The Hindu Business Line : Bonds zoom on surge in liquidity, weakening inflation

The weakening inflation prompted the Reserve Bank of India to cut some of its key monetary policy rates — the Cash Reserve Ratio (CRR) and the repurchase/ reverse repurchase rates. In a late evening decision on Friday last, CRR (the zero interest balance that banks maintain with RBI against their deposits) was snipped to 4 per cent. In addition, the reverse repo rate (removal of liquidity through sale of government securities) was cut to 4 per cent. The repo rate was cut to 5.5 per cent.

MSS auction

The reductions were largely effected partly to improve liquidity. The CRR reduction would improve liquidity by another Rs 20,000 crore. Liquidity has already improved as a result of redemptions of the Market Stabilisation Scheme (MSS) securities. At Friday’s MSS buyback auction, the cut-off yield to maturity (YTM) accepted was kept at 4.60 per cent for the 7.55 per cent 2010 security, implying that banks wanted higher prices for their holdings. But bids for the 5.87 per cent 2010 security were high, some at even 4.40 per cent. This prompted the RBI to reject all the bids. As a result, only bids for Rs 3,580 crore were accepted at the buyback auctions. But MSS redemptions have been taking place, especially of Treasury Bills issued for sterilisation operations. Between November 28 and December 26 at least Rs 12,000 crore of MSS securities were redeemed.

The reverse repo reductions were also a measure to reduce arbitrage operations by foreign banking institutions, particularly the American banks. Traders said that some American banks were using the dollar as a vehicle for carry trade operations. One source of low-cost dollar liquidity was through the US Treasury Liquidity Lending Facility . The arbitrage operation was evident from the high recourse to the RBI’s reverse repurchase window. The net recourse to the repurchase window was Rs 76,925 crore (There were also 2 banks that borrowed Rs 1,010 crore through repos). As a result of the short-term arbitrage, three-day forward premium remained firm at 5.08 per cent, unchanged from the previous week. Normally such premium drops towards to the reporting Friday, when banks prefer to contain liabilities.

The short-term inflows though were insufficient to meet the demand for the dollar from oil importers and corporates for meeting their requirements. Besides, FII net outflows amounted to $82.3 million. The dollar demand resulted in the rupee dropping to Rs 48.89 against the dollar.

Forward premia for one three, six and 12 months though softened to 4.51 per cent (6.26 per cent), 3.29 per cent (5.01 per cent), 2.41 per cent (3.42 per cent) and 1.83 per cent (2.39 per cent) respectively as exporters took cover ahead of inward remittances by non-resident Indians. Non-resident Indians were repatriating funds to rupee deposits (non- resident ordinary deposits) after losing confidence on international banks. Inflows were also expected to resume through the External Commercial Borrowings (ECB) route, as the RBI removed the cost ceilings temporarily till June 30 this month.

The dollar demand had little impact on liquidity. The high liquidity was evident from the weekly Treasury bill auctions. At the 91-day T-bill auctions, the cut-off yield was 4.71 per cent. The weighted yield was 4.59 per cent. The cut-off yield on the 364-day T-bill was 4.78 per cent. The high liquidity overhang as a result pulled down the ten year YTM to 5.17 per cent on a weighted average basis.

High trade volumes

The positive undertone manifested in high trade volumes. Average daily trade volume last week was about Rs 12,400 crore or about Rs 3,000 crore more than equity turnover in the National Stock Exchange. Thin bid offer spreads of barely 5-10 basis points reflected large treasury operations. The interest in bonds also benefited the Rs 10,000 crore government borrowing programme. The 7.46 per cent 2017 and the 7.40 per cent 2035 were placed at weighted YTMs of 5.7 per cent and 6.46 per cent each.

Besides, with oil import basket prices falling below $35 a barrel, inflation is expected to further decelerate. Inflation last week was 6.38 per cent. Nominal yields though remained above inflation.

The trends notwithstanding, a correction appears to be in the offing. Some obvious signs were in the form of sagging bid to cover ratios. The bid to cover ratio indicates the preference for government securities. But the ratios are on the decline. For instance, the bid to cover ratios for the dated G-sec auction was 2.79 and 1.93 times for 7.46 2017 and the 7.40 per cent 2035 securities respectively. For the T-bills however, the bid to cover ratios were about 11 times. This was a complete reversal from the trend three weeks ago, when dated securities ratios were high and T-bill ratios were low.

Besides, incremental investment deposit ratios were beginning to fall in line with sliding yields.

Incremental investment deposit ratio was down to less than 10 per cent. But the nominal ID ratio is over 30 per cent, implying banks still have large G-Sec surpluses to support additional deposit accretions. In fact, last week, banks sold more securities than purchases, ahead of the third quarter balance sheet dress up. Banks sold more than Rs 20,000 crore of securities, particularly long dated securities to institutions like the Life Insurance Corporation of India.

The major reason for this trend was the anticipated kickstart in credit offtake in the coming weeks. Bankers are preparing for a big fourth quarter push in credit offtake. This push is evident from the number of banks recapitalising. Recapitalisation is normally done when a big credit growth is about to happen. Last week alone, at least four banks raised capital, equivalent to about Rs 2,000 crore, almost half in the form of perpetual bonds. Perpetual bonds are technically Tier-I capital.

The focus on lending comes, as risk weighted assets have become attractive with the fiscal stimulus becoming the buzz word. The ice coating in risk weighted assets is the high spreads over sovereigns of close to 700 basis points. The high spreads could change profile of banks’ balance sheets in Q4.

Related Stories:
‘Bond market to gain from falling inflation, easing interest rates’
Bond volumes up 77% as banks churned portfolios

More Stories on : Debt Market | Govt Bonds

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
KVGB gets new Chairman

Banks look to deploy more mobile ATMs

Cross-subsidisation of health cover continues despite free pricing

Ceiling on insurance cos’ management expenses may go

Bonds zoom on surge in liquidity, weakening inflation

PNB back-office in Kerala

Banks keenly watching SBI’s Tier-II bonds issue to retail investors