WF: Now that we have the budget numbers with us, what is your take on the Government borrowing program and how will it impact bond markets?

Anil Bamboli: The gross supply is similar to last year - around Rs 451,000 crores (FY10) compared to Rs 457,000 crores (FY11). Net of maturities, it is around 345,000 crores - a little less than last year (Rs397,000 crores). But, last year obviously there were other avenues available - the Government used the Market Stabilization Scheme (MSS) money (approx Rs 88000 crores) as well as RBI used its own balance sheet to the extent of Rs. 57,000 crores. If you adjust for the MSS and the RBI support, the net number for FY10 actually comes to around Rs. 250,000 crores last year. Whereas this year, as of now, no other support is available. One must assume so - which will make net supply higher this year.

Market is concerned about it. If you do a back of the envelope calculation, assuming that deposits grow around 18 to 20% next year and banks maintain around 25 to 27% of that as SLR, their appetite will be around Rs. 225,000 to 250,000 crores. That much demand is there. Insurance, PFs and others put together I think will be another Rs. 150,000 crores - that takes the total demand to Rs. 400,000 crores.

While demand at Rs. 400,000 crores seems to be in excess of net supply of Rs. 360,000 crores, but what is not factored in here is supply from State loans. State loans this year I think is around Rs. 125,000 crores - next year we see that coming in at around Rs. 100,000 crores.

So you have a gap of around Rs. 50,000 crores. It is not a very large gap - but market is looking at two issues : (1) whether the RBI will use its balance sheet, if required and (2) how the demand-supply situation will get impacted if credit offtake starts picking up.

My view is that RBI may have the room to use their balance sheet now and remove the excess liquidity either in the form of MSS or a Cash Reserve Ratio (CRR) hike. Any Open Market Operation (OMO) that RBI does can increase liquidity in the system - which can be sucked out by a CRR hike. The concern of supply and demand can be met by RBI using around Rs. 50,000 crores of its balance sheet and removing that in the form of CRR.

WF: Do you see yields getting impacted more at the short end rather than the long end?

Anil Bamboli: Initially, yields at the long end also could go higher as the mismatch between demand and supply can be heavy in the first half. So yields could go higher on the ten year also. I think we should see 8.25% or slightly over that for the 10 year gilt. A lot depends on how RBI manages the situation. A range of 8.25% to 8.50% for the 10 year benchmark over the next 6 months is quite possible.

WF: In this scenario, if 10 year yields are likely to grind upwards over the next few months, should investors consider duration funds or stay away?

Anil Bamboli: Duration funds may not be a great idea when the 10 year is under 8%. But, whenever you see the 10 year yields in the 8.25% region or upwards of that, it may not be a bad idea to consider duration funds at those levels. The thing to remember here is that there is no magic figure like 8.25% or 8.50% - technically, 10 year yields can breach those levels for a brief while and go higher too - but you can't time the market to that level. If we think that 8.25% - 8.50% is a reasonable range, when you get that level, you should be willing to invest - and then don't worry about a short term technical blip if at all it happens.

WF: For investors who do have one year + money, should they look at 13 month FMPs in this month? March is usually a time when you get good deals due to year end tightening.

Anil Bamboli: Yes definitely, for 1 year + money, FMPs with double indexation is a good option.

WF: What kind of yields are you able to contract these days on 1 year paper?

Anil Bamboli: One year CD levels in the market are around 6.70% to 6.90% - whereas that is still not march crossing. But if you are crossing March, those yields are around 7% to 7.3%.

In an FMP, with the double indexation benefit - or even if there is only one indexation available because of certain provisions in the Direct Tax Code which may get implemented from April 2011 onwards, your effective post tax yield is likely to be quite attractive.

WF : If an investor has 1 year + money, should he invest this month in a 1 year FMP or a duration fund?

Anil Bamboli: As I have mentioned, I think you should invest in duration funds when the 10 year yields are in the 8.25% to 8.50% range. Now, if you do happen to get a spike in March, and the 10 year yields move to that level, it should be a good idea to go for a duration fund at those levels, rather than an FMP - that's my view purely on the basis of potential returns over this 1 year period. Of course, a lot will also depend on the risk appetite of the client etc.

WF: What would you advice investors who have 3-6 month money to do - go for short term plans or stay in the ultra short term category?

Anil Bamboli: If you are investing in a short term fund, I would recommend a holding period ideally of 6 months or more. We have two short term funds : HDFC Short Term Plan and HDFC High Interest Fund - Short Term Plan. Currently, HDFC Short Term Plan is having a maturity of around 12 months and the HDFC HIF - Short Term Plan is having a maturity of around 16 - 17 months. It is not long - but it captures the steepness in the 0 - 1 year segment. We are capturing this steepness - but it comes with some possible volatility as well - that is why the holding period of 6 months is also required.

Investors who have a shorter time horizon can consider our ultra short term funds.

Disclaimer : The views expressed by Mr. Anil Bamboli, Senior Fund Manager - Fixed Income of HDFC Asset Management Company Limited (HDFC AMC), constitutes the author's views as of this date and is based upon information that is considered reliable, but does not represent that it is accurate or complete, and it should not be relied upon as such. Statements of future expectations are based on current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. None of the information contained herein constitutes, or is intended to constitute a recommendation of any particular security or trading strategy or a determination that any security or trading strategy is suitable for any specific person. The recipient alone shall be fully responsible / liable for any decision taken on the basis of this Note. Neither HDFC Mutual Fund nor HDFC AMC nor any person connected with it accepts any liability arising from the use of this information/data. The recipient of this material should rely on their investigations and take their own professional advice.

Risk Factors: Mutual Fund investments are subject to market risks, please read the Scheme Information Document before investing. Statutory Details: HDFC Mutual Fund has been set up as a trust sponsored by Housing Development Finance Corporation Limited and Standard Life Investments Limited (liability restricted to their contribution of Rs. 1 lakh each to the corpus) with HDFC Trustee Company Limited as the Trustee (Trustee under the Indian Trusts Act, 1882) and with HDFC Asset Management Company Limited as the Investment Manager.