Fearing impact on bottomlines Banks not willing to sell benchmark securities

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C. Shivkumar

BONDS remained weak throughout last week ahead of the year-end as international events, particularly oil prices, kept traders edgy.

Traders said that the hike in the US Fed funds rate to 2.75 per cent last Tuesday was within expected lines, but most of them have already factored for more hikes in the coming months.

Anticipation of further hikes when the Federal Open market committee meets on May 3 was driving out some of the foreign institutional institutions from the domestic markets, traders said.

But, oil prices continued to roil the debt markets.

Last week, oil prices slipped slightly off the record high levels, prompting several companies to enter into the markets and tie up their future supplies.

Oil prices: Crude oil retreated from $57 a barrel to about $55. This pushed oil companies to lock into current prices for meeting their imports. The companies also simultaneously locked into forward covers in the foreign exchange markets to take advantage of the current dollar-rupee exchange rates.

Hardening yields: These events reflected in the 91-day Treasury Bill auctions. At the auctions, the cut-off yields hardened to 5.36 per cent, up 16 basis points from previous week's 5.20 per cent. Moreover, the events also led to a contraction in the reverse-repo auction mop-up.

The mop-up was barely Rs 10,000 crore, down from the average of Rs 25,000 crore siphoned out during the previous eight weeks through three-day reverse repo auctions.

Yet, the 10-year yield to maturity remained steady at 6.71 per cent on a weighted average basis last week. But bonds failed to react to the Finance Minister's statements that interest rates would not increase during the next six months.

Trading volumes were also low, indicating a weak undertone in the markets.

Trading volumes: Average daily trading volumes were barely Rs 2,500 crore during the week. What ensured the steady yields at these levels was year-end valuation concerns. Most banks were not prepared to sell their benchmark securities, leading to any price falls.

This was, particularly, because any sharp rise in yields would automatically impact their bottomlines for the year-end through high depreciation.

Shifting funds: Yields at the long-end remained flat, as life insurers, who had booked profits in equities, shifted some of their funds to government securities to lock into high-coupon securities at low prices.

The favoured securities were the 11.43 per cent 2015, 10.79 per cent 2015 and 9.85 per cent 2015. These securities were lifted at yields of 6.90 per cent and 6.77 per cent.

The outlook, despite the interest from life insurers, remained bearish. This was evident from the high spread of 142 basis points between one year and 23 years.

Inflation: Moreover, with inflation at 5.23 per cent, real yields widened slightly to 40 basis points (0.4 per cent) for one year, up from last week's 30 basis points. Despite the widening trend, real yields were still considerably below international levels of 1.25-1.5 per cent. This implied that there was scope for nominal yields to widen a little more in the coming weeks.

Traders said that foreign institutional investors' selling spree in the equity markets was also pushing up the yields. Yet, the spelling spree failed to impact the forex reserves.

Forex reserves: In fact, there was an accretion of $1.7 billion to the reserves, pushing it up to a record $142.13 billion.

But FIIs' exits were evident from the wide forward covers for up to one month.

This was close to two per cent, though long forwards, beyond six months remained narrow below 1.5 per cent.

This was partly on account of the fact that exporters have taken forward cover at the long end, hedging against any possible rupee appreciation. Besides, some corporates have also taken cover against their inward remittances of planned external commercial borrowings.

Credit growth: In addition to external factors, traders said, credit growth was also helping driving up yields, as more banks were keen to push down their high investment-deposit ratios of about 44 per cent, closer to the prescribed statutory liquidity ratio of 25 per cent.

The incremental credit-deposit ratio was 82 per cent. Almost the entire credit growth was powered by non-food credit growth.

Non-food credit growth since the beginning of this year has grown by over 25 per cent. Food credit has not shown the same pace since the Food Corporation of India was actually reducing its borrowings through foodgrain export earnings.

Traders said that next year yields were likely to harden further, help banks to reshuffle their low-yield portfolios with high-yielding ones.

Govt borrowings: This was on account of the large government borrowings planned during the first half of the year. Most traders were anticipating that if current trends continued, the cost of government borrowing was likely to escalate by at least another 25 basis points.

But the situation is likely to worsen for the State governments that are expected to directly tap the markets for about Rs 30,000 crore. Already their borrowing costs are at least 50 basis points more than sovereign's.

Direct foray into the markets is likely to widen those spreads further.

(This article was published in the Business Line print edition dated March 28, 2005)
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