Financial Daily from THE HINDU group of publications
Monday, Aug 01, 2005
Money & Banking
Banks stay away from fresh purchases
BONDS remained firm last week propelled by liquidity influx driven by deposit growth and also escalation in foreign currency inflows.
Traders said that part of the liquidity build up in the banking system was on account of refunds of advance taxes. Besides, oil companies also appeared to have exited from the markets despite the continuing high prices.
Yuan effect: Inflows into the domestic markets were partly fomented by the recent revaluation of the Chinese yuan.
Traders said that China was also expected to offload some of their large US Treasury securities holdings. China and Hong Kong together hold about $302 billion worth of US government securities. In fact, almost the entire China's balance of payments surpluses are invested in US treasury securities.
China's holdings were likely to become more on the lines of the India's holdings of US government securities. Unlike China, the bulk of India's holdings are held in short-term securities, mostly one year and below.
Besides, Indian holdings are more diversified - in euro and pound sterling - to ensure high weighted average returns.
China's gradual substitution with other securities, including other Asian papers, was expected to keep yields down in some of the target nations, including India.
Moreover, during the last few weeks, inflows into the country have picked up. Some of the inflows were from overseas corporate bodies and from non-resident Indians who have preferred to move their funds into Indian equities and mutual funds.
Besides, NRIs were increasingly keen on reinvesting their maturing deposits into non-repatriable domestic rupee time deposits.
Surge in liquidity: As a result, liquidity in the domestic markets has surged, evident from the increase in the mop up amount in the reverse repo auctions.
Last week's three-day reverse repo auctions resulted in a mop-up of about Rs 18,500 crore. The cancellation of the T-bill auctions last week also resulted in the increase in the mop-up amount, traders said, resulting in a liquidity overhang of about Rs 3,500 crore.
Traders, on the eve of the first quarterly review of Monetary Policy, had speculated that the market stabilisation scheme would be withdrawn with the T-bills hardening.
But the surge in liquidity and the yuan revaluation appeared to have altered that perception. This was because both the reverse repo-rate and the MSS mop-up amounts were left untouched by the RBI.
The 10-year yields softened further last week.The 10-year yield to maturity dropped to 7.03 per cent last week on a weighted average basis, down from 7.12 per cent the previous week. Traders said that even if the auctions had not been cancelled the trend would not have changed significantly.
Trading volumes: The firm sentiment was evident from the slight increase in trading volumes.
Despite the impact of monsoon in Mumbai, where financial markets were closed for two days, trading volumes remained upwards of Rs 3,500 crore during the week.
If repos are included, the volumes are much larger.
In fact, large volumes of trade in the markets are driven by repo deals. But, spreads between one and 23 years remained on the higher side, about 160 basis points.
Traders said that the high spread was largely on account of banks staying away from fresh purchases.
Investments profile: Banks were resorting to derisking investments, which essentially implied that they continued to shrink the average maturity of their investment books.
Currently, the average maturity of their investment book, in the `held for trading' and `available for sale' categories was two years.
In fact, many of the banks are looking at bringing down the maturity in the held till maturity categories to this average level, so as to help them in their transition to Basle II norms and conform to market risk categories.
As per international norms, there is little distinction between HTM and marked to market categories.
Market risks would therefore apply to all categories of investments. As a result, traders said they would prefer to remain at the short-end of the yield curve. Spreads would therefore continue to remain on the wide.
Softening of yields is therefore largely restricted to the short-end of the yield curve or in the 10 year minus categories.
Real yield: Besides, real yield for one year at 1.5 per cent is consonant with the international levels.
In fact, real yield had actually narrowed slightly due to the marginal increase in inflation to 4.18 per cent.
Even at this level, bankers find it attractive, as against the trend a few months ago, when it was actually negative.
Yet, the yield movements during the next few weeks were are likely to be ranged.
One major reason for this was accelerated move to shed external commercial borrowings by some of the domestic institutions and corporates.
This move is being encouraged by the central bank for taking the load of sterilisation of liquidity.
The slow shedding of external liabilities would allow for ensuring exchange rate stability and prevent any major appreciation of the rupee in the short term.
Last week, reserves dropped by a marginal $23 million to $137.538 billion.
Credit demand: Besides, traders said what was also driving yields were credit demand. Already, some of the banks were meeting short-term credit demand through repo operations.
Few banks were purchasing securities despite the large increase in deposit accretion.
This was aimed to bring down the G-Sec investment-deposit ratio, which is now at 41 per cent, way above the mandated statutory liquidity ratio of 25 per cent.
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