Liquidity crunch overwhelms

OUTLOOK

Call rates may touch 6.50 per cent on account of huge outflows; The benchmark govt bond yield looks range bound amid tight liquidity; The rupee is likely to trade in a wide range of Rs 45.20 to Rs 45.60 per dollar.

LIQUIDITY
The squeeze continues

Liquidity in the banking system is likely to come under severe pressure this week due to outflows arising from advance tax payments and redemption of India Millennium Deposits (IMD).

Money market dealers feel that the market may derive moderate comfort from injection of Rs 1,085 crore into the system by the RBI and continued cancellation of treasury bill auctions under market stabilisation scheme (MSS).

Also, the comments made by Reserve Bank of India governor Y V Reddy will have a telling impact on the liquidity position. Last Friday, Reddy said, "although there could be some pressure owing to IMD (outflows), that is frictional. So, liquidity management continues to be what it has been."

The Reserve Bank of India has announced the auction of 91-day and 364-day treasury bills for a notified amount of Rs 500 crore and Rs 1,000 crore, respectively, under the regular auction calendar.

Taking into account all relevant factors, the Reserve Bank has decided that the auction of 91-day treasury bills for Rs 1,500 crore and 364-day treasury bills for Rs 1,000 crore, scheduled for December 21 under the quarterly indicative schedule of MSS will not be conducted.

This implies a release of Rs 3,500 crore from MSS account since the 91-day treasury bills issued earlier under MSS on September 21 will redeem on December 23.

In rupee terms, IMD redemptions will lead to an outflow of Rs 33,000 crore.

This is the amount State Bank of India (SBI) is slated to pay RBI to buy dollars. The foreign exchange outgo of $7.3 billion includes $5.5 billion of principal amount.

The banking system is already witnessing a cash crunch because of advance tax outflows of Rs 20,000 crore. The liquidity in the banking system has dwindled to around Rs 1,035 crore from over Rs 15,000 crore.

The cash crunch is likely to continue because of the redemption of IMDs on December 29. Consequently, banks are conscious of where they are parking their funds as these outflows will impact their funds for lending.

On the influence of the US Fed rate increase on domestic rates, Reddy said the central bank was watching interest rate moves in the US as they were relevant for India.

"We watch movements and stance of monetary policies in all important economies and certainly the US is one of the most dominant. US Fed rate is relevant, but not the only factor influencing interest rates here," he said.

Slight tightness in liquidity has also taken its toll on the Rs 35,000 crore of daily put and call loans given by banks to corporates. Banks have exercised their call options to recall most such loans. Banks evolved this instrument to park their excess funds during times of high liquidity.

CALL RATES
Nearing the upper band of reverse repo

Dealers foresee call rates soaring to 6.10-6.50 per cent levels this week, as they expect a severe liquidity crunch. Call rates would come under further pressure, following the advance tax outflows this week. In fact, traders see call rates hovering around the upper band of the repo rate.

Call rates usually hover around the reverse repo rate of 5.25 per cent when liquidity in the banking system is comfortable. Cash surplus in the money market have dwindled in recent sessions due to advance tax payments estimated at around Rs 20,000 crore.

Recap: The inter-bank call money rate on Friday rose to more than 6 per cent, clearly indicating a cash crunch situation. There was a sharp fall in liquidity mop-up by RBI at its liquidity adjustment facility (LAF) window.

The RBI mopped up bids worth Rs 15,160 crore under LAF in the week ended December 17 compared with Rs 61,065 crore in the previous week. In the morning LAF sessions, the RBI collected Rs 7,725 crore, while under the second LAF it absorbed bids worth Rs 7,435 crore last week. The daily average mop up under LAF amounted to Rs 3,032 crore.

INFLATION
Steady expectations

Inflation is expected to remain steady this week amid expectations of a rise in global crude prices. According to debt market analysts, inflation is lower than expected as manufactured product prices seem to be showing signs of softening. Market players expect some of the fall in the fuel index to revert but primary article prices may move down due to seasonal effects.

Recap: The domestic wholesale price index marginally rose to 4.55 per cent on an annual basis in the week ended December 3, from the previous week's 4.54 per cent, due to higher food prices, government data showed on Friday.

While the index for primary articles declined 0.5 per cent to 197.3 from 198.2, the index for food articles was nearly flat at 200.2 against 200.1 a week earlier.

CORPORATE BONDS
In a dull zone

Volumes in the corporate bond market are expected to remain dull this week.

Dealers attribute this lacklustre nature of the bond market to a lack of appetite for these papers on account of liquidity crunch. Hence, most participants will continue to refrain from taking positions, said a dealer with a public sector bank.

Players tapping the market this week include Bajaj Auto Finance (Rs 950 crore via equity shares, debentures and warrants) and HDFC (Rs 250 crore). The spread on a five-year AAA-rated corporate bond was 56.37 basis points last week and is likely to remain flat this week.

Recap: State-owned Industrial Development Bank of India raised Rs 500 crore through an issue of bonds on Friday.

GOVERNMENT SECURITIES
In a narrow groove

The government securities market will be range bound with a bearish undertone as investors are expected to refrain from taking any fresh position during the year end. The yield on 9-year government bond is likely to trade in a narrow range of 7.02-7.05 per cent.

The yield on actively traded 8.07 per cent 2017 government paper will move in the range of 7.24-7.28 per cent. The benchmark yield is likely to be illiquid this week with its yield at 7.07 per cent.

"The market looks highly subdued till the year end with shallow volumes as traders are cautious about taking any positions," said a treasury dealer. Further, the government is scheduled to borrow in the first week of January 2006, which is adding to the lacklustre trading in bonds.

Liquidity is likely to come under pressure on account of redemption of IMDs. Since oil is India's biggest import, higher prices are causing concerns about a possible rise in domestic inflation and traders worry that the central bank could be forced to tighten monetary policy.

Recap: The yield on the nine-year bond almost nudged the 7 per cent mark on Friday from Monday's close of 6.99 per cent following the RBI governor Y V Reddy's comments on liquidity. He said that liquidity is likely to get squeezed ahead of the redemption of IMDs. In fact, government bonds fell by 15 paise following his comments.

The yield on the actively traded 8.07 per cent, 12-year government bond rose to close at 7.21 per cent from Monday's close of 7.23 per cent.

CURRENCY
Yen to provide cue

The rupee is expected to trade in a wide range of Rs 45.20 to Rs 45.60 per dollar. The Indian currency is expected to show a two"�way movement taking cues from Yen's rally versus the dollar and foreign inflows into the forex and equity market.

A currency dealer said, "The dollar looks volatile in the overseas market, which is highly unusual in December. If the Japanese yen continues to rally against the dollar, then the rupee will gain support at these level. On the other hand, if yen slides this week, then it will weigh on the rupee too."

Another determinant is the foreign investment flows. Data from the market regulator showed that foreign institutional investors bought Indian shares worth $529 million in the four days till Thursday last, taking the total since early January to a record $9.4 billion.

Dealers said, the demand for the greenback in the local forex market is likely to decline in the coming weeks. State Bank of India bought huge dollar supplies last week to meet the redemption of the India's Millennium Deposits (IMD). This is likely to boost the rupee.

Recap: The rupee rose to a fresh 1-1/2 month peak last week on foreign inflows. The rupee ended the week at 45.35/36 per dollar as against Monday's close of 46.11, reflecting a gain of 1.65 per cent.

The euro rose against the dollar and the yen on Friday. The euro was up 0.15 per cent at $1.1993 after rising as high as $1.2027. The Japanese currency shot to a six-week high against the dollar.