C. Shivkumar

Bangalore, July 13 Bond yields hit a high as oil prices and inflation continued to gallop. The high inflation numbers kept traders on tenterhooks. Inflation as measured by the wholesale price index was 11.89 per cent. Expectations of policy interventions by the Reserve Bank of India, as a result, remained high.

Hints of further tightening of liquidity were sent to the market, through a resumption of market stabilisation scheme operations. The MSS operations were through the Treasury bill auctions. At the weekly Treasury bill auctions, the notified amounts for both the 91-day and 182 day T-bills were Rs 3,500 crore and Rs 1,500 crore respectively. The normal T-bill components amounted to Rs 500 crore each. The actual mop-up through the 91-day bill auction, inclusive of the MSS, was Rs 4,700 crore at a yield of 9.02 per cent, up 21 basis points over the previous week. At the 182-day T-bill auctions the mop-up was Rs 2,000 crore, inclusive of the non-competitive bids, at a yield of 9.34 per cent.

For the current week, MSS components were kept at Rs 2,500 crore and Rs 1,000 crore. The resumption of the MSS came despite continuous recourse to the repurchase window by banks and primary dealers. At the week-end repurchase auction, the recourse amounted to Rs 45,295 crore. Traders said another hike in the repo rate in the near term appeared imminent.

However, tight liquidity was also beginning to impact oil companies. Oil companies were largely supported through special market operations of the RBI. But the purchases were made at high discounts. The 7.95 per cent 2025 oil bond was picked up at a yield to maturity (YTM) of 9.95 per cent. Clearly oil companies’ costs were on the ascent. As a result, purchase of oil bonds through the SMOs for the week ended July 4 dropped to Rs 2,610 crore, down from the previous week’s level of Rs 4,670 crore. The impact of the SMOs was evident from the steep drop in the country’s foreign exchange reserves by $3.3 billion.

Besides, foreign institutional investors remained sellers during the week. However, despite the FII sales, there was a net inflow of $589 mostly into debt securities. FIIs, traders said, picked up small quantities of government securities mostly short-dated and T-bills, to cash in on the high yields.

This helped the rupee to firm up against the dollar to 42.72. The rupee was also buoyed by non-resident and current account inflows. Forward premia remained almost steady for one, three, six and 12 months at 4.49 per cent (5.55 per cent), 5.34 per cent (5.28 per cent) 4.49 per cent (4.44 per cent) and 3.96 per cent (3.96 per cent) respectively.

However, it was the overnight forward premia that firmed up. Overnight forward premia towards the week-end largely reflected interest rate differentials. Overnight dollar borrowing for foreign banks in US markets cost about 2 per cent. However, lending the same to domestic banks earned about 9.5 per cent, implying a differential of about 7.5 per cent.

But credit expanded sharply. Since the beginning of this financial year credit expanded by Rs 51,000 crore as against a Rs 15,000 crore contraction during the corresponding period of last year.

As a result, liquidity remained tight. The ten-year YTM on a weighted average basis jumped to 9.51 per cent, up 45 basis points from the previous week’s level of 9.06 per cent. This is the highest level since 2001.

Average daily trade volume remained low at a little over Rs 3,000 crore during the week, though higher than the previous week. The rise in trade volumes was largely on account of the RBI’s SMOs. The weak undertone was also evident from the high bid-offer spreads, and the short inter-yield spreads. Bid-offer spreads remained above 20 basis points. The spread between the 91-day T-bill and the 10-year weighted YTM towards the weekend was just 45 basis points.

The bear overhang was also evident from the negative real yields. Real yield is the difference between inflation and nominal yield. The one-year real yield was at least 250 basis points lower than the current inflation rate. The 28-year YTM was lower by at least 220 basis points, implying very high upside risks.

As a result, banks had completely derisked investment portfolios, especially those in the marked-to-market categories. But insurers mostly abstained from making purchases. Purchases were largely by provident funds, traders said. Despite the derisking, banks still expect to see red lined investment portfolios.

Besides, banks’ preference was mostly for short-term securities for meeting reserve requirements. This was due to accumulation of short-term liabilities. Several banks floated certificates of deposits during the week for rates well above 10 per cent. The CDs were partly responsible for spikes in time deposits of banks.

Incremental time deposits this year so far comprised about 175 per cent of aggregate deposits. This trend, bankers said, was largely because many corporates were converting their current account balances into short-term time deposits and parking in T-bills through non-competitive bids.

However, despite this trend, initial signs of a credit slowdown appeared to be dissipating.

Farm credit offtake improved in view of the good monsoons. Farm credit offtake after the loan waiver pushed up the incremental credit deposit ratio to 61 per cent. Bankers’ bottomline worries as a result are now beginning to recede.

© Copyright 2000 - 2009 The Hindu Business Line