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Fund Managers Commentary

February 28, 2010

Debt Market

Post CRR hike last month, the gilt yields entered a bearish zone as the market participants began factoring in an incremental supply in government bonds from the budget announcements. The 10 year Government security benchmark bond touched an intra month high of 7.95% before the budget. However yields at new highs, relatively weak economic news flows like Q-on-Q GDP numbers at 6%, expectations that the ensuing budget would have a budget deficit pegged at 5.5% of GDP, road map for some fiscal consolidation in form of partial rollback of fiscal stimulus, disinvestments and revenues from 3G auctions helped the market to stabilize in the band of 7.78-7.82% till the budget. There was some marginal improvement in the primary articles’ inflation for the month which was placed at 14.52% v/s 14.88% in the previous month. The M-o-M WPI number was placed at 8.56% v/s 7.31%, surplus liquidity stood reduced around Rs.43000 Crs vs Rs.74000 crs in the previous month mainly accounting for a 75 bps CRR hike which took effect in the recent month. The Budget for 2010-11 was unveiled on 26th February, 2010.The highlights of the Budget were as follows:

Highlights

Fiscal deficit target pegged at 5.5% of GDP for FY11 against FY10 figure of 6.7%.
Rolling target of fiscal deficit pegged at 4.8% and 4.1% for FY12 and FY 13 respectively.
Government would be in a position to implement the Direct Tax Code and the Goods and Services Tax by April, 2011.
Non tax revenue receipts are estimated at Rs 1,48,118 crore.
Total expenditure allocation increased by 8.6% for FY11 over previous year to Rs 11,08,749 crore.
Government targets a net borrowing figure of Rs 3,45,010 crore for FY11..
Minimum Alternate Tax increased from 15% to 18% of book profits but surcharge on corporate taxes reduced to 7.5% from 10%. Income tax slabs revised.
Proposals on direct tax rates estimated to make a revenue loss of Rs 26,000 crore but proposals on indirect taxes estimated to result in net revenue of Rs 46,500 crore for FY11
Rate of service tax maintained at 10% but more services in tax net
To provide Rs 16,500 crore to Public Sector Banks to ensure that they are able to attain a minimum 8% Tier-I capital by March 31, 2011.
To provide additional capital to RRB’s to support increased lending to the rural economy. o Extension of existing interest subvention of 2% to exporters covering handicrafts, carpets, handlooms and small and medium enterprises.
Credit flow into the agricultural sector target set at Rs 3,75,000 crore for FY11.
The period for repayment of the loan amount extended by six months from December 31, 2009 to June 30, 2010 under the debt wavier and Debt Relief Scheme for Farmers.
Rs 1,73,552 crore provided for infrastructure development.
The spending on the social sector has been gradually increased to Rs 1,37,674 crore in 2010-2011, which is 37% of total plan outlay.

On the global front, the yield on US 10Y Treasury note ended at 3.64% given some reduction in holdings by the People’s Bank of China. Global crude prices moved a tad higher at around $79 per barrel given the strong technical support.

Going forward, some more pressure is likely on the short term rates in anticipation of quarterly tax payments coupled with general quarter-end issuances from banks. As expected, earlier the credit spreads had widened to 125 bps in the 5y segment in the backdrop of an incremental supply from the primary market while the spreads declined in the 10Y segment because of investor driven interest.

From the developments highlighted above, we believe that the budget was more or less in line with the market expectations. However, the gilts market would be closely eyeing the WPI numbers and the borrowing calendar next month. Inflation fears coupled with new supply of G-secs shall continue to exert upward pressure on sovereign yields. Credit spreads may decline in the medium term especially post the March 2010 quarter.