Nightmare on Bond Street as yields hit 5-yr peak, Rupee past 63

Written by fe Bureau | Mumbai | Updated: Aug 20 2013, 10:11am hrs
It was close to capitulation in Indias bond and currency markets on Monday with the rupee crashing 2.8% to a new low of 63.13 against the dollar and the yield on the benchmark bond soaring to a five-year high of 9.24%. Equities lost further ground with the Sensex closing the day 291 points lower at 18,307.52, a loss of 1,000 points in two sessions.

The combination of a strengthening dollar driven up by expectations of an early tapering of quantitative easing by the US Federal Reserve and a thin local market characterised by low supply drove down the currency to new lows, increasing chances of a further hit to corporate balance sheets since an estimated 40% of corporate forex exposure is unhedged.

The Reserve Bank of India (RBI) is understood to have stayed away from the currency market on Monday. The rupee has now lost 13.2% since July 15, when the RBI first attempted to tighten liquidity by clamping down on banks borrowings through the special window. The central bank has also initiated measures to check dollar outflows from corporates and eased interest rates on NRI deposits to attract dollar flows.

With the long-term sovereign yield now at over 9%, more than R15 lakh crore of bonds held by banks in their investment portfolios, is at risk of mark-to-mark losses. Short-term money also became more expensive the R11,000-crore auction of 28-day cash management bills saw a cut-off yield of 12.2%, 70 basis points higher than that in the previous auction on July 25. With the cost of funds rising, banks are hiking their base rates: On Monday, Axis Bank raised its base by 25 basis points to 10.25%, following HDFC Bank which had upped it by 20 basis points to 9.8%.

The sharp depreciation in the currency notwithstanding, World Bank chief economist Kaushik Basu was confident these economic woes werent comparable with the problems the country faced in 1991. Are we back to 1991 That is completely a non-question because if you just look at a couple of numbers, there is absolutely no comparison. Foreign exchange reserves in 1991 were down to $3 billion, India now sits on $280 billion, Basu asserted, adding there was no need for India to ask the IMF for a line of credit.

Neelkanth Mishra, head of research at Credit Suisse, believes its possible the current account deficit could be contained at $35 billion this year if receipts from invisibles come in at $112 billion, even if remittances stay unchanged. This can be funded with just FDI and NRI deposits and the underlying problem is therefore not as big as it seems, he wrote.

Bank of America Merrill Lynch, however, believes the rupee will not stabilise until the RBI recoups the reserves. The markets will be nervous till the import cover reverts to the 8-10 months critical for stability, economist Indranil Sengupta wrote in a report.

Volumes in the bond market on Monday were small at less than Rs 10,000 crore. Foreign institutional investors (FII) who have been selling Indian bonds, as the currency depreciated and US treasury yields rose, may find yields attractive at Tuesdays $9.4 billion auction of gilts at the July auction, they had opted to buy $4 billion worth of paper. FIIs have sold close to $10 billion of rupee bonds since May 22. Meanwhile, short-term rates remained elevated with the yield on the three month commercial paper (CP) at 12%.