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Monday, Feb 25, 2002

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Bond yields rise on profit-booking

C. Shivkumar

THE bond markets were mixed last week as profit-taking by non-bank players and fears that interest cuts are likely to be deferred briefly, pushed up yields.

The 10-year yield to maturity (YTM) ended last week at 7.44 per cent. In the previous week, it had touched 7.25 per cent, breaking the sustained rally since the beginning of the year. However, during the course of last week's trading, the 10-year yields breached the 7.50-mark, before settling back to 7.44 per cent.

Traders said the key elements that influenced the reversal in the markets was the sudden rush of selling by primary dealers, insurance companies and funds, who have booked profits.

The 11.40 per cent 2008 ended last week at 7.10 per cent; the 11.50 per cent 2011 at 7.40 per cent; the 11.03 2012 at 7.45 per cent; the 9.81 per cent 2013 at 7.46 per cent; and the 9.85 per cent 2015 per cent at 7.52 per cent.

In the previous week, these securities had closed at 6.87 per cent, 7.24 per cent, 7.26 per cent, 7.25 per cent and 7.34 per cent respectively.

Traders also said that PDs had booked profits on sales of the 8.07 per cent 2017 security auctioned in the previous week. However, the sales volumes were low, which is indicative of traders' prejudice against low coupon securities. Such a dislike for low coupon is due partly to the low current yields.

Traders said that last week's selling was also influenced by developments in the foreign exchange markets, where the rupee weakened to Rs 48.74 to the US dollar.

But dealers said that this development alone could not be attributed for the sudden yield reversal. The reason being that the foreign exchange flows into the country were likely to remain on course for the rest of the financial year. This, in turn, implies that the banking system is expected to see reserve money induced liquidity expansion.

However, several insurance companies have been resorting to aggressive selling of securities in the markets. What was being done in trickles has suddenly escalated, leading to a pushing down of prices or a pushing up of yields.

Among the sellers in the market was the Life Insurance Corporation, which sold Government securities to take advantage of low equity prices. Such portfolio balancing was also done by some of the mutual funds, especially the balanced funds. During the last few months, some of these funds had gone overweight in gilts and public sector bonds, which they shed to book profits.

For the banks, the yield pick-up is proving to be the light at the end of the tunnel.

Current data reveals the possibility of an industrial pick-up, especially in some of the infrastructure industries, including steel, power, fertilisers and petroleum. Banks believe that such a pick-up will, in turn, translate into better credit offtake.

Besides these factors, one of the key issues that triggered the selling wave was an advisory from the RBI cautioning the banks against investments in State Government guaranteed bonds.

Traders said that some of the banks have suddenly realised that such securities have already become non-performing assets (NPA) in view of the repeated interest defaults. These defaults are expected to exert liquidity pressures on banks, cooperative banks/institutions and provident funds.

In addition, with less transfers expected to the States due to revenue shortfalls, dealers were expecting more States to default on their debt servicing payments, bankers said. This was because in State Government guarantees, lenders have no access to central transfers, unless the securities are sovereign-guaranteed.

While these explanations appear plausible, there is considerable uncertainty about budgetary expectations. Traders believe that despite the real rates being high, major reductions in the key interest rates are expected to be deferred until the Credit Policy, or may even be phased out in small tranches. The real yields are currently over 6 per cent.

But the slight rise in yields is now beginning to worry a number of corporate borrowers. Many of these companies had hoped to pre-pay past borrowings and refinance them with low-cost funds, thereby, improving their bottomlines. These expectations are now pinned on the Budget, which is expected to indicate the trend in interest rates next year.

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