The Hindu Business Line : Bond traders await Credit Policy for direction

Bankers are expecting the reverse repo rate to be hiked between 25 basis points and 50 basis points to signal a hardening of interest rates. Besides, there is also considerable worry building up over the resurgence of inflation, fuelled by high oil prices.

Rate hike on cards: That a rate hike was likely to happen became evident from the high cut-off fixtures at last week's Treasury Bill auction.

The cut-off yield for the 91-day T-Bill was fixed at 5.53 per cent, up from the previous week's 5.49 per cent.

The weighted average yield also followed the same trajectory and was at 5.49 per cent, up from 5.46 per cent. What also strengthened the belief of the rate hike was the high cut-off yield for the 182-day T-Bill. This was at 5.78 per cent, up from the last auction figure of 5.65 per cent.

These rate increases took place despite a mop-up of close to Rs 16,000 crore in the weekend reverse repo auctions.

But the contradiction does not end there. The 10-year yield to maturity also went up last week to 7.25 per cent on a weighted average basis, up from the previous week's 7.22 per cent, despite high liquidity.

Weak undertone: The undertone was weak. Bankers said the rise would have been much larger during the week, but for the presence of some life insurance companies, particularly private sector for small volumes.

Among the largest traded securities during the week were high coupon ones, evidence that insurers were present. Bankers and insurance companies mostly preferred the switch route, swapping low tenors for high tenors.

Banks now want only low tenor securities in their investment books ahead of the RBI market risk implementation. The market risk guidelines for a capital charge on securities become effective from next year.

Steep yield curve: Consequently, banks ended up paying high prices for low tenor securities, evident from the steep yield curve - low yields at the long end and high yields at the short end.

Bankers said that some of these securities were sold more for derisking and improve their liquidity. Such switches, however, did not bring down the investment-deposit (I-D) ratios of the banks, which remain at 42 per cent.

The outlook for the markets also remained weak, evident from thin trading volumes.

Daily volumes: Daily trading volumes were around Rs 1,200 crore. Besides, the spreads between one and 28 years were at 170 basis points. Bankers said that weak outlook was partly on account of high ID ratios.

Few banks were interested in buying securities. Instead, the preferred option was to maintain current levels or align government securities holdings in line with statutory liquidity ratio of 25 per cent.

The reason was that inflation at 4.62 per cent implied real yields were at 1.2 per cent. Expectations were of hardening yields in view of the large foreign currency demand in the markets by oil companies and the exit of foreign institutional investors from Indian equities. Unlike in the past, the RBI has not been intervening aggressively in the markets.

Liquidity tightening: This in turn has created some liquidity tightening in the markets. In fact, during the last few weeks, the foreign exchange reserves have remained more or less constant at $143.43 billion. It is now unlikely that the RBI would intervene to support the rupee and is likely to leave it to the market. That the markets could reverse was evident from the low forward premia, which was under one per cent across all tenors.

The inflows, however, were unlikely to alter the situation of hardening interest rates, bankers said.

This was because the credit growth is at an all-time high of over 30 per cent. Incremental-credit deposit ratios are close to 100 per cent. What prevented banks from resorting to deposit rate hikes were the signals from the RBI.

RBI signals: Bankers said that if such a signal indeed came from the RBI, in the form of a upward hike in the savings bank rate, then most banks are likely to push up deposit and lending rates as well, though the prime lending rate itself is likely to remain unchanged through the busy season.

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