The Hindu Business Line : Bond yields rise as inflation soars; traders await policy cues

Bharti Axa Investment Managers Pvt Ltd, Chief Executive Officer, Mr Sandip Dasgupta, said, “We can see bond yield spikes for some time now with a full blown battle to contain inflation.”

Inflation topped 11 per cent for the first time in 13 years. The last time inflation breached this level was in 1995. HSBC Banking Corporation India Economist, Mr Robert Prior-Wandesforde, said, “We can probably look forward to more and more aggressive monetary and fiscal action. We see hikes of 75 basis points in the cash reserve ratio and 50 basis in repo rates.”

A large part of the inflation spike was on account of the rise in oil prices. Oil prices have continued to spiral, stoking fears of further upside risks. Import basket oil prices last week averaged $130.27 a barrel. Despite the oil price spikes, the impact on foreign exchange markets was limited. The exchange rate held at Rs 42.98. The restricted exchange rate volatility was largely on account of RBI interventions through the special market operations (SMO). Through the special market operations, the RBI purchased oil bonds from the public sector refining companies and in turn advanced equivalent foreign exchange. However, SMOs bled the foreign exchange reserves. Foreign currency reserves dropped $4.965 billion to $300.955 billion last week.

But exchange rates are likely to come under further pressure in the coming weeks. This is largely on account of limited inflows into the country. Non-debt capital flows are negative. Outflows on account of foreign institutional investors (FIIs) were to the extent of $251 million last week and $1.9 billion for the current month so far. Foreign direct investment flows are yet to pick up, traders said. Besides, debt flows have not yet taken off, despite the RBI’s relaxed ECB norms. Further, exporters deferred their inward remittances since they are now allowed up to 12 months to bring in their receipts.

Forward premia firm

As a result, forward premia remained steady. Premia for one, three, six and 12 months were 5.58 per cent (6.16 per cent), 3.91 per cent (3.92 per cent), 3.40 per cent (2.75 per cent) and 2.79 per cent (2.73 per cent) respectively. Short forward cash to spot also remained steady at 7.26 per cent (7.28 per cent) as foreign banks swapped dollar for rupees for taking advantage of the tight conditions in call money markets.

However, firm premia was also partly in anticipation of hikes in the Federal Funds rate (the rates at which American banks lend overnight reserve funds to each other) when the Federal Open Market Committee (FOMC) meets on June 24. With yields rising in the US markets, FIIs are likely to return to the home turf. The effect was a tightening of liquidity in the domestic markets.

Despite the near crunch conditions in call markets, recourse to the RBI’s window was restricted to just Rs 5,000 crore, from 4 bidders. However, at the Rs 6,000-crore auction of the Rs 8.24 per cent 2027 security, devolvements on primary dealers amounted to Rs 778 .64 crore. The devolvements were largely on account of RBI’s refusal to accept the high yields quoted by some of the bidders at the auctions. Bids amounted to about Rs 11,000 crore. The cut-off yield accepted was 9.25 per cent, though the weighted yield was at least 10 basis points lower.

The tight conditions also reflected in the weekly Treasury bill (T-Bill) auctions last week. The cut-off yield on the 91 day T-bill was 8.06 per cent or up 37 basis point over the previous week or at least 6 basis points over the current repurchase rate of 8 per cent. The weighted average though was 7.98 per cent or 32 basis points up over the previous week.

As a result, tight liquidity conditions pushed the ten-year YTM on a weighted average basis to 8.53 per cent last week-end, up 18 basis points over the previous week.

Volumes low

Trade volumes remained steady at low levels. Average trade volume during the week was about Rs 5,500 crore per day. The low interest was evident from the flat yield curve with an yield spread of just 40 basis points between one and 29 years. Besides, bid offer spreads widened to about 20 basis points implying weak debt markets.

One major reason for the low trade volumes was ironically credit off-take, bankers said. Corporates and some infrastructure companies drew on their credit lines. Bankers said among those that drew on credit lines included commodity trading companies. The drawdowns were partly in anticipation of monetary tightening by the RBI and consequent interest rate spikes. Bankers said that commodity firms expected select credit controls to kick in, as part of the measures to depress food price inflation.

Most of the credits that were drawn found their way back into bank deposits. Borrowers, bankers explained, used such methods for hedging interest rate risks.

This was particularly in the case of infrastructure entities. As a result, credit off-take since the beginning of this financial year went up by Rs 18,504 crore. For the same period, deposits increased to Rs 60,000 crore. Time deposits alone escalated by Rs 1.29 lakh crore. The increase in time deposits was also partly on account of insurance funds and mutual funds parking money in short-term bank time deposits, till such time yields peak out.

Yield peaking out though was still some distance away. This was largely due to the negative real yields extending across all maturities. However, HDFC Bank’s chief economist, Dr Abheek Barua, said, “It is not likely that yields will move into the double digit zone, simply because inflation is there. Yields are likely to remain tempered.”

The tempered outlook also stemmed from the chase for short-term securities by banks, after the accretion of corporate deposits. The deposit accretions pushed up government securities demand for maintaining the Statutory Liquidity Ratio (SLR). Investments since the beginning of this financial year increased Rs 54,640 crore, as a result. At least 88 per cent of the investments were in government securities with the rest of them moving into PSU and corporate debt. The preference though was mostly for short-term debts for fear of depreciation losses.

Banks took the present situation as an opportunity to attract long-term deposits, especially from retail investors, hamstrung by equity markets. Small hikes, with low-cost impact were becoming big deposit draws. Deposit rate hikes were mostly in the long tenure brackets. This is a trend that is likely to continue for some more time.