The Hindu Business Line : Bond yields slide; non-debt capital flows lift rupee

Bangalore, Jan. 13 Bond yields continued their southward momentum for the third consecutive week as traders shrugged off high international oil prices.

Traders said the softening yields (hardening prices) were supported by large demand from banks and from insurance companies. Part of the inflows was for subscription to some of the public offerings that include RITES and Reliance Power. RITES is the engineering services arm of the Indian Railways.

Besides, foreign institutional investors were also active. This was despite the continuing mortgage meltdown crisis in the US markets, the latest one being the Freddie Mac. Freddie Mac, a US government sponsored entity and among the world’s largest mortgage companies, shaved off asset values by about $31 billion.

Traders said that some of the non-debt capital flows into the country were coming from East Asia, including Hong Kong and China. These States are selling their investments in US treasuries and beginning to look at India as an investment destination for maximising their returns. As a result, net inflows last week alone were about $625 million. The inflows pushed up the rupee further to Rs 39.29. Traders said but for the RBI’s interventions last week, the rise would have been far higher. The interventions were in the form of buy-sell swaps.

The swaps, pushed down the forward premia for one-month to 0.92 per cent last week, down from 1.6 per cent the previous week as importers cancelled their forward covers for up to three months. However, traders said some corporates with cross border debt service obligations had taken forward cover, for up to one year, anticipating some correction. Six months remained at 1.78 per cent. One-year forward premia widened to 1.53 per cent from 1.27 per cent, in view of corporate hedging.

The high non-debt inflows were evident from the week-end liquidity adjustment facility auction. There were 20 bidders for the reverse repurchase window of the RBI that resulted in mopping up Rs 19,925 crore. Besides, the liquidity overhang was also on account of redemption of MSS securities — T-bills. Outstanding MSS securities shrank by Rs 3,882 crore as on January 4, according to RBI data. At last week’s 91-day T-bill auctions, the notified amount was raised to Rs 3,500 crore. Competitive bids were Rs 6,274 crore and the non-competitive bids Rs 3,500 crore. The retention was Rs 7,000 crore at a cut-off yield of 7.02 per cent, unchanged from the previous week.

However, the weighted average yields were 6.93 per cent, down from last week’s 7.02 per cent. The wide differential between the weighted and the cut-off yield indicated that some bids were far lower than the cut-off yield, implying a further fall in the coming weeks. The 182-day bill cut-off yield at the auctions were 7.23 per cent.

Reflecting the liquidity build-up, the 10-year weighted average yield to maturity (YTM) dropped to 7.57 per cent on a weighted average basis last week, down 19 basis points over the previous week. But the 10-year benchmark is changing. The new benchmark security is the 6.25 per cent 2018 that matures in January 2018. The yield to maturity on this security was 7.66 per cent.

The softening trend in the markets helped the government auction Rs 10,000 crore last week-end. The YTM for the 7.99 per cent 2017 security was 7.55 per cent. But the weighted average in the case of the 7.99 per cent security was lower than the cut-off yield on account of the liquidity overhang. But in the case of the 28-year 8.33 per cent security, the cut-off yield was 7.89 per cent and the weighted yield was higher at 8.05, indicating high bids by insurance companies, particularly Life Insurance Corporation of India.

Trade volumes

The undertone was bullish. This was evident from the high daily trade volumes. Average daily volumes during the week were in excess of Rs 15,000 crore, largely on account of purchases by banks and insurers. As a result, dated G-secs comprised about 90 per cent of trade volumes. However, yield spreads narrowed, as more banks moved into the long-dated securities. Of particular interest was the 8.33 per cent 2036 and 7.40 per cent 2035 per cent, both of which saw large trade volumes during the week, largely on account of purchases by LIC and other life insurers.

Bankers said the shift to longer term securities was also on account of anticipation of a stable interest rate regime.

Besides, traders said few expected major interventions by way of hikes in the form of the cash reserve ratio. They said Government borrowings were also likely to be lower than the anticipated Rs 19,000 crore for the remainder of the year. Buoyant tax receipts have reduced the need for government borrowings for the current year.

Moreover, the inflation outlook also remained positive. The one-year real yield was 3.8 per cent, despite the continuous yield slide, way above the internationally accepted levels. Consequently, the outlook remained positive.

The positive outlook was also due to the banks’ move to push up their average investment-deposit ratios for the current financial year to about 40 per cent, way above the SLR requirement of 25 per cent. Credit-deposit ratios rose up to 65 per cent, breaking the trend of sluggish growth. The growth, bankers said, was largely on account of farm credit off-take and some corporates taking the opportunity to prepay their external liabilities fearing exchange rate depreciation. In fact, HDFC Bank’s EcoTalk forecasts that the rupee is likely to breach the Rs 40- mark during the course of the year.

Credit growth

Yet, bankers said that the current pace of credit growth was far lower at just 21 per cent as against 30 per cent-plus averaged during the corresponding period of the last two years.

As a result, more banks braced for reduction in interest rates, particularly deposit rates in the coming weeks. In fact, banks expect to push through the cut in rates before the Budget itself. The cuts, however, are likely to come first for NRI deposits and the discounts to the London offered rate are expected to be hiked to discourage arbitrage flows.

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