Weekly views on Indian Interest Rates: Monday, 21st May, 2001

Inter-Bank Markets

Call Rates 3 Mth Forwards 3 Mth OIS

8.59% 4.96% 8.05%

Call Rates remained stuck near the RBI reverse repo rates of 8.75% and averaged the week at 8.81%, except on Saturday, when the CRR cut (declared the previous week), came into effect. It closed the week lower at 8.62%. Liquidity was tight, evident from the fact that the RBI lent an average of Rs. 2303 cr. per day to the inter-bank system through its reverse repo mechanism at 8.75%. The high overnight rates kept the 3 month Rupee-Dollar forwards stuck in the 4.95% to 5.00% range. Even the 3 month Overnight Indexed Swaps (OIS) - 3 month fixed rate which can be swapped against daily compounded overnight call rates - was around 8.05%, like the previous week.

Government Securities
Yields in the G-Sec market fell for the second week in a row. There was a major downmove in yields (rise in prices) in the long tenor bonds. Towards the end of the week, the labor ministry reduced the Employees Provident Fund rate from 10.25% to 9.50%. With the investment criteria of these funds already laid down, they would now be able to invest in their designated investments at lower yields. This led to a minor rally in the government security prices at the end of the week. Besides, this week the RBI continued its borrowing program, with its first issue in May. Last week�s issue of �Liquidity� had expected an auction of Rs. 4000 cr. in the long tenor, suited to the needs of institutional investors like the insurance companies, which were flush with funds. RBI auctioned Rs 4000 Cr 10.47% GOI 2015 paper, and the cut-off was very bullish at 10.19%. This led to an inter-week rally in the prices.

Credit Markets

Inter-Bank Markets | Expectation for the week | Liabilliies Management | Surplus Cash Management

3Mth CP(P1+)

9.23%

3Mth ICDs(P1+)

9.25% - 9.50%

1Yr AAA (spreads)*

9.75% (81 bp)

3Yr AAA(spreads)*

10.02% (91 bp)

5Yr AAA(spreads)*

10.25% (87 bp)

* All yields mentioned are annualized and spreads are over annualized GOI Securities

Commercial papers (CP) rates came down to 9.23% during the week. Some prime corporates managed to borrow through the CP route at 9.00-9.10% levels. This also pushed down the inter-corporate deposits rates by almost 50 basis points over last week. Prime corporates borrowed in the ICD markets at 9.25% levels. Activity in the 89 days letter of allotment with daily put & call option continued at Overnight inter-bank call plus 50-65 basis points. This is the fourth successive week that the corporate bond yields have come down, week-over-week. This week marked a new low for the 5 year AAA corporate annualized yields, with trades happening at 10.20-10.25% levels. Large corporates are actively raising money through the private placement markets at these low levels.

Expectations For The Week

Inter-Bank Markets | Credit Market | Liabilliies Management | Surplus Cash Management

The coming week should see liquidity return to the banking system, with the CRR cut coming into effect as also net inter-bank flows of almost Rs. 4400 cr coming into the market. We can expect a GOI security auction or Open Market Operation Sale List from the RBI (RBI selling the GOI securities held in its books to the market), at the end of the week to suck this excess liquidity.

Call rates are likely to come off and trade in the 7.75% to 8.75% range and then ease further to 7.90-8.00%. With this, our recommendation of receiving fixed rate 3 month OIS at 8.00% - 8.15% (receive a fixed rate of 8.00%-8.15% and pay a daily compounded overnight inter-bank call rates at the end of the 3 month period), will come into the money. Further, Active traders in the OIS markets can receive 1 year and pay 1 month. The curve is flat (1 month OIS and 1 year OIS are quoting at the same levels) and an expected bank rate cut should lower the short term interest rates.

GOI securities markets should rally another 5-10 basis points, with a larger move expected in the longer tenor bonds. The 10 year GOI security is expected to yield 9.85%-9.95% (s.a.), as compared to the current rate of 9.96%. With the call expected to cool down, Rupee-Dollar forwards would also look down and so will the other short term corporate rates like CPs and ICDs. 3 month CPs are expected to trade lower at 8.95%-9.15%. In the corporate debentures markets, the yields are likely to move lower for the fifth week, especially with the EPF rate cut being announced. 5 year AAA annualized rates are likely to move lower by another 5-10 basis points into the 10.15% region. The expectation is that these rates would quote further lower at 10.00% annualized levels - i.e. a AAA rated corporate would be able to borrow money at 10.00% annualized for a tenor of 5 years - an all time low.

Liability Management

Inter-Bank Markets | Credit Market | Expectation for the week | Surplus Cash Management

With the EPF rate cut coming in, the corporate debenture market interest rates are likely to move lower. The recommendation is to borrow 40% of annual requirements in medium and long tenor. We had suggested completing 50% of this amount in the current rally. We now recommend completing as much as 75% of the medium to long tenor borrowing in the current rally. The remaining 60% of annual requirements should be concentrated in the short tenors (depending upon the cash requirements, corporates could maintain about 50% of short term borrowings in floating rate form).

Short Term Liability Management
Commercial Papers:     The recommendation was to wait before issuing fresh CPs. With the call markets expected to cool off, corporates could start to actively inquire about raising money in short term CPs. Expect a range of 8.95%-9.15% for 3 month CPs and borrow at 8.50%-8.75% range. If possible, extend the CP borrowing tenor to 6 months at 9.00%-9.25% range.

MIBOR Linked 89 Day NCDs with Put/Call Options:     With Vyaj Badla being discontinued money is coming into liquidity funds. To take advantage of the mutual funds receiving inflows in their liquidity funds, Corporates should actively consider issuing MIBOR linked papers to them. These are short-term secured/unsecured, rated 89 day corporate Non-Convertible debentures (NCD. The paper matures in 89 days and hence does not require stamping, saving the issuer the initial cost. These NCDs are issued at floating rate i.e. depending upon the credit rating of the corporate, it would be priced at a certain basis points over the inter-bank call rates - hence the rates would change daily. To add further liquidity to the issue, these NCDs have a daily put/call option facility, i.e, both the issuer and the investor has a right to redeem the issue with 1 day�s notice to the other. This added liquidity further reduces the cost (i.e. the basis points added onto the call rates) to the issuer. The issuer faces Liquidity Risk if the markets become tight. However, with a fairly liquid market expected for the next couple of months, this should hardly be a risk to the corporate. Moreover, typical investors in such papers are money market mutual funds, which do not require liquidity unless faced with a major redemption. Depending upon the credit rating, such papers are dealt at 50-75 basis points over call rates in the markets. Thus, if Call rate were to average 8.25% compounded daily, for the next 89 days, the corporate issuing a paper at 75 basis points spread would have to pay around 9.00% (call average of 8.25% + 0.75% spread) for 89 days. The recommendation is to borrow through this route for the required 50% of the overall short term borrowing limit.

Short Term Foreign Currency (FC) Loans:       Here the recommendation remains for corporates to borrow short term FC loans on an unhedged basis. The same can covered after forwards ease in the next 5- 10 days.

Medium and Long Term Liability Management
Rupee Borrowings:     Corporates should look to complete at least 75% of their annual long term borrowing before this rally comes to an end. The following is the recommendation sheet for the tenor and rates which manufacturing corporates of different credit ratings could borrow:

credit

Foreign Currency (FC) Borrowings: For corporates with FC borrowing needs, the recommendation continues to be to borrow in Rupee for the similar tenor and swap it into FC loans.

Recommended Liability Structure

Expectation of Interest Rates for the week

Surplus Cash Management

Inter-Bank Markets | Credit Market | Liabilliies Management | Expectation for the week

For corporates with surplus short-term cash, �Liquidity� has two recommendations. First one is a repetition of the last week�s call to deploy it in short term financial institutions papers maturing in 3 months time. These papers yield around 9.50% to 9.80% for a Rs. 5 cr. lot (providing better return than normal ICDs), are liquid (easily saleable in the secondary markets) and are good from a credit perspective. For a longer tenor of 5 to 6 months highly liquid corporate names or PSU bonds, which could yield around 9.50%-9.75%, can be considered.

Short termCash Management

Indicative Returns