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Monday, Aug 23, 2004

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Money & Banking - Debt Market


Bonds get support from insurance cos

C. Shivkumar

BONDS firmed last week as insurance companies stepped in to support the markets though traders remained nervous as oil prices and inflation appeared to go out of control.

Traders, however, said that the fire fighting measures initiated by the Government somewhat assuaged them. Last week, the Government reduced customs and excise duties on petroleum products. But barrelling oil prices continued to put traders on the edge. Oil prices appeared to be within striking range of the psychological limit of $50 a barrel or $370 a tonne. In fact, oil futures have already crossed these limits. Oil companies, however, have learnt to manage the spike, traders said. Their entries for meeting the foreign requirements were partly in the spot and the forward markets. This was being done in a bid to ensure that there was no big depreciation of the rupee, the costs of which would have to be borne by them to a large extent.

Liquidity tight: Liquidity tightened during the week. This was evident from the auctions of the Rs 5,000 crore one year 6.18 per cent market stabilisation bonds, which were placed at 5.54 per cent. This was higher than the 364-day T-bill yield of 5.40 per cent weighted yield (weighted average 5.25 per cent). Despite the higher cut-off yields, the 364-day T-bill was undersubscribed by almost Rs 300 crore as against the notified amount of Rs 2,000 crore. However, the cut-off yield on the 91-day T-bill was 4.91 per cent (weighted average 4.88 per cent) and it was fully subscribed. Traders said that part of the reason for the low subscription of the 364-day T-bill was that the yield expectations were higher, especially since the one-day repos were fixed at 4.5 per cent.

The high cut-off yields at the T-bill auction and the high yield on the MSS auctions fuelled speculation among traders that a repo rate rise was in the offing. This ensured that yields remained firm. Large-scale interventions by the insurance companies though led to some corrections. As a result, the 10-year yields dropped slightly to 6.60 per cent on a weighted average basis last week, down from previous week's 6.64 per cent.

The underlying sentiment, however, remained weak. This was apparent from the low trading volumes. Daily trading volumes hardly exceeded Rs 2,500 crore during the week.

High coupons: More high coupons have also hit the market as banks attempt to prepare for higher depreciation requirements on the low coupon securities. Among the high coupons that have hit the markets include the 12.29 per cent 2010 and the 12.32 per cent 2011. These securities were traded at 6.99 per cent and 7.15 per cent respectively, well above the market yields for identical maturities. Such have meant steep losses.

For most of the banks the fall in prices have shaved off over Rs 50,000 crore. Not all the banks are likely to be knocked by it partly because of the investment fluctuation reserve. They have approached the RBI to increase the quantum of `held to maturity' category so as to partly neutralise the impact of depreciation.

Outlook weak: The outlook was also weak. This was evident from the wide spreads between one year and 24 years. The spread last week was 175 basis points. These large spreads were clearly evident that sellers outnumbered buyers. In fact, the dominant buyers were life insurance companies, which partly explained the reason for the sudden surge in the trade of high-coupon securities.

Besides, real yields were being cropped with the acceleration in inflation. Inflation is on the verge of breaching 8 per cent. This would mean that real yields up to 30 years were in the negative zone.

Further, oil majors are expected to enter the market in a big way in the coming week. Most oil companies have stopped bunching their entry into the foreign exchange markets. With inflows slowing down considerably, traders said the rising forward premia and depreciation of the rupee would remain the norm for the coming weeks.

Most oil companies were taking cover at the shorter end, up to 3 months. This was in fact one of the major reasons for the inversion in the yield curve. Short-end premia was upwards of 3 per cent, and at the six month-12 month spectrum, it was under 3 per cent.

Besides, interventions by the RBI to contain volatility in the foreign exchange market is also expected to fire the rising yields, as more liquidity would be sucked out by the surging demand on account of rising oil prices.

The interventions and reduced flows have impacted the accretion to the foreign exchange reserves.

Last week, the accretions were negative by $14 million.

Credit demand: Traders said that credit demand drove yields down. Last week, non-food credit grew by over Rs 9,500 crore. But bankers said that part of this growth was also due to refinancing of some of the older loans by corporates. Besides, corporates have also begun refinancing their foreign borrowings in a bid to cut costs due to weakening rupee.

Corporate borrowings have intensified, before the beginning of the peak season, when farm credit and food credit pick-up was expected. This has pushed up the spreads between corporate papers and sovereign papers beyond 100 points.

The 6.10 per cent 2008 IRFC paper was traded at 7.30 per cent last weekend or about 110 basis points above identical maturity sovereign papers. For other private sector corporates, it would mean another 50 basis points more, since they have no implicit sovereign support.

Appetite for corporate papers has completely diminished in the markets. This is likely to drive corporate credit demand, traders said.

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