The Hindu Business Line : Bonds perk up as inflation fears subside

Traders said that what prevented any major upswing was redemptions by some bulk depositors, including corporates that had made equity offerings during the last quarter. Besides, traders said oil companies also drew on their credit lines as international prices soared to $65 a barrel. Forward premia, as a result, remained between 4 and 5 per cent between one and 12 months.

Bankers said that inflows continued to swell, partly from debt and non-debt capital accounts. Debt capital account flows, including non-repatriable NRI deposits, lead the flows. Besides, some State Governments had also begun drawing on their Plan allocation funds for capital expenditure, leading to tight liquidity.

The tightness was evident from banks recourse to the repurchase window of the Reserve Bank of India. At the three-day liquidity adjustment facility, the RBI liquidity support was to the extent of Rs 19,680 crore. At the weekly Treasury bill (T-Bill) auction the cut-off yields were fixed at 7.65 per cent last week, up from the previous week's 7.60 per cent. The tight liquidity was also evident from the narrow spread between the weighted average yields and the cut-off yields. The weighted average yields last week were 7.60 per cent, as against 7.48 per cent. The bids made were Rs 5,746 crore, both competitive and non-competitive. The retention was Rs 3,403 crore or about 70 per cent more than the notified amount of Rs 2,000 crore.

At the 182-day T-Bill auctions also the trend was similar though there were no non-competitive bidders. The cut-off yield was fixed at 7.75 per cent and the weighted yield was 7.73 per cent.

However, what also compounded the liquidity situation during the week was the Market Stabilisation Scheme auction of 7.55 per cent 2010 per cent securities that mopped up Rs 6,000 crore at a yield of 8.07 per cent. Besides, two State Governments, Andhra Pradesh and West Bengal, placed 10-year State development loans mopping up Rs 1,400 crore at a yield of 8.35 per cent almost entirely by the Life Insurance Corporation of India.

Yet, despite the tight situation, the 10-year yield to maturity (YTM) ended soft last week at 8.17 per cent, 7 basis points down from the previous week's 8.24 per cent. In fact, the MSS mop up and the auctions prevented a major retreat.

The undertone was firm as evident from the increased trade volumes. Daily trade volume was close to Rs 1,400 crore during the week. Banks built up liquidity, through the LAF repo window in anticipation of a rally. Bankers said that this was one of the major factors that led to a contradictory situation of softening yields and draw down from the repo window. The yield spreads also remained narrow at 70 basis points.

One of the main pointers to potential rally was the one-year real yield. With inflation down for the third consecutive week to 5.44 per cent, the one-year real yield widened to 2.4 per cent. At this level, most traders now expect the rally to happen sooner than later.

Besides, bankers said that some of the banks were faced with a surge in time deposits. Time deposits, since the beginning of this financial year, have surged by close to Rs 19,000 crore. This was because some banks were offering rates of over 8.5 per cent for maturities between one-year and 18 months. Besides, with the government permitting public sector entities to park funds in mutual funds, the preference shift was expected. PSUs are expected to shift to funds though mostly to money market and debt funds in view of the high returns. Already mutual fund investments in debt are beginning to exceed that of equity.

Traders said that this trend would now accelerate. A PSU shift of a part of their investments into mutual funds could drive down yields. Yet this shift was unlikely to lead to any liquidity tightening. This was because, the bankers explained, the funds would remain within the banking system.

But this would also help banks to contain their investment deposit ratios closer to the Statutory Liquidity Ratio of 25 per cent. ID ratios are currently at 32 per cent. This, however, does not imply any selling of investments. It could simply imply that they restrict their participation in the debt markets to just statutory requirements to match the deposit surge. Besides, such a move would also help them to improve the credit availability to certain core sectors including infrastructure — credit rebalancing without upsetting the credit deposit ratio of 72 per cent. Big ticket infrastructure lending now finally appears to be on the verge of a takeoff.