The Hindu Business Line : Bond yields soften on easing global oil prices

Bangalore, July 27 Bond yields softened despite high inflation as global oil prices eased. Traders said improved inward flows from foreign institutional investors supported the bonds. Inflows from foreign institutional investors since the beginning of this month amounted to $977.4 billion, a reversal from the trend seen in the beginning of this financial year.

The inflows were also fuelled by relaxed external commercial borrowing norms. The new norms, notified on July 1, allow ECB lenders physical asset coverage. This is unlike the past, where ECB lending is clean or against guarantees of domestic financial institutions.

Oil payment needs

However, traders said that what also supported bonds was the sale of the foreign exchange directly to petroleum refineries for supporting their oil payment requirements. Since the beginning of the special market operations (SMO), the Reserve Bank of India continuously supported the refineries with foreign exchange against purchase of oil bonds or special government securities. The special Government securities were issued to oil companies against their subsidy dues.

The refinery support mechanism and FII inflows resulted in reversing the rupee’s depreciation against the dollar. The rupee appreciated to Rs 42.23 or an appreciation of 2.25 per cent since July 11. The rupee then had hit a low of 43.21. Last week alone, foreign exchange reserves depleted by $1.4 billion on account of SMOs.

But oil prices have begun easing. The import basket price is now down to about $119 a barrel, against the peak of $142.04 early this month. The easing of the oil price alone is partly responsible for the weakening of inflationary expectations.

Forward premia firm

Yet, forward premia remained firm. One, 3, 6, 9 and 12-month forward premia were 7.10 per cent, 5.97 per cent, 4.69 per cent and 3.67 per cent respectively. Traders said that the firm premia was largely on account of planned prepayments by some corporates with large foreign currency liabilities. Besides, refineries hedged their liabilities both through futures and in the foreign exchange markets to deflate the impact of any future spike in crude prices.

Tight liquidity

Many corporates, traders said, also took advantage of the favourable spot exchange rates for making prepayments, drawing down on their domestic credit lines. As a result, liquidity remained tight. The tight situation was evident from the weekend liquidity adjustment facility (LAF) auctions, where the recourse to the repurchase window (RBI’s overnight liquidity support to banks) was Rs 43,260 crore.

The tight liquidity was also reflected at the weekly Treasury bill auctions. The cut-off yield on the 91-day T-bill was 9.06 per cent or 56 basis points above the repo rate of 8.5 per cent. As a result, there are expectations of a further hike in the repo rate by at least another 25 basis points during the review of the monetary policy on July 29.

Alternatively, some bankers also anticipate a further increase in the cash reserve ratio (CRR). RBI’s current cash reserve ratio is 8.75 per cent.

The expectations kept the 10-year yield to maturity at 9.16 per cent on a weighted average basis. This was despite the fact that during the week 8.24 per cent 2018 was placed at a cut-off YTM of 9.06 per cent.

The undertone was weak. Average daily trade volume, though improved to Rs 5,000 crore during the week. However, the increase in trade volume was largely on account of RBI’s oil bond purchases as part of the SMO and LIC switches for purchase of the 8.28 per cent 2032 security at an YTM of 9.66 per cent.

Offer spreads

The fragility was evident from the high bid offer spreads and the short inter-yield spreads. Bid offer spreads remained above 20 basis points. The spread between the 91-day T-bill and the 10-year weighted YTM towards the weekend was just 10 basis points. In fact, many of the banks/primary dealers that picked up the 8.24 per cent 2018 security, anticipating a softening of yields, actually incurred losses of at least 8 to 10 basis points.

The outlook remains bearish in the near term. The bear hug is partly on account of inflation worries. Real yields remained in the negative zone in view of inflation at 11.89 per cent. Nominal yields, up to 28 years, were at least 226 basis points lower than inflation

In fact, there was little interest from banks in bonds. Banks are among the largest traders in the bond markets. Only LIC and other life insurance companies were buyers of long-term securities. Banks low interest was partly in view of the credit pick-up. Credit off-take, since the beginning of this year, was Rs 46,666 crore.

During the corresponding period of the previous year, the off-take was a negative Rs 14,812 crore.

Bankers said that despite high deposit accretions few required Government securities for meeting their statutory liquidity ratio (SLR). This was in view of the high G-Sec investment-deposit ratio of over 30 per cent. This was well above the prescribed SLR of 25 per cent.

Instead, with corporates rushing to shed foreign debt liabilities taking advantage of the window of opportunity, banks braced for further credit off-take in the coming weeks. The opportunity was through the appreciation of the rupee against the dollar. Depreciation tends to increase external debt service costs.

What also compounded the tight liquidity situation was the RBI’s continued interventions through the Market Stabilisation Scheme (MSS). Last week, the MSS mop-up was Rs 3,500 crore. This was despite the fact that outstanding MSS securities with the RBI were Rs 1.71 lakh crore. For the next week, T-Bill auction amount is Rs 5,000 crore.

Moreover, bankers said with little foreign funds flowing in, MSS was actually contributing to further tightening of liquidity. Bankers said that the pursuit of money supply containment to within 17 per cent was likely to lead to a cost push effect on the industrial sector.

Liquidity expansion is already slowing down, after the increase in the CRR. Money supply growth has decelerated to 20 per cent.

As a result, bankers are now pushing for discontinuing the MSS or holding back of future CRR increases to take off the liquidity pressures.