Liquidity squeeze to continue

Liquidity and global dollar movement hold the key

Yield on the 10-year benchmark paper may rule in the 7.78-7.90 per cent range

The spot rupee is likely to rule in a wide range of 44.40-44.80 against the dollar

LIQUIDITY
Eyes on equity market

Liquidity is likely to remain under strain, if not exaggerated further.

Dealers feel that the government may not continue with its expenditure since salary payments and interest payments on the special deposit scheme are over.

However, a section of the market feels that the equity market is buoyant and portfolio investors who have been lying low since Christmas may become active.

Portfolio investment will be augmented by inflows towards direct investment. However, the market is not sure whether these foreign inflows are going to make way into India this week or the week after.

The rush for setting aside funds for the reporting fortnight may cease since this is the second week.

Further, the passing of the ordinance to remove the 25 per cent floor on statutory liquidity requirement (SLR) may put on hold banks' plans to arrange surplus liquidity. Earlier, banks were scurrying for liquidity so as to provide for excess SLR over rising deposits.

Moreover, the Reserve Bank of India (RBI) will continue with its intervention measures both in the foreign exchange and domestic money market in case the situation deteriorates.

In the foreign exchange market, while banks are selling dollars to raise rupee resources, the RBI is buying dollars from the market to infuse rupee liquidity.

In the domestic rupee market, the RBI will continue with the injection of liquidity under the repo window. Repo is the liquidity adjustment facility for supplying the liquidity to the system for the collateral of government securities pledged by the banks.

CALL RATE
8-9% range seen

The interbank call money rates will continue to rule in a tighter zone.

The government's expenditure, including interest payments towards the special deposit scheme, for the month is almost over. While calls are not likely to witness highs of 18-20 per cent, it will albeit rule in the 8-9 per cent band.

Liquidity will further get a boost with the intervention of the RBI both in the domestic and foreign exchange markets. In the domestic market, it will continue infusing liquidity using the repo mechanism.

Repo is the liquidity adjustment facility under which banks take cash by pledging government securities. In the foreign exchange market, the RBI will continue infusing the rupee by buying dollars.

For the week ended January 5, foreign exchange reserves of the country by $666 million. While inflows have been subdued, custodian banks are also buying dollars for their FII clients since the equity market witnessed some correction.

This was further complemented by dollar buying by oil companies since the rupee has been appreciating.

This is a good time to pay for the oil bill as the appreciating rupee does not add to the inflationary pressure, said a banker.

TREASURY BILLS
Liquidity grip on cut-off yields seen

The RBI will auction 91-day and 364-day t-bills to raise a total of Rs 4,000 crore. According to market dealers, the tightness in the short-term liquidity might reflect in their cut-off yields.

Foreign bankers may be seen trading in t-bills in a big way, as foreign institutional investors (FIIs) are likely to start their allocation into the Indian markets, both equity and debt, with the holiday season coming to an end.

These banks have been investing in t-bills as part of investments as well for providing securities for entering into repo transactions with the RBI to avail of liquidity.

The t-bills are favoured since they do not require to be marked to market for valuation purpose. Mark-to-market is the exercise where investments are valued on the basis of daily price movements.

Recap: The annual rate of inflation for the week ended December 30 rose beyond the RBI's target of 5.5 per cent to 5.58 per cent. The rise in inflation rate is attributed to rising food prices and fuel products.

GOVERNMENT SECURITIES
Bearish outlook to continue

The government securities market is expected to remain bearish. Lack of buying demand and continued tightness in liquidity are the major factors for the lacklustre trading interest.

Most of the trading banks and primary dealers had piled up stock expecting the demand to grow with rising deposits. This is because banks have to maintain reserve requirement for raising additional deposits.

With the passing of the ordinance on the Banking Regulation Act, the market is of the view that the demand may not surface. Even as the RBI will take time to bring down the SLR, most of the banks have put on hold their plans to raise additional securities till the time they get some clarity.

However, a section of the market dealers feels the entry of Life Insurance Corporation may change the picture. LIC and other insurance companies are expected to enter the market for value buying since prices have dropped.

The demand may especially come for the new security auctioned last week - 8.33 per cent 2036. Dealers stated that the pattern of bidding in the auction suggest that it was picked up by numerous players in the market and non- life insurance companies in particular.

The state governments will be auctioning ten-year paper for a notified amount of Rs 1,245 crore. In this backdrop, yield for the ten-year benchmark paper is expected to rule in the range of 7.78-7.90 per cent.

Recap: Trading in government securities remained rangebound and lacklustre apprehending the announcement of the scheduled auction last week. Trading was mostly restricted to the benchmark securities in the medium- and long-term paper.

CORPORATE BONDS
Demand from mid-size firms

The corporate debt market may witness demand from public and private sector companies for raising funds. This is because the rising forward premia have made the cost of swapping foreign funds into the rupee expensive, which incidentally was the hallmark for borrowing overseas funds.

Dealers added that the triple-A corporates may continue to tap the foreign market for funding, but the medium-size companies are likely to tap the domestic market.

Public sector companies will follow suit soon, they added. What is holding back the plans is the uncertainty over the interest rates. Since the yields of the government securities market serve as the benchmark for corporate bonds, these corporates are in a wait-and-watch mode.

This is because after the CRR hike by the RBI and the government's move to provide flexibility to the central bank on SLR, prices of government securities crashed.

Consequently, the yields have gone up, anticipating a lack of demand from banks for government securities.

Banks, in the meantime, have resorted to various measures for tapping funds from the market. They raised short-term deposits of 7-15 days from mutual funds at 15 to 20 per cent interest rates. Public and private sector banks also raised one-year certificate deposits at 9.25-9.5 per cent interest rates.

Meanwhile, the government is also thinking of according tax exemption status to deposits up to three years and to infrastructure bonds to be floated by banks.

Recap: The corporate debt market continues to remain illiquid. The spread between the triple-A paper and the underlying government securities for 10- year maturity, however, narrowed down to 90 basis points as against a high of 120-150 basis points last week.

This is because of rising yields of the gilts. However, provident funds continued to remain investors for the bond papers floated by banks and oil companies.

RUPEE
May remain weak

The spot rupee is expected to rule with a bias towards depreciation and the pressure will be primarily on account of a strong dollar, said Mr R V S Sridhar, head, markets, UTI Bank.

Following robust data from the US economy, the world over, the dollar is expected to rally. In fact, there is growing perception in the international markets that the Federal Reserve Open Market Committee may not opt for a cut in Fed rates for the next 6 to 9 months.

A hike in interest rate by the Bank of England (BOE) was seen more as a surprise move and did not impact the market much. To counter the inflationary pressure, the bank may opt for another hike, some dealers feel. However, this has already been factored into the asset prices.

The yen, on the other hand, has started depreciating, as the market is settling with the expectation that there may not be any further hike in the Japanese interest rates. The positive triggers for the spot rupee movement will be the dropping of crude oil prices and an expected rally in the equity market.

According to bankers, low crude oil prices may dissuade banks from buying dollars and, in turn, take away the pressure. This week may witness inflows from the portfolio investors into the equity market. It will be further complemented by inflows of foreign direct investment.

The forward premia are likely to ease a bit, as the market is set to witness some relaxation in the liquidity conditions. The effect is expected to be more in the near term than in the long term.

Since it is the second week of the reporting fortnight, banks will not rush for additional cover. Inflows on account of portfolio investments may also augment liquidity.

The cost of rupee funds affects premia, as booking forward dollars requires banks to pay a premium in rupees, which have become expensive following a tight liquidity in the money market. In this backdrop, the spot rupee is expected to rule in a wide range of 44.40-44.80 to a dollar.

Recap: Even as the dollar appreciated against major currencies globally, the spot rupee remained volatile.

In the beginning of the week, dollar demand from importers pulled down the rupee. However, towards the end of the week, the dollar inflows into the equity market and proceeds of corporates helped the rupee appreciate.

The rupee premia for booking forward dollars continued to be high due to tightness in the rupee liquidity.