The Hindu Business Line : Bonds shaky on FII exit, tightening liquidity

Bangalore, Dec. 2 Bonds were shaky in listless trading last week as outflows from foreign portfolio investors gathered pace ahead of the year-end and fears of tightening global liquidity.

Traders said that refineries were drawing on their credit lines, anticipating further deterioration in the exchange rates. This pulled down the rupee-dollar exchange rates. In fact, currently bulk of the credit off-take, non food credit off-take, was on account of the oil companies’ drawals on their credit lines.

Exchange rates dip

Since the entire public sector oil companies make purchases from the spot markets, the dollar-rupee exchange rates dipped to Rs 39.67, down about 6.5 per cent or 34 paise on an annualised basis from October 13. But the drop is unlikely to stop. The HDFC Bank’s Chief Economist, Dr Abheek Barua, forecast: “We can see the exchange rate breaching Rs 40 over the next few weeks.”

The reason: FIIs have sold the equivalent of $398.1 million of equities and debt last week. Equities alone comprised $345.7 million during the period. Besides, exporters have begun holding back inward remittances and cancelling forward covers.

As a result, one month forward premia jumped to 1.51 per cent last week, up from the previous week’s 0.3 per cent. But three, six and 12 month premia remained soft in view of anticipated flows from non-resident Indians ahead of the mega equity floats by entities such as State Bank of India and Rural Electrification Corporation. Forward premia for 3, 6, and 12 months ended last week at 1.11, 1.16, and 0.93 per cent respectively.

With FII exits and refiners’ presence, liquidity remained tight during last week. This was evident from the week-end liquidity adjustment facility (LAF) auction, where the recourse was to the repurchase window. Repurchase implied injection of liquidity, through purchase of securities. At the weekend LAF auction, three bids for Rs 1,320 crore were accepted by the Reserve Bank of India. Besides, at the weekly Treasury bill auctions yields remained firm. The cut-off yield on the 91-day T-bill was 7.52 per cent, unchanged from last week. The weighted yield levelled to 7.52 per cent last week from 7.48 per cent. The bids accepted, both competitive and non competitive, were Rs 1,494.47 crore, short of the notified amount of Rs 2,000 crore. There were no non-competitive bidders at the 182-day T-bill auctions and the bids accepted amounted of Rs 500 crore as against the notified amount of Rs 1,500 crore at a yield of 7.71 per cent and a weighted average yield of 7.66 per cent.

The tight conditions pushed up the 10-year Yield to Maturity (YTM) to 7.94 per cent, up from the previous week’s 7.90 per cent. The rise would have been higher, but for the absence of the market stabilisation securities auction during the week, traders said.

The undertone in the markets was weak in view of the tightening liquidity.Trading interest remained low, apparent from the thin average daily trade volume of barely Rs 3,200 crore. Besides, the narrow yield spread between the 91 day T-bill and the 10 year paper, was just about 42 basis points. The flattening was largely on banks’ preference to remain cautious in view of the signals emerging from the RBI.

At the BANCON’07 early last week, the RBI’s Governor, Dr Y.V. Reddy, whose statements are closely watched by traders for cues, indicated that the bank preferred affirmative action in view of global developments. He said: “India cannot be immune to global developments but the RBI is actively monitoring global developments, articulating our assessments as well as responses in regard to impact on India and is in a state of readiness to act, as appropriate, in a timely manner.”

The RBI’s extraordinary vigilance stemmed from its inflation concerns. As a result, the message down to the trading community was that reserve ratios would be used as a weapon for inflation control and liquidity containment.

That inflation was no longer inside the target band of the RBI was evident from the reluctance to reduce interest rates. This was despite the Federal Reserve Board’s reduction in the key Federal Funds rate from 5.5 per cent to 4.75 per cent during the current year. In fact, markets globally were expecting another 25 basis points reduction at the December 11 meeting of the Federal Open Market Committee, likely to be the last one for the current calendar year. The fear was this cut was likely to result in increasing liquidity in the country, as arbitrage options open up further.

Broad money supply growth is around 24 per cent on a year-on-year basis, well above the RBI’s targeted 17-17.5 per cent.

Inflation as measured by the wholesale price index was 3.21 per cent. This translated into a real yield of 4.6 per cent, well above the internationally accepted level of 1-1.5 per cent. In fact, one-year real yields have remained at this level of more than two months. The Bank of Baroda’s Chief Economist, Dr Rupa Rege Nitsure, said: “If oil prices are allowed to pass through, inflation would be more in the range of 7 per cent.” This partly explained the high one-year real yields.

However, there are few expectations of any pass through of oil prices. Instead more oil bonds are likely to hit the markets in the coming weeks, leading to fiscal deterioration. Dr Barua said, “Such bonds are not likely to impact the government capital receipts, since oil bonds are largely off balance sheet items. Yes, revenue expenditure will increase by at least Rs 3,000 crore with the interest servicing costs.”

Yet most bankers expect the ten-year YTM to remain ranged between 7.9 per cent and 8.10 per cent, during the year. This was largely on account of the current low credit off-take as corporates prefer to draw on their cash reserves and encash bulk deposits. Besides, credit demand was yet to show a major increase. Credit-deposit ratio was around 44 per cent for the first 8 months of the current year, as against 84 per cent during the corresponding period of the last financial year. Investment-deposit ratios have, however, changed during the period, from 22 per cent to 51 per cent. But this could change in the coming weeks, as bulk deposits are redeemed and short-term NRI deposits migrate to the equity markets.

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