The Hindu Business Line : Yields continue to head south as inflation abates, oil prices fall

Traders said there was sustained buying of government securities on expectations of more policy interventions from the Reserve Bank of India. The anticipation came amidst mounting fears of a deceleration in the GDP growth. Last week, the RBI Governor, Dr D. Subbarao, had, in fact, expressed such fears, indicating growth projections were likely to face a downward revision from the targeted 7.5-8 per cent for the current year. Traders took these as signals of further rate reductions.

Besides, foreign institutional investors-led inflows during the week were about $250 million. Along with these flows, exporters also began remittances after receiving their delayed payments. In addition, inflow of non-resident deposits into public sector banks remained high.

Importers, including public sector oil refiners, took forward cover capitalising on the soft dollar- rupee exchange rate of Rs 48.71. Traders said refiners took forward cover at current prices. Currently, the oil import basket price is $41 a barrel. But during the week, oil prices have remained volatile, by as much as $2.5, after OPEC and Russia moved to reduce output. Consequently, there were fears that prices would see a spike especially since India imports close to about 2.8 million barrels per day. Forward premia firmed slightly across all tenures. One, three, six and 12 month firmed to 5.3 per cent (4.95 per cent), 4.61 per cent (3.58 per cent), 3.26 per cent (2.48 per cent) and 2.3 per cent (1.75 per cent) respectively. The short-end forward premia also widened as foreign banks stacked up government securities to book treasury gains. Three-day forward premia firmed to 5.3 per cent.

Deposit accretion and foreign inflows ensured a comfortable liquidity situation. Time deposit inflows into the banking system were in the region of about Rs 4,500 crore.

LAF auctions

The comfortable liquidity situation was evident from the weekend liquidity adjustment facility auctions. At the weekly LAF auctions, the recourse to the reverse repurchase window was Rs 24,035 crore. But HSBC’s Senior Asian Economist, Mr Robert Prior-Wandesforde, said, “If liquidity conditions remain comfortable, the reverse repo rate will become the monetary policy tool of choice for the Reserve Bank.” This indicates that one more round of policy rate reductions is in the offing. The high liquidity during the week was also manifested in the weekly Treasury bill auctions. At the 91 day T-bill auctions, the cut-off yield dropped 5.65 per cent, down from the previous week’s 6.58 per cent. The bid to cover ratio or the bid volumes as against the notified amount was 4.10 times. But it was at the 182 day T-bill auctions that the spread between the cut-off and weighted yield was high. The cut-off yield was 5.61 per cent, whereas the weighted yield was 5.10 per cent or close to the repo rate of 5 per cent.

Falling yields helped government securities auctions. At the weekend government borrowing auctions, through placement of the 7.27 per cent 2013 and the 7.34 per cent 2034 securities, the cut-off yields were 6.24 per cent and 6.99 per cent respectively. The large number of bids pushed the bid to cover ratios on both these securities upwards of 3 times. The borrowings are the first tranche of the additional Rs 45,000 crore borrowings planned for the current year.

The rush for securities pulled down the ten-year yield to maturity (YTM) last weekend to 6.17 per cent on a weighted average basis, from the previous weekend’s level of 6.89 per cent.

This is the lowest level since January 2003.

The undertone in the markets remained positive as average trade volumes during the week hit a record Rs 19,000 crore per day. Trade volumes were largely driven by the deposit inflows into the banking system. Deposit inflow gathered pace and time deposit accretion is currently about Rs 4,500 crore per day.

The demand was largely for meeting the statutory liquidity ratio of 24 per cent. Most purchases though were held in the marked to market categories. The bid-offer spreads also remained thin at barely 5 basis points. At least 25 per cent of the buy side volumes were driven by foreign bank purchases of dated securities. Foreign banks, however, stayed away from treasury bills, both on the buy and sell side during the week.

Some public sector banks used the opportunity to beef up their capital, through a sale of excess holdings in their respective Held to Maturity (HTM) category securities. Under the current regulations, banks are permitted to hold up to 25 per cent of their net demand and time liabilities as HTM securities, one per cent more than the current SLR. All profits from sale of HTM category are to be treated as the capital reserve. Banks took advantage of this opportunity, since other forms of raising tier-I capital — equity or through perpetual bonds — were still difficult given the current market conditions.

That some sales were taking place were evident from release of high coupon securities. Among the securities that have hit the market included the 9.81 per cent 2013 per cent that was unloaded at 6.32 per cent. Bankers said that additions to the capital reserve also gave them sufficient flexibility to raise a further tier-II capital in the form of bonds.

The chase for the securities kept nominal yields below the inflation of 8 per cent. But the spread between nominal yields and inflation narrowed to about 100-150 basis points. Moreover, a correction appears to be in the offing. G-Sec investment deposit ratio is currently about 29 per cent, well in excess of the SLR requirements.

pause likely

Consequently, a pause in the yield softening is likely, as banks book profits at current levels. A key reason for such a correction is that the average yield on investments is now down to 7.1 per cent or less than the weighted average cost of working funds for the banks that currently ranged between 7 and 7.5 per cent.

Consequently, further accretions are expected to take place after deposit rates are brought down. That quick reductions are in the offing is evident from the declining rates on certificates of deposits.

One year CDs are below 8.5 per cent and still falling. This rate is at least 200 basis points below the one year retail deposits, clearly implying that there is little interest in bulk funds for the moment. Retail deposit rates could follow suit in the coming weeks, along with lending rates.