The Hindu Business Line : Bonds advance on reserve money accretion, waning inflation

Traders said however, soaring oil prices continued to be a major "worry factor." Oil prices have moved upwards of $70 a barrel. As a result, the average import prices are now about $66-67 a barrel or about $490 a tonne. India currently imports the equivalent of about 2.74 million barrels per day according to data from the International Energy Agency. This translates into an equivalent of about $180 million per day at current prices or about $65 billion on the oil account alone.

Yet these numbers have failed to daunt the country's financial markets. The reason for this is the accelerated capital flows. Capital flows, on the non-debt and the debt account (external commercial borrowings), remained buoyant. The low forward premia indicated this was likely to continue for some more time. Three month, six month and 12 month forward premia dropped below three per cent. Three months premia were actually below 2 per cent implying that many of the potential new ECB aspirants were taking forward cover at current levels. The flows were also buttressed by flows from foreign institutional investors and non-resident Indians.

With demand low from oil companies, importers and for repayments, the net flows prompted the intervention of the Reserve Bank of India in the foreign exchange markets, resulting in an increase in the foreign exchange reserves by another $1.4 billion. Despite the intervention, the rupee-dollar exchange rate remained at Rs 40.74. The intervention also resulted in a liquidity expansion.

Moreover, there were no Market Stabilisation Scheme securities issued during the week, other than the Treasury Bills. As a result, at the weekend liquidity adjustment facility auctions, the bids were Rs 77,580 crore, though the RBI accepted only Rs 2,997 crore. The only issue floated during the week was the State development loans for Rs 3,565 crore, at an average yield of 8.45 per cent. Banks easily mopped up the issue though failed to make any dent in the liquidity overhang.

Yields down

The liquidity resulted in pushing down the yields at the T-Bill auctions. At the 91-day T-bill auction, the cut-off yields dropped to 7.19 per cent down 58 basis points from the previous week. The weighted yield dropped to 7.14 per cent down 60 basis points. As against the notified amount of Rs 3,500 crore, the total bids received were Rs 25,392 crore. Swamped by the large bids, the RBI retained Rs 14,950 crore, under the normal and the MSS scheme. This is the largest amount mopped up so far since the introduction of the 91-day T-bills in the country.

The entire non-competitive bids of Rs 11,950 crore that included insurance companies, State Governments and mutual funds were retained. At the 364-day T-bill auction, the cut-off yields were fixed at 7.65 per cent, very close to the one-year yield to maturity of 7.72 per cent. The retentions were only Rs 3,495.96 crore as against the combined bids of Rs 13,405 crore.

The high retentions at the 91 day T-bill were partly because, traders said, on account of the beginning of the peak season credit. The maturing of the T-bill would begin when credit demand picks up. The temporary liquidity overhang pushed down the 10- year YTM down to 8.19 per cent on a weighted average basis from 8.28 per cent the previous week.

Yet, despite the softening yields and the liquidity overhang, there was little sign of any rally in bonds. Daily trade volumes remained low at just about Rs 1,000 crore. Besides, the buy-sell spreads remain high at 15 basis points. Any rally or anticipation of a rally should normally reflect in narrow spreads belying such possibilities, bankers said.

This was evident from current yield spreads. The spread between one year and 29 years last weekend was 60 basis points, implying a flat yield curve.

This low interest was also largely on account of the absence of the life insurance companies, which are normally the largest buyers of long dated securities. But, bankers said that life insurance companies have also begun moving to the shorter end of the yield curve during the last few months, in view of shifting preference for unit-linked funds. The preference has resulted even in establishments like the LIC to shift to shorter dated securities of 10 years and below. Normally, it is usually the opposite for insurers such as the LIC.

Consequently, although there was ample scope for yields to retract further in view of waning inflation it has still not happened.

With inflation on a WPI currently at 4.28 per cent, the one-year real yield was 3.42 per cent. The high real yield indicated that borrowings costs were high for corporates and also partly influenced the shift to external funds, where the real yields were just about 1.5 per cent.

The high real yield notwithstanding there was little scope for a retreat in nominal yields, bankers said. This was largely on account of the rising cost of averaging working funds. The average cost of working funds for all the banks is currently about 5.5 per cent, and the yield on average assets is currently at 8-8.5 per cent.

However, the spread of 2.5-3 per cent is becoming indefensible, bankers said. This was largely on account of the shrinking incremental credit deposit ratio. For the last week, the ratio was just 20 per cent clearly indicating that public sector bank net interest margins were heading for deep trouble.