Yield Spread and Industrial Activity

MONEY MARKET REVIEW

Yield Spread and Industrial Activity

EPW Research Foundation

tight, short-term interest rates increase sharply, but long-term rates may also typically increase, though not as much as the short-term rate. As a result, the yield spread narrows or even turns negative when policy rates witness a steep hike. In time, higher interest rates reduce spend-

Two explanations are usually offered for the empirical relationship between yield spread and economic activity. One, yield spread may reﬂect the monetary policy stance, and two, it mirrors market expectations of a pickup in economic activity in the future. Using growth in the index of industrial production as a proxy for economic activity, it is seen that the gilt yield spread is able to predict the growth in IIP with a six-month lag. The data on recent movement in bond spreads for different maturities and issuer groups reveals that bonds of non-banking ﬁnancial companies have the highest spread in all maturities, reﬂecting a higher risk perception of investors. Public sector units and banks enjoy the lowest spread, signalling a higher level of investor conﬁdence.

Team led by K Kanagasabapathy and supported by V P Prasanth, Rema K Nair, Anita B Shetty, Pallavi Oak, Vishakha G Tilak and Sharan P Shetty.

Economic & Political Weekly

february 19, 2011

1 Introduction

he yield spread, along with the yield curve is widely used in ﬁnancial market analysis. The yield curve is normally a depiction of the term structure of the yields of government securities or gilt yields across the maturity spectrum. Yield spread has two connotations. First, it can be expressed as the slope of the gilt yield curve, or as the d ifference between yields of short- and long-term maturities. While this can be expressed as a difference between any two maturities, the difference between the 1-year and 10-year yields is generally used for analysing movements in spread over time. Second, the yield spread can also signify the difference of any bond yield over gilt yield of corresponding maturity. For convenience, this may be termed “bond spread”. Bond spread is a useful measure since the gilt yield curve serves as a bench mark for other bonds. Gilts, at least those issued in the domestic currency, are considered credit-risk free. Hence, pricing of other bonds issued in the market particularly by the private corporates can be bench marked against gilt yields, by adding appropriate risk premia.

Several studies have established that the yield spread acts as a lead indicator of economic activity. A positive spread is indicative of a future economic upswing and a ﬂat or negative spread indicates the likelihood of a slowdown in economic activity. This, however, presumes two things. First, that there is a market-determined yield curve, and it correctly reﬂects the expectations about inﬂation/future movements in short-term interest rates. Second, the ﬁnancial markets are integrated and fairly liquid.

Two reasons are generally offered for this empirical relationship. First, the yield spread may reﬂect the stance of the monetary policy. When monetary policy is

vol XLVI No 8

ing in interest-rate-sensitive sectors of the economy, in particular the industrial sector, causing economic growth to slow down. Consequently, a small or negative yield spread will be associated with slower real economic activity in the future. The alternative explanation for the link between the yield spread and economic activity is that the yield spread reﬂects market expectations of pick-up in economic activity in the future. If market participants expect growth to increase in the future, then it implies possibilities of profitable investment opportunities today. In order to take advantage of these investment opportunities, businesses increase their long-term borrowings. Long-term rates will therefore rise relative to short term rates, and the yield curve steepens. As long as these expectations of economic growth are at least partially realised, a steepening of the yield curve will be associated with a future increase in real e conomic activity.

In India, over the years, owing to several reforms in the government securities market, the gilt market has become very liquid and one can surely surmise that a market-determined yield curve exists. On this basis, an attempt is made here to see the extent to which the yield spread in gilts can predict economic activity. Second, we also analyse the recent movements in bond spreads for different maturities of bonds as also with reference to different issuer groups, even though the data on bond spread is limited.

1.1 Trend in Yields and Yield Spread

The data for yield and yield spread for 1-year, 5-year and 10-year maturities has been taken from “India Time Series”, an online data service introduced by the EPWRF since January 2011.

The trend in the monthly yields of 1-year, 5-year and 10-year maturities is

MONEY MARKET REVIEW

Month/	1-Year	10-Year	Spread -1 to	Growth
Year	Yield (%)	Yield (%)	10 Year	in IIP (%)
			(bps)
Mar-06	6.76	7.49	73.10	8.07
Apr-06	6.33	7.41	108.40	9.46
May-06	6.43	7.54	111.30	10.73
Jun-06	6.83	7.80	97.10	9.47
Jul-06	6.91	8.29	138.70	12.86
Aug-06	6.88	8.09	121.00	10.31
Sep-06	6.85	7.74	88.40	12.26
Oct-06	6.94	7.63	69.30	5.31
Nov-06	7.09	7.55	46.00	15.93
Dec-06	7.12	7.51	39.00	14.33
Jan-07	7.24	7.61	36.50	12.58
Feb-07	7.62	7.86	24.40	11.91
Mar-07	7.70	8.01	30.70	16.55
Apr-07	7.95	8.08	12.90	12.21
May-07	7.86	8.15	29.20	11.66
Jun-07	7.83	8.21	38.70	8.98
Jul-07	6.95	7.90	95.40	8.74
Aug-07	7.43	8.00	56.70	11.00
Sep-07	7.21	7.87	66.50	7.37
Oct-07	7.51	7.88	36.80	11.94
Nov-07	7.26	7.88	61.40	4.68
Dec-07	7.72	7.87	15.10	7.62
Jan-08	7.47	7.76	29.30	6.19
Feb-08	7.44	7.68	24.50	9.88
Mar-08	7.49	7.83	34.10	5.42
Apr-08	7.67	8.17	50.30	5.77
May-08	7.72	7.95	22.60	4.37
Jun-08	8.40	8.34	-6.10	6.83
Jul-08	9.21	9.17	-3.60	6.90
Aug-08	9.20	9.06	-13.80	1.86
Sep-08	8.81	8.41	-40.00	7.02
Oct-08	7.54	7.84	29.80	0.33
Nov-08	7.03	7.41	37.40	3.65
Dec-09	5.95	7.80	185.10	0.51
Jan-09	4.72	5.62	89.50	1.92
Feb-09	4.72	5.93	120.60	0.21
Mar-09	5.02	6.59	156.40	0.87
Apr-09	4.57	6.47	190.20	1.65
May-09	4.04	6.31	227.50	1.69
Jun-09	4.06	6.69	263.20	8.61
Jul-09	3.85	6.86	300.70	7.23
Aug-09	4.62	7.75	313.80	10.50
Sep-09	4.35	7.22	287.40	8.22
Oct-09	4.58	7.31	273.20	10.12
Nov-09	3.92	7.25	332.80	11.33

since March 2006. It is observed that the 1-year yield remained highly sensitive to policy changes and touched its peak around mid-2008-09, the onset of the recent global ﬁnancial crisis. This was the time that the policy rates were also at their peak. From April 2005 to mid-2008-09, the spread narrowed, since the short-term rates rose faster than long-term rates. Following the crisis, a highly accommodative monetary policy resulted in a steep fall in both short- and long-term rates, but the fall in long-term rates was not that steep.

As the 5-year and 10-year yields moved in tandem, the movements in yield spread can as well be captured by the spread between one and 10-year maturities. From Graph A, it is evident that the spread narrowed between April 2005 and mid 200809, and since early 2009 to late 2009, the spread widened signiﬁcantly following the successive easing of policy rates. Since late 2009, with the exit from monetary accommodation commencing, the spread gradually started narrowing.

1.2 Yield Spread and Industrial Activity

In the absence of a monthly indicator of aggregate economic activity, the growth in the index of industrial production (IIP) can be taken as a proxy for economic activity. Graph B (p 68) shows that the trend in quarterly variations in IIP and quarterly variations in the gross domestic product (GDP) are aligned, though not perfectly. Table 1 presents the data on 1-year and 10-year yields and the corresponding spread for the period since April 2005. Graph C (p 69) shows the movement in from the graph that the growth in IIP is in tandem with the movement in spread, a higher spread associated with a higher growth and a lower spread with a slowdown in the growth of IIP.

The relationship between the spread and the economic activity is not strictly contemporaneous – it holds true with a lag. The variations in spread are reﬂected in terms of a rise or fall in activity after some lapse of time. To capture precisely the relationship between the spread and industrial activity, it would therefore be useful to obtain a quantitative relationship between the two.

A simple regression exercise was attempted to check the predictive power of the yield spread with reference to industrial activity, captured through changes in the IIP.

The annualised percentage change in industrial production on a monthly basis measured by the IIP has been used along with the corresponding gilt yield spread between 1-year and 10-year maturity. The linear regression equation applied is G = a + b YS

t t-k

where = Percentage change in the IIP on y-o-y

Gt

basis; YSt-k = Yield spread between one and 10-year maturity; t = The month t and it ranges from April 2005 to October 2010; k = Forecasting horizon in months and t-k represents time lag with k months

Various regression results were ob tained with k taking the values from 1 to 7. The regression equation where yield spread is taken with a lag of six months

Table 2: Corpoarte Bonds Average Spread over Comparable G-Sec (in Basis points)

Dec-09	4.10	7.47	337.20	17.95	Maturity Buckets/ Month	<= 1 Year	> 1 Year - <= 2 Years	> 2 Years - <= 3 Years	> 3 Years - <= 5 Years	> 5 Years - <= 7 Years	> 7 Years
Jan-10	4.03	7.71	368.20	16.78	October-10	111.08	163.50	90.32	106.22	119.52	99.61
Feb-10	4.96	7.77	280.90	15.13	November-10	195.39	192.47	113.84	115.89	107.74	98.03
Mar-10	5.32	7.88	256.70	15.55	December-10	228.02	183.75	137.42	141.17	128.47	99.11
Apr-10	5.24	7.89	265.60	16.64	Source: CCIL Rakshitra, various issues (www.ccilindia.com).
May-10	5.09	7.51	242.90	12.19	Table 3: Corporate Bond Spreads for AAA Rated PSU, Banks & FIs & NBFCs & Corporates
Jun-10	5.21	7.54	233.20	7.17	Month	3 Years	5 Years	10 Years
Jul-10	5.54	7.62	208.10	15.09	PSU, Banks & FIs *	NBFCs	Corporates	PSU, Banks & FIs * NBFCs	Corporates	PSU, Banks & FIs *	NBFCs	Corporates
Aug-10	6.31	7.88	156.80	6.92	31-Jul-10	64	107	89	64	93	88	79	129	87
Sep-10	6.43	7.95	151.90	4.39	31-Aug-10	87	64	130	88	57	79	64	55	108
Oct-10	6.60	7.97	136.70	11.30	30-Sep-10	76	72	123	58	52	64	59	52	85
Nov-10	6.88	8.02	113.60	2.70	01-Nov-10	82 (78)	129	92	63 (62)	86	73	56 (61)	105	68
Dec-10	7.50	8.03	52.9	1.6	30-Nov-10	95 (86)	138	105	66 (56)	96	76	59 (48)	103	69
Jan-11	7.52	8.17	65.1	NA	31-Dec-10	126 (117)	163	138	89 (79)	131	99	86 (77)	140	96
Source: Ministry of Statistics and Programme Implementation	*: From November onwards the yield spread for banks given separately.
(mospi.nic.in), EPW Research Foundation (http://epwrfits.in)	Source: Fixed Income Money Market and Derivatives Association of India (www.fimmda.org).
66	february 19, 2011	vol XLVI No 8		Economic & Political Weekly

MONEY MARKET REVIEW

9.5

8.5

7.5

6.5

5.5

4.5

3.5

was observed to be the best ﬁt. Yield spread is therefore able to predict the growth in industrial production with a six-month lag. The regression equation for k = 6 took the following form:

G= 5.8 + 0.0254 YS

t t-6

(0.691) (0.005) R= 0.560 DW= 1.06 t = 5.453 R2= 0.314 F= 29.733

The industrial growth will differ by

0.025 units for a unit change in yield spread with a lag of six months.

Anecdotal evidence also reveals that the narrowing of spread around mid 2008-09 resulted in slowdown in economic activity

Table 4: Money Market Activity (Volume and Rates)

FIMMDA reports since February 2010, the maturitywise spreads for different issuer groups and also for different rating categories, over the corresponding yields of FIMMDA–PDAI-Bloomberg gilt curve, CCIL reports the maturity rangewise average spreads over

the corresponding yields of comparable maturities of government securities.

This data is presented respectively in Table 2 and Table 3 (p 66). The FIMMDA data presented is for AAA rated bonds. Since the secondary market activity in corporate bonds is thin, much cannot be read from this data. However, the following broad observations would be in order

(i) In terms of issuers, the bonds of non-banking ﬁnancial companies (NBFCs) have the highest spread in all maturities, and in the recent period, since September 2010, the spreads have increased sharply, reﬂecting the higher risk perception a ssociated by investors; (ii) The spread is high at the second level for the corporate sector, but it is signiﬁcantly lower compared with NBFCs. In the recent period, the spread has shown some increase;

(iii) While the spread in respect of public sector units (PSUs) and banks has shown some increase in the recent period, overall they enjoy the lowest spread, signifying the higher level of investor conﬁdence in these issues; (iv) The data on average spread for different maturities shows that longer the maturity, lower is the spread. For instance, the December 2010 data shows that the spread for less than oneyear at 228 basis points (bps) came down consistently to 99 bps for maturities of 7-year and above.

2 Money, Forex and Debt Markets

Despite the fact that India is poised to achieve a higher growth rate in 2010-11, unabated inﬂation particularly of food, liquidity crunch resulting from a lower growth in deposits and accumulating government cash balances, and a shaky IIP

January 2011 December 2010 index, all contributed to a bleak outlook in Instruments Daily Average Monthly Range of Daily Average Monthly Weighted Range of Weighted

ﬁnancial markets for the new ﬁnancial

Volume Weighted Weighted Average Volume Average Average (Rs Crore) Average Rate (%) Daily Rate (%) (Rs Crore) Rate (%) Daily Rate (%) year. Combined risks from inﬂation, cur-

Call Money 7,468 6.52 6.09-6.82 7,657 6.74 5.65-6.97 rent account deﬁcit and ﬁscal situation

Notice Money 1,757 6.50 5.10-7.23 1,888 6.72 4.00-9.22 also pose a challenge to ﬁnancial stability.

Term Money @ 134 – 6.00-10.20 150 – 6.00-10.00

Global geopolitical concerns battered the

CBLO 46,289 6.18 5.28-6.48 42,885 6.20 4.79-6.31

market sentiments from the ﬁrst month of

Market Repo 11,994 6.21 4.50-6.48 12,589 6.28 3.00-6.36

@: Range of rates during the month. Source: www.rbi.org.in. and www.ccilindia.com

following the crisis, and the widening of spread after easing of policy rates have boosted the growth in the current ﬁscal. However, the narrowing of spread consequent to tightening of policy rates combines with inﬂation and other downside risks, to portend some slowdown in industrial and economic activity in 2011-12. The extent of this impact will depend upon the intensity of policy response to contain inﬂation and extent of further narrowing of spread, apart from other downside risks.

the calendar year 2011. The overall mood thus remained cloudy, ahead of the central government budget scheduled in end Feb-

Table 5: RBI’s Market Operations (in Rs crore)

Month/Year OMO LAF (Average Daily ruary. The ongoing investigation of scan(Net Purchase(+)/Sale(-)) Injection (+)/Absorption(-))

dals, especially at the higher echelons of

August-10 -11 1,207

political power, hit the market sentiments

September-10 8 14,364

and continued to prevail during January.

October-10 -1 62,309

The escalating uncertainty in Egypt and

November-10 8,354 98,001

other parts of north Africa added new

December-10 41,383 1,16,355

dynamics to markets already under pres

January-2011 17,510 90,349 Source: RBI’s Weekly Statistical Supplement. sure due to the peripheral euro zone debt

Table 6: Details of OMO Purchase Auctions (Amount in Rs crore)

Date of Auction	Nomenclature	Notified	Accepted	Bid-Cover	Indicative YTM at Weighted Average Weighted Average
	of Loan (%)	Amount	Amount	Ratio	Cut-off Price (%) Yield (%) Price (Rs)
05-Jan-11	7.17 2015	12000	8858.56	1.85	7.82 (Rs 97.59) 7.83 97.55

1.3 Trend in Bond Spread 7.99 2017 1030.00 4.92 7.82 (Rs 100.87) 7.82 100.85

Data on corporate bond yields from secondary market trades are scanty. For the last year, there are two sources of data. The ﬁrst is the Fixed Income Money Market and Derivatives Association of India (FIMMDA) and the other is the Clearing Corporation of India (CCIL). While the

Economic & Political Weekly

february 19, 2011

6.90 2019 112.56 21.34 7.93 (Rs 93.73) 7.94 93.64

7.94 2021 ----

12-Jan-11	7.46 2017 6.05 2019	12000	1552.28 -	1.04	8.02	(Rs 97.17) -	8.03 -	97.07-
7.80 2020 8.07 2022 Total Source: RBI press releases.	24000	1733.12 4221.9917509	1.90 1.51 2.10	8.18 (Rs 97.57) 8.17 (Rs 99.35)	8.19 8.18	97.49 99.25
vol XLVI No 8						67

MONEY MARKET REVIEW

14

10

6

2 0

Graph B: Quarterly Movement of IIP and GDP (Growth in %)
IIP Growth (Left Axis)
GDP at Factor Cost (Constant Prices, Right Axis)

3/06 7/06 11/06 3/07 7/07 11/07 3/08 7/08 11/08 3/09 7/09 11/09 3/10 7/10 11/10

Table 7: Foreign Exchange Market: Select Indicators

Month	Rs/$ Reference	Appreciation (+)/	FII Flows	BSE Sensex	US Dollar
	Rate (Last Friday	Depreciation (-) (Equity +Debt) (Month-end	Index
	of the Month)	of Rs/$ (in %)	in $ Million	Closing)
Aug-10	46.86	-0.85	3163	17971	83.25
Sep-10	45.54	2.90	7100	20069	78.72
Oct-10	44.54	2.25	5468	20032	77.27
Nov-10	45.74	-2.62	4785	19521	81.19
Dec-10	44.81	2.08	710	20509	79.03
Jan-11	45.74	-2.03	1198	18328	77.86

Source: RBI (www.rbi.org.in), BSE (www.bseindia.com), SEBI (www.sebi.gov.in),

www.futures.tradingcharts.com

and the ﬁscal troubles faced by other developed nations. The stock market was headed towards its lows and the rupee has been showing an overall depreciating trend. Besides hiking policy rates by 25 bps each in repo and reverse repo, respectively, the Reserve Bank of India (RBI) signalled further policy rate hikes on the back of rising inﬂation projected now at above 9% for the ﬁscal year end. In January, relentless liquidity stress made the RBI further extend the time limit of the liquidity easing measures up to 8 April. Despite the pronouncement that the open market operations (OMO) in the bonds market was only a monetary policy tool for the RBI, and not a debt management instrument, the m oney market rates showed signs of easing

s table to easing tendency 11 during most of January. In 10 the foreign ex change mar

ket, the rupee showed an 9 overall depreciating trend 8 against other global curren

cies. The yields in the gov

7

ernment securities market 6 continued to harden on the 5 back of increased inﬂation

ary expectations while corporate bonds market yields remained steady.

2.1 Money Market

A sign of easing liquidity was observed in January, due to monetary measures by the RBI to keep the situation under control. However, the system continued to be under deﬁcit mode. The weighted average call rates

moved around the RBI’s repo rate during January and stood at 6.52% against 6.74% of December. The month started with the weighted average call rate ruling at 6.82%, but showed a considerable decline during the fortnight ending 14 January 2011 and the rates eased up to 6.09%. The demand from banks tapered off as banks preferred to borrow funds from the RBI’s repo window where repo rates turned lower than the call money rates. During the second fortnight, the rates ruled in a narrow range of 6.35% and 6.69% though the demand was high in the ﬁrst week of the fortnight to meet the reserve requirements. Other short-term money market instruments like notice money and term money rates also displayed similar movements. Compared to overnight money market rates, the weighted average rate of collateralised borrowing and lending obligations (CBLO) witnessed a faster easing. The market repo rates also softened. In general, the short-term money market rates witnessed some softening trend during January after a long gap, partly due to the rise in government spending combined with the OMO of the RBI.

Except CBLO, the daily average volumes in the other four short-term money market instruments together showed a marginal fall during January over December. However, CBLO recorded 8% rise in its daily traded volume since these rates were ruling lower than the RBI’s repo rates, thus facilitating investor preference to borrow from this route (Table 4, p 67).

The volume of outstanding certiﬁcates of deposit (CDs) increased remarkably by Rs 38,342 crore during a single fortnight and the total outstanding amount stood at Rs 3,61,408 crore on 31 December compared with Rs 3,28,566 crore on 17 December. The rates of this instrument sustained their increasing trend as ﬁxed deposit rates by banks increased in recent times amid tight liquidity. Contrary to CDs, the outstanding volumes of commercial papers (CPs) fell by Rs 16,371 crore during a period of 15 days and stood at Rs 98,913

Table 8: Turnover in the Foreign Exchange Market* (in $ billion)

Month	Merchant	Interbank	Spot	Forward	Total
Oct-10	398.9	(30.3)	1047.6	(27.8)	708.3	(26.7)	738.1	(30.3)	1446.4 (28.5)
Nov-10	369.2	-(7.4)	926.2 -(11.6)	634.1 -(10.5)	661.3 -(10.4)	1295.4 -(10.4)

after the central bank’s effort to relax the Dec-10 279.4 -(24.3) 769.5 -(16.9) 507.0 -(20.0) 541.9 -(18.1) 1048.9 -(19.0)

liquidity situation. The liquidity deﬁcit which has persisted	*: Includes trading in FCY/ INR and FCY/FCY. Figures in brackets are percentage change over the previous month. Source: RBI’s Weekly Statistical Supplement, various issues.
for several months showed some signs of	Table 9: Details of Central Government Market Borrowing (Amount in Rs crore) Date of Auction Nomenclature of Loan Notified Amount Bid Cover Ratio Devolvement on YTM at Cut-off	Cutt-off Price
cooling down, bolstered by change in the	(in %) Primary Dealers Price (in %)	(In Rupees)
RBI credit to government to the extent of	07-Jan-11 7.49 2017 R 4000 1.71 724 8.05	97.25
Rs 85,000 crore along with inﬂows in the	7.80 2020 R 4000 1.71 1486 8.19	97.48
form of change in bank credit amounting to Rs 28,000 crore. Variation in net foreign	8.26 2027 R 3000 2.08 nil 8.47 14-Jan-11 7.17 2015 R 4000 1.98 nil 8.11 8.13 2022 R 4000 2.09 nil 8.17	98.10 96.5699.66
currency assets also added Rs 33,000 crore	8.30 2040 R 3000 2.18 nil 8.53	97.54
to the kitty. However, government securities	21-Jan-11 7.99 2017 R 4000 1.71 nil 8.19	99.01

auctions/redemptions absorbed around Rs 41,000 crore while at the same time the RBI’s OMO infused around Rs 17,500 crore into the system. Supported by these factors, the money market rates showed a	8.08 8.26 Total for Jan 2011 Total for Dec 2010 R: Reissue. Source: RBI press releases.	2022 2027	R R	4000 3000 33000 23000	1.69 2.33 1.92 2.23	nil nil	8.25 8.52 8.25 8.20	98.7597.70 98.03
68				february 19, 2011	vol XLVI No 8		Economic & Political Weekly

MONEY MARKET REVIEW

Graph C: Movement of 1 to 10 Year Spreads and IIP Growth Rate the ﬁrst fortnight of January. ending 24 December 2010. But the RBI

IIP Annual Growth (in %,

18.5 However, thereafter the stopped with only two auctions in Janu-

Right Axis) 17 liqu idity tightened again ary. This follows the overall liquidity eas

350 15.5

300 1-10 Year Spread (in

14 and the daily repo amounts ing in the system combined with dismal

bps, Left Axis) 250

12.5 crossed Rs 1 lakh crore on an interest by participants as evident from 200

11 average till 25 January. The the bid cover ratio of the second auction

9.5 8 amount fell marginally after conducted on 12 January (Table 6, p 67).

150

6.5 the RBI increased both the The interest rate futures (IRF) segment

100 5 key policy rates by 25 bps of the National Stock Exchange (NSE) con50

3.5 each in its monetary policy tinued with lacklustre volumes and the

2 0

0.5 review. Over all, the average turnover recorded a marginal fall during -50

-1 daily injection of liquidity January and stood at Rs 31 lakh compared 4/05 8/05 12/05 4/06 8/06 12/06 4/07 8/07 12/07 4/08 8/08 12/08 4/09 8/09 12/09 4/10 8/10 12/10

in January amounted to to Rs 37 lakh during December. The Secu

crore on 15 January 2011. The rates contin-Rs 90,349 crore (Table 5, p 67). rities and Exchange Board of India (SEBI) ued to rule high as in the previous month As in the previous month, the RBI made is in the process of issuing amendments to and ranged between 6.60% and 11.95% use of its OMO window to purchase securi-guidelines governing IRFs, as the reguladuring the same period. According to ties to infuse liquidity into the system and tor wants banks to perform the role of FIMMDA, the traded volume in CDs and CPs released Rs 17,500 crore in two auctions market makers to enhance liquidity and showed a fall of 25% and 4%, respectively, by purchasing three securities each. While investor participation. during January 2011 over December 2010. the ﬁrst auction witnessed huge investor

The Liquidity Adjustment Facility (LAF) response, the second auction proved to be 2.2 Forex Market window showed some reduction in liquidity quite dull. It may be recalled that in a The Unites States (US) dollar witnessed a injection by the RBI. After ruling at higher press release dated 16 December 2010, the mixed behaviour during January 2011. than Rs 1 lakh crore almost continuously RBI stated that it will conduct OMO pur-The greenback depreciated against most during December, the average daily liquidity chase auctions of Rs 12,000 crore every of its major global counterparts, but injection came down to Rs 77,500 crore d uring week for four weeks starting the week appreciated against the Asian currencies.

Table 10: Secondary Market Outright Trades in Government Papers – NDS and NDS-OM Deals (Amount in Rs crore)

Descriptions January 2011 Previous Month Three Months Ago Six Months Ago Last Week (28th) First Week (7th) Total for the Month (December 2010) (October 2010) (July 2010) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

1 Treasury 2739.96 15545.52 18512.63 26139.26

Bills 3182.55 12902.86 A 91-Day Bills 2690.05 7.18 1983.51 7.04 11385.82 7.01 7883.3 6.99 12014.55 6.42 13697.18 5.5 B 182-Day Bills 187.50 7.40 198.10 7.25 1694.25 7.22 2191.23 7.16 1533.24 6.6 6904.65 5.51 C 364-Day Bills 305.00 7.40 558.35 7.34 2465.45 7.22 2828.33 7.17 4964.84 6.73 5537.43 5.71 2 GOI Dated Securities 31172.66 8.19 27068.02 8.05 124461.98 8.15 156555.86 8.04 240054.67 7.96 250927.49 7.57

Year of (No of Maturity Securities) 2011 4 4.30 7.48 115.32 7.38 780.62 7.34 1160.44 7.50 2335.27 6.60 5047.57 5.54 2012 4 380.41 7.62 725.00 7.40 1777.04 7.52 1773.13 7.41 6107.90 7.12 6952.23 6.47 2013 2 191.02 7.72 845.00 7.61 1308.13 7.64 68.86 7.53 1946.86 7.26 4821.41 6.88 2014 5 12.32 8.01 126.60 7.93 347.45 7.68 1815.42 7.55 1290.80 7.11 2015 4 1691.27 8.10 3946.33 7.88 12923.87 8.03 12297.53 7.92 18618.92 7.76 26850.90 7.38 2016 2 0.25 8.45 205.27 8.04 735.62 7.93 1131.63 7.90 4475.99 7.61 2017 4 2900.01 8.14 2394.26 7.94 17371.12 8.07 38087.79 7.95 31222.78 7.94 8767.96 7.62 2018 3 12.49 8.22 0.05 8.65 13.32 8.23 124.97 8.00 104.04 8.05 115.34 7.80 2019 3 11.08 8.24 13.30 7.95 31.13 8.07 12.23 8.14 213.65 8.03 159.93 7.75 2020 5 8.13 8.18 8.18 8.03 7.97 7.62

2686.97 3263.22 19299.17 76663.81

20517.54 154935.30 2021 2 1.24 8.15 5.00 8.05 23.00 8.17 8.07 8.11 96.05 8.03 331.61 7.99 2022 4 8.19 8.11 8.17 8.07 8.07 7.96

20928.02 14278.04 61817.99 88841.83

69298.49 25520.46 2027 2 2053.39 1170.35 6495.62 8768.77 7451.47 2953.68

8.51 8.41 8.48 8.42 8.34 8.23 2028 1 8.47 8.56 8.30 8.30 8.16

0.68 1.35 10.94 2.10 0.50 2032 3 27.00 8.48 17.68 8.36 67.43 8.45 243.11 8.42 216.76 8.35 2663.25 8.27 2034 1 5.25 16.99 34.41 168.00

8.36 8.37 8.27 8.13 2035 2.07

8.42 2036 1 8.42 8.35 8.47 8.32 8.29

5.39 9.39 110.62 80.50 128.13 2040 1 8.55 8.44 8.52 8.47 8.42 8.32

272.21 289.08 2969.09 1971.95

2205.64 3165.66 3 State Govt Securities 562.03 8.47 986.26 8.37 3265.12 8.45 2264.49 8.36 2368.83 8.35 3040.98 8.01 Grand total (1 to 3) 34917.24 30794.24 143272.62 171723.21 260936.13 280107.73

(-) means no trading. YTM = Yield to maturity in % per annum. NDS = Negotiated Dealing System. OM = Order Matching Segment. (1) Yields are weighted yields, weighted by the amounts of each transaction. Source: Compiled by EPWRF; base data from RBI, CCIL.

Economic & Political Weekly EPW february 19, 2011 vol XLVI No 8 69

MONEY MARKET REVIEW

8

7

5

3

1

0

-1

The euro continued its resurgence against the dollar as in the past two months, on easing of fears over euro zone government debt and heightened expectations that the European Central Bank would raise interest rates. The euro has therefore been on a recovery mode since the huge success of its ﬁrst ever auction of bonds from the euro zone’s rescue fund. The pound sterling also appreciated by 3% against the dollar for a period of one month, but the Q4 GDP growth in the United Kingdom reﬂecting a contraction in the economy limited its gains. However, the US currency recovered during the later part of January. This was supported by a healthy Q4 GDP growth rate of 3.2% released in January, which pointed towards the economic recovery gathering pace and consumption growing at its fastest rate in ﬁve years (4.4%). Among the Asian currencies, the rupee depreciated the most against the dollar followed by yen at 0.7%. The latter was due to the downgrade by Standard and Poor of the ing that the country did not

60

have a “coherent strategy” for

50 bringing down its public debt.

Overall, the performance of

40

the US dollar against the bas

30

ket of major currencies, also measured by the US dollar index, showed a fall of 1.17%

20

10

during the month.

0 Prompted by high inﬂation numbers, the rupee showed an overall fall against the global currencies during January. The rupee’s behaviour was also inﬂuenced by soaring crude oil prices coupled with the massive net outﬂow of funds in equities which amounted to Rs 4,813 crore or $1.05 billion in January 2011. The stock market turned bearish with the Bombay Stock Exchange (BSE) Sensex losing more than 2,000 points in a single month.

The rupee started the month at Rs 44.67 per dollar with an appreciation of 14 paise on 3 January 2011. However, from 4 January onwards it fell continuously for ﬁve days in a row tracking a huge fall in the domestic share prices on increased expectations about the interest rate hike by the RBI and

Indian equities and rising overseas crude oil prices put further pressure on the rupee. However, from 11 January onwards the rupee recovered by 31 paise and rose to Rs 45.13 per dollar on 13 January, supported by renewed stock market movements on 12 January. Nevertheless, it again lost 46 paise in just two days and fell to Rs 45.59 per dollar on 17 January and thereafter showed a capricious trend ahead of the monetary policy review. The improved domestic GDP growth prospects restricted the rupee from falling further whereas dismal IIP numbers for November 2010 and mixed corporate results in the third quarter underpinned the sentiments. After the policy rate hike by the RBI on 24 January 2011, the rupee lost its ground and depreciated further, closing the month at Rs 45.7 per dollar with a depreciation of 2.03% over the previous month (Table 7, p 68).

Following the sharp depreciation of the rupee against the dollar during January coupled with volatile market movements, the forward premia across the three maturities showed a mixed trend during the entire month, but softened a little compared

Table 12: Yield Spreads (Weighted Average) – Central Government Securities – also anticipating a widen-January 2011 (basis points (bps))
ing current account deﬁcit	Yield	January 2011	Previous	Three	Six Months
which impelled the demand for the dollar by importers.	Spread in bps 1 Year-5 Year 5 Year-10 Year	Last Week First Week 32 60 18 -	Entire Month 52 18	Month Months Ago 64 98 25 33	Ago 155 100
In addition, negative senti	10 Year-15 Year	-	-	-	46	-	-
ments by the foreign insti	1 Year-10 Year	50	-	70	88	131	255
tutional investors (FIIs) in	Source: As in Table 9.

Table 11: Predominantly Traded Government Securities (Amount in Rs crore)

Descriptions January 2011 Previous Month Three Months Ago Six Months Ago

Last Week (28th) First Week (7th) Total for the Month (December 2010) (October 2010) (July 2010) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

GOI Dated Securities

9.39 , 2011 0.50 8.06 55.32 7.35 392.32 7.34 945.28 7.52 1480.01 6.64 3112.00 5.48

7.40 , 2012 240.06 7.60 710.00 7.40 1506.24 7.49 1284.58 7.38 4266.00 7.14 6193.00 6.49

7.27 , 2013 181.02 7.72 845.00 7.61 1273.02 7.63 68.00 7.53 1940.50 7.26 4716.18 6.87

7.32 , 2014 5.00 7.94 25.00 7.79 200.00 7.70 1110.00 7.55 460.72 7.21

7.17 , 2015 1691.17 8.10 3946.21 7.88 12799.28 8.03 11967.00 7.92 17324.59 7.76 24437.73 7.37

7.02 , 2016 205.00 8.04 699.30 7.93 1076.00 7.89 4273.59 7.61

7.46 , 2017 0.25 7.80 805.25 8.09 1705.02 7.93 2869.90 7.94 99.79 8.32

7.49 , 2017 430.00 8.15 1808.97 7.96 7718.86 8.04 4050.71 7.97 0.00 9.50

7.99 , 2017 2464.57 8.14 585.00 7.87 8831.32 8.10 32317.80 7.95 28315.36 7.94 35.00 7.74

7.80 , 2020 1956.45 8.15 2458.22 8.13 13107.97 8.17 19182.50 8.04 76151.93 7.97 153975.62 7.63

8.08 , 2022 11007.15 8.20 8076.04 8.12 31844.88 8.18 28302.41 8.06 19529.75 8.07 40.00 8.01

8.13 , 2022 9899.89 8.18 6175.00 8.09 29923.60 8.16 40721.14 8.07 68923.61 8.07 105.00 8.00

8.20 , 2022 20.00 8.20 27.00 8.21 47.56 8.20 265.76 8.12 388.25 8.11 25375.46 7.96

8.26 , 2027 2051.59 8.51 1150.20 8.41 6370.24 8.48 8442.12 8.42 7275.32 8.35 2546.26 8.22

8.28 , 2032 20.00 8.51 4.95 8.41 41.95 8.50 160.01 8.43 53.54 8.36 1164.76 8.26

8.30 , 2040 272.21 8.55 289.08 8.44 2205.64 8.52 2969.09 8.47 3165.67 8.42 1971.96 8.32

Total (All Securities) 31172.66 8.19 27068.02 8.05 124461.98 8.15 156555.86 8.04 240054.67 7.96 250927.49 7.57

(-) means no trading. YTM = Yield to maturity in percentage per annum. (1) Yields are weighted yields, weighted by the amounts of each transaction. Source: As in Table 9.

february 19, 2011 vol XLVI No 8

Economic & Political Weekly

MONEY MARKET REVIEW

to the previous month. The prevailing u ncertainty in the domestic forex market mirrored in the near-month premia witnessing a softening behaviour in the initial days of the month, hardening in the middle of the month with some intermittent exceptions, and again easing somewhat towards the later part of the month. The other two premia also exhibited similar behaviour, but the 3-month premia softened a little compared to the 6-month premia. Overall, the near-month premia shed 39 bps in a period of one month implying that the rupee will bounce back in February, while the 3-month premia suggests that the rupee will limit its losses in 90 days. However, the 6-month premia indicates that the rupee will move upward against the dollar in the period of half year (Graph D, p 70).

As per the RBI data, the overall turnover in the forex market recorded a signiﬁcant fall of 19% during December over the previous month, partly due to appreciation of the rupee in December. The increase in exports during December did not help increase the forex market turnover as the fall in imports offset the trend. The turnover in merchant and inter-bank segment showed a considerable fall of 24% and 17%, respectively, while spot and forward transactions decreased by 20% and 18%, respectively, during the same period (Table 8, p 68).

The volatile movement in the rupee during January encouraged heightened activity in the domestic currency derivatives market. Thus the aggregate and average daily turnover of the currency derivatives market recorded a whopping 21% and 33% increase respectively, in a single month. Despite trading only in futures, the Multi Commodity Exchange Stock Exchange (MCX-SX) cornered 52% of the market share and topped the list among the three exchanges. The share of NSE remained at 42% while that of United Stock Exchange (USE) stood at 7% as the initial euphoria displayed by the USE gradually waned.

USD-INR contracts showed further improvements in trading volume by 19% during a period of one month due to weakening of the rupee against the US currency. Options trading showed some revival and the average daily turnover recorded

Economic & Political Weekly

february 19, 2011

a whopping 75% rise over the previous month. But their market share in the total derivatives turnover remained at just 3.4%.

2.3 G-Secs Market

Consequent to liquidity pres sure, the ﬁrst auction of January was devolved on the primary dealers for two out of three securities, 7.49% 2017 and 7.80% 2020, to the extent of Rs 724 crore and Rs 1,486 crore, respectively. Though these securities were among the top traded securities, the prices of these securities set in auctions were lower than the prevailing secondary market prices. The remaining two auctions were fully subscribed, raising Rs 11,000 crore each. However, response received during the month as reﬂected in bid-cover ratio has dipped to

1.92 times against 2.23 in the previous month (Table 9, p 68).

In the secondary market, the ﬁrst and third week of the month, which represent ﬁrst weeks of reporting fortnights, witnessed lower trading as compared to the second and fourth week. During the month, the traded amount of government securities was to the tune of Rs 1,24,461 crore, which was lower than the total traded amount of the previous month at Rs 1,56,556 crore. Overall, yield of government securities ﬁrmed up to 8.15% in January against 8.04% in December. During the month, the top ﬁve traded securities were 8.08% 2022, 8.13% 2022, 7.80% 2020, 7.17% 2015 and 7.99% 2017 contributing to more than 77% of the aggregate trade for the month. Barring a few securities, yields for most of the securities hardened over the previous month. The yield spread narrowed for one and 10-year maturities and similar was the case with the spread between one and 5-year maturities. The spread of 5-year and 10-year maturities also shrunk from 25 bps to 10 bps between December 2010 and January 2011 (Table 10, p 69 and Tables 11, 12, p 70).

2.4 Treasury Bills

The overall trade in the treasury bills (TBs) market both in primary and secondary segments, showed that the market preferred the shorter 91-day TBs against 182-day and 364-day TBs. Total issuance of TBs in January was to the tune of Rs 21,000 crore, which remained constant

vol XLVI No 8

over December. The auctioned amount of 91-day TBs increased from Rs 14,000 crore in the previous month to Rs 16,000 crore in January. Comparatively, the issue of 182-day and 364-day TBs was reduced by Rs 2,000 crore. The cut-off yields ﬁrmed up with every auction over the month. Bid cover ratios declined except in the case of 91-day TBs.

2.5 Corporate Bonds Market

The mobilisation of funds through the corporate bonds market nearly halved during the month of January on the back of un favourable market conditions. The ﬁnancial institutions/banks raised Rs 1,650 crore through four relatively small issues and cornered 47% of the total mobilised amount. Despite this, the number of issues and total garnered amount was lower than in the previous month. The offered rates witnessed a marginal upward trend and ranged between 9.07% and 9.48% as against 8.75% and 9.25% in the previous month for maturity periods ranging between three and 10 years. Infrastructure Development Finance Company came out with a non-convertible debenture (NCD) issue offering 9.15% for 15-year maturity bonds to raise Rs 200 crore. IDFC has been raising money continuously through bonds this ﬁscal and the offered rates generally showed an upward trend. The renewed interest of PSUs in the corporate bonds market continued in January also, though the mobilised amount was less by 20% compared to the previous month. Corporates remained in a wait and watch mode and only one Great Eastern Shipping Company garnered Rs 100 crore through issuance of NCDs. Coupon rates displayed stable movement. All the issues carried AAA ratings by rating agencies.

According to data published by the SEBI, the aggregate turnover reported by BSE, NSE and FIMMDA remained almost the same as in the previous month, while the daily turnover averaged to Rs 1,823 crore showing a rise of 10%. In the secondary market, the weighted average yield shows a notable rising trend and among the listed bonds the weighted average yield of ICICI Securities and Finance Company, IDFC and Reliance Capital NCDs were trading at 19%, 18% and 15.7%, respectively, the highest during the month.