Tuesday, December 13, 2011 15:36 Hrs IST

We expect the year end fiscal deficit target to be around 5.2%-5.4%

Fixed Income Market Outlook: DSP BlackRock Mutual Fund

• Sticky commodity prices, sustained depreciated level of INR/USD currency and volatility from European markets keep domestic markets on a tenterhook.

• Weekly reading of food inflation has moderated in last three weeks, from 10.61% yoy to 8.0% yoy for week ending November 19. This moderation has subsequently helped primary articles inflation readings. Moreover, primary articles inflation is expected to come down sharply in December due to strong base effect. While this is positive news for the policy makers, there has to be more than just statistical base effect that has to play out in order for inflation trajectory to change definitively. We believe that headline inflation will remain stubborn in the near term and above expected 7% level by March 2012.

• We expect RBI to maintain neutral bias in its December 16th policy meeting. Moderation in growth as demonstrated by latest GDP and PMI updates will prompt RBI to hold rates steady.

• Systemic liquidity has been in the negative territory to the tune of almost INR 1,00,000 crores for pretty much entire month of November 2011 and this could only get strained further as almost INR 40,000 crores is expected to leave the system for advanced tax outflow by mid-December. RBI has a tough decision to make on whether to give a CRR cut or not. While every 25bps of CRR cut will release about INR 15,000 crores of liquidity in the banking system, RBI also runs the risk of signaling a reversal of monetary policy. Hence, we believe that until the inflation data (especially core inflation) suggests a convincing reversal in trend, RBI will maintain frequent OMOs.

• Government has already completed nearly 75% of budgeted spending by October 2011. In addition, two supplementary grants has added further spending burden of INR 65,800 crore. It remains to be seen as how this will get funded. This keeps significant upward pressure on fiscal deficit target of 4.6%. Additional borrowing that could result from sustained subsidy burden keeps us circumspect on the year end fiscal deficit target and we expect it to be around 5.2%-5.4%.

• We expect money market rates to remain range bound with a marginal upward bias.