Liquidity Surge Triggers Crash In Gilt Yields On Gilts

Increased liquidity in the banking system has sent yields on government paper crashing across the board with all the securities issued in the current fiscal quoting at a premium of Rs 1.40 to Rs 3.

While the aggregate bank deposits have increased by Rs 10,521 crore in the current financial year, the corresponding rise in bank credit has been lower at Rs 2,011 crore. With no avenue to park their funds, banks have made a beeline for the secondary market, leading to a drop in yield on gilts. In fact, in the second fortnight of May alone, the increase in deposits was to the tune of Rs 4,032 crore.

 

Moreover, there has been a reduction in the floating stock in the market with the insurance companies mopping up a sizeable chunk of the securities at the auctions. The increase in the prices is likely to be smothered with the Reserve Bank of India (RBI) offering the 12.59 per cent 2004 on tap. The RBI had recently converted Rs 5,000 crore worth of special securities into a seven-year paper and it also listed it on its sale window. The price of the 13.05 per cent 2007 went up by a rupee and reached a high of Rs 103. The yield on this price works out to 12.50 per cent, a good 55 basis points lower than the issue yield.

After the prices of the 10-year paper moved up, the prices of other securities including the 10-year state government paper also underwent realignment.

The secondary market yield on a three-year paper is 11.47 per cent, on a five paper 12.05 per cent and 12.30 per cent on a seven-year paper. The yields at the auction of three-year, five-year and seven-year paper were 12.14 per cent, 12.69 per cent and 12.59 per cent, respectively.

Banks are also comfortable investing in government securities as a section of the market has revised its expectations on the interest rate outlook. While the market earlier believed that interest rates will move up from October, the impressive growth in aggregate deposits and sluggish credit growth have led to a revision of expectations. It is now felt that unless infrastructure projects take off, the demand for credit is unlikely to pick up significantly.