The Hindu Business Line : Bonds weaken as oil prices inch close to $100

In fact, bankers said that the hike in cash reserve ratio by 50 basis points to 7.5 per cent had come at a time when the global liquidity outlook was increasingly becoming bearish. The hike was expected to impound at least Rs 16,000 crore from the banking system.

More casualties

Bankers said that news of crisis among the global majors – Citigroup, Bank of America and Merrill Lynch, were beginning to trigger liquidity worries. Citigroup has taken a $6.5-billion hit on account of the US sub-prime meltdown. Bank of America has provisioned $2.3 billion in the third quarter for the same reasons. Investment bank Merrill Lynch has taken a loss of $2.4 billion, the biggest since its inception.

Yet, this is not the end of the story and more casualties appear to be in the making. This was evident from the Federal Reserve board’s intervention in the US money markets; it pumped in about $6.25 billion in debt towards the week-end. Wall Street bear guru, Mr Stephen Roach, has already made ominous forecasts on what the US banking crisis portends for Asian economies, including India.

Speaking at a conference in Mumbai on November 2, Mr Roach was quoted as saying, “Fault lines have opened up, courtesy sub-prime. Asian markets are vulnerable. We could see significant correction in the equity markets here.”

These worries are already evident from the slowdown in capital inflows into the country, as FIIs sell out and quit emerging markets’ equities for bail-outs back home. Net capital inflows into the equity markets were just $222 million last week.

Besides, petroleum refiners are beginning to draw on their credit lines with the public sector banks, as oil is poised to hug the $100-barrel mark. Despite the slowdown in capital inflows, the rupee remained firm at 39.37 to the dollar. But one-month premia firmed to 2 per cent in view of the RBI’s interventions, through swaps and simultaneously siphoning out the liquidity through reverse repurchases and issue of Market Stabilisation Scheme (MSS) securities.

Forward premia rise

Traders said the RBI intervention was triggered by inflows from non-resident Indians , on account of falling US interest rates and weakening dollar. The US Federal Reserve cut the key Federal Funds rate by 25 basis points to 4.5 per cent. Exporters have hedged their receivables to cut losses fearing further dollar depreciation.

But worried importers, including refiners and corporates, with foreign currency exposures returned to take cover. As a result, forward premia rose to 1.37 per cent and 1.32 per cent respectively for three months and six months respectively.

The CRR hike and refinery credit drawdown also impacted the liquidity. At the week-end liquidity adjustment facility auction, recourse to the reverse repurchase window was only Rs 7,165 crore from six participating banks. The low response was due to the Rs 6,000 crore mop-up through re-issue of the 5.87 per cent 2010 and 11.30 per cent 2010 MSS securities.

But liquidity in the banking system may be evaporating. This was evident from the weekly Treasury bill auctions. The cut-off yield on the 91-day T-bill jumped to 7.31 per cent, 29 basis points over the previous week, or 44 basis points short of repo rate of 7.75 per cent. The weighted average yield rose to 7.27 per cent over the previous week-end’s level of 6.98 per cent. The bids accepted at the auction were just Rs 880.99 crore inclusive of the non-competitive bid of Rs 380.99 crore, as against a notified amount of 3,500 crore. At the 182-day T-bill auction, the cut-off yield was 7.55 per cent, though only Rs 500 crore was accepted as against the notified amount of Rs 2,500 crore. The large rejection, traders said, was largely due to the high yields quoted by the bidders, an indication that liquidity may begin to tighten.

The 10-year yield-to-maturity (YTM) reflected this trend, firming to 7.90 on a weighted average basis last week, up from the previous week’s 7.84 per cent.

Bearish undertone

The undertone was bearish, evident from low trade volumes. Daily trade volumes were just about Rs 4,200 crore. But the bulk of the trade volumes were mostly in short-dated securities. Indications are that short-dated securities, including MSS securities, were the most preferred instruments. Banks preferred to remain derisked in view of the uncertain liquidity situation. Bid-offer spreads are currently in the range of 20 basis points plus for medium and long-dated securities.

With volumes remaining thin, the Credit Policy has taken the initiative to bring in new participants into the trading ring (Negotiated Dealing System) to widen and provide greater liquidity to debt markets. This was also intended to help keep the lid on yields.

Despite the bearish outlook, pressures are beginning to build for lower interest rates. ICICI Bank’s Chief Executive Officer and Managing Director, Mr K.V. Kamath, said, “Indian interest rates need to correct for the simple reason there is liquidity in the system. Interest rates have been high because of a signal that we could have inflationary tendencies.”

Currently, inflation is 3.02 per cent on the basis of the wholesale price index, translating into a one year real yield 4.5 per cent. This real yield is way above the internationally accepted levels. Bankers said that even after factoring for the current high oil prices, domestic inflation would still be well within the RBI’s targeted 5 per cent.

But the major worry was not just real interest rates, but also money supply. Money supply growth is currently at 22 per cent on a year-on-year basis, well over the 17 per cent target. In fact, the CRR hike is partly intended to correct that situation and address future inflation.

Yet, the CRR hike is beginning to have an unintended fallout, in the form of reduction in deposit rates. Banks are already beginning to prepare for a 100 basis points drop in deposit rates over the next three months. For bankers stung by shrinking credit offtake (credit since the beginning of this financial year has grown only 4.7 per cent against 9 per cent during the corresponding period of the last financial year), this was an opportune moment for defending their margins. For the banking regulator, such a move would address one component of money supply, though the disintermediation of bank deposits was likely to accelerate.

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