As a debt fund manager, what about the Budget has impacted you the most?
The key take-away from the Budget is the realistic revenue and expenditure assumptions (barring the oil subsidy) used by the finance minister. This year, the finance minister has avoided the rosy predictions such as a mere 3.4 per cent nominal growth in expenditure that he employed in FY12. For FY13, expenditure expenses are planned to grow by 13 per cent, which are much more realistic.


We also believe that a 'time-bound subsidy reduction plan' is a game changer for public finances. First time ever, there is a thought behind reducing the subsidies. Most importantly, subsidy priority has been set, as food subsidies get a priority over both fertiliser and fuel subsidies. The finance minister and his secretaries have communicated their intentions of bridging the gap between international fuel prices and domestic prices. That is why I believe that some sort of diesel price deregulation plan is coming.
Also, a plan has been proposed to replicate what's being done in Jharkhand, Rajasthan and Mysore (for food, diesel and LPG subsidies direct transfers). The market should be happy that we are close to implementing a direct transfer plan for most of subsidies.
Similarly, on the revenue side, assumptions on corporate, personal income, service and excise taxes are quite credible. For example, despite an increase in service tax from 10 per cent to 12 per cent, service taxes are expected to grow by only 30 per cent in FY13 while the same grew by 37 per cent in FY12. Similarly, corporate taxes are expected to grow by a lot more reasonable 14 per cent in FY13 versus a much more robust expectation of 21.5 per cent growth in FY12.
Overall, we like the credible numbers used by the finance minister. Even though the Rs 4.79 trillion net borrowing has surprised the market, it's probably better for the market to start with a reasonable number rather than be surprised by Rs 50,000-100,000 crore incremental borrowing in the second half of the year.

How worrying is the fiscal deficit?
The question of fiscal deficit sustainability needs to be answered in a broader context. The reason big and persistent fiscal deficits are bad is that ultimately they result in an unsustainable outstanding of debt; what we call the stock of debt. Currently, India does not have a stock of debt problem as our government debt to GDP is close to 64 per cent as compared to 120+ per cent for Greece and Italy. Also we do not have the low growth problem faced by most western countries currently. That said, we need to make sure that we control our fiscal deficit - even more than the FY13 expectation of 5.1 per cent - for two reasons.
First, if we keep running big fiscal deficits for 10-15 years, we risk increasing our stock of debt to an unsustainable 90-100 per cent of GDP.
Second, for a developing country like India it is very important for the government to keep its spending low and not crowd out the private sector investments of the country.

Do you see interest rates finally starting to fall?
Yes, we think the RBI will start cutting rates from April 2012. We are currently expecting a 25bps repo rate cut in April. Going forward, investors should pay a lot of attention to global commodity prices, especially oil, as they will play a significant role in determining the magnitude and timing of the RBI reaction function.

What is your view on inflation? It has again started climbing up in the last few weeks.
We think headline WPI will stabilize at 6.5 - 7 per cent over the next few months as the base effects of last year fades. We do think core (manufactured products) inflation will fall further to 5.1 per cent in the next few months versus 5.8 per cent in February 2012. Going forward, we expect the moderating YoY trends in commodity prices to be offset by fuel price hikes and service and excise duty pass through manufacturers and service providers. Both these trends will keep WPI range bound in the 6.5 - 7 per cent range over the next few months.

What direction should investors in debt funds take?
Our call over the last few weeks that in the "current environment it is better to own 1-3 year corporate bonds and lighten up on duration" has largely worked out. With the RBI focused on improving liquidity over the next two months, we think the front end of the yield curve offers the most attractive total return opportunity. Due to tight liquidity conditions in the money market space, partly due to seasonality and partly as a result of the new SEBI regulations, the three- and six-month CD rates widened 75-100bps over the last four weeks. We believe that both three- and six-month rates have peaked at 11.15 per cent and 10.75 per cent respectively. With one-year bank CD rates close to 200bps over the repo rate, we think there is significant opportunity for one-three year rates to be 50-100bps lower over the next six months.
Market borrowing numbers for FY13 look really big. At Rs 479,000 crore of net borrowing, its Rs 43,000 crore more than FY12's dated borrowing - from an overall borrowing point of view, its Rs 33,000 crore down - as T-bills borrowing is budgeted to be only Rs 9,000 crore verses Rs 116,000 crore last time. Net of OMO's, net borrowing was only Rs 355,000 crore in FY12. Unfortunately, this year's gross borrowing of the first half of this year is substantially higher than last year's first half (gross borrowing of Rs 370,000 crore versus Rs 250,000 crore net borrowing of Rs 285,000 crore versus Rs 190,000 crore. This may be the biggest negative for the capital market as such substantial borrowing may keep the long term rates high. Even the rate cuts will not bring down long term rates given that total borrowing is more than 50 per cent of the total aggregate deposit accretion now and it threatens to crowd out the private investments. We believe OMO's this year will be larger than last year with a small possibility of doing it in the first half itself and CRR cuts will keep coming in. Thus the best part of the curve remains the short end.
We think short end funds - in the one-three year range - provide the most attractive risk-return opportunity to investors.

GDP: Gross Domestic Product / FY: Financial Year / RBI: Reserve Bank of India / bps: basis points, 100bps=1% / WPI: Wholesale Price Index / YoY: Year-on-year / SEBI: Securities & Exchange Board of India / CD: Certificate of Deposit/ T-bills: Treasury Bills / OMO: Open Market Operations/ CRR: Cash Reserve Ratio