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From the Fund Managers Desk 1x1pix.gif (807 bytes)
1x1pix.gif (807 bytes)

Tuesday, November 09, 2010 15:30 Hrs IST

We Remain Bullish On Government Bonds over the Next 6 Months

DSP BlackRock MF Fixed Income Market Views

Fixed Income Market Review

The Reserve Bank of India (RBI) in its monetary policy review raised the Repo Rate by 25 basis points and the Reverse Repo Rate by 25 basis points to 6.25% pa and 5.25% pa respectively, maintaining its liquidity tightening stance. RBI also signaled a temporary pause to the tightening bias by stating that that the likelihood of rate actions in the immediate future remains relatively low. The main considerations behind the rate hike were high inflation, tight systemic liquidity and robust economic growth.

The Benchmark 10 Yr government bond yield moved up from 7.84% pa in the beginning of the month to 8.13% pa as on October 29, 2010 on the back of tight liquidity conditions and negative sentiment ahead of RBI's credit policy.

Money market yields continued to harden driven by the tightness in liquidity and a sharp surge in funding requirement for the Coal India IPO. 3M Bank CD yield has moved from 7.13% pa to 7.85% pa during the month while the 12M Bank CD yield has moved from approx. 8.07% pa to 8.55% pa during the same period. The spread between 3M Bank CDs and 3M T-Bills is 105 basis points.

10Y AAA PSU Bond moved from 8.67% pa in the beginning of the month to 8.79% pa as on October 29, 2010 while the 1Y AAA PSU Bond moved from 7.89% pa to 8.40% pa during the same period tracking upside movement in the government securities and tightness in the money market.

The liquidity in the system at the end of the month was severely negative at Rs. 1,30,000cr (US$ 29 bn).

Macroeconomic Review

The Industrial Production (IP) growth for August decelerated to 5.6% y-o-y compared to 15.2% y-o-y growth in July (revised upwards from 13.8% y-o-y earlier) and 5.8% y-o-y growth in June. On a seasonally adjusted basis the IP index was down 6.7% m-o-m (compared to (+) 7.5% m-o-m) in July. The key reason for this deceleration is the volatile capital goods component (-2.6% y-o-y in August against 72% y-o-y in the previous month). IP ex Capital Goods decelerated to 6.8% y-o-y in August compared to 7.4% y-o-y in July on account of base effect. Inspite of this, the other key variables such as passenger car sales, two wheeler sales and tax revenue collections did not show any major deceleration.

The WPI headline inflation came in slightly higher than expected in September, accelerating to 8.6% y-o-y compared to 8.5% y-o-y in August. Food inflation accelerated to 10.8% in September compared to 10.6% in the previous month while non-food inflation continued to remain high at 7.8% in September compared to 7.7% in August.

Export growth for the month of September accelerated to 23.2% y-o-y compared with 22.5% y-o-y in the previous month while Import growth decelerated to 26.1% y-o-y compared to 32.2% y-o-y in August. On a seasonally adjusted sequential basis the exports were up 9.9% m-o-m compared with 6.3% m-o-m in August while the imports declined 3.5% m-o-m compared with +0.4% m-o-m in the previous month. The monthly trade deficit narrowed to USD 9.1bn compared to USD 13bn in the previous month while the y-o-y growth in monthly trade deficit stood at 32.1% in September compared with 47.1% in August.

Fiscal Deficit: Tax Collections of the Central Government grew 21.5% y-o-y in September compared with 26.6% in the previous month. Fiscal year to date the tax collections have grown by 25.3%, ahead of the full fiscal year government budget estimate of 18%. Revenue expenditure declined 15.6% y-o-y in September but has grown 15.6% fiscal year to date (FYTD), compared to the budgeted estimate of 6%. On a FYTD basis, revenue deficit was down 54.6%, compared to the budgeted estimate of 16%.

Fixed Income Market Outlook

The RBI has communicated that there will be no further rate hikes in this calendar year. However, if inflation continues to remain high, we might see a change in this stance.

We remain bullish on Government bonds over the next 6 months. However, the combined impact of the deluge of FII inflows, tight liquidity, sticky inflation and moderating demand could lend to intermittent volatility in Government bond yields.

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