The Hindu Business Line : Bonds weak as traders await policy cues to rein in inflation

Inflation, as measured by the whole sale price index, moved to 6.68 per cent. Most of the traders prepared to lie low, after closing their trading books for the financial year.

They anticipated some monetary policy responses from the Reserve Bank of India, in the form of revision in interest rates or a hike in the cash reserve ratio. Interest rate hikes though appeared unlikely.

The ING Vysya Bank’s Chief Economist, Mr Janak Desai, said: “This is supply side inflation. So we can rule out monetary policy responses in the form of higher interest rates.”

Besides, credit off-take has remained low through most of the year. Credit growth this year was about 18 per cent till mid-March, far lower than last year and well within the central bank’s target of 20 per cent growth.

So the next option was in the form of containing liquidity inflows. Last week, foreign institutional investors (FIIs) pumped in about $725 million, according to data from the Securities Exchange Board of India, reversing a three- week exit.

The inflows coincided with the Federal Reserve Board’s injection of $75 billion through the Term Securities Lending Facility on March 27. The facility provides term liquidity for 28 days and allows borrowers to swap designated securities to US Treasuries for liquidity support. The stop out rate at this auction was 0.33 per cent. The bids are decided on the basis of the spread between the Treasury securities and eligible securities swapped. The spread referred to as the stop out is the lowest rate accepted for the 28-day auctions. Traders said that the low stop outs implied that dollar interest rates could move further southward.

Bankers said that the flows though failed to impact liquidity. This was evident from the fact that at the weekend liquidity adjustment facility auction, the recourse to the repurchase window was Rs 20,585 crore.

However, at the weekly Treasury bill auction, the cut-off yield was 7.23 per cent, down from the previous week’s 7.31 per cent. The actual mop up was Rs 7,540 crore through the 91-day T-bills. The mop up included reinvestment of maturing Market Stabilisation Scheme (MSS) securities. Funds and States invested Rs 7,040 crore through non-competitive bids. Funds picked up T-bills, anticipating a further correction in the equity markets, traders said. Besides, the levelling off— both cut-off and weighted yields — indicated that there was very little flexibility for further southward movement. At the 364-day T-Bill auctions the cut-off yield was 7.35 percent.

But selling pressure was high on dated securities. Oil companies sourcing funds from the markets added to the pressure. The selling was driven by high prices with weighted average import prices breaching $100 a barrel, and further slimming of the already thin refinery margins.

The continuous selling of oil bonds resulted in spreads rising to 125 basis points over sovereign securities. For banks, oil bond purchases meant further accretion to their investment portfolios. Oil bonds are Government securities, but are not eligible securities for maintenance of the statutory liquidity ratio.

Refinery demand for greenbacks had little impact on exchange rates. The rupee-dollar exchange rate firmed slightly to Rs 40.10 during the week as exporters repatriated their earnings. Forward premia, however, widened as importers and corporates with cross border liabilities took cover. As a result, forward premia widened.

One-month premium rose to 2.24 per cent (0.89 per cent). Three, six and 12 months premia firmed to 2.59 per cent (1.88 per cent), 2.14 per cent (1.53 per cent) and 1.52 per cent (1.26per cent) respectively.

The selling pressure in turn drove the 10-year yield to maturity (YTM) to 7.80 per cent last week on a weighted average up from the previous week’s level of 7.66 per cent.

The undertone remained depressed. Average daily trade volume remained low at about Rs 2,500 crore. The low trade volume was partly due to the year-end since the focus was on balancing trading books. But traders said that there were few buyers. This was largely on account of fears of depreciation. This resulted in high bid offer spreads, as high as 15 basis points.

Mixed outlook

The outlook remained mixed. This was largely on account of anticipated flows into the market and because liquidity flows and inflation remained dominant concerns.

Traders said measures for inflation control are therefore likely to be more in the form of calibration in capital flows and a slew of fiscal steps. The steps bankers said are expected to decelerate broad money expansion, which is already growing at 21 per cent, well above the RBI’s target of 15-17 per cent.

This implied a further tightening of the external commercial borrowings window. This was especially since the domestic system was already flush with liquidity, evident from the outstanding MSS securities that were Rs 1.69 crore, despite the redemptions. Besides, there was a central government cash surplus of Rs 1.61 lakh crore.

As a result, bankers looked forward to a slew of fiscal measures that included reduction in duties of some goods, including crude oil to put a brake on inflation. Revision in CRR is likely only during the lean season credit policy. But there is ample room for a CRR response. For instance, the Federal Reserve, despite the reduction in interest rates, continues to have a liquidity reserve ratio of 10 per cent. CRR, however, is a weapon of last resort, by the central bank, since banks normally tend to hike lending rates, in the event of an upward revision in interest rates.

The high inflation however, has resulted in further narrowing the one-year real yield down to under one per cent. This implied that yields are likely to remain stable at current levels. In fact, yields would actually see some softening from the beginning of the next financial year, when the lean season kicks in. Besides, banks are already sitting on a zero risk weighted asset pile of Rs 9.8 lakh crore or an incremental investment-deposit ratio of 42 per cent. The high ratio leaves little scope for lending rate increases.