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Bonds rallied even as cash tightened in the banking system. Bonds rose on the back of large foreign fund buying even though hopes of a monetary easing evaporated. The rally pushed up the price of the benchmark 10-year security, the 8.79 per cent falling due in November 2021 to Rs 103.76 (face value Rs 100) last weekend. The price translated into a yield of 8.22 per cent. The previous week the security had ended at Rs 103.24 (8.30 per cent).

The rally in bonds was despite the tight cash conditions. The tight cash was apparent from high borrowings from the collateralised borrowing lending obligations (CBLO) market, where rates touched 11 per cent. The CBLO is a market where financial institutions including banks borrow and lend against collateral of eligible securities. Besides, bank overn­ight borrowing from th­e Re­serve Bank of India (RBI) remained at 2.2 per cent of the aggregate deposits for most of last week above the comfort level of one per cent.

Traders said, the tight cash conditions were largely on account of foreign interest in Indian bonds. Corporation Bank’s treasury head, Rajaram Karanth said, “The cash shortage is largely driven by the foreign interest in bonds and the delays in government expenditure.” Normally it is in the fourth quarter that government expenditure begins and when cash conditions ease. This year though with fiscal concerns taking precedence, bank officials said spending was not happening at the same pace as before.

Normally in tight cash conditions bond yields tend to harden. Yet this has not happened presently. Instead, A K Capital’s associate vice-president, Vikas Jain said, “Yields are expected to soften further in the coming weeks.” The reason for the expectation stemmed from the low demand for credit. Credit demand this year so far was about Rs one lakh crore less than what it was during the corresponding period of last year.

Credit rating agency Fitch India’s director and banking analyst, Saswata Gupta said, “There is considerable amount of risk aversion still in the banking sector.” This was in view of the continuing uncertainty prevailing over the macro economic conditions. The risk aversion was partly apparent from the swelling deposits within the banking system, from investors that have fled equities and mutual funds. Investors, bankers said, have now switched to one-year deposits, that presently offer rates of up to 9.5 per cent. The swelling deposits, showed in the accretion in time deposit numbers of the RBI. Time deposits this year so far were Rs 6.23 lakh crore or about Rs 1.5 lakh crore more than the corresponding period of the last financial year.

The result, banker said that most banks now preferred parking funds investments. Investments in government securities this year so far was Rs 1.9 lakh crore or about Rs 1.27 lakh crore more than the corresponding period of last year. At the weekend government securities auctions, the bids were about 2.5 times more the Rs 14,000 crore offered. Only the offered amount was taken finally. A similar situation happened in the state government borrowings auctions as well, where the bids were about 2.2 times more than the offered amount.

Credit off take was mostly from the public and public sector petroleum refiners that require about Rs 1,500 crore per day for meeting the daily working capital requirements alo­ne. In addition thermal power generators also are also drawing down on their working capital limits for meeting their fuel purchase requirements.

Bankers said as a result, demand for foreign exchange was only expected to increase in the coming weeks. Buyers were mostly tying up their future resources as well, driving up the forward premia, across all tenors. Another round of turbulence awaits the markets in the coming week as S&P stripped France of its AAA status. In the Non-deliverable forward markets (offshore trading in Rupee where settlement is in $) the dollar was quoted at Rs 51.95, reflecting the volatility ahead.