The Hindu Business Line : Bond yields firm on CRR hike

Bangalore, Aug. 5 Bond yields firmed last week prompted by the Reserve Bank of India’s intervention through a 0.5 percentage point hike in the cash reserve ratio (CRR).

The CRR hike takes effect from Monday. The hike is expected to impound another Rs 14,000 crore of liquidity from the banking system. Along with the CRR, the cap of Rs 3,000 crore on the reverse repo has also been taken off. This, in effect, would ensure that the cost of sterilisation operations remain within tolerable limits, bankers said.

Besides, the prompt for the intervention was also provided by the firming international oil prices. Oil prices remained firm at $76 a barrel. With oil companiesand capital goods importers taking forward cover, the one-month forward premia mounted. Traders said the upward momentum for forward premia also prompted inward banking flows in anticipation of tightening of liquidity.

However, the spot rupee firmed, and was likely to remain that way, traders said, as short-term inward flows momentum was expected to exert upward pressure. Forward premia firmed to 1.4 per cent for 30 days, and nudged close to 2 per cent for 3 months, 6 months and 12 months.

The policy announcement had its impact on last week’s Treasury bill auctions. The cut-off yield on the 91-day T-bill yield jumped to 6.48 per cent, up 202 basis points from 4.46 per cent the previous week. The weighted average yield was 6.40 per cent. The bids for the auctions also dropped substantially as banks stacked up cash for meeting the new CRR norms.. The bids both competitive and non-competitive dropped to Rs 5,132 crore, down from the previous week’s Rs 8,500 crore. The cut-off yields on the 364 day T-bill also remained firm at 7.25 per cent. At the current level, the T-bill yields were within the repo – reverse repo band.

But traders said that low bids were largely because most banks preferred to wait for Monday’s liquidity adjustment facility auctions. This would ensure that the banks would be earning 6 per cent by parking funds on the reverse repo window. This anticipation impacted call and the collateralised borrowing and lending obligations rates that moved upwards of 4 per cent. What also powered the firming of call rates were the auctions during the week. The placement of the 5.48 per cent 2009 Market Stabilisation Security (MSS) removed Rs 5,000 crore at a yield to maturity (YTM) of 7.74 per cent. In addition, other Rs 9,000 crore was taken off towards the weekend through placement of 7.99 per cent 2017 and the 7.95 per cent 2032. The securities were placed at YTMs of 7.93 and 8.45 per cent respectively.

The weighted average 10 year as a result firmed to 7.91 per cent last week, up from the previous week’s level of 7.82 per cent.

Trade volumes down

Daily trade volumes were down sharply during the week. At the CCIL trade counter, outright trade volumes were down to about Rs 7,100 crore. The volumes have progressively come down during the last few weeks. Besides, yield spreads have narrowed. The spread between one year and 29 years was 154 basis points, down from the previous weekend’s 190 basis points, largely on account of firming short-term yields that rose by at least 30 basis points. At the long end however, yield movements have been little effected by liquidity inflows as most long-term securities were with the Life Insurance Corporation of India. Besides, most banks have completely derisked their investment portfolios, implying that the average tenures were just 1.5- 2 years. Consequently, the outlook for bonds appeared lacklustre in the coming weeks.

The RBI Deputy Governor, Dr Rakesh Mohan, said at SBI macroeconomic workshop, “It is our firm judgement that low and stable inflation is essential to maintenance of the growth process and we are determined to achieve this continuing goal.”

This focus is largely influenced by the current high growth rate in broad money supply, driven by reserve money expansion. Broad money has expanded by 21.5 per cent, way above the RBI’s targeted band of 15-17.5 per cent.

Bankers said that if this was the target, then liquidity could be expected to tighten in the coming weeks. This despite the fact that one-year real yield on the basis of last inflation data was over 2.5 per cent. But if the current oil international oil prices are passed through, bankers said, the real yield numbers would undergo a change and in fact narrow sharply, to well within international levels.

Many of the foreign institutional investors’ parent companies have large subprime exposures. These FIIs are expected to look for exits from Indian equities partly or fully to meet their subprime liabilities and other FIIs are likely to hit the stop-loss triggers. FII exits would also depend on the Federal Reserve Board when it meets next week. But the exits, traders said, would help meet the money supply growth targets and take the load of interventions.

Any potential impact on domestic interest rates in the event of such a contagion has been partly neutralised, by the RBI’s signalling to banks for lower rates, through the CRR hikes.

The signal has triggered lower deposit rates. Lending rates are unlikely to follow suit, bankers said. This was because CRR hike would bring pressure on the net interest margins (NIM) of banks in the coming weeks, if deposit rates were not reduced. Already they are under pressure.

The flipside is that banks are likely to contain growth of their incremental investment deposit ratios at the cost of raising incremental CD ratios for correcting shrinking NIMs. Incremental ID ratios are currently at 34 per cent. Incremental CD ratios are 17 per cent (inclusive of food credit it was actually — 0.5 per cent).

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