The Hindu Business Line : Yields retreat on high liquidity, weak credit offtake

Traders said sagging international oil prices and weak inflation also contributed to yield retreat during the week. India’s oil import basket price was $46.94 a barrel, down $4 from the previous weekend. Inflation numbers also remained in the sub-one per cent zone at 0.31 per cent.

The yield retreat came despite outflows from foreign institutional investors (FII). FIIs pulled out $180.2 million investments during the four days of trading last week. This was despite the additional liquidity pumped in by the Federal Reserve during the week and promises of more liquidity expansion at the G-20 meeting that concluded last week.

The current fiscal’s Government borrowing programme kicked off with a devolvement to primary dealers, despite the liquidity overhang in the banking system. The auctions offered two securities — 7.56 per cent 2014 and 7.94 per cent 2021. The cut-off yields were set at 6.80 per cent and 7.62 per cent respectively.

However, about 14 per cent of the latter security devolved to primary dealers. This was despite the high bid to cover ratiosof 2.2 and 1.95 times each. This implied that some bids were well over the cut-off yields.

Traders said that the RBI’s unwillingness to accept high bids was conveyed through the high commissions accepted at the underwriting auctions. The commissions were fixed at 23 paise and 39 paise for every Rs 100. Despite this signal, some banks, the largest participants in the Government securities markets, put in high bids, the traders said. Traders said that some banks appeared to be compensating for credit growth slippages and consequent weak net interest margins, pitching high bids at the G-Sec auctions.

Confusion over signals

But traders remained confused over the Reserve Bank of India’s signals to the markets. Traders said the signals appeared to favour yield stability at current levels. But at the special market operations during the week for oil companies’ foreign exchange purchases, yields on the oil bonds were at least 70 basis points higher than normal government securities of identical maturities. For instance, the oil bond 8.20 per cent 2023 was picked up at yield to maturity of 8.11 per cent. The G-Sec 6.30 per cent 2023 was settled at 7.38 per cent on the same day. The RBI’s own norms prescribe a discount of 25 basis points for valuation of such categories of securities.

The SMOs though mitigated the need for refineries to tap foreign exchange markets. The reduced demand for foreign currency as a result allowed the rupee-US exchange rate to appreciate to Rs 50.30. This was despite outflows on account of corporate debt service/redemption payments. But exporters also repatriated funds, taking cues from the Non-Deliverable Forward (NDF — offshore rupee trading where settlement is done in foreign currency, mostly in dollar), where the dollar softened to Rs 50.41 (Rs 51.41). The spread between the NDF and the domestic spot market also narrowed, ahead of the national elections, pointing to possibility of further short-term rupee buoyancy.

Forward premia

As a result, forward premia narrowed across all tenures for one, three, six and 12 months to 4.53 per cent (5.97 per cent), 3.64 per cent (4.30 per cent), 2.97 per cent (3.38 per cent) and 2.30 per cent (2.56 per cent). Cash to spot premia remained at 5.13 per cent as some foreign banks resorted to swaps, ahead of raising deposit resources, though domestic liquidity was comfortable.

The comfortable liquidity was apparent from high recourse to the reverse repurchase window at the weekly Liquidity Adjustment Facility auction. The recourse to the reverse repo window was Rs 69,985 crore. The high liquidity also reflected at the weekly Treasury Bill (T-Bill) auctions. The cut-off yield on the 91-day T-bill was 4.50 per cent and the weighted yield to 4.46 per cent last week, a 45 basis points drop over the previous week. The cut-off yield on the182 day Bill was 4.7 per cent.

The ten-year yield to maturity (YTM) retreated to 6.93 per cent on a weighted average basis last weekend, down from the previous week’s 7.01 per cent.

The undertone was positive as average trade volume per day rose to Rs 12,500 crore, up from the previous week’s Rs 8,700 crore. G-Sec trade volume was almost equivalent to equity trade volume at Rs 12,422 crore at the National Stock Exchange.

Outlook positive

The outlook, consequently, was positive. But traders were worried about the Government’s tight auction calendar for the first half of this fiscal targeted at Rs 2.41 lakh crore or about Rs 10,000 crore per week.

However, traders said, FIIs were beginning to pick up more Government securities instead of equities. In fact, FII investments in debt trade were $75.6 million during the four days of last week. Traders said that this trend was likely to continue and bonds were likely to head for a short rally, though at the cost of equity markets.

Besides, banks are also faced with deposit inflows, triggering requirement for government securities for complying with mandated Statutory Liquidity Ratio (SLR) securities.

During the first two days of the current fiscal alone, banks picked up Rs 2,000 crore of funds through one year certificate of deposit floats. In addition, some banks are also faced with large retail deposit inflows, particularly under the Non-Resident Ordinary Scheme. The inflows are now estimated at about Rs 4,000 crore per day, bulk of it going into the public sector banks.

The inflows prompted banks to resort to some cutbacks in deposit rates, especially at the shorter end. Already some banks have reduced short-term deposit rates. At the longer end though, interest rates would be kept competitive with the small savings rates of 8 per cent, the bankers said. For the banks, it was the weighted average cost of working funds that mattered. Short tenure term deposit rates are likely to come under pressure in the coming weeks.

The requirement, bankers said, was for long-term funds, especially for big ticket infrastructure projects, though credit offtake remained a major area of concern, with incremental credit deposit ratios of barely 57 per cent. This left banks with few alternatives other than parking resources in investments.

Besides, bankers said FIIs’ appetite for corporate debt papers was on the increase and yield spreads were therefore likely to drop.

This has already begun happening, at least for the public sector entities. Triple “A” rated corporate paper yields are currently about 8.1 per cent or a spread of just 120 basis points over 10 year YTM. Three months ago, the yield spreads were closer to 300 basis points. But similarly rated private sector papers still have to pay another additional spread of 100 basis points, though lower than what it was three months ago. But traders said that spreads were also likely to shrink. For the time being, PSU papers will remain the darling of risk-averse investors.

Related Stories:
Bonds dip on concern over rising oil prices
Bond prices dive on Govt’s borrowing plan

More Stories on : Debt Market | Credit Market

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