The Hindu Business Line : Bonds stable ahead of Budget; liquidity continues to be high

Bangalore, June 28 Bonds remained stable during the week, unaffected by firm global oil prices, as traders waited for the Government’s budgetary proposals for the current year.

Traders said that the stability was partly on account of weak credit off-take from the banks. This left banks with few alternatives other than parking funds in government securities. In addition, banks continued to be flooded with deposits, largely from non-resident Indians looking for the safe haven of domestic banks. The NRI deposit surge benefited even the small banks.

South Indian Bank Chief Executive Officer, Dr V.A. Joseph, said, “At least 20 per cent of our deposits are now from non-resident Indian sources.” In the case of the public sector banks, the figures are similar, though in absolute numbers the resources are large.

FII outflows

The inflows largely neutralised the impact of foreign institutional investor (FII) outflows and oil companies’ foreign exchange purchases. FIIs’ net outflows from both equities and debt amounted to $129.3 million (Rs 628 crore). FII net exit from the equity markets last week was $518.5 million (Rs 2,525 crore).

With oil import basket prices continuing at $69 a barrel, refineries remained large buyers of dollar for meeting their import payment requirements. Some non-food credit off-take last fortnight was largely on account of PSU refineries drawing down on their bank credit lines for their oil payments. However, bankers said the drawdown was minimal. Instead, PSU refineries mostly raised funds through collateralised borrowings. Oil bonds were used as collateral, instead of outright sales of the bonds as in the past.

The resultant dollar purchases pulled down the exchange rate to Rs 48.51 a dollar from last week’s Rs 48.13. But forward premia at the near and long ends narrowed as exporters hedged. One, three, six and 12 months narrowed to 3.13 per cent (3.43 per cent), 2.94 per cent (3.27 per cent), 2.78 per cent (2.90 per cent) and 2.45 per cent (2.49 per cent). Short forwards, cash to spot however widened to 2.32 per cent from 2.26 per cent, with the wide interest rate differentials between the dollar and the rupee. Last week, the Federal Open Market Committee had left the key Federal Funds rate (the rate at which US banks borrow overnight reserve funds from each other) at 0.25 per cent. Sell-buy swaps by foreign banks, particularly US banks, also pushed up short forward premium. Foreign banks arbitraged dollar for rupees and parked the same at the RBI repo window that offered a rate of 3.25 per cent. This led to a rise in the short forward premium.

The non-deliverable forward (NDFs are offshore rupee trading where settlement is done in foreign currency, mostly in dollars) however was down to Rs 48.54 from the previous week, implying that more depreciation could be under way.

The large capital and current account outflows had little impact on domestic liquidity. As a result, there were no open market operations by the Reserve Bank of India through purchase of dated government securities. The recourse to the reverse repurchase window amounted to Rs 1,31,984 crore, an indicator of the liquidity overhang in the financial markets.

The high liquidity, however, failed to help the Rs 15,000 crore government borrowing auctions last week. The borrowings were through reissue of the 6.07 per cent 2014, 7.94 per cent 2021, 8.24 per cent 2027 and the 7.40 per cent 2034 securities. The cut-off yields were 6.51 per cent, 7.34 per cent, 7.81 per cent and 7.90 per cent respectively. Both the long-term securities failed to ignite interest among traders.

The low interest was evident from the weak ‘bid to cover’ ratio (The ‘bid to cover’ ratio indicated interest in bonds at an auction). This, in turn, resulted in devolvement of both the long-term securities to the primary dealers who had underwritten the issues. Although the bids were far higher than the notified amounts, some bids were far higher than the cut-off prices, leading to devolvement.

T-Bill auctions

The banks were interested mostly in shorter and more liquid securities. This was evident from the turnout at the Treasury Bill auctions that saw ‘bid to cover’ ratios of close to 4 times. At the auctions, the 91-day T-Bill was placed at 3.32 per cent, down 4 basis points from last week. The weighted yield, however, levelled with the cut-off yield. The ‘bid to cover ratio’ for the T-bills was 3.6 times. A shift to shorter dated securities normally happens when liquidity is at a premium.

Traders said the low interest in the auctions was largely triggered by the debt fatigue among the banks.

Besides, traders said the securities offered through the RBI auctions were available at far higher yields in the secondary markets. For instance, the 8.24 per cent 2027 security was available in the secondary markets even at yields of 7.92 per cent.

The low interest for long-term securities was largely on account of the high incremental investment deposit ratios. The ratio is currently about 74 per cent as against the statutory requirement of 24 per cent. Besides, some banks are also beginning to worry about the impact on their respective interest margins, if the bids were made at low yields. The concerns manifested in the ten-year yield to maturity (YTM) moving up to 6.98 per cent on a weighted average basis, up from the previous week’s 6.85 per cent.

Despite the firming ten-year yield, average daily trade volumes last week rose Rs 400 crore to Rs 12,600 crore a day. Equity trade volumes dropped to Rs 18,800 a day, a drop of Rs 1,700 crore.

LIC, one of the large buyers of government securities, stayed away during most of last week. Non-bank buyers were mostly mutual funds, who preferred short-dated securities. But the traders mostly favoured short tenure securities, up to 5 years, implying that banks preferred to remain derisked. Besides, interest was mostly in high coupon securities in view of the high current yields. For instance, the 7.94 per cent 2021 trade volumes have exceeded that of the 10 year 6.05 per cent 2019 security.

Outlook mixed

Yet, the outlook for bonds remained mixed ahead of the Budget. As the Budget is expected to be an expansionary one, funding remains a worry. HSBC’s India Watch said, “We could see a rise in the Central Government debt from 48 per cent of the GDP to 53 per cent over the next couple of years, with overall (Centre and State) Government debt increasing by a similar amount from the current, already high, 79 per cent level.”

However, few domestic bankers expect a major increase in government borrowings over the estimated Rs 3.62 lakh crore.

The concerns were over the methods of funding fiscal expansion, without resorting to borrowing. This appeared to be a major factor that has kept bond yields higher than the GDP growth. This was especially in view of the practice of issuing bonds against subsidy payments, bank officials said.

On the flip side, with inflation in the negative zone at minus 1.41 per cent, real yields galloped to over six per cent. This implied substantial flexibility for a slide in yields in the coming weeks. Besides, with incremental credit deposit ratio continuing at minus 14 per cent, bonds are expected to remain in favour.

A top bank official said, “Where else do I deploy the funds?” That banks are continuing to remain flush with funds was evident from the inflows through Certificates of Deposits (CD).

Banks have managed to raise CD resources at rates as low as 4.3 per cent for six months. One year funds are available at rates as low as 5.4 per cent. Many banks were raising CD resources in a bid to shrink their weighted average cost of working funds that currently range between 6.5 and 7 per cent.

Although lending rates are also likely to follow suit, there are many ifs and buts in the process, traders said. State Bank of India which that brought down its prime lending rate to 11.75 per cent still has lending rates higher or almost on par with other public sector banks (PSB). As other banks also follow the SBI lead, rates are expected to match SBI or drop below it, if they follow an identical reduction. Traditionally, SBI's lending rates have always remained 50-75 basis points lower than other PSBs.

But historical aberrations apart, sharper rate reductions are expected n the coming weeks as banks jostle to beef up their shrinking asset books. The only area where banks are unwilling to compromise is the 3 per cent net interest margin. For PSBs, 3 per cent is a sacrosanct number.

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