extended debt borrowing

After witnessing huge crash in equity markets most of the investors are busy in celebrating rally in equities even without bothering the condition of other asset class. Yesterday GOI came with an unexpected announcement that in this fiscal year they will borrow 52,800 crores from the debt market in the second half of the year which is approximate 32% extra than the figure which was envisaged in the budget of this year. With this move govt will be raising its borrowing programme for this fiscal year which will reach upto 4.7 trillion which is again highest ever.
As per the statistics disclosed during budget the scheduled net borrowing for this second half was 1.56 trillion but now this amount will be 2.198 trillion (2.2 trillion). It’s difficult to say that what would be the intention of govt behind this move but one factor (among many others) can be considered that they want to push interest rates.

Domestic debt market reacted sharply on the announcement and benchmark 10 – year paper yield reaches to 8.44% (10 bps high) on Thursday. The announcement of increased borrowing of 52,800 crs was against expectation of market of maximum 20,000 crs. The way G Sec yields are moving, it may be a start of a new dawn because as the new papers will hit market the yields will really start moving up and it won’t be a magic if yields reaches till 8.7% level in coming weeks. This increase in yields will definitely make an adverse impact on the bond valuation which will be a major challenge for investors.

Stumbling JPY

Credit ratings agency Fitch cut its outlook on Japan's sovereign debt, warning that the vast cost of a March earthquake and tsunami and the still-unknown bill for the clean-up after the nuclear disaster would further strain the country's already shaky public finances which resulted in the USD/JPY again in stumbling position and dropped to the 80.82 level. The public debt size is already twice of the 5 trillion economy of Japan. On one hand japan is already working hard to rebuild its infrastructure while on another hand its given that it works hard on its financial soundness so definitely all this will create a doubt among investors that govt can make much headway in plans to reform tax and social security while the struggles with the nuclear crisis.

An ultra-loose monetary policy in developed markets coupled with weakening currencies, particularly in the U.S., Europe and Japan, growing demand from rapidly industrializing nations such as India, China and Brazil coupled with production disruptions across the world have led to a sharp rise in commodity prices and hence inflation.

Will it continue in the future? Doubtful, because most commodity prices, particularly oil, have reached a point where they start affecting growth. Sooner or later demand supply dynamics will take precedence thereby cooling off commodity prices.

Jan 2011: Market Move

The stock markets have reported their 4th biggest monthly fall since inception, after the FIIs started pulling out their investment from equities on concerns that rising inflation and interest rates (RBI raised the interest rates by 0.25% - 7th time since Mar’10) may dent the profit growth of India Inc. in the near future. If we will look towards GOLD then definitely it looks soothing as gold has been corrected around 3.1% in first month of 2011 as gold (INR per 10 gm) was 20,585 in Dec. 10 and 19,945 in Jan. 2011 but if we'll turn towards Crude then it doesn't looks in comfort level as it has been surged around 7.63% in Jan 11 (Dec’10 $ 92.25 per barrel - Jan’11 $99.29 per barrel).

• BSE Sensex continued the trend of last 3 years and once again decline in the opening month of the calendar year. Sensex lost 2,181 points or 10.64% in Jan’11 to close at 18,328, making it the worst monthly decline since Oct’08 when it lost 23.89%.

• Sensex ended in red 14 times out of 20 trading days in the month, while FIIs took outbound flight 15 times in the month, selling equities to the tune of over $1 billion. The fall in Sensex would have been much steeper but for buying by DIIs (DIIs were net buyers 13 out of 20 trading days in Jan’11).



• More than 800 stocks touched a 52-week lows in the past one month and included the likes of Reliance Industries and DLF.

• MTNL, NHPC, Ackruti City and JSW Energy were among the 65 stocks that hit all-time lows on the BSE.

Market in New Year

The movement of leading India equity indices in year 2011 can’t be considered in a proper way. SENSEX itself corrected around 6.95% in the first 6 business days of New Year. As per the current market scenario it won’t be wrong to say the SENSEX & NIFTY may slide further before market enter into some established position. Other than the fear of inflation there are other factors also which are causing this decline. The developed economies especially US and EURO zone are still not in good shape and as per the latest available figures they don’t seem improving condition. Once they (those developed economies) will start improving themselves then it might be possible that their investment fund managers will shift their concentration towards those developed market rather than emerging markets like India. So again this activity will result in terms of reduced FII activities in to the markets like India so definitely then the Indian paradigm will be less volatile.

Now another factor can be considered are anticipation of hike in the policy rates by RBI in coming rate review meeting (Jan 25). Food inflation touched 18.8% (Dec. 2010) may give a chance to regulators to hike key policy rates and ultimately this hike in policy rates will result in terms of surge in the interest rates in the country. If every thing happens as per the anticipation then it’s sure that this increased interest rate will become a reason to influence G-Sec markets. On Monday the yield of largest traded 10 year GOI bond was recorded 8.25% (4bps up compare to Friday close and highest since liquidity crisis of 2008). Second most traded GOI bond was 8.08%, 2022 which also closed high 3bps compare to Friday close and it was 8.21%.

Increasing oil prices are also not missing their part to strengthen USD which inversely impact on domestic FX market. In the stock market, sectors which are more sensitive to interest rates, like real estate, consumer durables, banking and auto, witnessed strong selling.

China and Inflation

The central bank of China has raised RMB reserve requirement ratio (RRR) by 50bps third time in last 5 weeks time and 6^th times in 2010 without touching its key 1 year lending rates. The goal of course is to try to slow lending and quell inflation. This has become a huge test and challenge for the Chinese government and even bigger if we consider the Nov CPI figure which is posted at a sizzling 5.1%. On Saturday China has reported that their Nov 2010 inflation (CPI) figures reached on 28 months high (y/y). This might be a possibility that this is a number that Chinese govt. is accepting and the real number most likely is much higher than exposed. If the Chinese fail to act aggressively we could see a sharp spiral in inflation.

It is not clear that the Chinese have the political will or the financial necessity to stop this inflationary tsunami. It seems like they are not very sure about their growth and this fear is resulting in the failure to allow their currency to float which is causing economical imbalances. Another reason can be considered is under developed financial instrument in the market which is making Chinese govt’s way difficult to react on inflationary problems. Over the years, the central bank has bought most foreign currencies flowing into the country to keep China's currency yuan stable and thus injected a huge amount of yuan cash into the system, which needs to be sterilized. Heavy foreign exchange flows in recent years have left commercial banks holding too much yuan, forcing the PBOC to use bill sales and bank reserve requirement ratios to sterilize it, Wu was quoted as saying. It sounds bad but seems to be true that “if China doesn’t stop inflation then inflation may stop china.”

Weekly FX update

USD rose against most of the global currency pairs on Thursday 09/12/10. The day was significantly good which initiated volatile trading. As a result the USD not only strengthen against EURO but was looking in sound position against GBP, since the economic figures in Britain left must be desired. The increase in the demands of US Treasury bond (hence lower yields) resulted in terms of decline against JPY. Apart from all this one more news came in market that Ireland’s opposition Labour Party decided to vote against the bailout of IMF and European Union and downgraded ratings of FITCH for Ireland turned into a positive factor for strong performance of USD.

The last trading session of the week was mixed for EUR, so was the market’s reaction to the market data. The disappointing factor for EUR was the poor demand at an auction of 2 year bonds on Wednesday (the third German bond sale in a row was undersubscribed). The good news was from US Treasury yields which helped EUR to cover most of its losses. The GBP was selling off against USD by the end of last trading session of the week. According to a report house prices in Britain went down (Y/Y basis) first time in last 12 months. The trade balance deficit grew to 8.5bn against 8.4bn (September) and 8.1bn (expected). According to a forecast, growth is slowing down, though the price is still creeping up, which may give the BoE new reasons for the toughening – and it can in no way be considered a positive factor for the British economy.

The pair USD/JPY declined on Thursday’s session and a mixed response on next session. US yields came off a little, which is a dollar negative, plus Japanese exports grew. Strong demand for the US 30-year bonds reduced yields a bit, triggering the dollar’s fall and, as a result, the yen’s strengthening. If there are no surprises in debt markets, in regards of US Govt. Bonds, this pair should perform consistently. Some rumours are circulating that China could raise interest rate which most likely will be a kind of support for USD despite of positive unemployment claims data.

Equity markets in India tumbled badly and underperformed all Asian peers and ended lower around 2.3% which was one of the reasons behind low performance of INR which closed low 0.3%. Some major economic events can be noted down as:

1. The total borrowing from Banks under RBI’ LAF was accelerated (124,780 Cr. On 9^th Dec, 2010)
2. Bond prices continue to consolidate. Yield on 10 yr benchmark Govt. bond almost ended flat.
3. INR ended lower against all major currency pairs.
4. FII’s outflow continues to accelerate (on week ended Dec. 9 the net sell was approx USD 287.63mn in equities while net buy was approx USD 3.4mn debt instruments.

Comments are most welcome.

Currency Options

Trading in Currency Options on the Currency Derivatives Segment was launched today. Near month contracts of Rs 45 call and Rs.44.50 put witnessed maximum liquidity and tight bid-ask spreads of 0.25 paise (1 tick). More than 3 lac contracts (about USD 300 million) were traded during the day with an Open Interest of about 95,000 contracts (about USD 95 million). Put call ratio of 2.8 : 1 was observed.

The first trade in the currency options was executed by East India Securities Ltd. About 130 members including State Bank of India, Axis Bank, IDBI Bank, Standard Chartered Bank and IndusInd Bank actively participated in the trading. Amongst the Bank participants Standard Chartered Bank executed the first trade.