The Hindu Business Line : Rising inflation, global oil prices propel yields further north

Traders said a pick-up in credit off-take from the infrastructure sectors propelled yields. They said that banks’ attempts to keep rates steady helped push up credit off-take. Some traders said they expected an RBI intervention for slowing down inflation.

Inflation as measured by the wholesale price index is currently at 8.24 per cent. After a hike in petroleum product prices, inflation is now estimated to breach the 9 per cent-mark. In fact, the final estimates are forecast to move into double digits.

The hardening of yields was reflected in the weekly Treasury bill auctions.

At the 91-day T-bill auctions, the cut-off yield firmed to 7.56 per cent, up from the previous week’s 7.48 per cent. But the actual mop-up through the auctions was Rs 7,426.94 crore as against the notified amount of Rs 3,000 crore.

The high mop-up was largely on account of non-competitive bids, largely from mutual funds (MFs). MFs parked funds in short-term Treasury bills in view of the weak equity markets. The yield on the 364-day T-bill was 7.60 per cent.

Yet the hardening of short-term yields failed to manifest in the weekend liquidity adjustment facility auction. At the LAF auctions, the recourse was mainly to the reverse repurchase window of the RBI. The mop-up through the reverse repo window was Rs 22,025 crore during the week. This was largely on account of deposit accretions and redemption of T-Bills and coupon flows that amounted to about Rs 6,500 crore last week.

Besides, traders said recourse to the reverse repo window was largely due to RBI’s purchase of oil bonds to support refiners.

The refineries’ cash position remained tight despite the hike in product prices. Under recoveries or negative spread between crude prices and weighted average return from product prices still remained as oil prices advanced to a little over $130 a barrel, pushing up the weighted import basket price close to $126 a barrel.

However, RBI’s intervention brought down the cost of working funds for the refineries.

Last week’s interventions brought down the spread between the 8.01.2023 oil bond and 8.35 per cent to 55 basis points. The refinery support mechanism implied purchase of oil bonds and at the same time, extending foreign exchange support to the refineries.

Refinery support

The effect of these operations was evident from the compression in foreign exchange reserves by $1.6 billion. The RBI’s refinery support was expected to increase the yield on foreign exchange assets. Foreign currency assets were currently invested only in earmarked foreign government securities or held in the form of interest bearing cash balances with some foreign central banks and multilateral institutions. Refinery support was expected to push up the weighted average returns to over 7 per cent for the RBI, well over the reverse repo rate of 6 per cent.

Yet the dollar demand remained high in view of the exit by foreign institutional investors. FIIs sold about $825 million of equities and debt papers, leading to a net outflow.

Besides, private sector refineries started sourcing foreign currency from the spot market. This was evident from the exchange rate depreciation over the last weekend. The rupee was down to 42.79 last week, from the previous week-end level of 42.59.

Forward premia

Forward premia remained wide at the short end with importers taking cover. Premia for one and 3 months widened to 4.21 per cent (3.38 per cent) and 2.99 per cent (2.44 per cent) respectively. But six and 12 months remained steady at 2.15 per cent (2.3 per cent) and 1.78 per cent (1.74 per cent). The softening at the long end was largely on account of anticipated current account flows, since exporters are now allowed 12 months time.

Exporters have taken advantage of the notification and begun hedging.

However, despite the anticipated inflows, fears of an RBI intervention ensured firm yields. The firm yields pushed up the cost of the Rs 10,000-crore Government borrowing.

The placement of the 8.24 per cent 2018 security and 7.95 per cent 2032 security at auctions saw the cut-off yield set at 8.26 per cent and 8.72 per cent respectively.

The ten-year weighted average YTM reflected the hardening trend and moved up to 8.27 per cent on a weighted average basis last weekend, up 12 basis points over the previous weekend.

Volumes remained thin as insurance companies stayed away anticipating further hardening of yields. Daily trade volumes averaged about Rs 2,700 crore last week. Besides, traders said, with RBI’s intervention insurance companies lost interest in oil bonds. The 8.01 per cent 2023 dropped to 8.9 per cent last weekend, down from the previous week end’s level of 9.2 per cent.

The outlook remained bearish. This was evident from the high negative real yields.

The one-year real yield was 40 basis below inflation. This implied that a further hardening of yields was imminent. Interestingly this trend was identical to dollar securities. The nominal one year dollar treasury yield is currently 2.12 per cent, as against the US inflation of 3.5 per cent.

Besides, with the credit pick-up, banks have lost interest in Government securities.

The incremental credit deposit ratio for the first time this financial year shifted from the negative zone to 36 per cent. With the advancing monsoons, traders expect the ratio to further improve.

Despite the credit pick up, the incremental credit-deposit ratio remained high. Incremental ratio was over 100 per cent, as against the mandated statutory liquidity ratio. But bankers explained that the high ratio was largely on account of the high portfolio of Treasury bills.

As the T-bills are redeemed the ratio is likely to drop. Besides, deposit accretions with banks have increased with the downturn in the equity markets.

Time deposits this financial year was at least 78 per cent more than the corresponding figure for the last financial year.

Bankers said that if the current pace of deposit growth continued, even without tweaks in interest rates, then ID ratio would align with the SLR. This also implied that banks would be in a position to absorb another hike in the cash reserve ratio without any damage to their interest spreads.