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Bonds remain firm on weak oil prices

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Liquidity remains high; trends point to impending correction

C. Shivkumar

Bangalore, Sept. 10

Bonds remained firm last week on weakening international oil prices and large purchases by life insurance companies.

Traders said that bonds were also helped by deposit inflows into the banking system. Deposit inflows have resulted in a higher demand for bonds from banks for meeting their statutory liquidity ratio needs. In addition, banks have also accelerated their tier-two capital raising programmes during the past few weeks. Bond raising has also triggered a rush for SLR securities during the last weeks.

But bankers said that oil companies were yet to make their presence felt in the foreign exchange markets, despite the drop in prices to about $66 a barrel that brought the weighted average cost of crude oil imports close to $60 a barrel. Oil companies' restrained presence in the forex markets was driven by continued liquidation by international hedge funds of oil futures/options.

These trends were evident from the high mop-up in the two week-end liquidity adjustment facility auctions. At the two auctions, banks had parked Rs 43,805 crore with the RBI. This was done as call rates were about five per cent. Parking in the reverse repos generated six per cent. In fact, some banks also attempted to arbitrage between the call markets and the reverse repo markets to earn spreads of about 0.5 per cent during the week-end, traders said.

Treasury bill auctions

The high liquidity also reflected in the weekly Treasury bill auctions. The cut-off yield on the 91-day T-bill auctions remained steady at 6.44 per cent. The weighted average yield was at 6.39 per cent which was the same level as the previous week. The cut-off yield on the 182-day bill yield was 6.74 per cent and the weighted average was 6.72 per cent.

The liquidity build-up resulted in pushing down the 10-year yield to maturity (YTM), to 7.74 per cent down sharply last week from the previous week's 7.92 per cent.

Insurers active

Bankers said that life insurance companies were active throughout the week. Insurers, however, resorted to choosing categories of securities based on their current yields. In fact, among the preferred securities were the 8.35 per cent 2022 and the 7.50 per cent 2034.

Trade volumes, however, dropped below Rs 1,000 crore towards the week-end. The bid-offer spreads also widened slightly to 10 basis points across all tenors. Similarly, yield spread also rose to over 160 basis points between one year and 29 years, all pointers to an impending correction.

Part of the correction was on account of advancing inflation numbers. Inflation was over five per cent implying a one-year real yield of about 1.6 per cent, close to the internationally accepted level of 1-1.5 per cent. Within the country however, real yields have remained close to 2 per cent. Traders said that this correction was expected to reflect in the 7.59 per cent 2016 bond auction slated for the week.

Moreover, traders said that oil companies were expected to reactivate their lines of credit with the banks as the Finance Ministry was not prepared to convert the oil bonds into SLR securities.

Some of the companies were selling their securities through the Collateralised Borrowing and Lending Market to raise resources and take advantage of the receding international oil prices.

Through the CBLO markets, oil companies were in a position to raise resources at about 100 basis points over their coupon rates. This was far lower than rates applicable for drawing down their credit line, where the rates are linked to the benchmark prime lending rates.

Credit off take

Besides, bankers said, credit off take was also expected to pick up in the coming months, especially farm advances. Bankers said that credit drawdown was expected during the coming weeks.

Already, banks have prepared themselves for credit off take from the farm sector by beefing up their capital and deposit base.

Bank deposit accretions since the beginning of this year was over Rs 1.25 lakh crore as opposed to last year's Rs 59,000 crore

(This article was published in the Business Line print edition dated September 11, 2006)
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