Future tense

Bond yields spike despite abundant liquidity

Bond prices have fallen steeply recently, with the yield on the 10-year bond going above 7 per cent on Friday.

The 10-year yield has risen by around 35 basis points since April 1, a rate of increase that must be worrying for both the Reserve Bank of India (RBI) and the government.

If the sentiment continues to be so depressing, the government's ability to place its long-term paper is likely to be hit.

Strangely, the rise in yields has occurred at a time when liquidity in the money market is abundant. Taking the amount in the liquidity adjustment facility, in the market stabilisation scheme and the government's surplus, the liquidity in the system is estimated to be over Rs 100,000 crore.

Overnight rates continue to be low. The last time 10-year yields moved up beyond 7 per cent was in November 2004, but that was when inflation was over 7 per cent. It's around 5 per cent now.

So what has spooked the markets? The OIS market, a leading indicator, indicates that while liquidity is abundant at the moment, it may not remain so in the future.

Dealers point to the steepness of the yield curve, with call money rates at around 4.80 per cent while 3-month paper is at 5.6 per cent. High oil prices are a worry. They also point to the government's high borrowing programme, but then the inflows coming in, at least in the first half, are also high.

Further, while foreign institutional investor inflows may have slowed down, inflows on account of external commercial borrowings continue to be high. Yet the RBI has reason to be worried. The experience with the auction has not been good, with dealers booking losses, and that could affect sentiment for future auctions.

According to market players, the RBI needs to cancel an auction or two to infuse confidence back to the market. The government must also be aware that pushing the states to borrow directly from the market, as envisaged by the Twelfth Finance Commission recommendations and reiterated in the Budget, could prove disastrous for the market.

Mid-caps do better than the market

It's exactly a month since the Sensex hit an all-time closing high of 6915, along with the Nifty which had also hit an all-time closing high of 2169 on the same day.

The markets have been on a downtrend ever since, with both the Sensex and the Nifty having declined about 6.3 per cent in the past month.

The fall in the markets has not quite been because of FII selling. FII net inflows in the past month totalled almost Rs 5000 crore, and if one were to exclude the sales made by FIIs in order to participate in ICICI's sponsored ADS programme, net inflows would be more than Rs 6500 crore.

Of course, FII flows have been negative since the last US Fed rate hike, when Alan Greenspan warned about inflation, but then mutual funds, flush with IPO proceeds, have been buying more than usual. Of the Rs 2400 crore worth buying mutual funds have done this year, about 60 per cent has happened in the past one month.

Clearly, there's been heavy selling from other quarters, and it's interesting to note that non-institutional investors have preferred selling large cap stocks relative to mid cap stocks. This is because the CNX Midcap 200 index has declined just 1.6 per cent in the past month, much lower than any other index.

Even on the advances-declines front, mid-caps have done better with a ratio of 0.54 for the past month, compared to a ratio of 0.33 for large caps. This seems strange considering that these stocks (as a whole) have risen faster than other categories.

Obviously, some mid caps have genuinely risen because of better growth prospects. But at the same time there are a number of stocks that have run ahead of fundamentals, thanks to the fixation with mid cap stocks.

Bajaj Hindustan

The Bajaj Hindustan stock was down around 5.8 per cent on Friday, as the company's March quarter results were below expectations. The stock has gained about 16.2 per cent during the past three months due to improved price realisations for sugar.

The company has declared a 107 per cent increase in its net profit for the March quarter, helped by improved performance by its sugar division and a large rise in its other income. Other income has expanded largely due to improved sales of bagasse to paper mills.

The company's production of sugar was up 37.3 per cent in the last quarter. Average price realisations were also up about 27 per cent on a y-o-y basis to Rs 17.3 per kg (net of excise).

However, sales volume were lower by 12 per cent. Senior company officials explained that during the production period (which is typically from October to March) price realisations are generally lower than the rest of the year.

Hence, in an effort to even out price realisations for the entire financial year, the company says that they consciously had sold lower volumes in the March quarter. Meanwhile, this strategy has led to a 45.83 per cent rise in inventory to 3.5 lakh tonnes.

Nevertheless, higher price realisations have allowed the sugar division's profit to expand 105 per cent to Rs 38.84 crore.

The distillery division's profit has also grown 37 per cent to Rs 3.37 crore, helped by price realisations for ethanol (sold to oil companies) and alcohol (sold to distillers) rising about 25 per cent. As a result, operating margins expanded 1932 basis points to 44.33 per cent.

The government had recently hiked the quota allocation on account of free sale sugar by 4 lakh tonnes to 44.5 lakh tonne for the January - March quarter, but that didn't prevent spot sugar prices rising about 2 per cent over the last three weeks. Clearly, bouyant realisations will play a key role in expanding profit for the company, going forward.

With contributions from Mobis Philipose and Amriteshwar Mathur