The Hindu Business Line : Bond yields firm despite weakening oil prices

As part of the continued efforts to tame inflation, the Reserve Bank of Indiapushed up the repurchase rate and the cash reserve ratio by 50 and 25 basis points each to nine per cent.

The RBI also introduced the second liquidity adjustment facility auctions on reporting Fridays. The first such auction was held last week. At both the LAF auctions, the recourse was limited. In fact, at the auctions, there was recourse to the reverse repurchase window to the extent of Rs 6,695 crore. In fact, traditionally, there is little borrowing activity on reporting Fridays as banks cut back on demand and time liabilities. The second LAF gave bankers an opportunity to park the surplus funds.

Liquidity remains tight

However, the recourse to the reverse repurchase window was expected to be confined to only reporting Fridays. Liquidity on all other days remained tight.

The tight situation was evident from the Treasury bill auctions during the week. At the 91-day T-bill auction, the cut-off yield was 9.36 per cent and the weighted yield was 9.32 per cent, up 30 basis points from the previous week. The yields were well above the new repo rate of nine per cent. The auction bids amounted to Rs 10,075 crore, inclusive of the non-competitive bid of Rs 800 crore. At the 364- day T-Bill auction, the cut-off yield also was 9.56 per cent. With the high T-bill cut-off yields, traders said, that the RBI policy interventions were far from over and further tightening was in the offing.

FII net outflows

The fears were largely driven by continued foreign institutional investors’ outflows. FII net outflows last week amounted to about $351.1 million. Oil refiners, however, resorted to swapping some of their foreign exchange selling spot and buying forward. Public sector refineries are largely cash rich currently in view of the RBI’s special open market operations (SMO). For the week ended July 25, the PSU refineries bonds’ pick-up amounted to Rs 900 crore.

Rupeee firm

As a result, the rupee remained firm against the dollar at Rs 42.37, down only marginally from the previous weekend. Forward premia, as a result, remained high. One, three, six and 12-month premia were 5.95, per cent, (7.10 per cent), 5.66 per cent (5.97 per cent), and 4.67 per cent (4.69 per cent) respectively.

Three-day forward premium, however, softened to 7.65 per cent largely in view of short term inflows. One such flow source was foreign banks who swapped spot for cash, for meeting their reserve requirements. This trend pulled down short premia down to 7.10 per cent last week-end, down from 9.80 per cent during the previous week-end.

Traders said there were some current account inflows and an absence of sustainable flows from all sources, including external commercial borrowings. In fact, most corporates with foreign currency liabilities were actually taking forward cover for making their respective debt service payments.

The tight liquidity reflected in the ten-year yield to maturity firming to 9.31 per cent on a weighted average basis, up from the previous week’s 9.16 per cent.

Reversal in Bond markets

There were few signs of any reversals in the bond markets despite the retreat in oil prices to less than $120 a barrel. The undertone remained bearish. Non-oil corporates drew down on their credit lines. This year, non-food credit growth was close to Rs 40,000 crore as corporates anticipated more interest spikes.

However, neither the Government nor the RBI was too keen to push down product sector credit growth from the current levels. At a meeting last week, the Finance Minister, Mr P. Chidambaram, said, “Banks must mitigate the impact of high interest rates.” The signal from the Government came amid mounting fears of a big slowdown in the economy. That a slowdown was in the making was evident from the inversion in yields. The 91-day T-bill yield is currently higher than the 10-year YTM by at least seven basis points.

Trade volume low

Moreover, the daily average trade volume remained low at barely Rs 4,800 crore. The bulk of the trade was in T-bills and short-term securities. The thin volumes were also partly on account of the absence of life insurers.

Despite the Government’s aversion to any big interest rate hikes, few banks see alternatives. One reason was that real yields up to 28 years remained below inflation. Inflation as measured by the whole sale price index for the latest week was 11.98 per cent.

As a result, the outlook remained bearish. The outlook was also partly driven by cross border factors, including expectations of a hike in Federal Funds rate from the current level of two per cent.

The sell pressure on bonds was also driven by increased liquidity requirements for the banking sector. Bankers looked for opportunities for replacing low coupon securities with the new high coupons from future Government security issues. This was also one of the major reasons for insurers’ abstention from the markets,

But banks are also faced with large deposit accretions. Deposit accretions come mostly from equity market flight. Yet despite the banks deposit accretions, there was little requirement for government securities. Most banks are already comfortably placed with Government security investment deposit ratio of over 32 per cent.

Bids for Government securities placements, as a result, are likely to be move into double digits.