The Hindu Business Line : Yields firm on rise in oil prices, inflation focus

Bangalore, Feb. 17 Bond yields firmed as global oil prices moved up and on government statements that inflation containment would remain the primary focus.

On Friday last, the Prime Minister, Dr Manmohan Singh, supported the Reserve Bank of India’s (RBI) inflation focus approach. He said, “I think no Government in our country can be oblivious to the objective of ensuring reasonable price stability without hurting the growth process.”

Besides, some of the foreign institutional investors (FIIs) also turned sellers, after statements from the Federal Reserve Board Governor that US interest rates would be allowed to sink further to stave of a looming recession. Already, the Fed Funds are down to 3 per cent. This prompted some FIIs to exit from Indian equities and move into the home market to build positions, ahead of a dollar treasury rally.

Moreover, traders said that oil companies were active, after international oil prices moved up. Oil ended the week-end at $95 a barrel, up from the previous week-end’s $91. Private sector refiners took advantage of the soft premia and began hedging their future payment liabilities. In addition, some importers and corporates with external debt service liabilities also hedged their open positions. The rupee-dollar forward premia, as result, reversed the shrinking trend. The discounts - forward dollar being cheaper than spot - narrowed, as the rush for forward cover grew.

Public sector refinery purchases pushed up spot dollar higher to Rs 39.66, up 11 paise over the previous week-end. The forward discount for one month shrank to 0.91 per cent from the previous week’s 2.43 per cent. Similarly, the discount of 1.01 per cent for three months turned to a premium of 0.2 per cent. For six months and one year, the premium widened to 0.78 per cent (0.66 per cent) and 1.08 per cent (1.01 per cent). With the rupee moving down, there was little intervention from the RBI. In fact, during the whole of last week, the RBI did not intervene in the foreign exchange markets, traders said.

LAF auction

The resultant tightening was evident from the reduced recourse to the reverse repurchase window at the week-end Liquidity Adjustment Facility auction. There were only four bids for Rs 7,585 crore at the reverse repo window. But there was a single bid for Rs 100 crore for the repurchase window.

The short-term tightening was also evident at the weekly Treasury bill auctions. At the 91-day T-bill auction, the cut- off yield remained steady at 7.27 per cent, unchanged from the previous week. The weighted yield moved up to 7.27 per cent, up from 7.19 per cent. As against the notified amount of Rs 2,500 crore, the RBI accepted only Rs 1,745 crore. However, at the 364-day T-bill auction, competitive bids were about 300 per cent more than the notified amount of Rs 3,000 crore. In fact, the retention was Rs 3,503.7 crore at a cut-off yield of 7.47 per cent and a weighted yield of 7.44 per cent, signifying banks’ move to longer dated securities.

But the ten-year yield to maturity firmed to 7.50 per cent on a weighted average basis last week-end, up from the previous week-end’s 7.46 per cent. The firming was partly driven by belief that interest rates were unlikely to retreat this financial year, in view of the inflation focus.

But the uptick in yields was also partly due to speculation that oil bonds would be converted into Statutory Liquidity Ratio securities. The speculation had sparked selling, as most banks have G-Sec investment-deposit ratio in excess of 31 per cent. Oil bonds currently come under the category of other investments. This year, the government has issued oil bonds for Rs 1,1257 crore. Conversion of all outstanding oil bonds would have implied an I-D ratio of close to 35 per cent. Besides, some of the banks attempted to book profits through sale of the oil bonds.

Bond buyers

Insurance companies, particularly, Life Insurance Corporation of India, took advantage of the situation. But buyers of bonds also included FIIs. FIIs purchased debt papers on Friday last, mostly government securities and PSU bonds equivalent to about $590 million (Rs 2,380.7 crore), taking advantage of the situation. The emergence of new buyers ensured high trade volumes. The average daily trade volume during the week was about Rs 8,100 crore.

The outlook was stable. This was evident from the buy-sell spreads. The spreads were about 7 basis points, up slightly from 5 basis points. However, the preference for longer yield securities resulted in pushing down the yield spreads. Yield spreads were 23 basis points between three months and 10 years and 35 basis points between one year and 28 years, implying a flat yield curve. The switch in preference resulted in pushing up the one-year real yield to 3.4 per cent or about 10 basis points over the last weeks.

But bankers said that this could change in the coming weeks. The anticipation stemmed from the correction in inflation, after the hike in petroleum prices. Besides, credit growth was beginning to pick up. This was evident from the improved credit-deposit ratio. C-D ratio for the first 10 months of the year was 58 per cent, improving from 46 per cent during the first nine months of the current year. Besides, large redemptions of bulk deposits are expected in the coming weeks.

Moreover, with inflation focus firmly anchored in the RBI and the Government, bankers said, there is unlikely to be any dramatic interest rate reduction. This is despite the expected cross border arbitrage flows. In fact, the fear is that large flows are likely to trigger further increases in the cash reserve ratio and further drop in the reverse repo rates. Few banks want this to happen. Some banks however, would, prefer to take their cues from the Union budget for 2008-09 to be presented this month-end.