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March 2010

In the near-term, we expect Indian equity markets to continue to take cues from the global markets. The market direction will be determined by liquidity flows, global economic data and the upcoming domestic quarterly corporate results. Although it is natural to be more cautious

following such a strong rally, we are still positive on Indian economy and market over the medium to long term, given its inherent strengths.

Fixed Income Outlook


The Indian economy has witnessed a sustained recovery in the last six months led by strong growth in industrial production and revival in external demand. The industrial production grew by 10.1% y-o-y in April-Feb FY 10 as against 3.0 % y-o-y in April-Feb FY 09. The massive fiscal and monetary stimulus injected by the governments around the world has had a significant impact on global growth. As per IMF estimates, world GDP is now projected to grow by 3.9% y- o-y in 2010 as against de-growth of 0.8% y-o-y in 2009.

The Purchasing Managers' Index (an indicator for economic activity) has been consistently above 55 since December, 2009 indicating expectations of improved business activity in the manufacturing sector. The recovery has been attributed to high domestic demand, boosted by fiscal & monetary stimulus and improving global economic conditions. In response to the improved growth outlook, the government partially rolled back some fiscal measures by increasing Central excise duty on all non-petroleum products to 10% from 8% as well as raising customs duty on crude oil, diesel & petrol and on other petroleum products.

While outlook on growth has improved, changing dynamics have altered inflationary expectations. Manufacturing inflation is increasing as prices of products like cement, steel, automobiles etc. are going up while prices of food products are stabilising. Similarly, prices of petroleum products have also inched up. The core inflation (inflation excluding food and fuel) has soared to a 12 month high of 4.7% y-o-y in Feb. 2010 from -0.9% y-o-y in Nov. 2009. CPI (Industrial Workers) currently stands at 16.22% y-o-y for Jan. 2010. A faster-than-anticipated industrial recovery currently also appears to be helping rekindle corporate pricing power. An initial food price shock thus is getting transformed faster over time into a broad based rise in inflationary pressures.

On the monetary policy front, RBI has raised the Cash Reserve Ratio (CRR) by 75 bps to 5.75% in Jan. 2010 followed by a repo and reverse repo rate hike of 25 bps each in March, 2010. Sustained and broad based economic recovery has prompted RBI to take a step closer to normalise the policy rates to reduce the risk of demand driven inflationary pressures.

On fiscal front, the budget has projected a fiscal deficit of 5.5% in FY '11 from 6.7% in FY '10 mainly through stronger revenue growth and low non-plan expenditure on heads like subsidies and administrative costs. The government's budgeted net borrowing for FY '11 is Rs. 3.45 trn as against Rs. 3.98 trn in FY '10. Although the quantum appears less on the back of higher redemption of Government securities in FY 11, yields are expected to remain under pressure due to improved credit demand & lower support from RBI in the form of explicit open market purchases.

The yield of Corporate bonds has remained stable. There is a consistent demand for corporate bonds from long term investors like Insurance companies, Provident Funds etc. which is helping sustain lower spreads. Due to higher yield of Indian bonds when compared to the developed world, of late, the debt segment has also witnessed unprecedented large investment by foreign investors. Appreciating INR has further magnified returns on such investments. We expect current spreads to remain stable.

Going forward, as economic recovery gets well entrenched, we expect RBI to continue its process of normalising policy rates. This along with large government borrowing programme will keep government bond yields firm.

Jyoti Vaswani, CIO & Director, Fund Management

SMS <EDUCATION> to 5676737.


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