The Hindu Business Line : Bond yields firm as RBI steps in to contain liquidity surge

Bangalore, Sept. 30 Bond yields firmed during the last week as the Reserve Bank of India (RBI) intervened and put in new measures for containing liquidity surge.

Traders said what also pushed down bond priceswas the last minute rush for payment of advance taxes by corporates. Oil prices at over $82 a barrel also influenced bonds. The high oil prices have driven refineries, both public and private sector, to tap the spot foreign exchange markets for taking delivery of their shipments.

But traders said that foreign institutional funds and non-resident fund inflows into the domestic equity markets outstripped the demand. Net FII inflows were over $1.7 billion, according to data from the Securities Exchange Board of India.

The inflows resulted in the rupee’s appreciation and further narrowing of forward premia. The rupee, since the beginning of this year, has appreciated by 15 per cent over the corresponding period of last year and close to 9 per cent from the beginning of this financial year. But there is little evidence that the inflows are likely to abate. In fact, the narrowing forward premia indicate otherwise. Forward premia across all tenures are well below one per cent.

The inflow prompted the RBI to relax some capital account transactions. Debt prepayments were hiked to $500 million.

The slew of measures included hiking domestic investments in foreign subsidiaries to up to 400 per cent of the net worth, enhanced portfolio investments by domestic corporates and increase in domestic mutual funds investments in foreign equities of up to $5 billion. This was partly to neutralise the liquidity in the banking system.

LAF auctions

The liquidity surge was evident from the week-end liquidity adjustment facility auctions. The recourse to the reverse repurchase window was Rs 9,735 crore.

The advance tax liability also drove some banks to the repurchase window (injection of liquidity through purchase of securities). Recourse to the repos window amounted to Rs 3,665 crore.

The high liquidity was despite the two market stabilisation scheme (MSS) and Treasury Bill auctions. The MSS placements through the 5.48 2009 and the 5.87 2010 securities mopped up Rs 10,000 crore.

At the T-Bill auctions, the cut-off yield on the 91-day security firmed to 7.19 per cent last week, up from 6.98 per cent. The weighted yield, however, was 7.10 per cent. Bids at the auctions amounted to Rs 5,255 crore (Rs 4,255 competitive and Rs 1,000 non-competitive) reflecting the liquidity accretions.

The actual retention was Rs 4,500 crore, inclusive of the single non-competitive bid of Rs 1,000 crore.

At the 364-day T-bill auction, the cut-off yield was 7.50 per cent last week. Against a notified amount of Rs 1,000 crore, inclusive of the MSS, the actual retention was Rs 3,375 crore.

The aggressive policy and market interventions, along with the tax payments pushed up the 10-year yield to maturity on a weighted average basis to 7.98 per cent last week, up from the previous week’s 7.90 per cent.

The under tone was weak. Daily average trade volume last week was Rs 3,600 crore at the CCIL trading platform. The bid-offer spreads were as high as 20 basis points due to low trading interest. Besides, insurers made some outright sales.

This was largely to substitute their G-Secs with equities. As a result, securities such as the 10.71 2016 returned to the markets at 8.09 per cent. Some losses were booked in the sale of this security, since insurers had picked this security in 2003 and 2004 when the YTM was under 6 per cent at that period.

The inflation numbers were positive for bonds. The year-on-year inflation was 3.23 per cent, the lowest in three years translating into a one-year real yield of over 4 per cent. But a correction was expected.

This was largely on account of the anticipated hike in oil prices in the coming weeks, with the weighted average oil import price nudging $80 a barrel. Consequently, any correction in the wide real yields would only be through inflation rising instead of nominal yields retreating, a bank economist commented.

One method of inflation containment was by allowing the rupee to appreciate.

However, there was little alternative to hiking domestic petroleum prices. As a result, bankers are now expecting another hike in the cash reserve ratio (CRR), as a low-cost liquidity mop-up mechanism to check money supply and inflation containment.

Credit off-take

Yet, the steps were unlikely to have any major hike in interest rates. Credit is yet to pick up. Since the beginning of this year, credit off-take was just Rs 54,908 crore, half of what it was during the corresponding period of the last year. Besides, the incremental credit-deposit ratio, for the first time since the beginning of this year, was over 100 per cent.

But this trend was largely on account of a drawdown on demand deposits by corporates. Incremental investment- deposit ratio was 48 per cent, well over the prescribed 25 per cent statutory liquidity ratio.

However, bankers were quietly beginning to dispose of their other investments that included equity holdings. For the latest reporting fortnight, banks had liquidated Rs 221 crore worth of investments.

Bankers said that despite the slow credit offtake, they still preferred to remain invested in short dated securities, particularly T-Bills.

Few banks were interested in extending the tenure of their investments beyond two years. The peak season policy is expected to provide an impetus to credit.