WF: Where do you see interest rates at the long end and the short end headed and what are the key drivers?

Dhawal: I believe that interest rates are likely to gradually move up at a very slow pace. We have already seen sharp upmoves in the 10 year rate over the last one year. and also moves in short term rates in recent weeks.

With the budget round the corner, markets are focusing on the possible size of the government borrowing program for the next fiscal year. There seems to be a consensus that the fiscal deficit number is going to come around 5.5%. There is still lot of ambiguity in terms of gross borrowing program. It is likely to be in the region of 4,50,000 crore to 4,70,000 crore. The worry here is that the net supply to the market is going to be 70,000 - 80,000 crores higher than this year. This year, we had MSS unwinding of 33,000 crores and RBI bought 55,000 crores of bonds. That was close to 90,000 crores that came from RBI. If next year's gross borrowing program is identical to this year's, there is still this gap of 80,000 - 90,000 crores that has to be addressed.

With economic growth picking up, corporate demand for money will also be there along with the government's requirements for the borrowings. If you take all these things together, there is a fair chance that we may move towards 8.10% to 8.15% on the 10 year gilt.

WF : What should investors do now?

Keeping this view in mind, it might be prudent for investors to invest in a low duration fund right now. Money market rates have gone up sharply. 3 months rates are trading between 5.7% to 6% as compared to 4.5% to 4.75%. So there is a fair amount of anticipated tighteness already priced in into money market rates. In my opinion, if the investors remains at the short end of the curve, they can probably get around 5% kind of a return. Once the yields tend to peak out - which may happen sometime in the July-Sep 2010 period, one can look at long duration funds.

This is the time to reduce duration - not increase it. We need clarity on the government borrowing program, we have advance tax outflows in March and from April onwards, we will have large supply of government paper. That should keep bond yields elevated, until a sizeable part of the borrowing program is absorbed.

WF: Do you see a case for bond yields to go up to 8.5% levels as some people are talking about?

Dhawal: I think it is very difficult to judge whether that will cross 8.25% and head towards 8.5% or even 8.75%. A lot depends on the sentiment of the market and the way RBI handles the situation. If the global sentiments for bonds is supportive then I guess the bond yields should hover between 8 to 8.25%, sometime till the system liquidity is comfortable and there is appetite for bonds. For some reasons, if the sentiment turns adverse and global bonds suffer because of that and at the same time banking system shows lack of appetite for bonds then you could probably see yields little higher. It is very difficult to judge which way bonds yields could go initially.

Just look at 2009-2010 : what had happened was that although the bulk of the borrowing program was in the first half, actually bonds yields headed higher in the second half. Similarly in January onwards when the borrowing program was almost over and when you expect yields to soften due to lower supply, yields have actually moved higher.

Markets would look for how RBI tackles inflation expectations and manages the government borrowing program.

WF: Which products should investors consider now?

Dhawal: For investors who have a 12 month plus horizon and do not need the interim liquidity, March should give them good opportunities to lock into FMPs with double indexation which can provide very healthy post tax returns.

When you see the 10 year gilt around 8.25% levels, you can consider longer duration funds. Presently, I think shorter duration funds are the best bet.

Within our product range, we have 3 funds to offer :

    (1) In the liquid fund category - the DSP Blackrock Liquidity Fund - the fund has got an AuM of around Rs. 1000 crore

    (2) In the ultra short term / liquid plus category, we have the DSP Blackrock Floating Rate Fund. The fund has an AuM of around Rs. 3600 crores and           returns of around 4.60% to 4.70% presently. The fund has a cash position of around 25% - in anticipation of advance tax related and March end related           outflows. The fund has substantial exposure to PSU bank CDs and high quality CPs. Most of the assets are in the money market segment which are not           marked to market.

    (3) The third fund that we have in our stable which could add value is the DSP Blackkrock Short Term Fund - the fund size is about Rs. 900 crores and the fund           is looking to deliver returns between 5% to 5.10% . It is also a fully money market portfolio of high quality of PSU bank CDs and high quality commercial           papers. The duration of short term fund is about 6 months, while the duration of floating rate fund is about 80 days.