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Bonds down on FIIs exit, inflationary concerns

C. Shivkumar

Bankers said that credit demand was expected to pick upfrom the end of next month when the peak season begins. Yet the major worry among the banks was funding the credit. Yield spreads remain wide on low interest from insurers, MFs

Bangalore , June 11

Bonds went into a tailspin during the week driven by large exits by foreign institutional investors and high international oil prices.

But what also pushed down the prices was the fear of inflationary pressures, bankers said. In fact, barely two days after retail prices were revised, the Reserve Bank of India intervened hiking the reverse repurchase and repo rates to 5.75 and 6.75 per cent respectively.

The hike, bankers said, was entirely driven by inflationary concerns. Yet despite this hike, the RBI's mop-up at the weekend Liquidity Adjustment Facility auctions was high, close to Rs 57,000 crore. Clearly, there was no dearth of liquidity in the banking system. Despite the surfeit of liquidity, yields remained firm at the weekly Treasury Bill auctions. The yield on the 91-day Treasury Bill rose to 5.74 per cent. The yield on the 364-day T-Bill was 6.48 per cent.

The wide spreads between the 91 and 364 day T-Bill yields indicated the preference for the former. The major reason for this bias for short term T-Bill was driven by liquidity needs of the banks. Banks normally prefer to remain liquid when interest rates are on the ascent, or when liquidity was expected to remain tight.

Trade volumes low

This trend was also evident from the hardening of the 10-year yield to maturity (YTM). The 10-year YTM on a weighted average basis hardened to a four- year high of 7.84 per cent up sharply from last week's 7.67 per cent.

Volumes remained low last week indicative of the weak undertone in the markets. Daily trade volumes remained under Rs 700 crore. In fact most trading was for short tenor G-Secs. Insurers, both life and general, remained restrained buyers of government securities last week also. The abstention was prompted as they were pushed to intervene in the equity markets that had come under intense bear pressure in the last few weeks.

But yield spreads remained wide. The spread between one-year and 29 years was 175 basis points, indicative of the low interest for long-term securities. The bid-offer spreads also remained wide on account of the low interest from buyers including insurers, mutual and provident funds.

In fact most of them prefer to wait for some more time. The reason for this was obvious. Mr Prakash Mallya Chairman and Managing Director of the public sector Vijaya Bank, said, "Yields may top 8.5 per cent by this year end." Insurers, accordingly, have preferred to hold their existing portfolios, when pricing would be more in their favour, given the chase for short-term securities and low interest in long tenure securities.

This anticipation stemmed from expectations of further flight by FIIs from the equity markets, when it opensnext week. Some accretion is likely to take place from inward flows from exporters, non-resident investors and foreign direct investments. These inward flows, however, are likely to be liquidity neutral, they said. This was because the additional flows would be absorbed by the oil companies for meeting their import requirements. Oil prices at current levels have made the oil companies large borrowers.

Demand for credit

Besides, bankers said that credit demand was expected to pick up from the end of next month when the peak season begins. Tthe major worry among the banks was funding the credit. Deposit accretions have still not picked up.

Options for selling investments also no longer existed, since most holdings are already close to the Statutory Liquidity Ratio (SLR).

The only option was to mobilise deposits. Deposit mobilisation efforts have still not begun yielding results. For the week ending May 26, aggregate deposits have grown by barely 2 per cent since the beginning of this year. This implied that some more deposit rate revisions could be under way.

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