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Bond markets witness surge in liquidity

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C. Shivkumar

BONDS firmed last week powered by a surge in deposits and a slight slowdown in credit off take towards the year-end.

Traders said that what also ensured the firm trend during the week was the absence of any large Government borrowings and coupon flows.

In fact, the Government had a cash surplus with the RBI equivalent to about Rs 45,000 crore.

Traders said that deposits accretion with the banks remained buoyant last week, as a result of rate adjustments, both at the short-end and at the long-end. Banks have faced a surge of short-term time deposits last week.

Further, traders said, oil companies stayed away from the markets.

Twin advantages: Oil companies were waiting for prices to drop below $40 a barrel, traders said. Below this price they expect twin advantages of both low prices and a favourable exchange rate.

Typically, when oil companies begin sourcing the market for foreign exchange, bond yields tend to rise.

Liquidity surge: There was a sudden liquidity surge in the markets. This was reflected in the week-end three-day reverse repo auctions where the RBI mopped up close to Rs 2,500 crore.

The surge also pushed down yields on the 91-day T-bills, slightly down to 5.41 per cent last week from 5.49 per cent.

The 10-year yield to maturity (YTM) also softened slightly as a result of the liquidity impact. The 10-year YTM on a weighted average basis was 6.77 per cent, down slightly from last week's 6.82 per cent.

With the transition into 2005, the Fixed Income and Money Market Dealers Association 10-year benchmark is the 7.38 per cent 2005 security.

Bankers also said that the rally was unlikely to be sustained, evident from the low trading volumes.

Trading volumes: Daily average trading volumes were only about Rs 3,000 crore as against the comparable period of last year, when it was more than double. Moreover, the yield spreads between one year and 23 years continued to remain wide at 140 basis points.

The only positive factor favouring a softening interest rate was inflation. Inflation continued to retreat for the fourth successive week. Inflation for the latest reporting week was 6.5 per cent.

At this rate of inflation, real yields beyond six years were positive by anywhere between 10 and 75 basis points. But these real yields were far lower than international levels, where it is about 1.5 per cent.

Bearish outlook: Despite retreat in inflation, the outlook for bonds continued to remain bearish. Traders said that some of the insurance companies were expected to sell in the coming weeks, as most of them would be requiring funds to settle claims.

Life insurance companies are selling since they have larger claims from the Tsunami disaster.

Further, traders said that liquidity was likely to taper off in the coming weeks when oil companies would begin to take advantage of the current exchange rates and low long-term forward premia. Foreign exchange inflows have already tapered off, especially current account flows.

Part of the reason, traders said, was that most exporters had still not begun repatriating their earnings back into the country.

FII inflows: The reason for this deferral was partly on account of the intervention of FIIs in the equity markets, they said. FII-driven inflows have pushed up the rupee-dollar exchange rate to 43.25. But, despite the appreciation, the forward premia continues to be inverted.

This was partly because most of the institutional investors have covered for the short term, one month, where the premia was close to 3 per cent.

At the long-end, six months to 12 months, it continues to be close to 2 per cent. The reason was that in the medium to long-term, major inflows were expected in the form of ADRs.

Forex reserves: The rupee appreciation resulted in inflating the exchange reserves.

For instance, in dollar terms, the exchange reserves went up by $394 million to $131.015 billion. On the other hand, in rupee terms, the reserves actually shrank by Rs 1,045 crore.

Quarterly results: Besides, traders said that credit offtake was expected to resume next week now that the third quarter results of the banks are being finalised.

During the last few weeks, the credit-deposit ratios slightly weakened to 61.5 per cent.

This was partly on account of Rs 11,000 crore surge in deposits, led by short-term time deposits. Non-food credit growth, on the other hand, was barely Rs 6,000 crore.

With investment-deposit ratios continuing to be in the region of about 45 per cent, traders said that most banks were in a position to sustain much higher incremental CD ratios. Already, in anticipation of large credit growth, several banks have begun hiking deposit rates.

Bankers said, however, that despite expected increase in credit growth and the possibility of a bunching in Government borrowings, there was unlikely to be any major pressure to hike the benchmark prime-lending rate that varied between 10.5 per cent and 11 per cent.

Only the discounts to the PLR would begin narrowing.

(This article was published in the Business Line print edition dated January 3, 2005)
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