Debt Investment Strategy

Inflation: Trending Down The WPI index for the month of Feb 2012 stood at 158.4 implying an annual inflation rate of 6.95%. The Feb 2012 inflation at 6.95% was higher than market expectations of 6.75% and last months inflation of 6.55%. Primary articles inflation surged to 6.28% in Feb 2012 from 2.25%. The increase in Primary articles inflation is attributable to rise in vegetable prices and protein items. Fuel inflation also fell to 12.83% in Feb 2012 from 14.21% in the previous month tracking a favorable base. Supported by high base, the Manufacturing inflation softened to 5.75% in Feb 2012 compared to 6.49% in the previous month. Core inflation also saw a sharp correction to 5.75% in Feb 2012 from 6.67% in Jan 2012 Growth: Slowing Down The GDP for the third quarter plunged to 6.1%, the lowest in last two years. Liquidity: Tight in the system Liquidity remained tight during march as well, and the banks borrowing through LAF window continued to remain at very high levels i.e. above Rs1.5lac crores. Even after CRR cut of 75bps and Rs.12000cr of OMO RBI could infuse the liquidity of Rs.60000cr.

Fiscal Deficit: The fiscal deficit for 2011-12 has been revised to 5.9% from the budget estimate of Sources : Bloomberg, Reuters, RB 4.6%.

Key Highlights of the Budget from Bond market perspective: The fiscal deficit for 2012-13 is estimated at Rs 513590 Crores which amounts to 5.1% of the estimated GDP. The fiscal deficit for 2011-12 has been revised to 5.9% from the budget estimate of 4.6%. An unprecedented 93% of the fiscal deficit is to be borrowed via dated government bonds vs. 83.5% in FY12. This translates into a gross market borrowing of INR 569,000 crores (INR 510,000 crores in FY 12) and a net borrowing of INR 479,000 crores (INR 436,000 crores in FY 12)

Sources : Bloomberg, Reuters, RB

- Sept GOI Borrowing Calendar: Details and Implications

Gross Borrowing in INR crs Net Borrowing in INR crs H 1 2012 H 1 2011 3,70,000 2,49,000 2,84,926 1,89,666 65% 59% 49% 44%

Gross Borrowing as % of Total Net Borrowing as % of Tenor Wise Borrowing Total 5 to 9 years 10 to 14 years Long Dated (above 14 years)

First half borrowing at 65% is at the upper end of market expectation of 60 65%. This translates into steady supply of bonds with per week auction size of INR 15,000 18,000 crores A larger part of the borrowing is via longer dated gsecs when compared with last year. However, this also means that market will be forced to absorb longer duration bonds at times when investor appetite is lower

H 1 2012 H 1 2011 28% 29% 41% 46% 32% 26%

Month-Wise Break up of Borrowing

April May June July August September

Total

65,000 63,000 60,000 61,000 75,000 46,000

3,70,000

Most of excess bond supply in FY 12 occurred in the second half of the year when govt revised borrowing plan by INR 92,800 crores. Fortunately for the market, this also coincided with the OMO programme of the RBI. Hence, all of this excess supply and more (RBI bought INR 1,30,000 crores of bonds) got absorbed by the RBI. This time, however, most of the Sources : the year. supply is focused in the first half of Bloomberg, Reuters, RB Hence government bonds would underperform shorter end rates over the

RBI in its forth quarter Monetary Policy Review 2011-12, left all the rates unchanged Clearly the growth inflation trade off has shifted towards growth and further rate cuts are warranted. However RBI has mentioned that without adequate support from fiscal side it will have limited room to cut rate LAF borrowings are persistently aboveRBIs comfort zone, further OMOs will be conducted as and when seen to be appropriate to infuse liquidity. Concerns on fiscal deficit continue however the RBI observes that likely slippage on the same has inflationary expectations.

Given high fiscal deficit, High Current account deficit, higher inflation and large borrowing plan would throw challenges to RBI to reverse interest rates in near term Long term rates are expected to be range bond with upward biased. We expect first short term rates will fall as they are at their historical highs. Longer end of the curve would react once there is clear sign of inflation coming down with RBI indicating of rate cuts Liquidity is still very tight and is expected to continue for next two weeks. Till that time short term rates would prevail at elevated levels

Investment strategy
Categor View y
Short term Neutral with Positive Biased

Positives
Rates are near peak RBI to conduct frequent OMOs CRR cut may come to counter liquidity tightness RBI is now concerned with growth Growth is slowing down prompting RBI to pause hikes

Negatives
Liquidity is very tight in the system Demand for short term funds by corporate is still very high as compared to ling term Government is also borrowing cash management bills quite frequently

Gilt

Neutral with Negative biased

Growth is slowing down, RBI and Still Inflation is above comfort government both are concern zone now on maintaining growth Risk of Higher fiscal deficit Inflation is trending down Pressure on bonds due to more supple Current yields are already at higher levels Spread between corporate papers and g-sec is narrowing Deposit growth is faster then credit growth High supply of corporate bonds will keep down side capped High FX volatility Rating downgrade is a fear factor

Income funds

Neutral with Negative biased

Portfolio strategy
Category Short term funds/ Medium term fund Dynamic /Income funds/Gilt
Rationale: We believe that short term rates will fall faster then long term rates in coming 1-3 months We have allocated 30% to dynamic bond funds to play safe duration calls to generate better risk adjusted returns We may allocate 10% to long term gilt depending upon incremental numbers and RBIs guidance towards OMOs On a over all portfolio we would like to have short to medium duration

Maturity Matrix Average maturity between 1-2years Active Management

Allocation 70% 30%

Portfolio Return as on April 2012

Scheme Name % Wt 1 3 Months 6 1 Year Month Months
1.87 1.13 2.71 3.16 2.01 2.70 13.59 9.41 10.50 1.40 0.80 1.87 2.00 1.03 2.10 9.21 7.83 8.78 1.62 1.04 1.96 2.06 2.19 2.00 10.87 9.87 8.82 1.49 0.97 2.05 1.95 1.88 2.04 10.38 7.96 8.35

Birla Sun Life Dynamic Bond Fund - Ret - 15% Growth IDFC SSIF - MTP - Plan A - Growth 10% Pramerica Short Term Income Fund 20% Growth PRINCIPAL Income Fund - STP - Growth 20% SBI Dynamic Bond Fund - Growth 15% Templeton India Low Duration Fund 20% Growth Total 100% CRISIL Composite Bond Fund Index CRISIL Short-Term Bond Fund Index
Returns as on 16th April 2012, Returns less then one year are annualized

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