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

Tuesday, March 08, 2011 11:12 Hrs IST

We expect benchmark 10 Yr yield to move upwards in the near to medium term on account of tight liquidity and concerns on inflation

DSP BlackRock Investment Managers-Indian Fixed Income Market

Fixed Income Market Review

The Union Budget announced by the Government on February 28, 2011, had the following key takeaways from the fixed income market perspective:

The gross borrowing is expected to be Rs. 4,17,000 crore while the net borrowing is estimated at Rs. 3,43,000 crore.

Fiscal Deficit for FY2011-12 expected at 4.6% while for FY2012-13 it is targeted at 4.1%.

Total Expenditure for FY2011-12 is targeted to be Rs. 12,57,729 crore.

Though, the Union Budget is positive for the fixed income market as all of the above figures are better than what was expected, the market participants are worried about lower petroleum subsidy for FY2011-12 and a potential oil price increase in the pipeline.

Recent developments in Egypt and Libya have resulted in crude oil trading above USD 100/barrel. Bond market participants are nervously watching the price trend of crude oil as any serious upward move in oil price may result in higher fiscal deficit in the medium term.

Market participants expect the RBI to increase rates on or before next policy meet (March 25, 2011) if crude oil trades above USD 100/barrel for long and food inflation remains elevated.

The Benchmark 10 Yr government bond yield moved down from 8.16% pa in the beginning of the month to 8.06% pa as on February 28, 2011. The Government is through with its borrowing for the fiscal year 2011. The lack of supply, therefore, has been putting downward pressure on yields.

Money market continued to move up higher given the tightness in the liquidity conditions, persistent inflation and continued restrictive monetary policy bias. 3M Bank CD yields moved from 9.43% pa at the beginning of the month to around 10.1% pa as of February 28, 2011. 12M Bank CD yields moved from 9.90% pa to around 10.2% pa during the same period.

10Y AAA PSU Bond yields have remained largely flat moving from 9.16% pa in the beginning of the month to 9.17% pa as on February 28, 2011 while the 1Y AAA PSU Bond yield has gone up from 9.45% pa to 9.68% pa during the month.

Systemic liquidity in the banking system at the end of the month was Rs. 70,000cr (US$ 16bn) negative.

Fixed Income Market Outlook

Bond market participants are cautious amid tight liquidity conditions, high credit offtake and de-growth in the deposit base, worsening current account deficit and rigid headline inflation.

We expect benchmark 10 Yr yield to move upwards in the near to medium term on account of tight liquidity and concerns on inflation due to recent rise in oil prices. We also expect the RBI to hike rates by 75 basis points during the year, in a sequential manner.

Geopolitical risk is a major concern, directly tied into oil and FII flows. High oil prices could upset the fiscal balance while the volatility in FII flows could push up the current account deficit. This could lead to corporate spreads widening from their current levels.

Money market rates are also at elevated levels on account of the tight liquidity conditions and are likely to remain range bound with an upward bias in the near term. With liquidity easing post FY end, rates could see some softening.

Macroeconomic Review

The Industrial Production (IP) growth for December moderated further to 1.6% y-o-y compared to 3.66% (revised upwards from 2.7% y-o-y) in the previous month. On a seasonally adjusted basis, the IP index was up 1.0% m-o-m in December compared to (-) 2.9% m-o-m decrease in November. On a quarterly basis, IP growth decelerated to an average of 5.5% y-o-y during the quarter ended December 2010 from 9.1% during the previous quarter. Growth in the manufacturing as well as mining segments moderated to 1% y-o-y and 3.8% y- o-y (compared to 3.2% y-o-y and 7.4% y-o-y in the previous month) while growth in the electricity segment accelerated to 6% y-o-y (compared to 4.6% y-o-y in November).

The WPI headline inflation decelerated marginally to 8.2% y-o-y in January 2011, compared to 8.4% in the previous month. The seasonally adjusted WPI Index was up 1.1% m-o-m. Food inflation (primary and manufactured) accelerated further to 9.5% in December against 8.9% in the previous month while non-food inflation decelerated to 7.7% this month from 8.2% in December.

India's GDP grew by 8.2% y-o-y in the quarter ended December 2010, which was slightly lower than market expectations of 8.8%. The strong GDP growth was on account of agriculture and services segments. The agriculture output grew 8.9% y-o-y which was significantly stronger than the 2.5% and 4.4% growth seen in the previous two quarters. The industry segment growth was 5.7% y-o-y which was substantially lower than 11.7% and 8.9% growth seen in the previous two quarters. The services sector saw a growth of 8.7% y-o- y, compared to an average growth of 9.5% in the last two quarters.

Non-Equity Market Update

Currency: In February, the Indian Rupee appreciated 1.38% against the US Dollar and by 0.16% against the EURO. The USD/INR FX rate closed the month at 45.27 against 45.91 as at previous month end. The EURO/INR FX rate closed the month at 62.65 as against 62.75 as at the previous month end.

Gold: Gold price moved up 5.9% in February to close the month at USD 1411.5/ounce.

Oil: WTI crude moved up 5.2% to close the month at USD 97/barrel. Brent crude was significantly higher at 111.8/barrel as on February 28, 2011.

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