The Hindu Business Line : Rise in oil prices, monsoon worry keep yields firm

Bangalore, Aug. 16 Bond yields hurtled northwards driven by surging global oil prices and fears that monsoon deficit may further increase Government borrowing requirements.

Traders said selling of Government debt papers by foreign institutional investors also drove up bond yields. FIIs’ net sell-off during the week amounted to $56.1 million (Rs 271 crore). Selling of both equity and debt amounted to $156.4 million (Rs 750.1 crore).

The sales translated into high demand for dollar, with consequent impact on the exchange rate. Moreover, with oil import basket remaining close to $74 a barrel last week, petroleum refiners covered their payment obligations purchasing forward dollar. However, bankers said refiners’ credit draw-down from the banking system remained moderate, on account of cash surpluses earned from selling their subsidy bonds to financial institutions such as the Life Insurance Corporation of India and from special market operations by the Reserve Bank of India till June.

Forward cover

The dollar demand resulted in the rupee depreciating to Rs 48.30 (Rs 47.86). Importer forward cover also pushed up forward premia across all tenures. Forward premia for one, three, six and 12 months ended the week at 3.05 per cent (2.92 per cent), 3 per cent (2.80 per cent), 2.92 per cent (2.58 per cent) and 2.57 per cent (2.32 per cent) respectively. But the short premia, cash to spot, ended last week at 2.24 per cent (2.35 per cent) in view of high demand for dollar liquidity as foreign banks were net dollar buyers. This was despite the Federal Open Market Committee leaving the Federal Funds target rate unchanged at 0.25 per cent. Federal funds rate is the overnight borrowing/lending rate between US banks and savings institutions.

But exchange rates are likely to stabilise at the current levels, traders said. A pointer in this direction was the Non-Deliverable Forward ((NDF—off shore rupee trading where settlement is done in foreign currency, mostly in US dollars) rate that settled last weekend at Rs 48.30 or lower than the domestic one-month forward rates by at least 10 paise.

Low interest in G-secs

Bond traders took cues from the RBI’s Rs 12,000-crore Government borrowing auctions. At the auctions, the new seven-year paper maturing in 2016 was placed at 7.02 per cent. The reissue securities, 6.35 per cent 2020 and 7.35 2024, were placed at 7.45 and 7.77 per cent respectively. The average ‘bid to cover’ ratio at the auctions was 1.92 per cent. This was an indication of low interest in government securities.

The firm yields and low ‘bid to cover’ ratio were despite the high recourse to the reverse repurchase window at the weekend Liquidity Adjustment Facility auction. Recourse to the reverse repo amounted to a whopping Rs 1,46,473 crore. The diminishing interest in the Government securities was also evident from hardening short-term yields at the weekly Treasury bill auctions. The cut-off yield for the 91-day T-bill was 3.36 per cent, up 8 basis points from the previous week, though the weighted yield remained unchanged.

The ten- year yield to maturity (YTM) closed the week at 7.09 per cent, on a weighted average basis, up from the previous week’s 7.07 per cent.

Most banks, continued to shift their marked to market categories of Government securities to shorter tenures, five years and below. This was also because some banks took in large amounts of certificates of deposits last week refinancing their bulk deposits. Corporates, mutual funds and non-life insurers preferred parking in short tenure CDs, as opposed to one-year bonds and 364-days Treasury bills. The reason stemmed from the better yields of the instruments. One-year CD floated by the Punjab National Bank last week had an yield of 5.87 per cent or about 170 basis points above the one-year G- Sec yields. CD placement volumes, therefore, picked up. Last week, about Rs 4,200 crore were raised through CD placements.

Trade volumes

Trade volumes for G-Secs improved a little. Last week, the average daily trade volume was Rs 8,500 crore (Rs 6,600 crore). But with nominal investment deposit (ID) ratio at 33 per cent and incremental ID ratio at 72 per cent, the increase in trade volume was largely for avoiding negative carry, traders said.

Some banks sold or switched their G-sec holdings to private sector insurers and provident funds as part of the derisking process. This pulled down the one to ten-year spread to 260 basis points. Comparable US Treasury yields were 325 basis points.

The high spreads indicated banks’ reluctance to ascend the yield curve. This was in view of the fiscal uncertainties, as a result of the deficit monsoon. Banks preferred to remain liquid anticipating Government action for the farm sector, credit waiver and increasing credit availability to the sector.

The outlook for bonds remained dim. It is feared that yields could go up further in the coming weeks. Mr A.C. Reddi, Partner, Derivatives Group, said, “Yields will go up by another 50 to 75 basis points by the end of the year.”

But incremental credit deposit ratio appeared to indicate a slight improvement. Last week, the ratio was 13 per cent, after remaining negative or in single digits since the beginning of this fiscal, indicating incipient signs of an economic recovery.

But HSBC’s Asia Economist, Mr Robert Prior Wandesforde, said, “While it is too early in the recovery for the central bank to contemplate tightening policy, the prospect of higher inflation meant further rate reductions are unlikely. We expect the next move in the policy rate to be up, albeit not until the April 2010 policy meeting.”

Inflation on the basis of the WPI was a minus 1.74 per cent, though food price inflation remained over 10 per cent. With monsoon deficit there are fears of further escalation in food prices.

Despite the high food price inflation, deposit rates are likely to come under pressure in the coming weeks. This is because at present deposit accretions into the banking system remained at Rs 2,000 crore per day, with public sector banks cornering the bulk of it. With credit off-take still low, few banks need such high deposit increases. The only way to contain accretions is to snip rates. Some have begun pulling down the short-end rates. More rate rationalisation could be expected soon.

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