of the held-to-maturity category to the LIC. These included securities like the 8.33 per cent 2036 and 7.40 per cent 2035.

Daily trade volumes though remained low at about Rs 500 crore. Insurers demand pushed down the inter yield spreads between 1 and 29 years to 70 basis points.

This also helped banks further de-risk their investment books and keep them highly liquid.

Banks have been priming their investments to maintain high levels of liquidity. This is particularly on account of the current inflation combat mode of the RBI. Inflation, despite past efforts, has remained at 6.09 per cent, well above expectations of a 5 per cent. Given this situation, bankers said, " mid-term surprises cannot be ruled out."

Correction Expected

So most banks prefer to remain alert to avert losses on account of portfolio depreciations in future. At the current inflation level, one-year real yields were 1.66 per cent though a correction was expected. Any such correction would either imply a retreat in inflation or an advance in yields. Given the current trend in international oil prices, bankers said, the latter appeared to be a likely scenario in future.

Moreover, bankers said that there was little demand for dated securities from them. This was in view of the already high investment deposit ratios. Banks holding of Government securities is currently about 31 per cent, well above the prescribed statutory liquidity ratio of 25 per cent. Given the current projection of deposit growth this year at Rs 4,90,000 crore, assuming the current level of G-Sec holdings, ID ratios would be 26 per cent, still about 1 per cent more than the SLR.

Farm Credit

But credit was also growing, bankers said, especially farm credit. In fact, during the last few months, farm credit growth has been one of the major drivers that have contributed to a credit growth of about 28 per cent on a year-on-year basis.

To fuel this bankers have begun tweaking their deposit rates, though this was beginning to pinch the net interest margins. That is likely to prompt some adjustments in lending rates. It could be the beginning of the chill for borrowers!!