LIQUIDITY, VALUATIONS AND EVENTS

1. LIQUIDITY,VALUATIONSANDEVENTS Jul – Sep 2012

2. MOVEMENTS OF MAJORINDICES

3. MOVEMENT OF SECTORAL INDICES * Our predictions from the last study regarding Banking, Pharma, and Metals turned out to be correct while those regarding Auto, IT and FMCG turned out to be incorrect.

4. CHANGE IN COMMODITY PRICES

5. COMMENT • The flattish performance of Sensex is deceptive • It is actually made up of 2 major moves • From 21st February to 23rd May: -13.46% • From 23rd May to 30th June: +9.29% • Between 21st February to 30th June 2012: -4% • Peak to bottom and retracement was a move of 22.75% in absolute terms

6. MAJOR SECTORS ON THE WAY DOWN (21st February to 23rd May) • Sectors which led during the downward phase • Defensives like FMCG, Healthcare, Consumer durables outperformed • The trend was triggered by heavy FII selling, confusion linked to GAAR and concerns on fiscal and current account deficits

7. LEADERS ON THE WAY UP(23rd May to 30th June) • Sectors which led during the upward phase • This strong performance of Infrastructure related sectors was in line with our March’12 outlook

8. FII FLOWS • FII Flows in Equity • FII Flows in Debt

9. NOTES ON EVENTS

10. DECLINING COMMODITY PRICES-Our prediction from previous quarterly study comes true • Global commodity prices as measured by the S&P GSCI Commodity Index fell 14% during the April-June 2012 quarter. One of the major losses have been reported by Brent crude (-21%). • Causes: • Economic slowdown: The biggest consumer of commodities, China is showing signs of slowdown because of the Eurozone crisis and slowdown in the US as both the regions account for the bulk of exports from China.

11. DECLINING COMMODITY PRICES • Impact: • Reduction in inflationary pressures in China • The impact was less evident in India as it was offset by a depreciating rupee. • Countries like Brazil, Malaysia, Thailand and Indonesia are likely to get impacted negatively as they are net exporters of commodities.

12. ELECTION RESULTS IN EUROPE • GREEK NATIONAL ELECTIONS: The election was seen as a vote on whether Greece should stay in Eurozone. • Impact: Fears of ‘Grexit receded after the conservative New Democracy party came first and pro-bailout parties won enough seats to form a joint government. The crisis may resurface later • FRENCH PRESIDENTIAL ELECTIONS: Socialist François Hollande received 51.62% of the votes, while Nicholas Sarkozy got 48.38% of the votes. • Impact: Hollande has been inclined to renegotiate a hard-won European treaty on budget cuts that Germany's Angela Merkel and Sarkozy had championed. He is a supporter of more government stimulus, and more government spending in general despite concerns from markets that France needs to urgently trim its huge debts.

13. SPANISH BOND YIELDS • The Spanish sovereign bond yields have remained elevated and increased by 18% from 5.35% to 6.33% in the April-June quarter. It touched a high of 7.16% on June 18. • On June 7, Fitch downgraded Spain by three notches to BBB which is just two notches above junk status following a downgrade to BBB+ by S&P in May. • On June 9 Spain sought a European bailout of 100 billion euros ($125 billion) to support ailing lenders, the fourth euro member to seek a rescue since the debt crisis started almost three years ago. Following this Moody's lowered Spain's grade from A3 to Baa3 which is just one notch above junk on its scale.

14. WEAK US RECOVERY • The first quarter GDP growth stood at 1.9% compared to 3% growth in the previous quarter. • Markit's US Manufacturing PMI fell from 54 in May to 52.5 in June – the lowest in 18 months. • There has been a decline in consumer spending as reflected in the retail sales data (excludes services) which declined for three straight months in the Apr-June quarter. • Spending in June fell in nearly every major category — from autos, furniture and appliances to building, garden supplies and department stores.  • The US monthly employment data has become an increasingly important barometer of the progress in US. • U.S. companies added 115000, 69000 and 80000 jobs in April, May and June respectively with June being the third straight month of tepid job growth. Unemployment stood steady at 8.2%.

15. INDIAN GDP • GDP growth for the last quarter of FY12 was seen at 5.3% (y-o-y) which was much below market expectations of 6.1%. Last quarter growth remained considerably weak with the industry segment witnessing weak growth of 0.7%, while the services sector growth remained strong at 7.5%. The full year GDP growth thus decelerated to 6.5%. • IIP data: Industrial production growth rate slowed down sharply to 0.1 per cent in April following a 3.2% fall in March • In April, S&P lowered the outlook on India's BBB-minus rating to negative from stable and had said there was a one-in-three chance of a downgrade over the following 24 months. Fitch followed in June citing the same reasons – absence of reforms and corruption

16. RBI RATE CUTS & LIQUIDITY MEASURES • RBI cut repo rate by 50 bps in its annual monetary policy statement 2012-13 in April • In a move aimed at arresting the unrelenting fall of Indian rupee, RBI on 25th June hiked the limit of foreign investment in government bonds by $5 billion to $20 billion. Of the $20 billion threshold, FIIs can now invest $10 billion with no residual maturity restrictions and another $10 billion subject to a residual maturity of three years. • RBI also raised limit of external commercial borrowing (ECB) to $10 billion.

17. RBI RATE CUTS & LIQUIDITY MEASURES • Qualified foreign investors (QFIs) will be allowed to invest in mutual fund schemes that hold at least 25% of their assets (either in debt or equity or both) in infrastructure sector, under the current $3 billion sub-limit for investment in MFs related to infrastructure.  • RBI increased the limit of export credit refinance for banks to 50% of outstanding export credit from 15% expecting such a move to infuse Rs. 30,000 crore of additional liquidity

18. OTHER EVENTS • FUEL PRICES • In the steepest ever increase, petrol rates were raised by a massive Rs 7.54 per litre in May. • INDIAN MONSOONS • POOR START- India’s monsoon rainfall, which accounts for 70 percent of the nation’s total rains, was 29 percent below normal in June according to the weather department. Showers in June, which account for 18 percent of season’s total, have been the least since 2009 when they were 47.2 % below a 50-year average

19. EVENTS TO LOOK FORWARD TO - GLOBAL

20. EUROPE: WHAT NEEDS TO BE DONE • To prevent a collapse, Germany will have to agree to share the liabilities of peripheral European nations. • Germany wants them to adopt fiscal austerity and bring their budgets in balance. It also wants a tighter fiscal union. • Austerity measures are causing a rise in unemployment and reduction in government benefits. They are also reducing growth, and hence governments’ revenues in peripheral nations. • To solve Europe’s problems, some large open-ended commitment will have to be made, either in the form of ECB standing behind government debt or a mutualisation of debt by governments (issue of euro bonds). • Piecemeal solutions will not work and the region will lurch from one crisis to another.

21. USA ECONOMIC DATA & FOMC • In June when the Federal Open Market Committee (FOMC) met, it expanded Operation Twist by $267 billion. Minutes from the meeting reveal most members felt that the risk of slowing growth and higher unemployment had increased. • If growth falls further, the Fed may have to launch a third round of quantitative easing. • The US government needs to shelve its budget deficit reduction program temporarily until growth is on a sound footing and undertake some stimulus spending (especially on infrastructure).

22. CHINA: WHAT NEEDS TO BE DONE • After growing at an average rate of 10 per cent for the last decade, GDP growth in China is slowing down – to 8.1 per cent in Q1 2012 and to 7.6 per cent in Q2 2012. • China has cut interest rates twice. In May it reduced banks’ reserve requirements, which will allow them to lend more. • According to Credit Suisse, this may not be of much help since the private sector is not interested in investing in real businesses amidst the current slowdown. • The government is likely to encourage infrastructure investment. But local governments, which implement these projects, are heavily indebted and don’t have the capital to bear their share of the burden.

23. CHINA: WHAT NEEDS TO BE DONE • Credit Suisse argues that every 10 years China has undergone structural reforms that have boosted its productivity. Now it needs to undertake more reforms. • Some of the reforms it suggests are opening up the service sector, doing away with monopolies in banking and utilities, and deregulating interest rates and the exchange rate. • In recent times, China has allowed the yuan to trade within a broader range. • Moreover, the Chinese government’s debt is only 22 per cent of GDP, so it does have a lot of fiscal ammunition for stimulating demand (unlike India).

24. EVENTS TO LOOK FORWARD TO - DOMESTIC • Progress of Indian monsoons • Progress on key reforms – GAAR, FDI in multi brand retail • Economic data – inflation, industrial output, Fiscal deficit • Who is chosen as Finance Minister • Rate cuts by RBI • Q1FY13 results to be declared in July/Aug

25. OUTLOOK FOR ASSET CLASSES Our prediction from the previous quarterly study comes true – yields softened across the board this quarter

26. OUTLOOK FOR KEY SECTORS

27. ANNEXURE: EUROPE’S FESTERING CRISIS • After Greece, Spain has emerged as the new epicentre of the European crisis. • Spain’s banks are in trouble with bad loans rising in the wake of a bust in its property market after the global financial crisis. (See annexure: Europe: What has been done)

28. ANNEXURE: EUROPE: WHAT HAS BEEN DONE • On June 21, European leaders met in Rome and agreed to take steps towards a banking union. • On June 30, European leaders reached a breakthrough deal on recapitalisation of banks. • They agreed to create a single supervisory body to oversee euro zone banks. This body will use the area’s rescue fund, the European Financial Stability Fund (EFSF) or its successor, the European Stability Mechanism (ESM), to aid banks directly. • Thus banks in trouble will be able to receive capital without adding to the country’s sovereign debt. • On July 9, European Commission leaders extended the deadline for Spain’s deficit reduction targets. They also promised that Spain’s banking sector would be recapitalised to the extent of 30 billion euros.

29. ANNEXURE: CHINA: WHAT IS CAUSING THE SLOWDOWN • The Chinese economy is export driven (exports constitute 39.7 per cent of its GDP). With demand in Western markets weakening, China’s exports, and hence economic growth, has been affected. • The massive stimulus package launched after 2008’s financial crisis led to inflation, and to a property bubble which has priced middle-class families out of the property market. It has also led to bad loans in the banking sector and to indebtedness among local governments. So China is wary of launching another stimulus program this time. • Moreover, a few structural factors are also at play, which suggest that double-digit growth may be difficult to achieve in future.

30. ANNEXURE: WHAT IS CAUSING THE SLOWDOWN • Per capita income in China has crossed the $5000 mark. It is after crossing this level that growth in other Asian miracle economies – such as Japan, Korea and Taiwan – also slowed down. • In the recent past, China’s growth has been predominantly investment driven. Last year investment accounted for 50 per cent of China’s GDP. Last year it spent more on infrastructure than US and Europe combined. Such a rate of investment is unsustainable. Besides, the infrastructure that China needs has already been built, so it can’t keep on adding to capacity.

31. ANNEXURE: WHAT IS CAUSING THE SLOWDOWN • Productivity increase in the Chinese economy occurred due to rural to urban migration as workers found more productive jobs in cities. Now the pool of under-employed workers in rural areas who can migrate to cities has been nearly exhausted. • Demographic factors. The strict implementation of the one-child policy since 1979 means that fewer workers will enter the working population henceforth, compared to 1990s and 2000s. • Wage inflation in China is now running at 15 per cent. • The above two factors mean that China’s advantage of low-wage workers will get eroded in future.

32. ANNEXURE: WHAT IS CAUSING THE SLOWDOWN • Real estate bubble. To fight the financial crisis of 2008, China expanded credit. A lot of this money went into the property market. • Switch to consumption. It is argued that China needs to shift from being an export and investment-driven economy to a consumption driven economy. But as Ruchir Sharma of Morgan Stanley argues in a recent article in ET, consumption in China has already been growing at 9 per cent for the past decade. The scope for increasing that rate further is small.

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