The Hindu Business Line : Bonds remain steady even as RBI warns of global market turmoil

Bangalore, Sept. 2 Bond yields remained steady last week as traders looked for cues from the Reserve Bank of India’s reactions to the uncertain conditions in the global financial markets.

But traders said that the renewed flows from foreign institutional funds provided some comfort. FIIs were largely drawing support from the liquidity extended by the Federal Reserve Board to parents troubled by the sub-prime meltdown.

Yet the Reserve Bank of India, in its annual report, said that there could be more turmoil in the offing for financial markets. The report warned: “Further deterioration in the sub-prime delinquencies could lead to reassessment of risk by investors across products and markets and retrenchment of capital from emerging market economies given the contagion and herd mentality.”

The RBI’s warnings come as the rupee gained against the dollar last week to 40.90. But the short-term nature of the flows was evident from the hardening forward premia at the short end. One-month forward premia was up over one per cent towards the week-end.

But the hardening of premia was also partly due to the oil companies rushing to hedge to take advantage of the current exchange rate. They also wanted to offset the impact of thin refinery margins, as the government has baulked at hiking oil prices, despite the hardening trend globally.

International oil prices are currently back to $74 a barrel. The rising prices were also triggered by fears that the US agencies would be replenishing their strategic petroleum reserves. The net impact was that the weighted average import price for India was now over $70.

LAF auctions

The inflows were evident from the week-end liquidity adjustment facility auctions. At the LAF auctions, there were 18 banks that took recourse to the reverse repurchase window for Rs 16,855 crore.

But bankers said that part of the liquidity accretions were largely from Treasury Bills, and coupon flows between August 20 and August 31 were the equivalent of Rs 11,000 crore. In addition, bankers have seen deposit accretions during the last week. Part of the deposit accretion was from non-resident accounts. Deposits are currently growing at close to 26 per cent over the last year.

With credit offtake still at 22 per cent, bankers were parking the funds in short-term Treasury Bills. In fact, at the weekly 91-day T-Bill auctions, the bids amounted to Rs 7,552 crore, though only Rs 3,500 crore was accepted.

But the cut-off yields firmed to 7.10 per cent, well over the previous week’s yield of 6.73 per cent.

Traders said that the sharp increase in yields was largely on account of the fact that most deposits were coming in the high rate band, mostly between one and two-year band, that offered rates anywhere between 9 and 10 per cent. Besides, some of the banks were also loading the cost of maintaining 7 per cent cash reserve ratio to T-Bill pricing. CRR currently does not earn any interest. The weighted average yield for the 91- day auctions firmed to 7.02 per cent, up 25 basis points over the previous week.

The firm short-term yields, notwithstanding, the ten-year YTM remained steady at 7.94 per cent on a weighted average basis last week, as against 7.93 per cent the previous week.

But the undertone was weak. This was evident from the drop in daily trade volumes to just about Rs 4,100 crore.

Besides, the yield spreads also indicated a declined trading interest. The spreads narrowed to about 55 basis points last week, down from 80 basis points the previous week.

The lack of interest was also evident from the high bid-offer spreads that ranged between 15-20 basis points.

The outlook also appeared bearish. This was despite the drop in inflation to less than 4 per cent pushing up the real yield close to 4 per cent. The reason — traders said that cross border factors weighed heavily on the markets, especially the US response to the continuing sub-prime crisis.

Above all, bankers said, banks preferred to remain derisked.

This implied going long on short dated securities, especially at a time when liquidity was expected to tighten in the coming weeks.

This was also one of the reasons for the huge appetite for short-term securities such as 91-day T-bills that commanded the least discounts in the collateralised borrowing and lending obligation markets.

For long-term securities, the discounts were high since they are treated as less liquid. Besides, short-term papers were also instruments eligible for statutory liquidity ratio (SLR).

With the result, even at the current pace of deposit growth, most banks were compliant with SLR ratio. In fact, most of them still continued to be close to about 28 per cent on an incremental basis.

Clearly the focus was on credit as bankers are worried that the increased CRR would impact the second quarter net interest margins. The focus was to offset that impact.

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