Home > Fund Managers Commentary

Fund Managers Commentary

December 31, 2011

Debt Market

The sovereign bond market turned extremely bullish during the month, driving the yields to 2 months low, as the RBI resorted to series of OMOs to infuse liquidity in to the system. Slew of weak growth data as well as the dovish comments in the mid quarter policy review, raising hopes of reversal of tight monetary going forward, also added to the bullish sentiments. In the much anticipated and much warranted move, the RBI chose to maintain status quo on policy rates in the mid quarter review, after remaining in a tightening mode for around 20 months. RBI explicitly acknowledged the pressures on growth and also exhibited guarded optimism over inflation that has more or less traversed the projected trajectory hitherto. They further stated that, if the inflation confirms to its expected path of moderation, the next move would be towards easing of policy rates. As a result of this, 10 year yield touched a low of 8.29% during the month. However, the market failed to maintain the bullish momentum towards the end of the month, as concerns on the fiscal position and expectation of upward revision in the borrowing numbers forced the participants to pare positions. Nevertheless, the 10 year closed the month at 8.56%, down 18 bps compared to previous month close of 8.74%.

The improved sentiment seen in g-sec market was visible in the Corporate Bond market as well, with yields softening as much as 15-30 bps. While the 10 year AAA bond closed the month at 9.42 %, down 29 bps, the 5 year AAA bond yields closed at 9.52%, down 12 bps. The credit spreads for the 5 year and 10 year bonds stood at 90 and 68 bps respectively.

The liquidity deficit in the system widened significantly during the month largely on account of advance tax outflows. The average LAF borrowing during the month was at INR 1.17 Tn, as against INR 910 Bn in the previous month, despite the series of OMOs by RBI through which it has infused close to INR 410 Bn. The highest LAF borrowing during the month was at INR 1.73 Tn. The huge stress in the liquidity also led to some banks tapping the high cost MSF facility from RBI at 9.5% during the month.

As a result of tight liquidity, the money market rates firmed up by 40-50 bps during the month. The 3 months and 12 months CD rates touched a high of 9.90-95% during the month. However, towards the end of the month, on expectation of liquidity situation easing, by way of government spending and OMOs, the rates softened significantly to close at 9.45% and 9.75% respectively.

On the macro economic data released during the month, inflation for the month of November 2011, as measured by WPI index, grew at 9.11% compared to 9.73% in previous month. The dip in inflation number was mainly due to significant fall in primary article inflation which is the lowest since July 2009 that carries approximate 20% weightage in inflation basket. After remaining in double digit figure for successive 22 months, for the first time primary article inflation rose at rate of 8.53% compared to 11.40% in previous month. Food inflation which is part of primary article basket accelerated at 8.14% compared to 11.36% in last month. Though primary article index shrank to 201.1 from previous month figure 204.3, the high base effect is prime contributor for fall in primary article inflation. Fuel & power inflation which constituted nearly 15% of WPI basket rose at a highest pace since Oct 2008 at 15.48% as compared to 14.79% in previous month. Manufacturing products, which constitute the major portion i.e. nearly 65% of WPI basket, accelerated at 7.70% in November 2011 compared to 7.66% in previous month. More importantly Core inflation (Mfg ex-food) which is 55% of total basket has accelerated at 7.96% in Nov 2011 and has shown continuously increasing trend, which is a worrying sign.

The index of industrial production (IIP) contracted at a rate of 5.1% in month of October 2011, compared to an impressive growth rate of 11.4% in same period for previous year reflecting drastic decline in economic activities. IIP grew at a slowest pace since March 2009, much below market expectation of -0.7%. The sharp contraction in IIP number in October was basically attributed to sharp contraction in mining and manufacturing, as well as waning consumer demand and lackluster investment. Manufacturing output, which constitutes major pie in IIP basket, fell by an annual 6% in Oct compared to grow by 2.4% in previous month whereas electricity output which constitutes approximately 10% of Industrial production expanded by 5.6% in October after expanded at 9% in previous month. Mining activity shrank by 7.2 percent in October, constrained by bureaucratic bottlenecks. The capital goods segment continued to remain volatile contracting by 25.5% in month of October compared to 6.5% in previous month. Intermediate goods shrank 4.7% with basic goods contracting by 0.1%. Consumer durables and consumer non-durables fell 0.3% and 1.3% in October, respectively.

Fiscal deficit during the period Apr-Nov 12 stood at Rs 3.93 Tn which is 85.6% of Budgeted Estimate (BE), sharply higher than 48.9% of BE in the same period last year. The sharp increase in the fiscal deficit is mainly attributable to lower revenue growth and higher outlays under non plan expenditure.

Going forward, though the market is wary of rising fiscal deficit and the resultant higher borrowings, we expect the market to remain bullish due to continued OMO purchases by RBI and expectations of monetary easing bias from RBI in the light of easing inflation and faltering growth.