The Hindu Business Line : Bond yields harden on hopes of credit impetus

Bangalore, Oct. 18 Bond yields sustained the upward momentum ahead of the Reserve Bank of India (RBI) peak season Credit Policy with mounting expectations of a credit impetus.

Traders said the hardening was also caused by the absence of large buyers such as insurance companies and provident funds during the week.

The upward momentum was also powered by incipient credit off-take in the farm and retail sectors. But the off-take was not very significant.

Buoyant non-debt foreign capital inflows also failed to prevent yields from hardening. The inflows were mostly driven by Participatory Note (PN) issuances of foreign institutional investors (FII). According to data available, outstanding PNs were in excess of Rs 1.1 lakh crore till August this year. FII inflows amounted to $1.15 billion this month so far.

Year-end phenomenon

However, traders said, the FII inflows were largely a ‘year-end phenomenon’. This was because FIIs traditionally tend to buy in the last quarter to book profits during the year-end. Besides, the $700-billion Troubled Asset Relief Programme of the US is expected to come up for review in December. Accordingly, traders said, till such time, the US dollar was likely to continue its status as a carry currency for investments in markets such as India.

Supported by FII inflows, the rupee appreciated to Rs 46.27 (Rs 46.5) against the dollar. But the forward premia for one, three, six and 12 months hardened to 2.76 per cent (2.61 per cent), 3.11 per cent (2.90 per cent), 3.46 per cent (3.23 per cent) and 3.40 per cent (3.22 per cent) respectively, as importers, refiners and corporate took forward cover. Exporters stayed away, preferring to wait for some more time.

But short forward premiums eased, as interest rate differentials narrowed slightly as takers for sell-buy swaps shrank in the markets. Traders said that the low interest for dollars was also on account of the exchange rate appreciation that cut the arbitrage spreads from the RBI’s reverse repurchase window. The overnight premium, cash-spot, was 2.38 per cent (2.92 per cent).

Although a correction appeared imminent towards the year-end the upside bias still remained. The bias was evident from the Non-Deliverable forward (NDF — off shore rupee trading where settlement is done in foreign currency, mostly in US dollars) rate that ended the week at Rs 45.85 (46.49) or about 50 paise cheaper than the domestic one month rate leaving the arbitrage window wide open. However, traders said that this window could close after the TARP programme review. Besides, the FII outflows could also trigger the correction.

Bid to dampen inflation

Traders said that liquidity slightly tightened during the week. The tightening was largely on account of the RBI’s non-intervention in the financial markets and allowing the rupee to appreciate. The stance was largely on account of inflationary concerns. Allowing the rupee appreciation tends to dampen inflation. This effect was evident from the retreat in food price inflation to 13.34 per cent down from the previous week’s 15.4 per cent.

Tight liquidity was reflected in the reduced recourse to the reverse repurchase window at Rs 76,500 crore at the weekend LAF (Liquidity Adjustment Facility) auction. But the tightening also pushed up the costs of the Rs 10,000- crore government borrowings. The new five-year security that was issued at the auction was bid at 7.32 per cent. But the reissue securities — 6.35 per cent and the 7.35 per cent 2024 were bid at 7.92 per cent and 8.35 per cent respectively. The auctions saw a ‘bid to cover’ ratio of 2.5 times. The acceptance of the high yield bids, traders said, indicated that the RBI was not averse to such increases to ensure placement of the borrowings.

But that yields were on the accent was also conveyed at the weekly Treasury bill auctions. At the weekly auctions, the 91 day T-bill cut-off yield was 3.23 per cent unchanged from the previous week. The high yields at the placements though pushed up the 10-year yield to maturity on a weighted average basis to 7.41 per cent, up from the previous week’s 7.3 per cent.

Trade volumes weak

Trading activity remained weak during the week and was evident in the trade volumes of barely Rs 3,500 crore per day. More banks were sellers ahead of the Credit Policy. Yield spreads, between one and 10 years, remained close to 300 basis points, as long-term yields hardened. The high spreads were in line with international trends. The US dollar- treasury spreads between one and 10 years still remained at around 295 basis points. In the domestic market, the high spreads were largely because banks prefer to remain derisked in their investment portfolios, preferring to keep their ‘marked to market’ exposures to the barest minimum.

The low trade volumes were also compounded by the festival season, as banks attempted to push credit. The credit push resulted in improving the incremental-credit deposit ratio to 34 per cent. In absolute terms, credit growth this fiscal year so far was Rs 97,000 crore but only half of last year’s level of Rs 1.89 lakh crore.

Bankers admitted that the credit increases were mostly teaser loans or short-term credit, at low initial rates of interest. Investment-credit demand remained weak, as corporates deferred off-take of sanctioned advances. As a result, incremental investment-deposit ratios remained high at 73 per cent. The high incremental IDR continued to bring in investment fatigue into the banks.

The fatigue was also because, the average yield on funds were down. Yield on funds, weighted average of both credit and investments, is barely 8.4 per cent. In fact, traders said one major reason for the high bids at the auctions were the shrinking yield on funds. But bankers said that even this yield on funds was not defensible, if the current weak credit off-take situation continued.

Deposit rates

Banks therefore tinkered with the deposit rates to protect their respective net interest margins. Banks raised their quantum of certificates of deposits to take advantage of the prevailing low rates. One year CDs are just 5.5 per cent.

The more aggressive banks preferred shorter tenure CDs of barely three months at 3.8 per cent. The shift to longer tenure deposits are expected only after the RBI’s peak season Credit Policy announcement.