The Hindu Business Line : Yields soften on purchases by insurance cos, MFs

Bangalore, Jan. 27 Bond yields resumed their softening trend powered by purchases by insurance companies and mutual funds and supported by weakening global oil prices.

Traders said that the southward journey of bond yields (rise in bond prices) was also propelled by exporter inward remittances. Exporters took advantage of the slight weakening of the exchange rates as the rupee dropped to Rs 39.40 against the dollar from last week’s Rs 39.18 after some of the foreign institutional investors and participatory note holders with FIIs sold out. FIIs sold about $2.4 worth of equities/debt last week.

Traders said that some of the exporters also hedged at current exchange rates to defend their exchange rate gains.

As a result, forward premia dropped sharply during the week. One month forward premia dropped to 0.30 per cent (1.07 per cent). Three, six and 12 months also softened to 0.91 per cent (1.84 per cent), 1.73 per cent (1.89) and 1.55 per cent (1.63 per cent) respectively.

But the Reserve Bank of India (RBI) did not intervene in the foreign exchange markets, traders said. Instead, intervention focused towards containing the liquidity impact.

At the weekend reverse repurchase auctions, the RBI mopped up Rs 11,650 crore from four bidders, mostly state-owned banks.

However, there were also bids for liquidity support from some private sector banks for Rs 10,665 crore. The bids from the repurchase window for liquidity support were largely on account of huge sell-out by foreign institutional investors (FII).

As a result, some of these banks had sold their holdings of treasury bills and also accessed the collateralised borrowing and lending obligations markets for liquidity support. The liquidity demand resulted in driving up yields at the weekend Treasury bill auctions.

At the 91-day T-Bill auctions, the cut-off yield was 7.19 per cent last week, up from the previous week’s 7.10 per cent. However, the weighted average yield remained unchanged at 7.02 per cent. Traders said that the wide differential between the cut-off and the weighted average yield was largely due to bids made by public sector banks.

The competitive bids, banks and primary dealers, were about Rs 2,974 crore, but the non- competitive bidders pitched for Rs 3,000 crore. As a result, against the notified amount of Rs 3,500 crore, the RBI retained Rs 5,589 crore, inclusive of the market stabilisation scheme component. At the 182 T-bills the amount retained was Rs 2,105 crore as against a notified amount of Rs 2,500 crore, at a yield of 7.19 per cent.

T-bill mop-up

One reason for the reduced T-bill mop up from competitive bidders during the week was also on account of the large mop up through market stabilisation scheme securities during the week. There were two MSS securities — 6.57 per cent 2011 and the 12.25 per cent 2010 for Rs 6,000 crore. Both these securities were placed at yield to maturities (YTM) of 7.36 per cent and 7.41 per cent respectively. The bids for both the securities amounted Rs 15,385 crore. Banks sought these securities due to the short maturity and the attractive current yields particularly the 12.25 per cent 2010.

Chase for the securities were also partly triggered by expectation of changes in the reverse repo rates, currently at 6 per cent.

The expectation stemmed from last week’s massive 75 basis points reduction in the US Fed funds rate. Canara Bank’s Chairman and Managing Director, Mr M.B.N. Rao, said: “The Fed reduction is likely to trigger liquidity inflows into country. Some softening now appears imminent if other indicators like money supply and inflation are within targeted bands.”

However, the Finance Minister, Mr P. Chidambaram, indicated at the Davos meet that the Government and central bank would respond to the Federal Reserve’s key Fed fund rate reduction at the third quarter monetary policy review meeting next week. He did not spell out the intervention methods. But bankers expect revision in the reverse repo rate, so as to contain arbitrage flows into the country, in view of the money supply impact.

The expected softening pushed the 10-year YTM of 7.42 per cent on a weighted average basis last week down 15 basis points from the previous week’s level of 7.57 per cent.

The undertone lost some of the bull steam. This was evident from the low daily trade volumes. Last week, trade volumes were just about Rs 6,500 crore.

Traders said that insurers had reduced purchases of G-Secs to return to equity markets. However, during most of last week, insurers were net buyers, after booking profits in the equity markets. But mutual funds and insurers were beginning to return to the equity markets to look for bargains.

The outlook was flat. This was evident from thin inter-yield spreads.

Yield spreads between the 91-day T-bill and ten YTM was just 23 basis points. The spread between one year and 28 years was only 35 basis points, implying a loss of trading interest. The loss of trading interest was on account of the third quarter monetary review. Most bankers preferred to wait for cues from the RBI.

Push for rate reduction

Industry lobby bodies are already pushing for reduction in interest rates, for providing a demand stimulus.

The move stemmed from an anticipated slowdown in some sectors of the economy, evident from the increased inventory levels. Besides, credit off-take, despite a pick up, was still far lower than last year. Incremental credit-deposit ratios are currently 57 per cent indicative of a pickup from what it was about a month ago. A year ago, the ratio was 94 per cent.

But one-year real yields were beginning to narrow due to the combined effects of advancing inflation and falling nominal yields.

As a result, one-year real rate was now currently about 3.45 per cent, down by 60 basis points from three weeks ago. But real yield was still on the high side, compared to international levels of 1.5 per cent.

Yet, major retreats are not expected due to fears of liquidity expansion from cross border arbitrage flows.

Currently, despite RBI’s efforts, money supply continues to rise by 22 per cent, way above the nominal GDP growth. That clearly implied that cuts in the cash reserve ratio are unlikely this quarter.

That the RBI intended maintaining its stance was evident from the announcement of a MSS security auction for Rs 3,000 crore and another Rs 2,000 crore MSS mop-up through T-bill route.

Consequently, most banks have discounted the possibility of any major rate cuts at this juncture.

But with deposits within the banking system surging 26 per cent on a year-on-year basis, bankers are pushing for deposit rate reductions.