Week ended September 21, 2012

Sept 2012 Monetary Policy Review

ICICI AMC
Credit to productive sectors by banks possible with a tamed deficit (diesel price hike) A diesel price hike and a slew of economic reform measures point to a strong resolve to contain fiscal deficit. A tamed deficit can bring down the anticipated Government borrowing by a good measure, thereby reducing total demand of public loans in the system. Banks should be able to extend credit to productive sectors of the economy. So even as RBI puts formal rate cuts on hold with an eye on inflationary pressures, the climate looks conducive for a yield correction by market forces. A stubborn inflation may keep a rate cut away, but the 25 bps relaxation in CRR implies that the RBI is willing to move in step, if Government walks the talk.

IDFC AMC
Shift in stance in line with expectations Over the last few months, RBI has been hard-lining its inflation concern in context of relative Govt. inaction on policy. What we were looking for in this monetary policy was not an actual rate cut but some shift in stance to acknowledge the recent govt action and its impact on growth versus inflation dynamics. In that, we were not disappointed.

ICICI Bank
Growth concerns have increased while inflation remains sticky The Central Banks rhetoric has shifted from primarily inflation-focused stance in last few months to taking cognizance of the rising growth risks in the economy and the important role of monetary policy in supporting the growth revival. The RBI has appreciated the reform process set in motion by the Government last week, to help support the weakening growth trajectory.

Inflation and Growth expectations

Rate cut expectations

We will not rule out rate cuts from OctDec 2012 If the government were to follow through recent steps with more on the fiscal side (the finance minister has promised as much in his media response to the policy today), we believe the conditions will start to fall in place for the RBI to support growth via rate cuts. In this regard, we will not rule out rate cuts from Oct December 2012. However, what is also true is some delay in these cuts will by no means take away from the medium term bullish view

RBI likely to cut rates by at least 50 bps in rest of FY2013 given the rising downside risks to growth While the inflation trajectory does not provide room for policy easing policy easing, however we continue to hold onto our call of at least 50 bps repo rate cut in rest of FY2013, on rising growth concerns in the economy and in keeping with the fact that Delhi has initiated crucial policy reforms.

Short Term Rates going ahead

The 25 bps CRR cut will inject Rs. 17000 Bottomed out for now, Upward pressure on Crs, keeping primary liquidity in the short end rates from September system in a desirable zone. The short end of the yield curve (1-3 years) is likely to remain supported

While the liquidity conditions have remained comfortable since the June policy meeting, the situation is likely to deteriorate in the coming weeks. We believe that CRR cut would help put downward pressure on lending rates apart from the recent spate of deposit rate cuts by various commercial banks amidst a sharp improvement in the liquidity situation and the narrowing wedge between the credit and deposit growth. Gilts likely to witness upward pressure Overall, the gilts are likely to witness upward pressure on the promise of continued fiscal reforms by the Finance Minister while the gains could be limited on rise in international crude prices post the introduction of QE3 by the US Federal Reserve.

Time to incrementally add duration Large supply of government bonds continues to weigh heavily on market sentiments. However, OMOs by RBI is likely to keep yields capped. The opening of 10 year G-Sec FDI in several sectors may improve the Yield going ahead overall investor sentiment followed by good inbound capital flows via FII as well as FDI route. This in turn may help Indian Rupee appreciate in near term - a clear plus for long term yields

Final opportunity to enter long duration Investors should welcome the absence of rate cut today. This, along with lower probability of OMOs before November given the CRR cut today, should still keep bonds in a range thereby providing a final opportunity to enter long duration for those still sitting on the side-lines.

WEEKLY ROUND UP Global update German Chancellor Angela Merkel expressed doubts over the creation of a European banking supervisory body by January 2013. Spanish Prime Minister Mariano Rajoy said in the Parliament that his government was committed to cutting the budget deficit. He emphasized that curbing spending was necessary to be able to finance the Government. The Bank of Japan, in its policy meeting, announced an increase in its asset purchase program by JPY 10 tn to JPY 80 tn. An IMF official said that the fund would cut global economic forecasts by a few decimal points, in the report due to be released on October 09. The IMF projected 2012 and 2013 global economic growth at 3.5% and 3.9% respectively in June India update The RBI kept the repo rate unchanged at 8.0% in its policy meeting in line with expectations. The Central Bank though cut CRR by 25 bps to 4.50%. In the policy statement, the RBI took cognizance of the fact that growth concerns have increased, while continuing to focus on the inflationary persistence in the economy. In Indian politics, the Trinamool Congress party withdrew support from the ruling United Progressive Alliance (UPA) Government over opposition to recently announced reforms of diesel price hike and allowing FDI in retail. The UPA was left with 254 seats in the Parliament, 18 short of the required 272- mark. But later, Samajwadi Party said their party would support UPA from outside. MARKET UPDATE Global Markets Overview US stocks traded weak amidst profit Indices Sep 14, 2012 Sep 21, 2012 Change booking. A weaker reading in Empire BSE Sensex 18464.27 18752.83 1.56% manufacturing index also weighed on Dow Jones 13539.86 13596.93 0.42% sentiment. US stocks rose amidst FTSE 100 5901.1 5851.15 -0.85% upbeat existing home sales data and as Nikkei 225 9159.39 9110 -0.54% global risk sentiment improved Hang Sang 20629.78 20734.94 0.51% following announcement of further Strait Times 3070.42 3078.23 0.25% stimulus by the Bank of Japan but gains were countered by increasing global growth concerns. Dow Jones is trading half a percent positive for the week (15:30 IST) Asian stocks traded in a mixed territory at the week's beginning, closing in the positive territory for the week. Hong Kong Monetary Authority announced measures to stem the spike in the economys property sector with Hang Sang edging lower. Shanghai Composite slumped with the realty sector being the prime laggard. Market sentiment remained subdued over worsening political tensions between China and Japan but remained supported by expectations of policy stimulus by China. Asian stocks traded lower as Chinas HSBC flash manufacturing PMI for September came in at 47.8, posting the eleventh consecutive sub-50 reading. Domestic Equity Market Overview Indian stock markets opened firm amidst optimism after the Government announced a slew of reforms post market hours last Friday. The Reserve Bank of India (RBI) in its monetary policy meeting kept benchmark repo rate unchanged at 8.0%, but cut the cash reserve ratio by 25 bps to 4.50%, thereby further aiding market sentiment. However, the gains remained capped owing to weak cues from the European stocks and profit booking by investors. However losses were limited as the Finance Minister in his comments reiterated the Governments commitment to fiscal consolidation and assured that steps were being taken to address the issue. The power sector gained amidst reports that the Government was likely to restructure the debt of state electricity boards and power distribution companies. Indian stock markets traded lower amidst political uncertainty as Indian political party Trinamool Congress withdrew its support to the Government over its opposition to the recently announced diesel price hike and approval of FDI in multibrand retail. Indian stocks remained on the back foot for the most part of yesterday amidst considerable political flux. But Sensex spiked 403 points as Samajwadi Party offered that they would support UPA from the outside and Finance Minister announced cut in withholding tax, closing 1.56% higher from the week's opening levels.

Fixed Income Indian sovereign bonds opened firm as Governments Indices Sep 14, 2012 Sep 21, 2012 announcement of the much awaited FDI reforms 10 year G-Sec 8.17% 8.16% coupled with hike in diesel prices last week supported IIP (July) 0.1% YoY market sentiment. However, gilts pared gains as the Inflation (August) 7.55% MoM RBI refrained from cutting interest rates, though GDP FY2013 Q1 5.5% YoY surprised the markets with a 25 bps CRR cut. Indian 10 years US treasury yield 1.80% 1.78% gilts opened on a firm note as the sharp overnight fall in crude oil prices somewhat eased inflation concerns. Meanwhile, political uncertainty led investors to seek the relative safety of Government bonds. However, gains were pared later in the day as traders trimmed positions ahead of weekly gilts auction (worth INR 150 bn) on Friday. The 10 year Benchmark Bond yield remained flat for the week. USD INR The Indian Rupee opened firm breaching the 54-mark for the first time in four months amidst improved market sentiment. However, Dollar demand by oil importers, weakness in the Euro, uncertainty in domestic events and the weak sentiment in the stock markets also weighed on the Rupee. Cues from Asian peers are positive amidst stimulus measures administered by global Central Banks. Rupee spiked due to gains in domestic stocks on broad-based buying after the cut in withholding tax by the finance minister and Samajwadi party's support to the Congress to stay in power. Rupee is trading strong by more than 1.5% for the week (15:30 IST) Dollar Index (DXY) The US Dollar remains under pressure amidst improvement in risk sentiment owing to two recent developments the US Fed announced the third round of quantitative easing (QE3) last Thursday while Eurozone debt concerns eased amidst policy action. The US Fed announced that it would purchase USD 40 bn of mortgage backed securities each month until economic conditions improved. Dollar Index , currently trading at 79.38 levels, has fallen by more than 6% from a 2-year high of 84.1 levels seen in July end. In the near-term, we expect the Dollar to remain under pressure owing to Fed action and improvement in risk sentiment. EUR The Euro has witnessed a rally in the last two weeks as the ECB delivered a positive surprise by outlining the modalities of its bondbuying plan in its policy meeting on September 6 th. The Euro added to its gains post the US FOMC decision to embark on QE3. Consequently, the Euro breached the 1.30-level last week and is currently trading around 1.3120 against the US Dollar. Going ahead, markets will look forward to the Spanish Government to ask for a bailout from the EU (which would make it eligible for ECB intervention in the secondary bond market), given that Spain has heavy debt redemption scheduled in October. The common currency is expected to trade firm in the near-term amidst increasing efforts by European policymakers to address the regions debt concerns. Oil Third round of QE undertaken by the Fed provided some support to the crude prices. But crude prices have declined sharply over the past few days and the WTI contract has dipped below the USD 92 per barrel level from the week's opening level of USD 99 per barrel. This sudden drop in oil is mainly linked to bearish fundamentals, which showed that US crude inventories showed an unexpected increase of around 8.5 mn barrels. Along with this, the recent assurances by the Saudi Government that they will work to keep oil prices under check is weighing on crude. Weak economic data from China will also have a bearish impact on oil markets. However, crude prices have edged up a bit yesterday amidst continuing uncertainty in the Middle East, which threatens to destabilize the region. Recent attacks in Libya have constrained output and a fire in a refinery in Venezuela is also exerting an upward pressure on crude prices. Brent and WTI prices corrected by around 5-6% for the week (15:30 IST)

Gold Gold prices continue to trade at elevated levels and spot is trading at USD 1775/oz after having reversed losses at the beginning of this week. The yellow metal will remain supported amidst the stimulus injected globally and probably has the potential to move up further. Investment demand is slowly picking up in the bullion and the SPDR Gold Trust, which is the worlds largest ETF has reported that its holdings are at a one year high of around 1308 tons. Gold prices are trading marginally positive for the week (15:30 IST) Indices Gold spot ($/ounce) Brent ($/bbl) WTI ($/bbl) USD / INR DXY Index EUR USD Sep 14, 2012 1770 116.66 99.00 54.3 78.85 1.313 Sep 21, 2012 1775.9 110.46 93.01 53.38 79.38 1.3032 Change 0.33% -5.31% -6.05% -1.69% 0.67% -0.75%

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