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C. Shivkumar

The securities market was dominated by the insurance companies last week. Banks, insurance companies and mutual funds have been aggressively churning their respective debt portfolios during the last few weeks to boost earnings profile. As a result, average daily volumes are about Rs 12,000 crore both in the National Stock Exchange and Subsidiary General Ledger counters.

BOND markets continued to propelled by the liquidity overhang and yields plunged to two-decade lows.

The ten-year yield to maturity (ytm) dropped to 7.65 per cent last weekend. The previous week the ten-year ytm was 7.77 per cent. This fall was accelerated by a surge in high-powered money supply growth, primarily foreign exchange reserves.

The foreign exchange reserves of the country are now on the verge of hitting a record $50 billion. By the end of this fiscal, expectations are that the foreign exchange reserves could be swell above this level.

The market's favourite securities benefited from this bull run. The 11.40 per cent 2008 ended last week at 7.19 per cent, the 11.50 per cent 2011 at 7.65, the 11.03 per cent 2012 at 7.66, 9.81 per cent 2013 at 7.69 and the 9.85 per cent 2015 at 7.82 per cent. The previous week end these securities were quoted at 7.31 per cent, 7.77 per cent, 7.78 per cent, 7.82 per cent and 7.96 per cent respectively.

But traders said, falling yields have created two many skews in the yield curve. One such glaring skew is the repo rate which is currently at 6.5 per cent. For almost two weeks financial markets have been expecting a repo rate cut, though this has still not materialised.

Currently, traders say, with yields now headed towards 7.5 per cent during the course of the next month, drastic corrections in the repo rate would be necessary.

The securities market was dominated by the insurance companies last week. Banks, Insurance companies and mutual funds have been aggressively churning their respective debt portfolios during the last few weeks to boost earnings profile. As a result, average daily volumes are about Rs 12,000 crore both in the National Stock Exchange and Subsidiary General Ledger counters.

However, some of the asset management companies are still holding to Government securities. This is because of budgetary expectations. Funds expect the Budget to offer major sops for foreign direct investments in the country. This in turn is expected to create further expansion in the reserve money induced liquidity.

While liquidity surge has resulted in plunging nominal yields, real yields continue to remain unchanged ranged around 5 per cent. Further downward drifts of inflation rates cold in turn push down yields further, they added.

But this is hardly good news for the banks. Average asset yields have been falling too fast, which is now beginning to become a cause of worry.

Further the scope for reduction in deposit rates is also becoming slim for the public sector banks.

This is especially because the some of the private sector banks like ICICI and UTI Bank have begun offering higher rates on term deposits, compared to nationalised banks.

Consequently one of the major worries is the low incremental credit deposit ratio growth, which is barely 30 per cent, for most of them.

Earnings are entirely from incremental investment deposit growth. As a result incremental spreads are also becoming thinner for banks.

For insurance companies, the portfolio churning is necessary to compensate for the low growth in the premium income profiles and the need to balance their income streams from investments to neutralise the impact of high claims. Insurance companies have traditionally been incurring underwriting losses in the country.

Traders now indicate that this selling is unlikely to abate during the rest of the fiscal year and could lead to a further plunge in yields. The reason attributed for this trend, is liquidity overhang.

But one element that is beginning to worry the banking sector is the low inflation level. Inflation is under 2 per cent. "These low levels of inflation actually imply a deflation, with wide ramifications on the rest of the economy,'' they said.

The major worry is that instead of credit off take, the deflationary situation currently prevailing would lead to a build-up of non-performing assets in their portfolios. Such fears are already becoming evident in the widening spreads between corporate securities and Government debts. These spreads are currently about 4 per cent over sovereign yields.

The high spreads notwithstanding, the fact of the matter is that corporates are still in a position to raise resources at sub PLR rates from the bond markets.

Consequently given this kind of a situation, banks are now expected make a further correction to these rates, traders said.

At least through this method, some credit expansion is expected to push up demand.

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