Losing steam

FIIs will shun debt unless interest rates go up

If foreign institutional investors (FIIs) are gung-ho about buying stocks in India, their sentiment for the debt market is just the opposite.

From the beginning of this year till November 30, FIIs have been net investors of over Rs 38,000 crore in equities, whereas in debt they have been net sellers of almost Rs 4,000 crore. In November, FII net outflow in debt has been rather intense at Rs 2,343.79 crore, the highest-ever net outflow.

It is not that FIIs have been major investors in debt even in the past.

They invest mostly in short-term instruments such as treasury bills and corporate bonds which mature within a year. What they have banked on is the interest arbitrage between Indian interest rates and other countries.

Debt market dealers attribute some of the recent sales to sales/redemption of investments that FIIs had made in last November and December, which had amounted to a total net inflow of Rs 3,453.8 crore.

But the bigger reason for accelerated sales this year is that there is hardly any profit to be made from the interest rate arbitrage.

Global interest rates have risen - the 6-month dollar Libor has gone up from 2.62 per cent in November 2004 to 4.58 per cent this year. The current yield on one-year government paper is around 5.9 per cent.

FIIs would have to pay a small premium over the Libor, plus the cost of covering the foreign exchange risk, makes the spread non-existent.

The US dollar has strengthened significantly this year "" the dollar has appreciated from a low of Rs 43.09 to the current Rs 46.16.

Last year, it made sense for FIIs to borrow money abroad and invest in India and earn a net return of around 3 per cent on their investment.

But, today making even 1 per cent is difficult. The rupee has depreciated substantially and the short-term outlook is still down. FIIs will stay away from the Indian debt market unless interest rates in India go up.

Aluminium prices: Adding sheen

International aluminium prices have jumped to near 10-year highs at $2,200 a tonne. Even over the past month, this non-ferrous metal has gained about 10 per cent. Hence, it was no surprise when domestic players such as Nalco have also hiked prices by about 8 per cent.

In the first week of November, Nalco had hiked prices by about Rs 3,350 per tonne.

As metal prices are up, Nalco has done well on the stock market, gaining over 30 per cent since the end of October.

The current Hindalco stock price cannot be compared with its price in October, as the stock has gone ex-rights.

On Friday, ferrous stocks faced profit taking with Hindalco falling 0.4 per cent to Rs 128 and Nalco dipping 0.88 per cent to Rs 207.

What has led to the recent hike in aluminium prices? Around 23 Chinese aluminium smelters, as well as Aluminium Corporation of China, and China Minmetals Corporation have recently agreed to cut production by 10 per cent.

The production cut is due to higher costs of inputs such as alumina coupled with surging power costs, which has resulted in Chinese authorities taking steps to curtail production.

Alumina prices are currently hovering around $600 a tonne compared with $350 in the previous year.

Meanwhile, domestic integrated players such as Hindalco and Nalco do not face similar cost concerns given their in-house supply of alumina.

And with demand for aluminium exceeding supply by an estimated 3.3 million tonne in Asia and the Middle East in 2005-06, Indian players would be keen to leverage this buoyancy in aluminium prices.

Non-ferrous stocks are reasonably priced "" Hindalco trades at about 7.8 times estimated 2005-06 earnings, while Nalco trades at almost 10 times.