Bond prices up despite tight cash conditions

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BOND prices stayed on the ascent through last week with the inflation on the reversal and mounting risk aversion among the banks and funds.

The rise in the bond prices was despite the tight cash conditions. The price of the benchmark 8.79 per cent sovereign bond falling due in 2021 rose to Rs 102.44 (par value Rs 100) last week end translating into a yield of 8.42 per cent.

The previous weekend this security was priced at Rs 101.78 (8.51 per cent).

Last week's yield brought the security within the Reserve Bank of India repurchase rate band. The yield retreats were also triggered by RBI comments that a reversal in policy rates could be considered, though the statement came with the rider, that inflation risks remained. Yet most traders ignored the riders and instead pushed down yields.

Bank economists agreed and said there was little the RBI can do at this juncture.

This is especially in an environment where growth had already slowed down. Canara Bank's chief Economist Manoranjan Sharma said, The risk of inflation remains, particularly from imported commodities,

particularly energy. Energy imports pass through will impact prices across all commodities." The soft bond yields were despite the high bank overnight borrowing from the RBI last weekend of Rs 1.17 lakh crore, far beyond the comfort zone of the RBI. Last weekend the borrowings were close to 2 per cent of the aggregate deposits as against a ceiling of one per cent and comfort zone of just 0.5 per cent.

The main source of the cash deficit bankers was from the high government borrowings. Government's ways and means advances from the RBI till December 09 was Rs 34,717 crore.

The high cash deficit has prompted speculation that the central bank was likely to follow up the pause in rate hikes with liquidity easing measures. ING Vysya bank's economist, Upasana Bharadwaj said, "We expect the RBI to support its ongoing open market purchase programme with a Cash Reserve Ratio cut of 25 basis points in the March meeting. However if the European crisis were to worsen substantially, the action may be sooner." Risk aversions in the markets remained a dominant drive of sovereign bond prices. A trader said, "For the moment there are no safe investment avenues. Credit at the moment is high risk and we banks are conserving capital for the moment."

The aversion to credit was apparent from the low non-food credit off take this year so far. Non-food credit was Rs 2.76 lakh crore this year so far or about Rs 65,000 crore lower than the corresponding period of last year. Deposits on the other hand grew by over 1.5 lakh crore for the year. The increase deposits also contributed to a demand for government securities for meeting the statutory liq uidity ratio (SLR) obligations. SLR is the mandated investments of banks in government securities as a component of their deposits. Last week alone banks raised Rs 17,400 crore through issue of certificates of deposit.

Bulk of the credit off take presently was from working capital draw down by public sector refineries.

Refineries drew down their credit limits for meeting payment obligations to crude suppliers. With limited supplies of dollars, with exporters postponing inflows, the RBI was forced to act, by imposing controls on cancellation and rebooking of forward contacts. This was expected to provide some respite to the foreign exchange markets. The move was also followed up by deregulation of non-resident rupee deposits. The move would now allow NRIs to obtain competitive rates on their domestic savings and at the same time improve the flow of foreign currency into the markets.

However, Rupee continued to remain under pressure as downside risks mounted. The mounting downside risk was from low foreign inflows. Traders said that real yields in the countries, like Italy, Spain and Portugal that have low risk credit risk ratings are upwards of 3 per cent.

India despite being at the bottom of the investment risk pyramid has a negative yield of over per cent.

The pressure on rupee showed up in firm forward premia that remained. One month premium at 7.67 per cent (Rs 53.15) was the highest since the beginning of this year. So was the three month premia. Non-deliverable forward (offshore trading in rupees where settlement is in dollars) was lower than the domestic spot rate at Rs 52.70 the dollar, indicating some inflows in the coming weeks.

Yet despite the possibility of some inflows, oil and year end settlement payments was likely to exert pressure on exchange markets.

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