The Hindu Business Line : Bond prices buoyant even as liquidity remains tight

Top traders said that they anticipate some loosening of liquidity during the Reserve Bank of India’s peak season credit policy announcement slated later this month. Bankers said the anticipation stemmed from weakening global commodity prices, which resulted in the inflationary outlook becoming positive. Inflation, as measured by the whole sale price index, is currently at 11.99 per cent.

However, liquidity remains tight, largely on account of the massive unwinding of positions by hedge funds and foreign institutional investors for repatriation of capital back home to their beleaguered parents. The tight global liquidity situation was despite the massive Federal Reserve programme for liquidity intervention. The bid to cover ratio for the Federal Reserve’s auction of Feds Treasury security lending facility (TSLF) was 1.96. A high ratio indicates high demand. The TSLF is a 28 day liquidity support mechanism, where participants are provided Treasuries in exchange for eligible collateral securities, mostly mortgage backed securities.

Yet, FIIs and hedge funds remained cash strapped. FII unwinding, both debt and equity, amounted to $1.3 billion in September alone. Bankers said that with the RBI’s limited interventions in the foreign exchange markets, the rupee slid against the dollar during the week as FIIs sourced the dollar from the open markets. The fall was also contributed by oil companies’ purchases for meeting payment obligations. Oil prices are down to $95 a barrel, translating into a weighted average import price of about $89.5 a barrel. Since the beginning of this year, the rupee has depreciated by 17 per cent.

Traders said the depreciation was deliberate, so as to correct the real effective exchange rate of the rupee. The six currency basket REER (base 1993-94) in August was 110.08 as against the corresponding 2006-07 figure of 102.26. This implied that phased depreciation of the rupee is far from over.

Forward premia

Exporters though began repatriation of their proceeds. Some also took forward cover, fearing the slew of measures initiated by the RBI would result in foreign currency inflows. As a result, forward premia, barring short term premia, fell below one per cent. One, three, six and 12 month forward premia was down to 0.26 per cent (2.97 per cent), 0.60 per cent (2.37 per cent ), 0.73 per cent (1.68 per cent) and 0.64 per cent (1.36 per cent).

But the three-day forward premia hardened to 40 per cent on the back of foreign banks arbitraging in the domestic money markets. With liquidity remaining tight, foreign banks sold spot dollar taking advantage of the tight call money markets. But traders said that some foreign banks also resorted to picking up some certificates of deposits floated by public sector banks.

The tight situation was evident from the recourse to the liquidity adjustment facility window. At the weekend LAF auctions, banks and PDs borrowed Rs 65,095 crore. The tight liquidity conditions were also evident from the high cut- off yields at the 91 day T-bill auctions. The cut-off yield was 8.86 per cent last week, or up 30 basis points from the week. The weighted yield was also level.

However, despite the hardening of short term yields, the ten-year yield to maturity (YTM) on a weighted average basis retreated to 8.34 per cent, or down by 15 basis points over the previous week. Traders said that the reason for the drop was largely on account of the signals emerging from the RBI favouring a more a relaxed liquidity regime.

The signal came in the form of a low mop up through the T-bill auctions. The notified amount at the 91 day T-bill auction was Rs 5,000 crore. The actual mop up was just Rs 1,000 crore through competitive and non-competitive bids. In case of the 182 day T-bill auction also, the situation was identical. As against the notified amount of Rs 2,000 crore, the retention from both competitive and non-competitive bids was Rs 675 crore. The low levels of retention, as against the notified amount, conveyed the signal that the RBI is unlikely to pursue the tight liquidity stance, traders said. Evidence of this trend was also available from the reduction in the market stabilisation scheme outstandings. Outstanding MSS till September 26 this year was Rs 1.74 lakh crore, down from Rs 1.76 lakh crore a week earlier, implying redemptions.

Trade volumes

Traders said bonds reacted to the signals and moved upwards. The upside bias was also evident from the improved trade volumes in the bond markets. Daily trade volume was about Rs 7,200 crore during the week, up from the previous week’s Rs 5,900 crore. Traders said that the volumes would have been far higher, but for the shortage of securities in the markets. In fact, there were few sellers for Government securities.

The reluctance to sell Government securities stemmed from the burgeoning deposits with the banks. Time deposits with the banks so far this year was Rs 2.65 lakh crore or about Rs 63,000 crore more than the corresponding period of the last financial year. The bulk of the accretions though came from reverse flows from the equity markets. With most investors staying away from stock markets, the preference was for bank deposits.

As a result, the outlook for bonds remained bullish. This was apparent from the thin bid offer spreads of barely 5-7 basis points.

Institutional investors also shifted to Government securities as a safe haven. The shift was pulling down yields, the bankers said.

However, the flip side was that credit continued to expand. Incremental credit deposit ratio this year so far was 62 per cent.

As a result of the credit and deposit expansion, M3 in the latest week grew by 21 per cent, or well over the targeted band of 15-17 per cent. Has the RBI eased off on the M3 growth targets? It clearly appears so!