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Bonds bearish; PSBs keen to trim tenure

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Pressure on RBI to lift interest rate floor as inflation is set to go up

C. Shivkumar

`Once the full impact of the oil price hike sinks in, yields would begin to harden again tracking inflation'.

Bangalore, July 2

Bonds ended weak last week-end as high international oil prices and inflation worries haunted traders.

Traders said that oil companies were active in sourcing foreign currency to meet their import payments. International oil prices reached $73 a barrel. But oil companies' presence had little impact on the foreign exchange markets. This was in view of the current account and non-debt capital account inflows.

But traders said that forward premia remained narrow, despite the pullout by foreign institutional investors and hedge funds. Many of the FIIs had pulled out in anticipation of sharp increase in the US Fed funds. But the actual increase, the eighteenth time, was just 25 basis points to 5.25 per cent.

Tight liquidity

The FII pullout and oil companies' presence ensured that liquidity remained tight. This was evident from the fact that the RBI could mop up only Rs 1,075 crore as against the notified amount of Rs 2,000 crore inclusive of the market stabilisation scheme component at the weekly 91-day Treasury bill auctions. The 91-day bill yield moved up to 6.36 per cent. Many of the bids for the 91-day T-bill were rejected, since some were way above the cut off yield prescribed. Similarly, at the 182-day T-bill auction, the amount mopped up was only Rs 1,100 crore inclusive of MSS against the notified amount of Rs 1,500 crore.

However, despite the tight liquidity, at the weekend LAF (liquidity adjustment facility) auction, the mop-up through reverse repos was Rs 42,585 crore. The reason for this was that most of the deposit accretions were of short tenures, current, savings and term deposits with maturities up to 90 days. Consequently, most bankers preferred to park the short-term funds only in highly liquid instruments.

The tight liquidity not withstanding, the 10-year yield to maturity softened slightly last week to 8.14 last week on a weighted average basis. In the previous week it was 8.18 per cent.

Despite the slight softening, there was little evidence of any rally or reversal in the bonds markets.

This was evident from thin trading volumes and the wide bid-offer spreads. Trade volumes were less than Rs 500 crore. Besides bid- offer spreads remained wide. At the short-end, the spreads were 15 basis points. At the long-end, the spreads were as high as 25-30 basis points. The outlook also remained bearish evident from the high yield spread between one and 29 years. The spread was 190 basis points.

Growing inflation

The bearish trend was also driven by the advancing inflation, though one-year real yields narrowed to 1.5 per cent close to international trends. But bankers said once the full impact of the oil price sinks in, yields would begin hardening again tracking inflation.

In view of this many bankers are already beginning to expect a further round of hikes in the repo/reverse repo rates. This anticipation was evident from the fact that the 182-day T-Bill cut off yields was higher than the repo rate. In fact, bankers are already beginning to look for even more short duration of their investment portfolios.

Currently, the average duration of the portfolio is 3 years for the public sector and one year for the private sector bankers. But PSU bankers are looking for pushing it down to less than 2 years. The problem was that there were not many takers for the securities. Insurers were present only at the long end though only for small volumes. Insurers, faced with accretions into their unit-linked insurance policies, prefer the equity markets.

Savings rate revision

Besides, some of the bankers are also beginning to push for a change in the current savings bank rates. This is the only administered interest rate and is currently pegged at 3.5 per cent.

The revision is sought for moving the interest rate floor up so that term deposit rates could also be revised accordingly and help accretion of deposits. Such a revision is essential in view of the high credit growth targets.

Already bankers are beginning to find the going tough for raising long-term funds. Some of the funds raised in the subordinated capital for 10 years are priced at 9.25 per cent or 100 basis points over the sovereign yields.

The effective costs are close to 10 per cent. It is this situation that is prompting many of the bankers to push for revision of the savings rates.

(This article was published in the Business Line print edition dated July 3, 2006)
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