Liquidity, gilt auction hold key

Liquidity Still a concern

Liquidity tightness continues to be the cause for concern for the market. But according to market dealers, it is expected to ease a bit on government expenditure towards salary payments. Interest payments on the special deposit scheme (SDS) are also likely to ease the liquidity strain.

The Reserve Bank of India (RBI) will continue with its intervention measures in foreign exchange as well as in the domestic money market. In the foreign exchange market, while banks sell dollars to raise rupee resources, the RBI buys dollars from the market to infuse the rupee liquidity in the system.

In the local rupee market, the central bank has opened both "� the cash refinance window of export credit and repo. However, banks are not able to avail of the repo window as most of them have trimmed their portfolio of government securities around the statutory requirement of 25 per cent.

One negative trigger for the market will be the announcement of the scheduled government security auction, which is expected to mop up around Rs 9,000 crore from the market.

The next tranche of outflow towards the cash reserve ratio hike, on January 6, will suck out around Rs 6,000-7,000 crore. In all, the market may witness outflows of around Rs 17,000 crore, which includes the auction of treasury bills.

Call rates Likely to soften

The interbank call money rate is likely to moderate with expected inflows through government spending and SDS payments. Dealers are of the view that even as call rates will continue to rule high "� above 10-11 per cent, they may not again nudge the high level of 20-25 per cent seen last week.

Most banks have already prepared themselves for the CRR outflows well in advance. A majority of banks are also borrowing funds at 7.25 per cent through the repo window and are investing in the call market at above 12-13 per cent, thus earning a spread of around 4-5 per cent.

Treasury bills Yields to inch up

The RBI will put up 91-day and 364-day treasury bills for auction in the market to garner a total of Rs 4,000 crore. Yield on t-bills is expected to inch up in tune with the rising trend of interest rates in the short term.

The yield on the 91-day t- bill has been gradually moving up from 7.10 per cent to 7.18 per cent in the past two auctions. Given the fact that banks are raising 7 to 15-day money through CDs at 15-16 per cent, the yield on the 91-day paper may also inch up this week.

Recap: The annual rate of inflation for the week ended December 16 rose to 5.43 per cent, up from 5.32 per cent in the previous week on account of higher prices of cereals, pulses, tea and coffee etc.

Government securities To stay in a range

The government securities market is expected to remain rangebound and trading will be lacklustre. Most of the banks are caught in a fix since they have bought the papers at high prices and now are unable to offload the stock since the prices have crashed with rising yields.

Moreover, if the RBI announced the gilt auction as per the calendar, the prices will further crash, pushing the yields to 7.75 per cent.

Some of the banks may buy bonds to build up the portfolio of the government securities to repo with the RBI for availing liquidity.

Most of the banks will be busy securing funds to meet liquidity requirements not only for the outflow towards second tranche of CRR hike but also for the credit since the amount of lendable resources have been squeezed through a CRR hike by the RBI.

While the CRR hike is meant to curtail the excessive liquidity in the system as evident from currency in circulation and money supply, it may impact the flow of bank funds into credit. Therefore, banks will have to set aside funds towards committed loans .

In this scenario, trading in government securities is likely to remain restricted and need based. Foreign banks , who a re mostly traders in the market are staying away from the market with approaching year end since most of them finalise their books for calendar year closing of the parent overseas.

In this scenario, the yield on the ten year is expected to rule in the range of 7.55-7.75 per cent.

Recap: The trading in the government securities remained highly rangebound and lacklustre last week. However during the end of the quarter, banks managed to push up the prices of the government securities to make up for the mark to market valuation.

Corporate bonds Firms make a killing

The corporate debt market was dull with volumes going down to Rs 100-200 crore. Most of the public sector undertakings have postponed their borrowing programme since the yields of the benchmark papers went up, thus pushing up interest rates for the corporate to raise funds.

Banks resorted to various measures for mopping up funds. They raised short-term deposits of 7-15 days from mutual funds at 15-20 per cent and even public sector and private sector banks raised one"�year certificate deposits at 9.25-9.5 per cent.

While long-term fund raising has been pushed to the backburner, most of the corporates are earning good returns by investing funds as deposits to the banks. Most of these corporates are offering these funds to banks as certificate of deposits (CDs). As for CDs, the rates quoted for bulk deposits by banks range from 10-15 per cent for short term of 7-15 days and 9.25-9.5 per cent for one year.

Many corporates used the collateralised borrowing and lending obligation (CBLO) window to lend at rates ranging between 10.50 per cent and 13 per cent. CBLO is similar to the repo window of RBI where banks could raise funds by keeping government securities as collateral. In the whole process, corporates have earned a cool profit of 3-4 per cent.

Recap: The corporate debt market continued to remain illiquid. The spread between the triple A paper and underlying government securities for 10- year maturity widened to 150 basis point as against 75- 80 basis point earlier. However provident funds continued to remain investors for the bond papers floated by the banks.

Currency To rule low

The spot rupee is expected to move with a bias towards depreciation. Most of the data released in the US "� jobs, sales, inflation etc "� have been dollar-bullish. The dollar has been gaining against other major currencies, and following the cross-currency effect, the rupee may also lose against the dollar.

Oil prices continue to remain firm and most oil-importing companies are trying to book dollars for the payments at a time when the spot is appreciating. The spot rupee, on the other hand, is gaining as most banks are selling dollars in the market to raise rupees. With liquidity situation being tight, banks do even hesitate to pay 26-28 per cent for swapping the dollars into rupees.

However, the appreciation of the spot rupee may get checked once liquidity situation comes under control. This is because the spot rupee would have otherwise depreciated as demand for dollars far exceeds supply.

Foreign exchange inflows into the equity market have taken a backseat with most overseas markets having a cooling period owing to the Christmas and New Year holidays.

The rupee premium to be paid for forward dollars will continue to remain firm on account of rising cost of rupee funds. This is because the premium in the form of rupees that banks pay for booking forward dollars has become expensive following the tightness in liquidity in the money market.

On the other hand, corporates will have to book dollars to pay for imports, since the fourth quarter is usually a busy season for credit.

Moreover, the premiums for the near-term funds, of one month and three months, will be affected much more than the funds of the longer term. This is because the impact of the CRR hike has been more on the short-term maturity than the longer-term one.

In this backdrop, the spot rupee is expected to rule in the range of 44.25-44.40 to a dollar.

Recap: Opening at 44.60 and closing at 44.28, the spot rupee appreciated in the past week. Even as the dollar gained against major currencies globally, the spot rupee appreciated since banks sold dollars to raise rupee resources.

The rupee premiums paid for booking forward dollars went up on the tightness in rupee liquidity.