The Hindu Business Line : Weak sentiments keep bond yields north-bound

The weakness in the markets largely emanated from Reserve Bank of India’s (RBI) signals in favour of a tight money regime. That came out in the form of a hike in cash reserve ratio or CRR. The hike by 50 basis points in two stages would become fully effective from May 10 this year and push the ratio to 8 per cent or to the same level it was till May 2001. The CRR hike was timed to absorb the redemptions of Government securities expected by May. The two-phase hike mops up about Rs 18,500 crore. Redemption flows in May from G-Securities are estimated at a little over Rs 20,000 crore.

The aggressive RBI stance comes at a time when the Federal Reserve Bank’s 28-day Term security Lending Facility Auction (exchange of designated securities for US treasuries), a mechanism for injecting liquidity, fixed the stop out (cut off ) spread at 10 basis points, down 25 basis points from the previous week.

Consequently, traders said that the message of the hike was that the RBI was prepared to push up the CRR for containing the liquidity overhang. The impact of the RBI’s message was evident from the low turnout at the weekend Liquidity Adjustment Facility. The recourse to the reverse repurchase window at the auction was only Rs 7,045 crore from 10 bidders.

In fact, at the weekly Treasury bill auction the cut off yield on the 91-day T-bill was set at 7.44 per cent or up 22 basis points from the previous week. The weighted average yield was 7.35 per cent or 29 basis points over the previous week. But out of the Rs 5,500 crore notified amount, only Rs 3,000 crore was accepted against competitive bids of Rs 7,192 crore.

In addition, at the auction of the market stabilisation scheme (MSS) security 6.57 per cent 2011, the cut-off yields were set at 8.08 per cent. There were, however, lower bids at the auctions, evident from the weighted average yield to maturity (YTM) of 8.02 per cent. Traders said that the acceptance of bids at higher yields was clearly intended to convey the central bank’s aggressive monetary policy stance, traders said.

Another clear message sent out was that arbitrage opportunities would be choked, bankers said. Several banks in the past have resorted to taking advantage by sourcing cheap overnight cross border funding sources. Since these funds are also treated as part of the net demand and time liabilities, some of the banks had parked part of the resources at the RBI’s reverse repo window that gave them securities for meeting their Statutory Liquidity Ratio (SLR). The operations generated spreads of at least 3 per cent for the banks, traders said.

The arbitrage funds, however, ensured a steady exchange rate at Rs 39.96, almost at the same level as the previous weekend. This was despite refinery demand and limited supply through non-debt capital account flows. In fact, the net inflow through foreign institutional investors was just $86 million. Overnight forward premia though remained firm at 2.82 per cent as a result of the arbitrage flows. Premia for one, three, six and 12 months also firmed to 2.10 per cent (2 per cent), 2.30 per cent (2.10 per cent) and 1.70 per cent (1.58 per cent) respectively.

The ten-year YTM firmed to 8.08 per cent on a weighted average basis last week, up from the previous week’s level of 8.02 per cent, on fears of further monetary tightening at the time of the lean season credit policy announcement.

Trade volumes remained low during the week. Average daily trade volume was about Rs 2,600 crore. In fact, most banks preferred to remain cautious. The caution was evident from the low trading interest that saw wide bid-offer spreads of over 15 basis points. In fact, the preference remained for short- dated securities, where yields dropped by 10 to 15 basis points. Among the preferred securities was 7.00 per cent 2009 at YTM of 7.60 per cent. Traders have begun hoarding this security, expecting yields to firm up. Life insurers also stayed away from the markets ahead of the Credit Policy, weakening interest in long dated securities.

The outlook remained mixed. Inflation control, which is the RBI’s declared anchor, is currently about 7.14 per cent. This translated into a one-year real yield of 0.5 per cent. Inflation was way above the RBI’s declared target of 5 per cent.

Bankers said that the repo corridor was likely to be raised from the current band of 175 basis points. In addition, some selective credit controls are also expected to rein in food prices. This was especially on private sector food grain and edible oil warehousing entities.

However, bankers said that both these moves were unlikely to impact lending rates. One banker said, “Where is credit growing.” This year so far, there was little sign of any credit growth. Consequently, even if reverse repo and repo rates are hiked as expected, lending rates are unlikely to be affected.

Bankers expect a correction in bond markets. This is likely to be fuelled by selective credit controls on certain sectors sensitive to inflation. But the final fall-out is expected to be in the form of lower deposit rates as banks rein in liability costs.