C. Shivkumar

BONDS remained flat last week as traders remained cautious concerned over the likely inflationary pressure on account of spiralling crude prices in the global markets.

Bankers said that oil companies were active during the week since most of them are now reconciled to oil prices remaining close to the current levels in the coming months and have begun accessing the forex markets. But traders said that most of them preferred the spot markets.

International oil prices are currently about $68 a barrel or close to $63 a barrel on a weighted average basis. The weighted average is on account of the fact that Indian imports are a mix of heavy and light crudes. This was expected to push up the import bill for the current fiscal year substantially.

Moreover, inflows from foreign institutional investors had substantially slowed down, traders said, primarily on account of the high interest rates in the US markets, after the last hikes of the Federal funds and the federal discount rate. Despite the slowdown in FII activity, traders said, foreign exchange flows from current account receipts continued to remain buoyant.

Reverse repo: These flows were evident from the high mop-up by the RBI during the week-end reverse repo auction.

At the auctions, the RBI mopped up close to Rs 26,000 crore.

Besides during the week, at the 91-day and the 182-day treasury bill, yields dropped further. The cut-off yield on the 91-day T-bill auction last week was 5.16 per cent (5.20 per cent in the previous auction) and the weighted average yield was 5.11 per cent (5.16 per cent).

Similarly, in the case of the 182-day T-bill auction, the cut-off yield was 5.37 per cent, down from the previous auction's 5.46 per cent.

Abundant liquidity: Traders said that the rising spread between the weighted average and the cut-off yield was indicative of the high liquidity in the markets.

Traders said that during the week-end, the RBI also mopped up about Rs 6,000 crore through reissue of the 11.90 per cent 2007 under the market stabilisation scheme (MSS). The high reverse repo mop-up was despite the high MSS, traders said. But through this MSS issue, the RBI sent out a powerful signal to the markets.

The yield to maturity (YTM) on this MSS security was 6.62 per cent. What prompted oversubscription to the security was also the high current yield (10.86 per cent). The fixing of a high YTM scotched any possibility of a reduction in rates.

The high YTM had some effect on the 10-year YTM that ended the week at 7.12 per cent as against 7.08 per cent the previous week.

In range: In fact, for the last six weeks, the 10-year YTM had remained in a range.

Indications are that the 10-year YTM is likely to remain ranged for some more time, traders said.

That the RBI was not likely to allow yields to soften, despite the surging liquidity, was evident from the high yields fixed at the MSS auction.

In fact, this high fixing of the yield has completely foxed markets and driven down daily trading volumes towards the week to about Rs 1,500 crore.

RBI signals: Another signal sent out to the markets that the yields would not be allowed to soften was the increase in the notified amount for the 91-day T-bill auction effective from the next auction.

The mop-up through the 91-day T-bill auction, both normal and the MSS, would now be Rs 3,500 crore, though the 364-day T-bill amounts were pruned to Rs 1,000 crore.

Traders said that corrections would take place at the auctions and yields would harden prompted by the RBI's signalling. That the markets had taken the RBI's signals were apparent from the wide spreads between one and 23 years towards the week-end. This spread was 180 basis points, up from the previous week's 158 basis points.

Inflation: The main worry of the RBI was the possibility of a resurgence of inflation. Inflation is currently 3.13 per cent and accordingly the real yield was on the higher side at 2.4 per cent, way above the international levels.

Inflation was expected from two quarters. One from barrelling oil prices in the international markets and the consequent cost push effect when these high prices translate into domestic increases. High liquidity was also another concern for inflationary pressures, especially foreign currency-generated liquidity.

The RBI's moves last week were expected to reduce the high one-year real yield to more realistic levels of less than 2 per cent.

In fact, some liquidity correction had taken place on account of intervention in the spot markets by the RBI to meet foreign currency demand.

As a result, reserves dropped by $1 billion. This, however, failed to impact the forward premia, which continued to be low. One month forward premia is barely 0.2 per cent and the one year 0.6 per cent.

Credit demand: What is rattling bankers is the sagging credit demand. Incremental credit-deposit ratio is less than 25 per cent though the nominal ratio continues to be 64.51 per cent. But, some bankers said this was largely due to the accretion in short-term deposits.

During the last few weeks there has been a surge in deposits, partly driven by conversion of some of the foreign currency deposits into domestic non-repatriable rupees. Somealso included the India Millennium Deposits coming up for redemption.

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