LIQUIDITY, VALUATIONS AND EVENTS

1. LIQUIDITY,VALUATIONSANDEVENTS Apr – Jun 2012

2. MOVEMENTS OF MAJORINDICES

3. MOVEMENT OF SECTORAL INDICES

4. CHANGE IN COMMODITY PRICES

5. Recap of Jan – Mar 2012 Flows • FII Flows into equities (in Rs. Million) • FII flows into debt (in Rs. Million)

6. Flows from Domestic Institutional Investors

7. Recap of Jan – Mar 2012 Major Events that drove the market • Monetary easing – fuelled liquidity • Prime driver of the rally in asset prices – both stocks and commodities – during Q1 was the ECB’s twin LTRO programs (December 21 and February 29) worth 1.02 trillion Euros. • Rising Global uncertainty • Rising Spain bond yields • Greece came on the borderline of default • US recovery • Surprised currency market worldwide • Domestic • Cut in cash reserve ratio (CRR) • Outcome of election in 5 states, particularly UP and its impact on policy paralysis • Union Budget

8. Notes on Events

9. LTRO-2 • Feb. 29, 2012: The ECB held a second 36-month auction, known as LTRO2, that provided 800 euro zone banks with 529.5 billion Euros in low-interest loans. This flood of liquidity boosted asset prices across the world during Q1.

10. SPAIN BOND YIELDS • Rising yields of Spanish bonds signalled that problems in the euro zone flaring up again. • During March yield on 10-year bond rose 93 basis points to 5.8 per cent. • A Spanish bond auction on April 4 barely managed to raise the minimum amount sought. • Will Spain follow Greece, Ireland and Portugal in seeking a bailout? • Unemployment level in Spain at a very high 23%.

11. US RECOVERY • News flow from US has improved. • GDP grew at an annual pace of 3 per cent in Q4 2011. • Unemployment rate down to 8.2%. • But recovery in jobs stalled in March. Only 120,000 jobs added compared to 240,000 in Feb. • Strong growth in the US could lead to slowdown in fund flows to EMs owing to home-country bias of institutional investors.

12. RATE CUTS • Inflation has abated but is not yet in RBI’s comfort zone. • High oil prices due to Israel-Iran stand-off pose a risk. • Reining in of government expenditure, as announced in the budget, was inadequate. • Government will have to rein in fiscal deficit (read, raise fuel prices) to create comfort zone for RBI to proceed with further rate cuts. • CRR was cut by 50 bp

13. IMPACT OF UNION BUDGET -1 • Budget contained no major reforms and evoked mixed reactions from the market. • Rajiv Gandhi Equity Saving Scheme introduced which will give tax incentive for investing in equity markets. First-time investors with annual income less than Rs 10 lakh may invest up to Rs 50,000 in equities and get a tax deduction of 50%. Scheme carries lock-in of 3 years. • Security Transaction Tax (STT) reduced by 20 per cent on delivery-based trades from 0.125% to 0.1%. • GAAR, which will tax FIIs that don’t have a substantial presence but merely route investments through tax havens, has created uncertainty.   • Disinvestment target reduced from Rs 40,000 crore in FY12 to Rs 30,000 crore in FY13 in the light of large slippage last year.

14. IMPACT OF RECENT STATE ELECTIONS • The Congress Party performed poorly in the recent state elections, losing in UP, Punjab and Goa. • Had it done well in UP, it could have offered support to the Samajwadi Party in the state and received reciprocal support at the centre. • This would have enabled it to pass reform-related bills in Parliament. • Now the party is likely to grow more cautious and not undertake any reforms. Many allies oppose key reforms, and the UPA does not have a majority in the Rajya Sabha. Only reforms that don’t require Parliamentary approval are likely. • Later this year elections are scheduled in Gujarat and Karnataka. • More dole-outs prior to them would have adverse implications. • If Congress fares badly in them too, calls for mid-term elections could become more strident. • Political uncertainty would be negative for the markets.

15. Liquidity flows • What factors will impact global portfolio flows? • Impact of GAAR • LTRO • QE3 • Slowing Chinese economy

16. Notes on Liquidity

17. IMPACT OF GAAR • General Anti-Avoidance Rules (GAAR) announced in budget spooked many FIIs. • Entities investing in India via a tax haven such as Mauritius or Singapore must have "substance" in those tax havens. • Funds being invested in India must have been pooled in that tax haven or at least one senior investment manager must be present there.

18. GAAR – who will be affected? • P-note issuers able to demonstrate substantial presence in Mauritius or Singapore won’t be affected. • FIIs whose funds are pooled elsewhere (say, US or UK) and who route funds via Mauritius will be affected. From April 1 will become liable to pay taxes in India. • May relocate to Singapore to avail of double taxation avoidance agreement (DTAA ) between Singapore and India. • But to avail of that benefit, fund has to demonstrate that it has had operations in Singapore and has incurred expenses of around $200,000 per year for last two years. • GAAR could affect short-run FII inflows. Long-term impact unlikely to be significant, given India’s importance. • Only when more clarity on GAAR emerges can impact be gauged.

19. MORE MONETARY EASING: LTRO • The most prominent sign of problems in the euro zone flaring up again comes from the yields of Spanish sovereign bonds rising once again. • This could force the ECB to undertake further rounds of monetary easing.

20. Quantitative Easing 3 • Operation Twist scheduled to close at end of June. Once it ends, Fed Chairman Bernanke could launch another dose of bond purchase program (despite signs of recovery). • Would get required alibi if euro zone deteriorates. • November presidential election might make it difficult for him to launch new initiative in second half of 2012. • May do it in Q2-Q3 2012, or in January 2013, when effect of the recent fiscal tightening shows up. • Both forms of QE (LTRO and QE3) would drive risky assets in EMs like India up.

21. SLOWDOWN IN CHINESE ECONOMY • China’s growth rateexpected to slow down from 9-10 per cent in recent past to 7.5-8 per cent in 2012 due to monetary tightening. • If world’s biggest consumer of commodities slows down, commodity prices could soften. • Would be a big positive for a commodity importer like India.

22. OUTLOOK FOR ASSET CLASSES

23. OUTLOOK FOR KEY SECTORS

24. Annexure-Union Budget • On subsidies, we got a target – it will be kept under 2 per cent of GDP in FY13 and reduced to 1.75 per cent in 3 yrs. • FM has projected a fiscal deficit of 5.1%, a more credible target than last year’s 4.6%. • Both excise duty and service tax rate hiked by 2 percentage points, which could prove inflationary. Move to a negative service tax list to increase its coverage. • Boost to infrastructure development by increasing the limit of infra tax-free bonds from Rs 30,000 crore to Rs 60,000 crore. ECB allowed for road construction and power. • Budget doubled custom duty on gold and platinum from 2 to 4 per cent to curb consumption.

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