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Oil prices, insurers support bonds

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Good deposit accretions have banks chasing SLR papers

C. Shivkumar

Bangalore, Sept. 24

Bonds remained firm during the week supported by weak oil prices and stepped-up purchases by insurance companies. Traders also said that with the oil outlook remaining bearish, some of refiners and marketing companies had deferred their drawdowns on their credit lines. International oil prices are currently at $60 a barrel level and India's weighted average import prices have dropped to $55 a barrel.

But credit offtake remained buoyant, resulting in liquidity remaining tight. Advance tax payments by corporates also ensured a slight tightness in liquidity. This was reflected at the week-end liquidity adjustment facility auctions, the Reserve Bank of India mopped up only Rs 14,555 crore through the reverse repurchase operations.

Cut-off yield

At the weekly Treasury Bill auction this tightness was evident from the hardening yields. The cut off yield on the 91-day T-bill was 6.52 per cent, though the weighted average price was 6.48 per cent last week. This was up from the previous week's 6.44 per cent. Similarly the 182-day T-Bill also remained high at 6.78 per cent.

However, despite the hardening at the short end, the 10 year yield to maturity softened to 7.66 per cent on a weighted average basis last week, down from the previous week's 7.75 per cent.

Fed Funds Rate

The softening was partly on account of the US Federal Reserve board pre-empting market expectations of a hike in the Fed Funds rate. The Fed Funds rate is the inter bank interest rates for overnight borrowing / lending. Some of the foreign banks in the country had borrowed in call and used the resources to purchase foreign currency hoping to take advantage of the rise in Fed Funds rate.

The return of these funds resulted pushing down yields. Besides, insurance companies were also large buyers, especially the life insurance corporation of India. LIC is buyer for the Government securities, putting on hold its equity purchases for the moment. This strategy was copied by LIC's private sector rivals as well, who have preferred to follow the leader as a strategy to avert losses. Preferred purchases were of the 8.35 per cent 2022. Provident and mutual funds picked up the 7.59 per cent 2015 oil bonds at yields as high as 8.5 per cent.

Dated Securities

The outlook remained firm, traders said despite the hardening at the short end and thinning trade volumes. Trade volumes dropped to under Rs 1,500 crore. But the yield spread between one year and 29 years widened to 143 basis points, down from the previous week's 160 basis points. Besides, the bid offer spreads also remained narrow up to 20 years.

The reason for this was that few banks have long-dated securities in their portfolios. Only some mutual provident funds have long-dated securities. Most of the long-dated securities have been cornered by the LIC. Consequently, for thin volumes, the yields quoted tended to be very high.

SLR obligations

Besides, banks are also chasing securities for meeting their Statutory Liquidity Ratio obligations with the deposit accretions. Deposits are growing at 21.5 per cent, pushing up the demand for securities. In fact most banks currently have a G-Sec investment-deposit ratio of only 27 per cent, almost consistent with SLR of 25 per cent.

The fundamental factors favoured a firm trend in bonds, traders said. Currently the real yield is 2.4 per cent. International real yield trends are about one and 1.5 per cent. With oil prices, retreating inflation threat has abated. Consequently real yields are also expected to retreat to international levels.

Besides, most bankers are still not keen to push up credit beyond current levels anticipating the RBI's peak season credit policy. With currently money supply growth at 19.5 per cent, bankers are beginning to speculate about another rate hike in the offing, or a change in the saving banks rates, which at 3.5 per cent is acting as a floor.

(This article was published in the Business Line print edition dated September 25, 2006)
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