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C. Shivkumar

BANGALORE, June 15

BOND markets remained subdued in the face of aggressive interventions by the Reserve Bank of India to regulate any build-up of liquidity on the eve of the Government's securities buyback programme.

Traders said liquidity mopping up operations by RBI continued with simultaneous interventions in the foreign exchange markets, both in spot and forward. As a result, short-term yields have begun moving up.

Short-term rates have remained at the repo rate of 5 per cent. This was evident from the weekly 91-day Treasury bill auctions where yields stayed at 5.08 per cent during last week's auctions, almost at the slightly above previous week's level of 5 per cent. However, yields on the 364-day Treasury bill were 4.97 per cent indicating that hardening yield bias was only a short-run phenomenon.

In fact, this was evident from the movement of the ten-year yield to maturity. The ten-year YTM was 5.75 per cent, unchanged from the previous week. The ten-year YTM has been arrived on the basis of a weighted average of a select group of ten-year securities, where trading volumes are high.

Traders said that the liquidity mop-up by RBI also pushed down trading volumes. The average daily trading volumes in the market were about Rs 4500 crore

The market's favourite securities, as a result, ended slightly weaker. The 11.40 per cent 2008 ended last week at 5.34 per cent, 11.50 per cent 2011 at 5.76 per cent, the 11.03 per cent 2012 at 5.81, the 7.40 per cent 2012 at 5.74 per cent, the 9.81 per cent 2013 at 5.77 per cent, the 7.27 per cent 2013 at 5.73 per cent, the 6.72 per cent 2014 at 5.78 per cent, the 9.85 per cent 2015 at 5.90 per cent, the 10.71 per cent 2016 at 6.04, the 7.46 per cent 2017 at 6.01 per cent, the 8.07 per cent 2017 at 5.97 per cent, the 6.25 per cent 2018 at 5.97 per cent, the 10.03 per cent 2019 at 6.13 per cent, the 8.35 per cent 2022 at 6.14 per cent and the 10.18 per cent 2026 at 6.22 per cent.

In the previous week, these securities had ended at 5.29 per cent, 5.75, 5.79, 5.72 per cent, 5.73 per cent, 5.76 per cent, 5.75 per cent, 5.89 per cent, 5.94 per cent, 5.99 per cent, 5.95 per cent, 5.95 per cent , 6.10 per cent, 6.11 per cent and 6.20 per cent respectively.

Yet, despite this weakening, the undertone of the bond markets remained firm. This was because the YTMs up to 2015 remained below the rate of inflation, that is the real yields were negative. Besides, the yield spread between one and 29 years remained at barely 4 basis points per year. In fact, the short yields are virtually flat. Similarly at the long end, 24 and 29 years, yields were flat. Ideally, if there was any hardening trend in the market, traders, real yields should have become positive and the inter-tenor spreads should have widened. Neither of these has happened.

Traders said that the short-term impact on the markets was also partly due to the credit build-up for funding the maiden initial public offering of Maruti Udyog Ltd. Several banks have been financing purchase of these shares to intending investors.

Besides, bankers said that some of insurance companies, who were major buyers, had stayed away from the markets. This was because insurers expect yields to drop in the short-run due to credit funding by the banks as in the case of the MUL public offer. Once this is completed, insurers expect yields to harden or prices to fall. It is only at that point they are expected to make purchases.

The support for yields at the short-term was partly because traders were awaiting the Government's buyback programme. Any build-up of liquidity during this phase would have a big price impact on the buyback programme, traders said. Besides, the Government is also faced with resistance from larger banks from participating in the buyback programme. This is because there could a severe drop in the yield on investments. Currently, only the incremental yield on investments is below 6 per cent, whereas the average yields are above 8.5 per cent. If the average yield on investments drops below 6 per cent for all investments, bankers fear it could have a disastrous impact on the equity. This is because almost 45 per cent of the working funds are deployed in investments.

Therefore, bankers expect yield softening to continue only after the buyback programme is concluded. But any softening could be upset if there were a large pick-up in credit, bankers added. However, the build-up of foreign currency-induced liquidity could some what mitigate the impact.

In fact, last week, the impact of the RBI's intervention in the foreign exchange markets became evident from the fact that the although there were flows to the extent of $343 million, the rupee liquidity created was negative to the extent of - Rs132 crore. Traders said that RBI had already pushed out some of the foreign currency flows in the form of prepayments. Besides, the reserve accretion during the last week was entirely due to changes in the asset and currency valuation, evident from the fact that the rupee equivalent was actually negative at Rs 136 crore.

In the medium term, yields are expected to harden. This is partly because of the large differential between investments yields and yields on advances. Yields on advances are falling, since there are no takers. But with the incipient recovery in the markets, the credit offtake is expected to improve. CD ratios during the last few weeks have been falling and it is now in the range of 54 per cent. On an incremental basis, however, the ratios were even lower, bankers admitted, on account of slack credit demand. Credit recovery could pick up once the peak credit season begins after September, traders said.

Therefore, state issuers for the debt swap are in the market. They are there to raise funds at 6.35 per cent. But given the aggressive pricing, the securities are likely to move without any difficulty. But the soft rates are making some of the States more ambitious, with many of them attempting to restructure their existing high coupon securities as also the low coupon bonds.

Besides, some States have begun forced restructuring of their Government guaranteed securities, by insisting on servicing at the current interest rates instead of the original coupons. This is now becoming a battle between bankers and States. Some banks that they would invoke the State Government guarantees and insist on calling back the securities as permitted in covenants. A default in guarantees would imply a messy legal battle and compound the difficulties in future funding raising programmes for the States. Bankers, as a result, say that status quo ante would remain at least for the time being.

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