The Hindu Business Line : Bond yields continue to rise on inflation woes, high oil prices

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Bond yields continue to rise on inflation woes, high oil prices

Traders await policy intervention from RBI

C. Shivkumar

Bangalore, April 13 Bond yields remained north bound during last week as inflation concerns dominated market sentiments.

But traders said, what also compounded the worries was the high international oil prices that reached a record $112 a barrel. With inflation at a three-year high of 7.41 per cent, traders expect some policy intervention from the Reserve Bank of India (RBI).

Policy interventions though are constrained by fears of a slowdown. With credit off-take already low, there are fears that the flexibility for monetary policy interventions, through hikes in repo rates or through hikes in the Cash Reserve Ratio, is very limited. Impounding liquidity, bankers said, is likely to translate into higher lending rates.

However, even if the CRR is hiked, banks would be left with few alternatives other than absorbing the cost. The IndusInd Bank’s Executive Vice-President, Mr Moses Harding, said, “We are expecting a CRR hike, but lending rates will not go up, certainly not in the current environment.”

Besides, interest rate signals emanating from across the border indicated a softening trend. At the Federal Reserve’s Term Securities Lending Facility (TSLF), the stop out rate was 0.25 per cent. The stop out rate is the lowest spread at which bids on the TSLF are accepted. TSLF programme provides Treasury securities on loan for up to 28 days against a collateral of certain asset-backed and mortgage-backed securities.

This is the second Fed’s TSLF auction designed for injecting liquidity into markets and bailing out institutions struck by the sub-prime pandemic. The low spreads sparked off speculation of another cut in the key Federal Funds rate this month-end from the current level of 2.25 per cent. Fed Funds is the overnight borrowing and lending of reserve funds between US banks.

The Fed’s liquidity injection programme appears to have bolstered foreign institutional investors (FII). This was evident from the net inflows, a complete reversal from the previous four weeks. Net inflows during the last week were $284 million and they ensured that the rupee remained at the sub-Rs 40 level.

That the rates are likely to remain stable was evident from the shrinking forward premia. One-month forward premia was 1.58 per cent (1.73 per cent), three months 2 per cent (2.60 per cent), six months 2.10 per cent (2.45 per cent) and the 12 months at 1.58 per cent (1.73 per cent) respectively. However, it was the short forward premium, cash to spot, that was wide at 3 per cent. This was largely on account of foreign banks arbitrage operations. In fact, some of the foreign banks used cooperative banks as fronts for making bids at the reverse repo window of the RBI, traders said.

This was in view of the dollar overnight and rupee interest rate differential that is currently about 3.75 per cent. The arbitrage operations and the liquidity over hang resulted in a mop- up of Rs 37,370 crore, from 37 bidders, through the reverse repurchase window.

The high recourse to the reverse repo window was despite the Rs 10,000-crore Government’s borrowing through reissue of the 7.38 per cent 2015 per cent and the 7.995 per cent 2032 security for the current financial year. The cut-off yield to maturities (YTM) on the securities were 8.14 per cent and 8.55 per cent respectively, though the weighted yields were at least 10 basis points off the cut-off yields. The lower weighted YTMs are largely due to some low priced bids.

The auctions saw bids from competitive bidders of over Rs 11,000 crore for each of the securities. Moreover, at the market stabilisation scheme auctions, through placement of 6.57 per cent 2011 security, the cut off yield was set at 7.95 per cent, and the weighted average YTM was 7.85 per cent.

At last week’s Treasury bill auction, the cut-off yield on the 91 day T- Bill was 7.22 per cent and the weighted average yield was 7.06 per cent. The high spread between the cut-off and the weighted yields were due to large non- competitive bids from mutual funds and States. But some of the banks also bid for the 91 day T-bill at prices well below the cut off yields, traders said. As a result, as against the notified amount of Rs 6,000 crore, the mop-up was about Rs 8,422 crore. At the 364-day T-bill auction the cut off yield was 7.37 per cent.

However, the high liquidity failed to stem hardening of 10-year yields. The weighted ten-year yield to maturity moved up to 8.02 per cent last week, up from the previous week’s 7.92 per cent.

Yet trade volumes remained high during the week and the undertone was positive. This was on account of large purchases by mutual funds. Funds and banks picked up securities from primary dealers. Banks favoured securities were the 7.38 per cent 2015. This security was picked up at 8.06 per cent, giving PDs a spread of anywhere between 8 and 10 basis points.

Since the beginning of this month, mutual funds remained active in the debt markets. Fund interest in short-term securities and T-bills was also largely on account of weak equity markets and anticipation of further corrections. But funds mostly remained at the short-end of the market. The combined interest ensured that the daily trade volume remained close to Rs 6,200 crore.

Traders said that some banks preferred to move up the yield curve since many discounted the prospect of a hike in interest rates despite the inflation surge. One reason was the fear that rate hikes would worsen the current slowdown. As a result, the only option available for containing money growth is revising the Cash Reserve Ratio. This is to contain money growth. But traders said that another reason for the positive outlook was due to the front ending of the government borrowing programme. In the first half of this financial year, the target was to complete at 66 per cent of the government borrowing programme. For the entire financial year, government borrowing is estimated at Rs 1,45,126 crore. A trader said, “Allowing yields to rise during the period will result in a deterioration of the fiscal estimates.”

Consequently, the outlook remained mixed. But upside risks remained. This was evident from the fact, that the one- year real yield was negative, or lower than the rate of inflation. One-year real yield was 10 basis points below annual inflation.

The upside risks notwithstanding, bankers said that there were few alternatives to investments. As a result, investment-deposit ratios are likely to remain well above the 30 per cent. In the lean season, the ratios are likely to even rise further, when credit off-take traditionally is weak. The alternative was to clip deposit rates further to contain liability costs. Any such tweaking though was likely only after the lean season credit policy announcement at the end of this month.

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