Outflows set to fuel tightness

Liquidity
Rs 30000 cr tax outflows

Liquidity is likely to remain tight in the short term, definitely this week. The collection towards customs, excise and service taxes has been to the tune of Rs 18,000 crore.

Advance collections towards direct taxes are expected to mop up around Rs 20,000-30,000 crore. The auction outflows will be at Rs 9,000 crore. Over and above these, the system will start preparing itself for maintaining liquidity to meet reserve requirements for the coming fortnight.

These were the scheduled outflows that will now be complemented by the 50 basis points hike in cash reserve ratio (CRR) announced on Friday by the Reserve Bank of India (RBI).

The hike will be effective in two tranches of 25 basis points each on December 23 and January 6, absorbing around Rs 13,500 crore from the market. Even if the CRR effect will actually happen a week later, the banks will be wary of spending.

The impact of the hike on liquidity could be gauged from the fact that even before the announcement was made, banks were seen taking steps to set aside funds to meet the liquidity requirements.

Banks across the board have excessively borrowed one month term money through interbank. They have even bought treasury bills and government securities so as to stock themselves with papers for repoing with the RBI.

There will be an inflow of around Rs 1,423 crore as against an outflow of around Rs 5,463 crore, including the treasury bill auctions and sale of state development loans.

Call rates
May rule high

The interbank call rates are expected to rule higher since the market is expecting the liquidity situation to be tight. While outflows towards the auction and advance tax materially impact the liquidity, the sentiment will get bearish following the CRR hike by the RBI.

Bankers are of the view that unlike the last quarter when call rates surged following the advance tax payments, they may not inch up so high this time.

This is because, liquidity is evenly distributed among market players and not concentrated in the pockets of public sector banks.

This was the reason why the call rates last quarter zoomed to 8-9 per cent despite reverse repo bids remaining high. Reverse repo is the liquidity adjustment facility (LAF) of the RBI through which it absorbs the excess liquidity from the market.

The even distribution of liquidity with the banks has been a result of the steps taken by all banks to set aside funds beforehand to tackle the tightness apprehended in the months to come.

Treasury bills
Cut-off yields to rise

The government will auction 91-day and 182-day t-bills to raise Rs 3,500 crore. The cut-off yields may inch up following concern on liquidity. They are also likely to get affected by the CRR hike which, in turn, will dent liquidity and in the process get factored in pushing up the short-term interest rates.

The t-bills secondary market trading is also likely to be thin since banks will be cautious of investing and would rather be earmarking funds to tackle liquidity tightness.

However, if liquidity becomes too vulnerable, then banks might buy t-bills for reserve requirements and also for repo with the RBI to borrow short-term funds.

Recap: The inflation rate dropped marginally to 5.30 per cent for the week ended November 25 due to a fall in food prices.

Year-on-year inflation based on the consumer price index for industrial workers, urban non-manual employees, agricultural labourers and rural labourers worked out to 7.3 per cent, 7.2 per cent, 8.4 per cent and 8.1 per cent in October 2006 as against 4.2 per cent, 4.6 per cent, 3.2 per cent and 3.2 per cent, respectively, a year ago.

Corporate bonds
Wait and watch approach likely

The corporate sector may like to take sometime before they decide on raising funds through bonds. This is because the market is likely to witness the liquidity squeeze following outflows towards auction and advance taxes.

Moreover, the tightness in liquidity may further aggravate with the CRR hike.

These events may have an indirect impact on the interest rate which is poised to go up. Therefore the companies may like to wait till the interest rates stabilise before they decide to raise money from the domestic bond market.

However, banks will continue with their fund raising programme, both for their interbank regulatory requirements and finance the credit opportunities. The funds will be dearer since most of the banks will be vying for the same pie.

The secondary market demand for corporate bonds is also likely to remain lacklustre. This is because most of the banks running short of funds and first preference for investments will be government securities. Foreign banks, which have been stocking up corporate bonds especially perpetual bonds floated by banks, are away from the market due to the calendar year end.

Recap: The spread between the triple-A corporate paper and government security of similar maturity narrowed down to 100-120 basis points as against 125-130 basis points earlier. The banking sector raised around Rs 1,282 crore through certificate of deposits for the fortnight ended October 27 while corporates mobilised only Rs 239 crore through commercial papers for the fortnight ended November 15.

Government Securities
To remain bearish

The government securities market is expected to remain thin, accompanied by a sentiment bearish. Banks will be rather busy securing liquidity, and the recent hike in cash reserve ratio (CRR) by the RBI is likely to add to the panic.

This week will witness outflows towards auction of government securities held last week and advance taxes.

While Rs 18,000 crore has already been collected as advance taxes for excise, customs and services taxes, another Rs 18,000-30,000 crore will go towards advance payment of direct taxes. Over and above, banks will have to secure funds for credit since the lendable resources have been squeezed through the CRR hike.

While it 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, which are there in the g-sec market mostly as traders, are staying away from the market with the year draws to a close, as most of them finalise their books for calendar year closing of the parent overseas.

Even as they are largely surplus with funds, each of public sector banks has a regulatory limit as well as counterparty limit for lending to another bank.

Market players expect to see buying interest from banks, provident funds, mutual funds etc after gilt prices fall considerably.

At the global level, as the dollar is expected to depreciate against major currencies following the weak non-farm payroll data, this could push down prices of US treasury bonds.

However, a section of the market feels that US treasury bonds may see a rally since most fund managers will be parking money in fixed-income instruments such as US bonds by exiting riskier assets. Moreover, the impact of the Federal open market committee meeting will be crucial for US bonds' yields, which will be closely monitored by the domestic gilt market players.

In this backdrop, the yield on the ten-year benchmark paper is likely to rule in the range of 7.37-7.45 per cent.

Recap: The market remained rangebound amidst lacklustre trading. There was apprehension of receding liquidity and auction. Even as both the government papers were subscribed well by the market at expected cut-off yields, banks and traders were busy preparing for liquidity rather than trading in gilts.

The trading of gilts was mostly for stocking up the papers to be exchanged with the banking regulator under the repo mechanism to borrow liquidity for the next week.

Rupee
On a seesaw

The spot rupee is likely to be on a seesaw. On one hand, the market is expecting moderate inflows "� mostly in the form of portfolio investments from institutional investors.

These funds will make way into the domestic equity market, which is getting ready for big-ticket IPOs. Otherwise, no major foreign inflows are expected this week as the western world is gearing up to enjoy Christmas holidays.

On the other hand, there is not much demand for dollars from the corporate. However, if oil prices remain volatile or continue rising, the demand may go up. If the dollar-rupee levels change either owing to cross-currency impact or RBI intervention to infuse rupee liquidity, interbank may panic and cut its positions.

The dollar, globally, is expected to remain bearish against major currencies. This is because, even if the non-farm payroll data released in the US had been better than the market expectations, the manufacturing payroll data for the last month have been revised downward from -39,000 to -44,000.

This has already initiated a bout of rally in all major cross-currencies against the dollar. The week will see many a trigger. The US will release data on trade balance and the Federal Reserve will hold the open market committee meeting to spell out its stance on interest rates.

As the RBI has raised cash reserve ratio and the market is expecting a tightness in liquidity, particularly after the advance tax outflows, the rupee premia to be paid for booking forward dollars are likely to move up.

Even as the market will be thinly traded as regards to demand and supply, interbank players may stock up dollars for the future by booking them at a forward date.

Just as lendable resources have come down with a hike in CRR, the rupee interest rate may go up as banks will be reluctant to lend. Therefore, cost of booking rupees for paying dollars is also likely to rule higher.

In this backdrop, the spot rupee is expected to rule in the range of 44.50-44.80 to a dollar.

Recap: The spot rupee remained rangebound during the week, finding it difficult to break the upside limit of 44.60 to a dollar. While foreign exchange inflows were abundant in the market, the RBI was quite active in buying dollars and infusing the rupee liquidity in the market. During the beginning of the week, the rupee fell owing to tracking a strong dollar. This is because with the year coming to an end, most global fund houses are withdrawing from riskier assets and are shifting to fixed-income assets, primarily US treasury bonds.

Because of the inflows into the dollar, it appreciated against other currencies. Towards the end of the week, cross-currencies rallied against the dollar, and this also brought about a round of appreciation for the rupee against the dollar.

The premia for forward dollars remained higher owing to apprehension on the liquidity front. And since liquidity is expected to be tight owing to advance tax and auction outflows, it was factored into the rupee premia paid for booking forward dollars.