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RBI's placatory stance improves sentiment

Pranav Thakur

BONDS continued their rally this fortnight on the back of easy liquidity and the Reserve Bank of India's strategy of going slow on auctions. After three weeks of no Government issuance, every trader in the market expected an auction in the first week of July. The central bank pleasantly surprised everyone by doing a private placement instead (the first this year), of 10.95 GoI 2011 for Rs. 3,000 crores.

A private placement when the whole market was expecting an auction did the trick and bonds rallied. Realising that there were big SLR maturities in the near-term and banks would be looking to replace it with some short-end stock, the RBI followed the pri vate placement with an OMO sale of 11.15 GoI 2002 and some short-dated treasury bills. The sale of these gives it the flexibility to take on further private placements in the future.

There was a Rs. 5,000-crore zero coupon maturity on July 13. The central bank continued with its placatory stance and announced only a Rs. 3,000-crore auction in the five-year tenor as its replacement. Both the tenor and the amount further boosted sentim ent and the rally continued. The five-year yield cut off at 10.20 per cent, whereas it was not long back that five-year paper was trading at around 10.35 per cent.

The RBI followed its actions with soothing words as well. The central bank chief reiterated that inflation was not a matter of concern and that any interest rate hike was not on the anvil in the near-term. He has also said the Government borrowing should happen in a dispersed manner so that it does not put any undue pressure on interest rates. These remarks showed that the central bank was concerned about rising interest rates (their actions in the past had been contrary to this) and, hence, had a posit ive impact on the market.

The Centre has also done its bit in arresting the sharp rise in interest rates. Its non-Plan expenditure net of interest payments for the months of April and May this year has actually been lower than that of last year. Plan expenditure is albeit higher, but given that the non-Plan expenditure forms the bulk of the Government spending and that it is the stickiest of all, cutting it is the healthiest form of expenditure control. There has been good news for the Government on the revenue front as well. Ta x collections in the first-quarter of the financial year have grown by 24 per cent as opposed to the budgeted 18 per cent, of which, direct tax collections have grown by a whopping 67 per cent.

In spite of such healthy tax collection numbers (which is a clear sign of industrial pickup), the IIP data has confused everyone. The strong 12.2 per cent growth in industrial output recorded in April has been sharply revised downwards and the revised Ap ril-May industrial output shows benign growth of 5.5 per cent. Part of the downward revision has been on account of using the new WPI series (which is higher than the old one) to deflate the value of output for 2000-01.

But given that the index is primarily a volume-based index and there is only a small basket of goods where the volume is arrived at by deflating the value of output by the ruling WPI, the new WPI deflator should cause only a marginal downward revision.

The only other plausible explanation to the revision is fresh reportings, which have been drastically lower than the earlier ones. We will ideally have to wait for another couple of months to take a call on industrial growth and, hence, the credit pickup story.

The market has taken the latest auction announcement (Rs. 2,500 crores of 12-year paper) in its stride and has continued to go up. It is slated to cut off between 11-11.05 per cent, depending on where LIC puts its bids. The long-end has gone up quite sha rply in the last fortnight, but I do not think that the market has too much incremental appetite.

Although the auction is for a small amount, I still do not see it filling without substantial LIC participation. It is best to get out of the long-end before the auction and wait for the cut-off before re-entering (if LIC realises its position of strengt h, it just might surprise the market by bidding at a higher rate).

The medium tenor looks absolutely safe as the outlook on call seems easy and we have another Rs. 6,000 crores worth of maturities in the last week of July.

The primary yield on 3-month P1+ CPs has already fallen to 10 per cent. It does not look like falling too much from here, but one could still hold them for another month or so for carry. At 9.30 per cent, one-year T-bills have clearly bottomed out.

Switching out of the one-year and the long-end into the medium tenor (three to five years) seems to be a sound strategy. One could re-enter the long-end after the auction results, provided the sentiment continues to be upbeat.

Looking at the credit story for now, medium-term corporate bonds continue to be a hold. One could even look to buy them afresh if one is certain of getting the certificates soon.

(The author is Trader, Interest Rates, HSBC. The views expressed here are his own and not necessarily those of his employer.)