The Hindu Business Line : Bond yields rise on Credit Policy concerns

Bangalore, Oct. 4 Bond yields resumed their upward momentum as banks and mutual funds sold some of their holdings ahead of the peak season Credit Policy.

Traders said the uptick in yields was also partly triggered by fears that the Reserve Bank of India was likely to initiate an exit from the easy liquidity policy. The concerns were also reinforced by the high food price inflation in the country. Food price inflation remains close to 16 per cent. Besides, statements that wholesale price index rise was likely to accelerate to 6 per cent before the end of this fiscal, by Ministry of Finance Economic Advisor, Mr Arvind Virmani, also made traders nervous.

Capital inflows

But foreign capital inflows sustained during the week, though they were largely driven by Participatory Notes. The inflows, traders said, accelerated after the G-20 meeting concluded in Pittsburgh. The meeting had called for eliminating regulatory arbitrage around the world and making banking haven operations transparent. As a result, FII inflows last week were $855 million (Rs 4,104 crore).

However, there were little export inflows. Export growth actually contracted 19.4 per cent in August. Yet the rupee remained firm at Rs 47.86 (Rs 47.98) against the dollar on the back of non-debt capital inflows. But imports also continued to contract. In August, import contraction was 32 per cent. Non- oil imports fell 26 per cent. This trend was evident from the direction of the forward premia. Forward premia eased slightly, last weekend indicating that few importers were taking cover. But exporters were also not hedging either.

Forward premia

As a result, forward premia for one, three and six months eased slightly to 2.67 per cent (2.78 per cent), 2.78 per cent (2.86 per cent) and 3.02 per cent (3.10 per cent) respectively. Most of the hedging was entirely on the capital account, by corporate settling or refinancing external liabilities, leading to a slight hardening of 12-month forward premia to 3.12 per cent (3.08 per cent).

Short forward premia remained firm at 2.35 per cent (2.33 per cent) as foreign banks took advantage of the long weekend in the Indian markets and resorted to sell-buy swaps, for arbitraging on the RBI’s reverse repo rate at 3.25 per cent. The outlook for exchange rates remained stable, though with a slight upside bias in the coming weeks. Traders said that more inflows are expected through PNs. But banks are also seeing inflows from non-resident deposits, mostly short-term deposits. Traders said that these funds were mostly coming in for taking advantage of the IPOs expected in the next few weeks from some public sector undertakings.

This expectation was reinforced by trends in the Non-Deliverable Forward market (NDF is the offshore rupee trading where settlement is done in foreign currency, mostly in US dollars), where the rupee-dollar rate closed the week at Rs 47.83 (Rs 48.15) or about three paise above the spot exchange rate. The rupee’s upside, however, was likely to face resistance, according to the HDFC Bank’s treasury and economic research report.

The report said, “Any sustained move below the 47.50 mark is unlikely at this stage because of the key reasons: (a) global oil prices are likely to increase over the next quarter and act as a natural resistance to significant rupee appreciation, (b) we believe that the equity market valuations are entering bubble territory and this will trigger selling both in the stock and foreign exchange markets.”

Tightening of liquidity

The capital inflows notwithstanding, liquidity slightly tightened last week. This was despite the absence of government borrowing. The tightening was evident from a compression in the recourse to the reverse repurchase window. Recourse to the reverse repo was only Rs 80,265 crore. Till September-end, the amount parked in reverse repos had topped Rs 1 lakh crore. Traders said that the tightening was partly on account of banks’ attempts to shore up their loan books ahead of the second quarter.

Most credits though are short-term loans. Redemption of the loans was expected to translate into a liquidity overhang once again. Expectation of the overhang was evident from the Treasury Bill auctions.

The cut-off yield on the 91-day T-bill dropped to 3.15 per cent, down from the previous week’s 3.40 per cent. The softening trend was also discernible in the 182 day T-bill, where the cut-off yield was 3.8 per cent.

A fortnight ago, the cut-off yield on the 182-day bill was 4.03 per cent. The ten-year yield to maturity, however, ended the week at 7.21 per cent on a weighted average basis, up from the previous week’s 7.12 per cent.

Average daily trade volumes dropped sharply last week to Rs 14,500 crore (Rs 16,200 crore). Traders said that the drop in trade volumes were largely on account of selling pressure from mutual funds anticipating repurchase pressures from banks. Banks' outstanding holdings of mutual fund units were about Rs 1.56 lakh crore. But last week was marred by holidays and had only two trading days. Equity trade volumes remained high averaging about Rs 20,000 crore per day. Traders said selling by banks and funds was also partly triggered by the RBI's calendar for the second half of the current year.

So far, the RBI has completed about 66 per cent of the gross borrowing target. Average borrowing is expected to be around Rs 7,000 crore per week or about Rs 3,000 crore lower than the first half. Traders said most of them expected to churn their investment portfolios. The outlook for bonds remained buoyant, as a result. Most traders also expected the RBI to restore the Statutory Liquidity Ratio (the quantum of mandated G-Sec investments by banks as a component of their deposits) to 25 per cent. At present, ly the SLR is 24 per cent. This was partly to facilitate the Government borrowings. An SLR hike was possible, traders said, in view of the already high investment-deposit ratios of banks. Banks currently have investment-deposit ratios of close to 33 per cent. Incremental IDR this year so far is 72 per cent. An SLR hike would, therefore, have a minimum impact on the weak credit, though at same time conveying a signal of interest stability. "The options for hiking policy rates to contain inflation are very limited in a weak credit off-take environment," a trader said.

Hikes in the cash reserve ratio (CRR - mandated bank cash balances as a component of deposits) was also ruled out for the same reason. Policy rate hikes or CRR hikes tend to have a pass through impact, leading to higher rates with the potential to further dampen the credit environment. Already most banks are operating under an incremental credit- deposit ratio of barely 19 per cent and stressed net interest margins (NIM). The stress prompted banks to park funds in short-term loans with the corporate and also pick up of corporate debt to boost their asset books. This was evident from the increased corporate debt trade volume in the NSE that was close to Rs 1,000 crore per day last week. To mitigate NIM stress the banks are expected to further cut-back short-term deposit rates. The focus has shifted to long-term deposits. This trend was evident from banks insisting on one-year certificates of deposits, though rates were on the retreat to about 5.75 per cent. This is likely to fall further in the coming weeks in tandem with mounting inflows.

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