Bond yields may hold steady on CRR hike

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Credit offtake slowing; NRI remittances, FII inflow at steady clip

C. Shivkumar

Bangalore, Dec. 10

Bonds softened last week; the Reserve Bank of India's move to hike the cash reserve ratio by 50 basis points came as a shock to the market.

Traders said the RBI step was prompted by the large accretion in the liquidity, largely from expansion in foreign currency flows. The flows were mostly from non-debt capital account both from non-resident Indians and from foreign institutional investors.

At the same time, oil price spikes are beginning to trigger inflation worries. International oil prices are currently at $63 a barrel, implying a basket import price of over $55 a barrel. This has belied market expectations of the basket price falling below $50.

The spike has prompted many companies to resort to forward cover. Besides, banks have also begun taking forward cover against the FCNR deposit redemptions. Forward premiums up to 12 months are now over 2 per cent. Bankers said that forward was resorted to since the NRI deposit inflows have accelerated in recent months. Bankers said that unless they were non-repatriable funds they were all taking forward cover.

The foreign exchange inflows were creating two kinds of problems for the economy. One major problem was that this liquidity was growing at faster pace than the nominal GDP growth and hence was potentially inflationary, bankers said. But the bigger problem faced by the RBI was the cost of interventions in the market, where it was earning a negative spread.

The difference is on the basis of the sterilisation through the reverse repo auctions and the cost of deployment of the dollar resources in dollar denominated short-term securities. The deficit was a little over 1 per cent. On the other hand, using the CRR as tool for intervention addressed both the issues, bankers said.

The high liquidity was evident from the weekend Liquidity Adjustment Facility auction, where the RBI mopped up Rs 17,095 crore. This was despite the auctions of two dated securities, the 7.37 per cent 2014 and the 8.33 per cent 2036. Both these securities were placed at yield to maturity of 7.31 per cent and 7.63 per cent. The securities had attracted bids of over Rs 10,000 crore each. But the retained amount was only Rs 9,000 crore. But for these auctions, the amount mopped through reverse repos would have been higher, traders said.

The liquidity overflow was also evident from the Treasury bill auctions. At the 91-day T-Bill auctions, as against the notified amount of Rs 2,000 crore, the competitive and the non-competitive bids received were Rs 4,216 crore and Rs 1,500 crore respectively. The cut-off yield at the auction was 6.65 per cent, down from the previous week's 6.69 per cent. The weighted yields were also 6.65 per cent at the same level as the previous week. Similarly, at the 364-day T-Bill auctions cut-off yields were fixed at 6.94 per cent, the weighted yields were lower at 6.91 per cent.

With this kind of liquidity situation, there was little upward pressure on the ten-year YTM, which ended at 7.43 per cent last week on a weighted average basis as against 7.45 per cent, the previous week.

Firm undertone

The undertone remained firm, with buyers outnumbering sellers. Last week, for the first time, some of the life insurance companies put out their portfolios for sale that included the 11.43 per cent 2015, which was sold at 7.44 per cent. But the outlook remains mixed in view of the CRR hike. The CRR hike, bankers said, would absorb another Rs 12,000 crore of liquidity from the system in two phases. This siphoning-off of liquidity, traders said, was likely to have some impact during the week.

Yield Curve

Traders said the major impact would only hold yields steady and prevent any further softening. In fact, the flattening of the yield curve would now stop, they added. Last week, the spread between one year and 30 years was rock bottom at 70 basis points. In fact, if yields do rise next week, the real yields are likely to narrow to internationally accepted levels. Based on last week's inflation of 5.30 per cent, the real yields were 1.65 per cent and close to those levels.

Yet credit offtake was also slowing down as more banks have taken note of the Government's concerns over credit directions.

This was evident from the last week's figures released by the RBI, where the incremental credit deposit ratio had dropped to 52.5 per cent way, off the 100 per cent plus figure sustained for over two years.

The fall has, however, translated into a hefty increase in the incremental cash-deposit ratio. On an incremental basis, the cash deposit ratio was 65 per cent. Only a small part of this comprised the statutory balances.

A major portion of this was being parked with the RBI for want of deployment avenues and for arbitrage purposes since some of it was largely short-term funds.

With banks beginning to tinker with deposit rates, long-term funds were likely to become available in the near future for meeting the needs of medium-term and long-term credits.

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