MF investments taper on rate hike expectation, redemption

A 100 basis points rise in short-term rates hasn't tempted the biggest purchasers "� mutual funds "� to increase investments in short-term money market instruments as they believe the peak is yet to be reached.

Issuers have queued up to raise funds, but demand is yet to pick up as investors are waiting for at least 20-30 basis points further rise in rates in coming weeks on expectations of tight liquidity conditions.

So far this month, Rs 6,200 crore of certificates of deposit (CDs) have been issued. This is double the amount raised in July.

Commercial papers (CPs) issuances have also risen to Rs 1,300 crore from Rs 1,000 crore in July.

"The market is factoring in a view that call money rate will go to 7.75 per cent in next few weeks. From here on we expect 20-25 bps rise (in short-term rates)," said Murthy Nagarajan, fund manager, Tata Mutual Fund. The overnight rate has been around 6.25 per cent since last week.

The rise in call money rate coupled with increased supply of such papers would drive up short-term rates, debt fund managers said.

On Monday, the rate on 3-month paper was around 8.40 per cent, up from 7.25 per cent as on August 6, the day call money rate bounced back to 6 per cent from near-zero levels.

One-year certificates of deposit are being dealt around 9.50 per cent compared with 8.50-8.75 per cent.

Most mutual funds also refrained from investing due to steady redemptions in their liquid funds ever since call rate touched 6 per cent.

"Ever since call went to 6 per cent, most banks have withdrawn the excess cash they had invested in mutual fund schemes. Liquid funds have shrunk considerably and regular redemptions are still continuing," said another fund manager.

The second quarter corporate advance tax payments by mid-September could also result in heavy redemptions, fund managers said.

"Liquidity is going to be in the negative for at least a week after these tax payments move out. This would mean higher rates," said a senior treasury official at a state-run bank.

With most banks directing their funds to credit, their investments into mutual fund schemes may also slow down.

"We are heading towards days of tighter liquidity. With most banks directing their funds to credit, flows into mutual fund schemes will dry out," the fund manager said.

This along with Reserve Bank of India's weekly auctions under its cash-draining Market Stabilisation Scheme would gradually tighten liquidity, fund managers said.

"Liquidity depends on RBI completely. If it continues to announce MSS every week then liquidity will tighten further," said Nagarajan.

Last week, RBI did not announce a gilt auction under MSS but increased the MSS component in treasury bills to Rs 3,000 crore from Rs 1,500 crore.

So far RBI has sold Rs 47,000 crore of gilts under MSS in 2007-08 (April-March).

The outstanding issuances under MSS stood at Rs 1 trillion as on August 17, according to RBI data.