JM MORGAN STANLEY - Debt Funds Investment Strategy

Debt Market Outlook We expect money market rates to moderate marginally as a sign of relief post year-end tax flow, otherwise money market rates will continue to remain high. Amidst our expectation of tight liquidity conditions in the coming quarter followed by another. Short end of the yield curve ( 1 yr – 5 yr ) is expected to remain with some upward basis in case of 25 bps hike in reverse repo. Apart from a policy shock, we do not see any other factor, which could drive up yields in the short end of the yield curve. Long end of the curve ( 10 yr and above) is expected to inch in the coming two quarters. The government borrowing calendar for the first half of 2007 – 08 indicates borrowings of Rs.70,000 crore in 10 year and above segment. Bearish market sentiments amidst tight liquidity conditions, large borrowing progarmme in the long end and expected drop in SLR demand from banks based on our expectations that credit offtake will sharply moderate, will drive up the long end of the yield curve. The benchmark interest rate (reverse repo rate) continues to be behind the G Sec yield curve. Thus inspite of current round of measures to curtail liquidity in the system, we believe with RBI’s uneasiness with robust credit cycle, money supply expansion and strong economic growth rate, their exist considerable chance of reverse repo rate hike of 25 bps in the upcoming monetary policy.

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