The Hindu Business Line : Liquidity build-up rises

THE spate of equity issues by public sector undertakings has increased the pressure on the banking system, already awash with liquidity from foreign currency inflows.

Among the major issues slated to hit the market are those of Power Trading Corporation, Gas Authority of India Ltd, IBP and ONGC Ltd. Already one round of divestment by IPCL was oversubscribed heavily on the first day itself.

Banking sources said the incremental liquidity flows had pushed down short-term rates.

Call rates, for instance, are already in the 4-per cent levels and in Tuesday's dealings, tested even 3.5 per cent. What is making the situation worse was the complete absence of government borrowings through dated securities, the sources said. In fact, the high liquidity in the markets is already evident from the large repurchase operations of the Reserve Bank of India. The per-day repurchase operations are currently in the region of about Rs 38,000 crore. But during the weekend, the figure overshot Rs 45,000 crore — the largest amount since the beginning of open market operation policy.

Adding to the liquidity flows are also coupon flows from government securities. But the sustainability of these repos at the current levels is increasingly under question.

This is in view of the continuing foreign currency inflows into the market, both through the current account and the non-debt capital account receipts. The inflows are estimated between $225 million and $4,250 million daily. This translates into a liquidity expansion of Rs 1,100 crore per day.

What is also adding to the liquidity situation is the steadily weakening dollar in the international markets.

The liquidity has already led to a paradoxical situation where the real interest rates are negative to inflation. Real interest rate is currently negative for yields up to 15 years.

This is contrary to international trends, where the real yields are at least 1.5 per cent (150 basis points) above the inflation rate.

But the costs of the intervention is beginning to be expensive. This is especially since open market operations cost about 4.5 per cent and the earnings on US dollar treasuries are still in the region of about 1.2 per cent.

Only at the long-end of the US Treasury are the rates higher than the open market operation costs.

Consequently, the bankers said RBI's international treasury operations are oriented towards keeping the costs of domestic intervention to the barest minimum.

This would imply that investments would be in a mix of securities both at the short and long end.

Besides, part of the view in the markets is that in the short term, US dollar yields would be pushed down in view of an international efforts to ensure a strong dollar and weak domestic currencies.

As a result, Asian and European central banks have emerged as the largest buyers of US treasuries.

This would imply that while yields would remain low. But keeping the costs of domestic intervention implied aggressive international treasury operations, through continuous selling and buying to take advantage of the current situation.