Govt debt gains over equity as inflation eases, rates fall

MUMBAI: With the domestic inflation rate falling more quickly than expected and interest rates coming down across the world, investors are favoring


debt market as an attractive investment over equity.

The clear signals of softening interest rates in the medium to long term have led to a sharp fall in bond yields and rising bond prices. Bond yields headed further south as banks rushed to buy securities anticipating a reduction in Reserve Bank of India's policy rates.

Traders said bonds also gained from the surge in deposits and falling crude oil prices. The expectations were confirmed when over the weekend; the RBI reduced reverse repo to 5 per cent and repo rate to 6.5 per cent, a 100 basis points cut.

"Given the severe slowdown in the global economy, players are pessimistic on the corporate performance in the near term and are refraining from investing in stock markets. But the falling inflation and softening interest rates over the medium to long term, have attracted investors to invest in the bond market,” said Ankit Sinha, CEO-Spark Advisory.

“However, given the significant deterioration in the global and domestic economy, traders are playing safe and prefer government securities over corporate bonds. The credit freeze across the global markets and lack of liquidity in the domestic economy is stressing borrowing levels of India Inc. At the same time, higher than expected government borrowing to stimulate the economy is not seen as too negative for the yields, as a rate cut expectation is likely to increase demand for gilts," Sinha added

Bank deposit accumulations are currently taking place at about Rs 4,000 crore per day. Time deposits this year have surged by 16 per cent this year. During the corresponding period of last year, the growth was just 13 per cent. As a result, demand for government securities continued to dominate the banking system.

The slight dip in credit off take also helped bonds to surge. Several large corporate held back withdrawals from their credit lines in



anticipation of weekend rate cuts. This, along with the surge in deposits, created a temporary liquidity overflow.

“Despite the continued FII exit from emerging markets, including India, there was overflow of liquidity as the de-leveraging accelerated in the US markets. Even gold-- considered a safe heaven--is losing shine. Foreign funds have exited from equities and commodities while several of them moved into government securities to gain from the rising bond prices," said Rajesh Kamdar, fund manager at Kreg and Bordan Wealth Management.

In the current month, FII debt purchases stood at Rs 1,054 crore while they bought equities worth only Rs 266 crore. Mutual funds net bought debt worth Rs 3,883 crore, while they net sold equities to the tune of Rs 406 crore.

The undertone in the debt market continues to be positive as average trade volumes were double that of the daily equity turnover on the National Stock Exchange. This is the highest that bond volumes have reached. Clearly, this trend reflects the acceleration in deposit inflows into the banking system.

The speeding up is also evident from the resources mobilized by public sector banks through Certificates of deposits during the week. According to rough estimates, at least Rs 2,000 crore was raised through one year CD, as corporate moved to banks even at rates as low as 9 per cent.

But yields could drop further, traders say. This is largely in view of falling crude oil prices. India's oil import basket has come down to $42.41 a barrel. Experts say that one key factor driving this trend is the slowdown in credit off take.

However, the slowdown is also partly on account of capital constraints faced by banks. Bankers said that most of them had reached their capital limits for the absorbing risk weighted assets.

Banks are currently expected to maintain CRAR of 12 per cent, higher than the regulatory requirement of 9 per cent. Credit--other than retail credit--is risk weighted at 100 per cent. Only government securities are zero risk weighted assets. As a result, government securities will remain favourable for near term over the equity markets






Source : Economics Times – 09 Dec08