The name is bond

Incremental credit-deposit ratio is at a comfortable level

There has been a sea-change in the bond markets over the last month. A month ago, doom and gloom was the prevailing mood, the yield on the 10-year government benchmark was at 7.25 per cent, everybody expected interest rates to rise and banks were not touching bonds with a barge pole.

Cut to the present, and even nationalised banks are back in the market, the yield on the 10-year government bond is down to about 6.9 per cent, and some bond dealers say it will touch 6.5 per cent by July.

What has changed? First, long-bond yields have been falling worldwide, with the US 10-year bond yield going below 4 per cent before bouncing back.

In the euro area, in the UK and even in Japan, long-bond yields are now well below the levels they were a year ago. Bonds are rallying across the world.

Next, the inflation data have been benign, with softer commodity prices pointing to lower inflation in future. And so far as crude prices are concerned, the government's repeated assurances that they would do all they can not to raise prices have been helpful.

Add to that the support provided by the Life Insurance Corporation in the primary auctions, and you have plenty of comfort on interest rates, a comfort evident from the lack of nervousness in the market despite the advance tax outflows.

Now consider the numbers. Reserve Bank of India data show that aggregate deposits with scheduled banks rose by Rs 69,748 crore in the two months between March 25 and May 27, while credit increased by Rs 52,043 crore.

That's an incremental credit-deposit ratio of 74.6 per cent. Contrast the previous two-month period between January 28 and March 25, when the incremental credit-deposit ratio was 118 per cent. Clearly, liquidity has improved.

But it hasn't improved all that much. In 2004, the incremental credit-deposit ratio between March 26 and May 28 was only 52 per cent.

The biggest contrast lies in the growth of non-food credit "" while this had increased by a mere Rs 1,022 crore between March 26 and May 28 last year, it has risen by Rs 47,869 crore in the corresponding period this year.

Shipping

Shipping freight rates in the both the spot tanker and dry bulk segment have dropped sharply over the past few weeks.

For instance, in the Suezmax segment, freight rates have fallen about 20 per cent from April's average and are currently hovering at about $24,400 per day, while in the case of the Baltic Dry Index, there's been a dip of about 36 per cent. Also, on a y-o-y basis, freight rates are about 45 per cent lower in the Suezmax segment.

Why are freight rates dipping ? Crude prices have held above $50 per barrel for several weeks. However, in the tanker segment, about four million dead weight tonnage capacity has been added over the past three months and at the same time, scrapping of old tankers has reduced.

As a result, freight rates have cooled. In the dry bulk segment, the recent cutback in Chinese imports of iron ore (the result of a large increase in iron ore inventory at Chinese ports) has led to a cooling off in dry bulk rates. Of equal importance is slower demand emanating from the industrial sector in Western countries due to reduced growth rates.

However, officials from shipping companies pointed out that this time is traditionally a slack period for the industry and freight rates should stabilise in the short term.

Indian shipping companies are largely focused on transporting petroleum products. Hence, lower freight rates in the tanker segment are expected to severely limit profit growth in the June quarter, both on a y-o-y and sequential basis.

However, a cooling off the industry is also expected to help companies manage costs better and that should help prevent operating profit margins from dipping.

FII inflows

FII flows have turned positive after two months of net outflows, or so it seems. In the cash segment, FIIs have pumped in Rs 1830 crore till date this month, if one were to exclude the blip on Monday owing to Infy's ADR conversion.

That this comes on the back of net outflows of Rs 808 crore and Rs 1047 crore in the previous two months gives the impression that there is a trend reversal in FII flows.

But it's important to watch FII activity even in the derivatives market, since hedge funds are known to arbitrage between the cash and derivatives market. Looking at the data for both markets suggests that FIIs were positive even in May.

Although they had net outflows of Rs 808 crore in the cash segment last month, they bought stock and index futures worth Rs 1628 crore in the same period.

The positive stance has only continued this month "" sales in the futures segment were only around Rs 275 crore this month, which hardly offset the net inflows of Rs 1830 crore in the cash segment.

This agrees with data from EmergingPortfolio.com Fund Research data, which show that the Indian market was the biggest beneficiary of the inflows to emerging markets in the week to June 8.

With contributions from Amriteshwar Mathur and Mobis Philipose.