The Hindu Business Line : Bonds rally as banks chase SLR securities

Bangalore, Sept. 7 Bond rallied for the second week in succession on the back of frenetic purchases by banks for meeting Statutory Liquidity Ratio requirements. The rally came despite the large mop-up of liquidity through the week through Treasury bills.

The T-bill auctions of both 91-day and 182-day during the week saw at least Rs 8,500 crore taken out of the banking system. But traders said the auctions failed to dent the markets’ appetite for government securities for meeting their SLR requirements.

Some of the banks, particularly foreign banks, had short-sold their government securities holdings, anticipating to pick them up when yields hardened . Bankers said that the same banks were making purchases for conforming to SLR. Few had expected a 22 per cent time deposit growth on a year-on-year basis.

Liquidity tight

Despite the deposit flows, liquidity remained tight, as was evident from the week-end liquidity adjustment facility auction.

The recourse to the repurchase window at the auction was to the tune of Rs 18,550 crore even as another Rs 4,500 crore of bonds were due to be redeemed. The liquidity tightness was also evident from the issuance of a series of short tenor certificates of deposit by some of the large public and private sector banks.

SBI associate banks raised three-month CDs at 11.05 per cent. But private sector banks such as Axis Bank raised CD resources at rates as high as 11.42 per cent.

Traders said the tight liquidity was largely on account of large foreign currency purchases by refineries that pushed down the rupee-dollar exchange rate down to Rs 44.37 per dollar.

The depreciation of the rupee was also largely driven by conditions in the Non Deliverable Forward (NDF) markets. NDF markets are mostly hedges in emerging market currencies, including the rupee, though settlements are done in dollars.

Foreign institutional investors are among the largest players in the NDF currency markets. However, trends in the NDF market had little impact on the forward premia which softened across all tenors.

One reason for the softening was exporters resorting to hedging. Exporters took forward cover to lock into the current exchange rates. Importers shying away from hedges also hastened the drop in premia. One, three, six and twelve-month premia dropped to 2.16 per cent, (6.58 per cent), 2.43 per cent (4.48 per cent), 2.61 per cent (3.93 per cent) and 2.41 per cent (2.67 per cent) respectively. But FII- and oil-driven demand overwhelmed exporter inflows.

Besides, traders said the RBI intervened in the foreign exchange markets through swaps. But for the sell-buy swaps, the fall would have been sharper, bankers said. The swaps resulted in removing some more liquidity.

Moreover, credit offtake by the farm sector also continued to be robust. Incremental non-food credit deposit ratio is currently 56 per cent. The offtake was mostly in the form of loan disbursements, cash credit and overdrafts.

Traders said the tightness was also attributed to government delays in transfer of loan waiver compensation to the banks. Bankers said the delays were on account of fears that money supply targets would face slippages.

Money growth expansion

The present target is 15-17 per cent, though money growth is currently about 21 per cent, one per cent from the previous week’s 19.6 per cent, partly from expansion in bank credit to the commercial sector. Bankers expect farm loan waiver compensation amounting to about Rs 72,000 crore to be paid in the form of bonds.

Trade volume

The chase for SLR securities pushed up the trade volumes in the market. Daily trade volume last week averaged Rs 10,800 crore. In fact, on many days, trade volumes in the debt markets exceeded that of the equity markets. This was the first time debt volumes were overtaken by equity markets since 2003. Bid-Offer spreads remained thin at barely five basis points. Traders said that the thinning of spreads and shortage of SLR securities were also largely due to the public sector banks’ holding of investments.

This year, several PSU banks transferred their high coupon holdings, the 8.24 per cent 2018 to the Held- to-Maturity Account, to avert depreciation losses. Trading was possible in government securities only in the held-for-trading and available-for-sale category accounts.

The rapid yield drop pulled down the spread between the 28 year security, 8.33 per cent 2036 and the wholesale price index based inflation to 2.71 per cent. This implied that real yields were negative up to 28 years. But bankers said a technical correction was overdue. The correction was anticipated from a further tightening of liquidity in the coming weeks in view of advance tax payments. Coupled with this, about Rs 17,000 crore was expected to be mopped up during the week through issue of Treasury bills and securities.

WPI inflation

Moreover, the fundamentals also favoured hardening of yields. There is, however, a flip side. The downturn in the equity markets was driving the deposit growth of the banking sector. If the flight from the equity markets to bank deposits is sustained, bonds would remain the largest beneficiaries.