The Hindu Business Line : Bond yields continue to rise on inflation, oil price hike

Traders said most banks cut back purchases to contain depreciation losses. Many, in fact, were nervous sellers expecting further intervention from the Reserve Bank of India. The expectation largely stemmed from the high inflation of 11.42 per cent.

Last week, the RBI hiked the Cash Reserve Ratio and the repurchase rate by 50 basis points each.

The CRR is the zero interest cash balances that banks are mandated to maintain with the central bank. The repo is the RBI’s overnight liquidity support mechanism against collateral of Government securities. The hikes notwithstanding, downside risks continued to loom over the financial markets, traders said. Downside risks implied that bond prices would remain under pressure.

The risks of escalated intervention also heightened, after the US Federal Reserve Board’s decision to hold the key Federal Funds rate at 2 per cent.

Traders explained that the Fed decision escalated the risk of a further money supply expansion.

Broad money supply is currently expanding at 21.7 per cent, well above the targeted band of 15-17 per cent. Arbitrage flows are likely to escalate in view of the low dollar interest rates, triggering reserve money expansion.

Such flows were evident from the high short-term forward premia. Three-day forward premia topped 9 per cent last weekend, up from 7.26 per cent from the previous weekend. Long forwards also hardened as oil companies and importers took forward cover in view of the rupee’s appreciation. The rupee appreciated to Rs 42.79 last week, from the previous week’s Rs 42.98. The appreciation was despite foreign institutional investor-led outflows by $625 million.

Arbitrage-led and FCNR-led inflows though partly negated the impact of the FII outflows, bankers said. As a result, the RBI, in fact, purchased dollar though sales were effected to refineries through special market operations (SMOs).

Arbitrage flows were mostly by banks, moving in to take advantage of the possibility of tightening short-term call rates in the country. This also led to the sharp push up in forward premia in the short and middle ends. Forward premia for one, three, six and 12 months firmed to 5.89 per cent (5.58), 8.60 per cent, (3.91 per cent), 5.38 per cent (3.40 per cent) and 3.69 per cent (2.79 per cent) respectively.

Traders said that refiners took forward cover only up to a month, anticipating further spikes in oil price. Global oil prices topped $142 a barrel. India’s import basket price, as a result, rose to a little over $136 a barrel. This month, India’s average import price averaged $128 a barrel.

Oil companies, however, were supported by the RBI’s SMOs. The RBI provided liquidity support to refiners to the extent of Rs 4,140 crore. At current exchange rates the support translated to a little over $1 billion. The support was entirely in the form of outright purchases, though the RBI had the option to conduct repos as well.

Yet, the SMOs notwithstanding, liquidity remained tight. At the weekly liquidity adjustment facility (LAF) auctions, bids at the repo window amounted to Rs 32,090 crore. The tightening also reflected at the weekly Treasury bill auctions. At the weekly auctions, the cut-off yield on the 91-day T-Bill was 8.73 per cent, up 67 basis points from the previous week. However, as against the notified amount of Rs 500 crore, the actual mop up was Rs 5,800 crore. The large mop up was despite the liquidity tightness in the financial markets. These trends, bankers said, were largely on account of corporate draw down on sanctioned credit limits and parking the same in the liquid financial instruments like T-Bills. Corporate bids were in the form of non-competitive bids that amounted to Rs 5,300 crore.

But the tight liquidity situation pushed up the ten-year yield to maturity (YTM) to 8.71 per cent on a weighted average basis, up from the previous weekend’s 8.53 per cent.

Oil bonds trade

Trade volumes sank last week to Rs 3,600 crore during the week, down from Rs 5,500 crore. Most trades were in fact oil bonds. But for oil bonds, trade volumes would have contracted even further. Oil bonds trade accounted for almost Rs 2,700 crore of the volume. The chase for oil bonds was mostly the 8.40 per cent 2025 security, from insurers. LIC, traders said, picked up this security at an YTM of 9.22 per cent.

The low interest in Government securities trade was also largely on account of the first quarter results. Few banks wished to burn their bottom lines with high depreciation. High depreciation has a direct impact on capital requirements, especially at a time when rates are on the rise. The low trade interest was evident from the high bid-offer spreads, of almost 30 basis points. Besides, the sale pressures reflected in thinning inter yield spreads. The 91-day T-bill yield was higher than 10 year weighted YTM by three basis points, a pointer that short-term yields were poised to harden further.

Besides, the bearish outlook was conveyed through the real yield movement. Real yields, the difference between inflation and nominal yields, up to 28 years, remained in the negative zone. The real yield on the 8.33 per cent 2036 was in the negative zone by 229 basis points.

Investment deposit ratio

Yet, investment deposit (ID) ratio remained high on an incremental basis at about 91 per cent. The high ID ratio was largely on account of bank purchases of short-term bonds, for balancing the corporate-led deposit inflows. Corporate credit drawdowns were partly pushed back as deposits to hedge against hikes in interest rates.

That window is currently beginning to close, with spreads between triple rated borrowers and the ten-year YTM hardening. The spread is currently a little over 300 basis points for term credit, though still at a discount to the bench mark prime lending rate. The escalating spreads though was beginning to result in a credit off-take slow down, which was evident from the incremental credit deposit ratio.

The nascent credit growth witnessed during the last month appears to have evaporated, signifying that the economy is headed for a slowdown, belying official optimism.