The Hindu Business Line : Yields soften on merchandise inflows, weak credit offtake

Traders ignored the current spate of outflows driven by foreign institutional investors and high international oil prices. Oil prices are on the verge of embracing a record $100 a barrel mark. Domestic refiners were active in the foreign exchange markets lifting dollar for meeting their payment obligations.

Last week, FIIs continued to exit ahead of the year-end. But there were other reasons as well. There are expectations of further cuts in the Federal Funds Rate. Foreign funds are consequently moving back in the hope of booking treasury profits. There are no meetings of the Federal Open Market Committee slated for the current calendar year.

The FOMC is expected to meet only by the end of January. But the FII flight was also triggered from the escalating numbers emerging from the US sub-prime meltdown. Exits from domestic equity markets are meant for meeting the bailouts back home.

PREMIA DOWN

The combined effect of both oil demand and FII exits pulled down the rupee last week to Rs 39.57. Both FIIs and refineries were active only in the spot markets. Only private sector refineries access the forward markets. As a result, there was little impact on the forward markets. In fact, with the rupee weakening, many exporters moved to hedge at the current levels. Forward premia across all tenures consequently softened. One-month premia dropped to 0.3 per cent (1.30 per cent), three month to 1.01 per cent (1.42 per cent), six-month 1.16 per cent (1.42 per cent) and one-year to 0.91 per cent (1.17 per cent).

The merchandise and inflows from non-resident Indian repatriation provoked RBI intervention. This resulted in a return of the liquidity overhang. At the liquidity adjustment facility (LAF) auction, banks and primary dealers returned to the reverse repurchase window. At the three-day weekend LAF auction, the central bank accepted 9 bids for reverse repurchases for Rs 8,710 crore. Besides, at the auction of the 10-year 7.99 per cent 2017 per cent and the 15-year 8.35 2022 papers, the bids were in excess of the notified amount. The notified amount was Rs 7,000 crore, but the bids were close to Rs 21,000 crore. As a result, the cut-off yield to maturities on both the securities was favourable at 7.90 per cent and 8.20 per cent respectively.

The liquidity overhang was also partly on account of the absence of Market Stabilisation Scheme securities (MSS). In fact, only the notified amounts were accepted at the Treasury bill auctions. At the 91-day T-bill, the cut-off yield was 7.52 per cent and the weighted yield was 7.48 per cent. The bids made were Rs 3,407 crore against a notified amount of Rs 2,000 crore. The bids accepted were only Rs 500 crore from competitive bidders and a single non-competitive bid of Rs 970 was lifted. In the case of the 364-day T-bill auction, the 90 bids made amounted to Rs 4,550 crore, though only 17 were accepted for Rs 1,000 crore at a yield of 7.75 per cent.

Undertone mixed

The liquidity influx pushed down to the 10-year YTM on a weighted average basis to 7.90 per cent down last week down from the previous week’s 7.94 per cent.

But the undertone remained mixed. Part of this trend was evident from the low trade volumes. Average daily trade volume was down to Rs 2,500 crore on the electronic trade platform from the previous week’s Rs 4,100 crore. Besides, the yield spread between the 91-day and 10 years was just 38 basis points, indicative of the flat yield curve. Bankers said that the main reason for the flattening curve was the low credit offtake.

The credit deposit ratio for the first seven months of the current year was 43 per cent, against 84 per cent during the corresponding period of the last financial year. As a result, banks were beginning to shift to longer tenure securities. Credit offtake since the beginning of this year was Rs 1.35 lakh crore, as against Rs 1.7 lakh crore during the corresponding period of last year. That banks were shifting to investments to offset the sluggish credit offtake was apparent from the investment numbers. For the first 7 months of the current year, investments in Government securities amounted to Rs 1.54 lakh crore against Rs 43,000 crore during the corresponding period of the last financial year. This translated into a G-Sec investment deposit ratio of 49 per cent and 22 per cent respectively.

Outlook positive

Besides, insurers, especially the Life Insurance Corporation picked up the 15-year and 20-year papers. The favoured 15-year paper was the 8.35 per cent at par and the 18-year FCI paper at an YTM of 8.71 per cent. Besides, insurers were also picking up oil bonds from the refineries strapped for cash at steep yields. The 8.20 per cent 2024 oil bond was picked up by insurers at an YTM of 8.69 per cent.

As a result, the outlook for bonds remained positive. Bankers said that liquidity may further increase in the coming weeks, as investments from the long-term investors flow. This was evident from the low forward premia. Part of this stemmed from the falling dollar interest rates and steady domestic rates. Consequently, university and pension fund investors are expected to shift to emerging markets, especially India.

The positive outlook for bonds was also driven by the high real yields. One-year real yield is currently upwards of 4.5 per cent. Yet, there was unlikely to be any major drops in interest rates, bankers said.

Instead, bankers said that additional liquidity flows were likely to be mopped up through further hikes in the cash reserve ratio. However, since CRR is a disincentive for deposit accretion in the banking system and imposes a cost. This was because there are no interest receipts on CRR balances. Consequently, banks are expected to move deposit rates further southward in the coming weeks.