Reserve Bank of India (RBI) governor Bimal Jalan did not cut interest rates in his April credit policy. Yet interest rates across the spectrum have moved in just one direction since the beginning of the current fiscal: south. The driving factor is a surfeit of liquidity in the system.
Gilt yields at the medium and long end have come down by around 20 basis points since the beginning of this fiscal. The weighted average yield on Central government borrowings dropped from 9.44 per cent to 7.53 per cent between April-August 2000-01 and April-August 2001-02.
The fall in yields is steeper (around 150 basis points) on best-rated corporate bonds because banks and mutual funds have turned their attention to non-statutory liquidity ratio (non-SLR) papers.
With credit offtake sluggish in the first few months of the fiscal, commercial banks chased gilts and corporate bonds to park their money.
The yield on the benchmark 10-year paper, which was at 7.23 per cent on April 1, 2002, is currently hovering at 7.05 per cent. With gilt yields moving southwards, banks and mutual funds chased corporate paper over the past six or seven months. These financial entities first targeted the best-rated corporate papers.
When primary supply of these papers became thin, yields fell drastically. Consequently, banks and mutual funds developed an appetite for lower- rated papers too. Corporate bond spreads (the difference between the yield of a comparable maturity gilt and corporate paper) have come down drastically over the last few months. The yield of five-year gilts (as on April 1) was 7.10 per cent and the spread of a comparable maturity AAA paper over gilts was around 140 basis points.
The spreads for a AA+ paper was 215 basis points, while that for a AA paper was 265 basis points. Currently the yield on five-year gilts is 6.28 per cent; the spread for AAA paper has fallen to around 65 basis point while the spread for AA+ paper is around 100 basis point.
The spread for AA paper has fallen by more than 125 basis point to around 125 basis points. Theoretically, the compression of spreads is a sign of change in risk perceptions. In other words, when the risk perception about a corporation changes for the better, the cost of raising money for the corporation declines and the spread between corporate paper and sovereign paper shrinks.
But market watchers feel that the recent spread contraction has nothing to do with risk perception. It is the fallout of the liquidity overhang in the system. Incidentally, the spreads of AA paper have shrunk more because there was a feeling that some of these companies could be re-rated on the back of recovery and better performances ; this was the case with one of the cement companies.
The scenario in AA+ papers is the same, with the five year Gujarat Ambuja paper, which was trading at 9.25 per cent on April 1, is now quoted at 7.25 per cent
