The Hindu Business Line : Private life insurers active in gilts market

Traders said that this firm trend was due to intervention of private sector life insurance companies in an otherwise thin market. Consequently, yields went down.

THE bond markets were subdued last week, but yields underwent some correction with support at low prices from funds and life insurance companies.

Ten-year yields dropped last week to 6.59 per cent with prices firming up as against the previous week's 6.76 per cent. Traders said that this firm trend was due to the intervention of private sector life insurance companies in an otherwise thin market. Consequently, yields went down. But traders' volumes remained low. Average trading volumes in the markets were just Rs 2,100 crore, as against the peak trading volumes of nearly Rs 10,000 crore in December 2002.

Traders said that among the major sellers in the market was the Unit Trust of India due to reshuffling of portfolios between UTI I and II. UTI has been split into two separate entities. General insurance companies were also sellers in the markets — particularly the private sector companies — in a bid to meet some of their claims liabilities. Private sector insurance companies have been selling securities, partly because they are faced with liquidity pressures due to falling premium accretions.

Traders also said that issues like the standoff between Iraq and US no longer influenced the markets, since the impact of it had already been discounted. In fact even at international oil prices of close $38 a barrel, there is very little panic among the oil companies.

But foreign exchange markets continued to drive the yield momentum in the markets. Large corporates in a bid to settle their liabilities have begun to take advantage of the exchange rates and eliminate any future exchange rate fluctuation risks. This in turn has pushed up demand for foreign currency in the markets. Among the buyers seeking to settle such foreign exchange liabilities were central public sector power utilities, which have large foreign currency liabilities.

This demand was met partly by the $616 million inflow, which took up the reserves to $75.283 billion. This prepayment demand in fact obviated any open market operations. This demand prevented any major fall in yields, traders said.

These factors reflected in the market's favourite securities. The 11.40 per cent 2008 ended the week at 6.39 per cent, 11.50 per cent 2011 at 6.66 per cent, 11.03 per cent 2012 at 6.71 per cent, 7.40 per cent 2012 at 6.53 per cent, 9.81 per cent 2013 at 6.59 per cent, 9.85 per cent 2015 at 6.84 per cent, 8.07 per cent 2017 at 6.92 per cent, 7.46 per cent 2017 at 6.87 per cent, 10.03 per cent 2019 at 7.03 per cent, 8.35 per cent 2022 at 7.19 per cent and the 10.18 per cent 2026 at 7.22 per cent.

The previous week, these securities had ended at 6.53 per cent, 6.88 per cent, 6.88 per cent, 6.66 per cent, 6.76 per cent, 7.13 per cent, 7.21 per cent, 7.21 per cent, 7.29 per cent, 7.41 per cent and 7.57 per cent respectively.

Yet the undertone in the market was weak as was evident in the wide inter-tenor spreads. This was evident from the high cut-off yields quoted in both the 91-day and the 364-day T-bill auctions. The 91-day yield was fixed at 5.95 per cent and the 364-day yield at 5.81 per cent.

Besides, inter-tenor spreads have been widening during the last two weeks due to large scale selling for arbitrage purposes. The arbitrage between advance taxes and bond markets are now almost concluded. As a result inter-tenor spreads are nowhere in the region of about 10 basis points per year and at the longer ends it is closer to 12 basis points. Large inter-tenor spreads indicate shrinking appetite for the Government securities. In fact indications of this were already evident from the banks some time back when yields dropped below the weighted average cost of working funds. The weighted average cost of banking sector's working funds are currently in the region of about 6.4 per cent and yields now appear to have stabilised in this range.

Traders said that in the coming months there would be slight upward pressure on yields partly on account of the Government's demand from the banking sector. The Government, which is the largest equity holder in the banking sector, is now seeking higher dividends than what has already been estimated in the Budget. Last year the Budget estimates of dividends and financial institutions were made on the estimate that yields would remain in the region of about 8 per cent.

However, with yields dropping very sharply during the year by almost 3 percentage points below the estimates, dividend demands had escalated. This in turn was expected to push up the weighted average costs to slightly close to about 6.5 per cent, though reduction in the deposit rates could lead to some corrections.

Moreover, banks were keen to cut exposure in gilts way above the mandated 25 per cent statutory liquidity ratio. This high exposure has shrunk their average yield on assets. As a result, the only way to achieve this correction was by expanding risk weighted assets. In fact this is precisely what has happened during the last month.

Most incremental credit growth therefore has been driven by treasury profits and less by new liabilities. In fact aggregate deposit growth has actually been showing negative growth rates. Figures in the latest weekly statistical bulletin show an aggregate deposit growth falling by at least Rs 4,000 crore. On an incremental basis credit deposit ratio is about 83 per cent and with deposit to non-food credit alone being close to about 75 per cent.

Investment deposit ratio however appears to have gone up during the last week to 42 per cent. But this is more of statistical aberration. This is because deposits have shown a negative growth during the week, whereas investments have remained constant with little investments in the 91-day and 364-day T-bills.

Traders said funding credit demand through internal resources would allow banks to operate within their capital adequacy ratios in building up their risk weighted assets.

Besides the attraction to credit assets is growing with average yields from risk weighted assets in the region of about 13 per cent, a spread of nearly 700 basis points over the average weighted cost of working funds even after netting for bad assets. This in fact is the highest spread in almost five years in more than a decade.

Two key concerns would remain, one trader said. These were inflation and efforts to bring down the weighted average cost of working funds. This rise in inflation in the last few weeks has pushed down the real yield differential to 2 per cent. Second is the issue of the weighted average cost of working funds. Part of this has already been addressed by expanding the repo market. However, repo rate at the RBI window continues to be at 5.5 per cent.

However, traders said that this was not likely to be a major problem if the weighted cost of working funds drop below 5.5 per cent.

If these costs fall, even the repo rate was unlikely to stop the yield fall. But this can be achieved only in the coming months as banking sector moves to reduce their non-performing assets and write back the provisions on some of the hitherto substandard assets and loss assets.

The Finance Minister's Budget speech is expected to throw up some cues for such a reduction in the cost of working funds.

Traders said that any major yield movement was therefore likely to take place only after next week. In the meanwhile, corporate spreads have gone up. Spreads for corporates over sovereign yields are now about 50 basis points for public sector companies and about 75 basis points for high rated private sector corporates.

The State Government utilities have been completely pushed out of the market. Bankers have already conveyed that they were not interested in State utilities even at high spreads. "When good securities are available at good yields now, who wants high risk paper," one trader said.

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