The Hindu Business Line : Bonds stable; liquidity tight despite fund inflows

Traders said the flows were driven largely by foreign institutional investors after the Federal Reserve Board dropped the key Fed Funds rate by 50 basis points during the week to 4.75 per cent. The drop partly reversed the outflows of the last two weeks.

Inflows during the last few weeks were estimated at about $1 billion. As a result, the rupee-dollar exchange rates closed at a 10-year high of 39.95. Forward premia also softened, implying that the rupee was likely to gain further strength in the coming weeks. One-month premia narrowed to 0.15 per cent. Three, 6 and 12 month narrowed to 0.9, 1.05 and 1.30 respectively.

Traders said the appreciation of the rupee could have been much higher. Intervention by the oil companies partly helped stem the rise of the rupee.

They were active in the spot foreign exchange markets for their payment obligations as oil prices soared to a record $84 a barrel. If this trend continued, India’s weighted average import prices are likely to shoot up to a record of about $78 a barrel.

Besides, some oil majors are reported to have cancelled their forward contracts to take advantage of the exchange rate appreciation. Bankers said that the cancellation was also triggered by exporters resorting to forward cover. Many had anticipated a slight weakening of the rupee during the current month and had left exposures unhedged.

Despite the flows, liquidity remained tight. Bankers said the tightness was partly on account of the limited intervention by the RBI in the money markets and advance tax payments. Advance tax outflows are estimated at Rs 50,000 crore. As a result, the RBI actually pumped in Rs 1,200 crore at the week-end liquidity adjustment facility auction.

But traders said that the recourse to repurchases was also on account of the large mop-up carried out during the week through Treasury bills.

At the weekly 91–day T-Bill auctions, the RBI mopped up a record Rs 10,600 crore. The bids, both competitive and non-competitive, amounted to Rs 15,000 crore. The competitive bids accepted were Rs 3,500 crore, whereas the non-competitive bid of Rs 7,100 crore was fully accepted.

The cut-off yield and the weighted yield both dropped to 6.98 and 6.94 respectively last week. During the previous week, the corresponding yields were 7.10 and 7.06 respectively.

The trend was almost identical at the 182-day T-bill, where both competitive bids amounted to Rs 9,980 crore, though only Rs 2,500 crore was accepted at a cut-off yield of 7.25 per cent.

However, the impact on the ten-year yield to maturity (YTM) was muted. The weighted average ten-year YTM dropped to 7.90 per cent as against 7.92 per cent the previous week.

Trade volume

The undertone was firm. Daily trade volume last week was Rs 7,100 crore at the CCIL trading platform. The tight liquidity situation notwithstanding, bid-offer spreads narrowed to 10 basis points. The buyers were mostly insurers and mutual funds. Funds and insurers picked up high coupon securities. Insurers switched short-dated securities for long-dated ones. But funds took advantage of banks’ liquidity requirements and picked up high coupon securities like the 9.39 per cent 2011 at 7.70 per cent. Insurers picked up the 8.33 per cent 2036 at 8.36 per cent. This partly contributed to a widening of the yield spreads to 100 basis points.

But traders said that the RBI was expected to carry out liquidity mop-up, through issue of two-year Market Stabilisation Securities in the coming weeks. This implied that the yields were likely to hover around the current levels.

Said Birla Sun Life Mutual Fund Chief Investment Officer, Mr Navneet Munot, said “Expect the 10-year YTM to remain ranged between 7.75 and 7.95 per cent in the coming weeks.”

In fact, some traders said that the RBI was likely to carry out more aggressive intervention exercises.

This was partly to ensure that the money supply remained within the target of 17 per cent. M3, the broad money supply, was still about 19 per cent plus, well above the targeted level. With high liquidity, the risk of inflation loomed large.

This was partly on account of the high international oil prices. Inflation is currently 3.32 per cent that translated into a one year real yield of 4.08 per cent. The restrained intervention in the foreign exchange markets also resulted in keeping the inflationary impact contained. However, any oil price hike is likely to bring the real yield to internationally accepted levels. Credit offtake remains one of the major worries. The offtake since the beginning of this financial year was just Rs 31,000 crore as against the Rs 90,000 crore for the corresponding period of the last year.

Incipient signs of a pick-up are already visible. Incremental credit-deposit ratios are now up to 76 per cent. Incremental investment-deposit ratios remained low at about 10 per cent. This is partly due to the fact, that the existing stocks of government securities with the banks are sufficient to meet the reserve requirements.

But bankers still preferred to remain at the short end of the yield curve. Few banks were interested in extending the tenure of their investments to beyond two years. No banker was prepared to take long-term liabilities, given the current volatile situation.