Financial Daily from THE HINDU group of publications
Monday, Oct 04, 2004
Money & Banking
Revenue shortfall, oil prices pressure bonds
BOND markets went into a tailspin on fears that Government borrowings were likely to overshoot targets after a shortfall in revenue receipts.
Also, markets were worried over the oil price spike after crude crossed the $50 mark. The spike translated into an increase in oil bills to be met by the companies themselves or subsidised by the Government
In addition, there are also fears in the markets that the oil companies themselves would begin borrowings. This emanated from the failure to further reduce customs and excise duties in line with crude imports, to offset the spike in international prices.
Indian imports per day are in the region of about 1.7 million barrels.
Revenue receipts: Compounding these effects was the shortfall in revenue receipts. Revenue receipts for the first five months were at least 30 per cent short of the targeted estimates. The combined effect, traders said, would translate into additional borrowings well beyond the Rs 1,55,000 crore for the fiscal.
With the revenue shortfalls the flexibility for further tax cuts appeared to have weakened. Further duty cuts would mean more fall in revenue receipts, unless direct or other indirect taxes neutralised any possible shortfalls.
These fears were already evident at the treasury bill auctions during the week.
Cut-off yield: At the 91-day T-bill auction last week, the cut-off yields overshot 5 per cent. The 91-day T-bill yield was fixed at a high 5.04 per cent, though the weighted average yield was lower at 4.99 per cent. During the previous week, the cut-off yield on the 91-day T-bill was 4.91 per cent.
Similarly, in the case of the 364-day T-bill auction, the cut-off yield was 5.39 per cent and the weighted average yield was5.39 per cent.
Part of the reason for the high cut-off yields was due to bids being made in both auctions at high yields, traders said. The RBI had the option of rejecting the bids. The RBI's failure to reject the bids at these high yields has confirmed bankers' worst fears of a possible hardening of yields in the coming weeks.
Most of them are now speculating of an imminent hike in the reverse repo rates, which are currently at 4.5 per cent (the nomenclature has changed with the RBI's liquidity mop-up operations now being referred to as reverse repo and the liquidity injection as repo).
Bankers are now expecting that the rate hikes are likely to be announced well before the Credit Policy season. The rate hike anticipated is anywhere between 0.25 and 0.5 per cent.
These fears reflected in the 10-year yield to maturity (YTM). The 10-year YTM hardened steeply to 6.47 per cent on a weighted average basis last weekend, up from the previous weekend's 6.12 per cent.
Trading volumes: The undertone in the markets remained weak. Daily trading volumes dropped to about Rs 2500 crore last week, unlike the previous when they went up slightly to Rs 4,000 crore.
Besides, the weakness was also partly driven by the pullout of insurance companies and mutual funds. In the process, some of high coupon bonds indeed entered the markets as several banks have shifted some of these high coupons into the held for trading category.
High coupons: Among the high coupons that have entered include the 11.30 per cent 2010 and the 12.29 per cent 2010. At the middle end of the yield curve, the high coupons available include the 9.85 per cent 2015 and the 11.43 per cent 2015. Some banks are likely to end up making profits in such selling. This was because bankers have been holding them since acquisition. Clearly, given the current circumstances, the outlook for bonds is bearish in the coming weeks as well, traders said. This was clearly evident from the widening spreads between one year and 24 years.
Last week, such spreads widened to 175 basis points, after narrowing to about 150 basis points during the previous week. The bearish outlook is despite the retreat in the inflation numbers to 7.8 per cent.
However, the real yields continued to remain negative up to 30 years. Besides, there was marked slowdown in foreign currency inflows during last week.
The China effect and oil price effect have resulted in accretions to US Government securities pushing up prices and driving down yields to under 4 per cent, as more surpluses are parked in US Treasuries.
As a result, some of the FIIs slowed down anticipating US yields to drop. Average inflows were down to about $60 million per day, traders said. Foreign exchange reserves rose by $407 million during the week. Since import and oil demand were tempered, forward premiums remained low. Some oil companies preferred to take forward cover for one month to two months, avoiding long-term covers.
Credit offtake: Credit offtake, especially non-food credit, remained buoyant. Non-food credit offtake went up by Rs 7,800 crore. Food credit offtake fell by Rs 2,000 crore.
Bankers said that the improved CD implied that government borrowings in the coming weeks would end up being priced higher, indicating a higher revenue deficit due to rising interest costs.
Some banks, however, are attempting to offset the bottom line impact by reducing their gross non- performing assets and fixing higher recovery targets.
Even for corporates, borrowing are beginning to become expensive as is evident from the rising spreads to sovereigns.
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