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Carry trades favouring trend taking shape?

T.B. Kapali

AFTER ruling stiff for more a fortnight -- averaging around 13 per cent -- overnight call money rates have backed off quite noticeably at the commencement of the new reporting cycle.

Call in afternoon deals on Monday was around 7.5/8 per cent, maintaining the soft tone noticed even at the close of the previous week on Saturday on the back of expected coupon inflows and redemptions of maturing gilts (estimated around Rs. 11,000 crores ) during the course of this month.

The question now is: Will this slide in call renew market interest in bonds? Particularly amongst the traders. For reviving interest among the trading banks will be quite crucial even for the Reserve Bank of India since it will be the trading banks whic h can set the pace and sometimes even the direction for the entire market. Or will the market continue to exercise circumspection because of doubts about the sustainability of the softness in call money? For a positive carry will be absolutely critical to revive and sustain market interest.

In this backdrop, it may be interesting to have a glimpse into the historical behaviour of carry. And find out if any trend in movements in call money and the rate on the Government borrowings can be discerned. Such a trend, if any, can in turn indicate the potential or otherwise for carry trading.

In 10 out of the 19 years up to 1998-99, the weighted average call money rate (reported by select banks) has been lower than the weighted average rate at which dated Government securities were issued in those years. That, of course, does not give any lic ence to create asset/liability maturity mismatches which carry trades in bonds involve (borrowing in call to fund asset positions).

A positive carry for only 50 per cent of the time covered in the study is not definitely a big confidence booster. More significantly, the positive differential in the nine years has been quite small. More critically, the negative differential in the bal ance 10 years has been substantial. In retrospect then, running long positions in bonds accompanied by funding risk, in the past two decades, may not have been a paying proposition at all.

More pertinent will be what the prospects are for carry trading. The portents here appear to be somewhat favourable if developments in call money in the three years up to 1998-99 -- a period during which the overnight rate has been clinically employ ed by the RBI to defend the rupee -- are any indication. Even on a historical basis, volatility measures in call money (SD) do not appear to be high enough to rule out carry trading.