The Hindu Business Line : Bonds stable as liquidity eases on arbitrage flows

Traders said although Government borrowings this year were on target and that for the next year were lower, there were major causes of concern. Gross market borrowings this year were estimated at Rs 1.56 lakh crore and for the next financial year at Rs 1.45 lakh crore.

Loan waiver

The concerns were over the Government’s farm waiver scheme. The Rs 60,000-crore waiver impact would be shared among 53 public and private sector banks and regional rural and cooperative banks including the National Bank for Agriculture and Rural Development. Besides, the Finance Minister had assured the banks of supporting them. It is precisely the method of funding that the traders are concerned about.

Bankers said the fear among them was that the waiver would be financed through off-balance sheet methods, as in the case of oil and fertiliser subsidies. The inherent problem of funding subsidies through deferred compensation methods would be its adverse impact on the revenue deficit. This was evident from this year’s interest payouts. Although the government largely managed to contain borrowings, interest payouts actually breached the budgeted estimates by a whopping Rs 13,000 crore. If the farm waiver was also included , the ability to comply with the Fiscal Responsibility Budget Management Act target is likely to come under stress. This comes at a time when global oil prices are hovering above $100 a barrel and refineries under-recoveries entail issuance of more bonds.

CRR cut unlikely

Moreover, traders said the Government’s concern over mounting cross border capital flows implied that there would be no reduction in the cash reserve ratio (CRR). The concern was partly on account of the capital flows exceeding the current account flows, implying large arbitrage flows. This was evident from rising FII investments in debt instruments, mostly government securities, bank and public sector bonds since the beginning of the year.

Fear of further interventions prevented the 10-year yield to maturity from softening below 7.57 per cent on a weighted average, the same level as last week. This was despite the fact that the turbulence in the money markets had considerably reversed. At the week-end liquidity adjustment facility auction, the recourse to the RBI’s reverse repurchase window was for Rs 8,085 crore. The recourse was also partly driven by current account inflows as exporters encashed their exchange rate profits.

The inflows allowed the rupee to advance against the dollar to Rs 39.92. However, forward discounts were beginning to reverse track. Six months forwards moved back into a premium of 0.25 per cent last week from a discount of 0.3 per cent the previous week. The 12-month premium widened to 0.48 per cent from 0.25 per cent.

Mid-week, the tight situation in the markets had pushed up the 91-day Treasury bill to 7.44 per cent, up from the previous week’s 7.39 per cent. As against the notified amount of Rs 500 crore, the RBI’s mop-up was Rs 1,248.97 crore, inclusive of Rs 748.97 crore from two non-competitive bidders.

Insurers absent

The undertone was depressed during the week partly on account of the absence of insurers. As a result, daily volumes were moderate at Rs 6,700 crore. Besides, the low interest was evident from the wide buy-sell spreads that had moved up to 10 basis points. Another reason for the flagging insurer interest was the thin inter-yield spread. The spread between 91-day T-bill and 10- year YTM was just 12 basis points. The 364 day T-bill and the ten-year YTM was level.

But a flat yield curve or a rising short-term yield is a pointer to a slowdown. Credit growth this year was just 14.6 per cent, as against 21 per cent during the corresponding period of the last financial year. Credit-deposit ratio though improved to 65 per cent for this financial year. The spike in the ratio was largely on account of negative deposit flows. Negative flows of demand deposits for the fortnight ended February 15 amounted to about Rs 77,758 crore, partly due to refunds on initial public offerings, bankers said.

Outlook bearish

The outlook remained bearish for bonds. On the fundamentals, inflation continued to climb , within striking distance of 5 per cent, which is the RBI threshold. But the one year real yield narrowed to 2.66 per cent. The high real yield was because the full impact of global oil prices was yet to be passed on to consumers. Therefore, there was little reason to foresee a drop in yields.

In fact, with banks faced with an investment-deposit ratio of 45 for the current financial, more investments implied a hit on their net interest margins. Already the margins have dropped to less than 2.5 per cent. Consequently, bankers are expected to sell for redemption of high cost deposits, driving up yields in the process. This is precisely what the insurers are waiting for.