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C. Shivkumar

Bangalore, May 6 With bulk deposit rates plunging below the Reserve Bank of India’s new repurchase rates of 4.75 per cent, general insurers and mutual funds are beginning to chase high rated commercial papers.

With financial markets inundated with liquidity, Certificate of Deposit (CD) rates have crashed. Public sector banks United Bank of India and Punjab & Sind Bank were able to place six-month CDs at 4.49 per cent. United Bank also managed to place 3-month CDs at 3.7 per cent. In April this financial year, CD rates were as high as 7 per cent or at least 200 basis points over the then prevailing RBI repo rate.

The low rates now implied that banks had little interest in raising bulk funds. Consequently, banks, particularly public sector banks, were in a position to dictate rates. Banking sources said that faced with low interest in such funds, some of the public sector insurers were beginning to park some resources in CPs to improve their mean yields on investments. General insurers prefer short-term instruments for liquidity.

The shift in preference was largely in view of the high yields on CPs. CPs are short-term debt instruments floated by non-bank entities and corporates for maturities up to one year. The chase for CPs has resulted in yields dropping sharply. CP yields were 14 per cent in January this year. Among the companies that are in the CP market currently include L&T Finance that raised Rs 25 crore at an yield of 5.5 through three-month CPs. Sundram Finance paid 7.10 per cent for one-year CPs to raise Rs 50 crore.

The sources said insurers were faced with sinking mean yields this year with the sharp drop in government security yields.

Insurers normally prefer high yields since it implied high investment incomes. A drop in mean yields implied that investment incomes would come under pressure, especially since insurers seldom resort to large treasury operations.

That mean yields were under pressure was evident from the trend in the ten-year yield to maturity that is currently hovering around 6.1 per cent. Given the current liquidity overhang in the financial markets, these rates are now expected to drop below 6 per cent.

The liquidity overhang was evident from the high recourse to the reverse repurchase window. Reverse repurchase implied removal of excess liquidity from the banking system through sale of securities. At Wednesday’s Liquidity Adjustment Facility auction, recourse to the reverse repo window amounted to a record Rs 1.44 lakh crore. At the 91- day T-Bill auction, the yields, as a result of the high liquidity, dropped below the reverse repurchase rate of 3.25 per cent to 3.15 per cent. The weighted yield was even lower at 3.11 per cent.

As a result, there was intense speculation among bankers that there could be one more reduction in the policy rates. Mutual funds, accordingly, were purchasing CPs hoping to sell the papers at lower yields in the secondary markets when the policy rates drop further.

More Stories on : Short Term Instruments | General Insurance | Mutual Funds | Interest Rates

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