The Hindu Business Line : Bond yields up on inflation concerns, rising global oil prices

Bangalore, March 9 Bond yields headed northward on inflation concerns and escalating global oil prices. Traders said that with inflation breaching the 5-per cent mark, hopes of a reduction in policy rates or reserve ratios had completely evaporated.

In fact, the major concern now was liquidity, with foreign institutional investors, who hit their stop-loss triggers, heading home for bailing out their parents.

FIIs pulled out about $481 million during the week or about $120 million per day during the week. In addition, some private equity funds were also exiting from the markets, triggered by worsening credit worries back home.

The panic in the markets was also driven by anxiety over some of the largest private equity fund collapse.. Besides, traders said there were also mounting concerns over the state of affairs of the world’s largest bank, Citibank.

To top it, oil refiners drew on their credit lines for making their import payments. Refiners’ large requirements pulled down the rupee to Rs 40.53 per dollar, about the same level as in July last year.

But what also worsened the pounding on the rupee, were cancellations and re-bookings of forward covers by exporters. In fact, with the exchange rate in their favour, bankers said that exporters were taking forward cover beyond six months as well. In addition, banks, faced with a shortage of cash/spot dollars, swapped their forwards for cash/spot. This entailed selling their forward receipts in exchange for cash/ spot for meeting oil and FII requirements. The result — rupee-dollar forward moved into discount for up to six months. A discount happens when forward dollars are cheaper than spot. But such a situation also reflected that exchange rates are likely to reverse their trend at a future point of time, when swap settlements have to be made.

Tight liquidity

The rupee’s slide obviated the Reserve Bank of India’s intervention in the markets. Consequently, liquidity remained tight. This was despite the liquidity released by maturing Market Stabilisation Scheme securities. At least Rs 5,400 crore was released by the MSS components of maturing 91 day and 182 T-bills.

As a result, the tightness though did not reflect in the weekly T-bill auctions. At the 91- day T-bill auctions, the cut-off yield was 7.39 per cent and the weighted yield was 7.35 per cent as against the previous week’s 7.44 per cent and 7.39 per cent respectively. The retained amount at the auctions amounted to Rs 1,850 crore, including the non-competitive bids of Rs 1,350 crore. The 182 T-bill auction mopped up Rs 1,355 crore at a cut-off yield of 7.53 per cent. The net liquidity released amounted to a little over Rs 1,300 crore and another Rs 2,937 by way of coupon flows.

That this liquidity was insufficient was evident from the weekend liquidity adjustment facility (LAF) auction.

At the weekend LAF auction, trader-banks took recourse to the repurchase window (liquidity support by placing securities as collateral) of Rs 8,085 crore. The 10-year cut-off yield to maturity (YTM) firmed to 7.58 per cent on a weighted average basis, up from previous week’s 7.55 per cent

The undertone in the markets remained depressed. This was evident from the shrinking daily trade volume. Average daily trade volume during the week was Rs 4,800 crore last week, down from the previous week’s Rs 6,700 crore.

More bonds likely

But the low trade volume was also largely on account of anticipation of more bonds coming into the markets at high coupons after the conversion of the Rs 60,000-crore farm loan write-off.

Traders expect the bonds to be eligible for SLR, to make them liquid, unlike the oil bonds.

This is especially since MSS securities are eligible for a similar status. In the absence of an SLR status on the bonds, rates could not be expected to fall, traders said. Besides, traders said that this month many were faced with advance tax outflows. This is likely to propel a further down slide in bonds.

Moreover, with inflation at 5.02 per cent, the real yield is down to 2.7 per cent. Although, the real yield is still about 100 basis points above the internationally accepted levels, few expect any contraction. This is in view of inflation worries stemming from firm global oil prices. Global prices are currently at a record high of $105 a barrel, which translates in a weighted average import price of close to $100 a barrel.

The bleak outlook is also reflected in a flat yield curve, apparent from the difference between 91-day and 10-year YTM. The spread is 19 basis points. The spread between one year and 28 years is 43 basis points. Clearly, this is a pointer to a slowdown.

The concerns of a slowdown were also evident from the Finance Minister, Mr P. Chidambaram’s calls for a further reduction in lending rates to the home loan sector.

Evidence of a slowdown was also beginning to show up in the low credit off-take. Credit off-take since the beginning of this year has grown only 14.6 per cent.

During the corresponding period last year, it was 21 per cent. But the incremental credit-deposit ratio remained high at 65 per cent. This was largely on account of the Rs 52,000-crore bulk deposits redemption during the last fortnight.

However, deposit growth was also slowing down. Since the beginning of this year deposit growth has decelerated to 16.3 per cent, almost the same level as last year.

But this is a reflection of bankers’ tight rope walk. The demand is for higher dividends on equity and demands for lower rates. Both the demands are from a government in election mode. This is a rough year for PSU bankers!