FICC TIMES

THE WEEK GONE BY AND THE WEEK AHEAD

01 Feb 2013

The world has suddenly blossomed into a serious bull market. Euro has risen sharply, probably buoyed by large short squeeze, US data has been mixed but generally risksupportive, and equities have continued to rally as tail risks have materially reduced in the Euro Zone. Furthermore, Central Banks continue to work their printing presses overtime.

The US Fed chairman in the FOMC meeting kept the policy rate unchanged and signalled a continuation of the asset purchases till unemployment rate reached 6.5 percent and remained above it and inflation remained lower than 2.5 percent . The US stock markets ended the week stronger with the improved job data combined with positive housing data, PMI, consumer confidence and construction spending data offsetting the impact of a lower than expected GDP data released earlier this week. In Europe, waning worries about Europe's debt crisis and the European Central Bank's relatively more upbeat outlook for the region have led to a rally in euro against the dollar and the yen. The euro has gained more than 10 percent against the dollar since July 2012, ending the week at a 15-month high. Asian markets except Japan trended lower on the back of a lacklustre manufacturing PMI data from the region. Chinas official PMI came in slightly lower whereas India and South Korea reported slower growth in January. Manufacturing PMI in Indonesia shrank for the first time in eight months. The Japanese yen continued to slide, touching a 30month low of 92.75 against the dollar as Japanese unemployment rate jumped by 4.2 percent and household spending declined 0.7 percent while the Japanese stock markets continued to rise buoyed by the falling currency with the Nikkei closing the week at a 32month high. The Japanese government meanwhile continued to talk up the economy by giving a target of a nominal GDP growth of 2.7 percent in 2013. Closer home, the RBI finally delivered the eagerly awaited rate cut by reducing repo rate by 25 bps in its third quarterly review earlier this week and also packaged a 25 bps CRR cut, somewhat surprising the markets. The INR strengthened for the fourth consecutive week closing the week at a four-month high on the back of strong foreign inflows in January. The repo rate cut also aided the INRs rise. The Indian stock markets however, closed lower on profit booking.

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The key events of last week:

US fourth quarter GDP contracted by a marginal 0.1 percent after growing at 3.1 percent in the third quarter. The marginal drop was driven by a sharp decline in defence spending, slower inventory growth and the possible effect of hurricane Sandy whereas the housing, consumer spending and business investment remained strong, suggesting that the contraction is more of a pause while the mainstays of the economy remain strong, a fact also bolstered by the recent positive economic data The US manufacturing PMI signalled a strong expansion in the US manufacturing sector. The January index was reported at 55.8 as against 54 in December, the fastest growth in nine months. New orders grew the fastest since May 2010 on the back of improving market conditions and new product launches. Export orders were also boosted by firmer demand from China and Germany while manufacturing job creation was at a nine-month high. The non-farm payrolls in US increased by 157, 000 in January with the unemployment rate remaining unchanged at 7.9 percent The HSBC China manufacturing PMI for the month of January increased to 52.3 from 51.5 in December, indicating steady improvement in domestic conditions. Output expanded at the quickest pace since March 2011 and purchasing activity along with new orders increased at the fastest rate in two years. However, Chinas official PMI was recorded at 50.4, slightly lower than 50.6 in December Japans manufacturing sector posted a further deterioration in operating conditions in January with output, new orders and employment all registering contractions. Input prices also increased due to the recent depreciation in the yen. The manufacturing PMI for January at 47.7, although a significant improvement over Decembers 45.0, remains below 50, indicating that business conditions still remain challenging. A reading above 50 indicates expansion while a reading below 50 indicates contraction Euro zone manufacturing PMI came in at 47.9 as against 46.1 in December, an elevenmonth high although still in contraction zone. There were however, wide disparities between member nations
Euro zone Germany France Spain Greece 47.9 49.8 42.9 46.1 41.7 11 month high 11-month high 4-month low 19-month high 2-month high

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Italy

47.8

10-month high

And closer home....

Third Quarter Review of Monetary Policy
Ending the pause, the RBI, in its third quarterly monetary policy review, finally cut the Repo rate by 25 bps. Along with Repo, CRR was also reduced by 25 bps. Consequent to the Repo cut, the Reverse Repo rate, Bank rate and MSF rate have been adjusted by 25 bps each. Although the RBI guided that it will continue to contain inflation and anchor inflation expectations it acknowledged that near-term inflation risks have moderated with the softening of non-food manufactured inflation, even though food inflation remains sticky. RBI projection of WPI inflation has been revised from 7.5 percent in the second quarterly review (SQR) to 6.8 percent. The effect of the staggered increase in diesel prices, if not set off by easing global prices and adverse currency movement, will start reflecting on the inflation number only in H2CY13

Despite CRR cuts and OMOs, Liquidity conditions tightened from the second week of November on account of a build-up in the government cash balances with RBI, RBIs forex intervention and structural pressures brought on by the widening wedge between deposit growth and credit growth. The Reserve Bank conducted open market operations (OMOs) on five occasions during December 2012 to January 2013, injecting liquidity of Rs. 470 billion into the banking system. Despite these measures, the average net LAF borrowings at Rs. 910 billion in January (up to January 27), were above the Reserve Banks comfort level. So far in 2012-13, the RBI supplied primary liquidity of Rs. 1.1 tn through OMOs and daily LAF and Rs. 229 bn through NDS-OM. The latest CRR cut will release Rs. 18 bn into the system, easing liquidity pressures. However, given the tight liquidity situation, RBI may continue to infuse further liquidity into the system through OMOs 108, Madhava, Bandra Family Court Lane, BKC, Bandra(E), Mumbai 51 Page 3

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RBI has also highlighted the risks of widening of CAD to a record high along with an already high fiscal deficit, which will crowd out private investment and stunt growth The RBIs baseline projection of GDP growth for 2012-13 has been revised from 5.8 percent as given in the SQR to 5.5 percent. Money supply growth for the year remained below projections. Therefore keeping in mind the seasonal pattern for last quarter, M3 growth projection for 2012-13 has been revised to 13 percent from 14 percent The RBI policy stance has therefore prioritized growth over inflation, by encouraging investments and improving liquidity conditions to support credit flow

Other key events

The manufacturing PMI for January was reported at 53.2 in January, lower than 54.7 reported in December. Rise in production was slowest in three months due to power outages. New orders continued to rise although at a slower pace while export orders increased for the fifth consecutive month. Input and output price inflation continued to ease The government raised Rs. 31 billion through the Oil India offer for sale this week. With the success of this issue, the third such divestment this fiscal, the government remains confident of reaching its divestment target of Rs. 300 bn by the end of the fiscal The INR strengthened for the fourth consecutive week closing the week at a four-month high on the back of strong foreign inflows in January. The repo rate cut earlier this week also aided the INRs rise

So what does the next week hold...?

The US debt limit worries have eased for the near term and as indicated by the positive economic data, the US economy seems to be on a slow although unsteady recovery. The euro revival looks set to continue for some time driven by the ECBs backstop for sovereign risk and low inflation danger due to lack of economic growth. Selling the yen has become an easy one-way bet with newly elected Prime Minister Shinzo Abe persistently pressurising BOJ to jerk the economy of a recession. 108, Madhava, Bandra Family Court Lane, BKC, Bandra(E), Mumbai 51 Page 4

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The outlook for Indian markets remains very positive for now. The equities markets have witnessed record flows through the month of January, supported by large inflows into EM in search for higher yields. INR has had a very good month, appreciating over 3% in January. We expect positive sentiment to continue and seriously expect USD INR to fall all the way to 51.65 in the next few weeks

Locally, the RBI in its policy review acknowledged the softening of both growth and inflation and hence revised its projections downwards. Also, unless liquidity conditions improve, rate cuts are unlikely to reflect in lending rate cuts by banks and hence in a pick-up in credit. Consequently, there has been a definite change in the policy stance from managing inflationary pressures to supporting growth and improving liquidity conditions. Given its concerns on slowdown in investments, we feel in the near term, RBI will focus on providing stimulus to credit growth. Therefore, although non-committal in its guidance, there is a distinct possibility of further rate cuts from the RBI in H1CY13.

Important upcoming International events to be tracked:

Date 02/02/2013 02/04/2013 02/04/2013 02/05/2013 02/05/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/07/2013 02/08/2013 02/08/2013 02/08/2013 02/08/2013 02/08/2013 02/08/2013 Country Japan EMU US EMU US China UK UK UK Germany EMU US US US US US US US China China Germany US Event Unemployment Rate PPI Factory Orders (Factory Orders - M/M change) Retail Sales Redbook Merchandise Trade Balance Merchandise Trade Industrial Production Merchandise Trade Industrial Production ECB Announcement Jobless Claims Productivity and Costs (Nonfarm productivity) Productivity and Costs (Unit labor costs - Q/Q change - SAAR) Bloomberg Consumer Comfort Index EIA Natural Gas Report Consumer Credit (Consumer Credit - M/M change) Fed Balance Sheet Consumer Price Index Producer Price Index Merchandise Trade International Trade (Trade Balance Level) Period Dec, 2012 Dec, 2012 Dec, 2012 Dec, 2012 wk2/2, 2013 Jan, 2013 Dec, 2012 Dec, 2012 Dec, 2012 Dec, 2012 wk2/2, 2013

wk2/3, 2013 wk2/1, 2013 Dec, 2012 wk2/6, 2013 Jan, 2013 Jan, 2013 Dec, 2012 Dec, 2012

Important upcoming Domestic Events

Date 05/02/2013 05/02/2013 06/02/2013 06/02/2013 Event HSBC India Services PMI HSBC India composite PMI 91 day T- Bills auction of Rs 50 bn (cut-off yld) Reserve Money (change on wk) Period Jan Jan Wk to Feb 1 Frequency Monthly Monthly Weekly Weekly

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USD INR maintained its downward momentum through last week thanks to large offers emanating from equity stake sales. USD/INR closed the week at support levels of 53.10-20, we expect to see 52.50 by end of next week

06/02/2013 06/02/2013 06/02/2013 06/02/2013 08/02/2013 08/02/2013 08/02/2013 08/02/2013 08/02/2013 08/02/2013 08/02/2013 08/02/2013 08/02/2013

Foreign tourist arrivals (YoY Chg) Automobile sales data (y/y chg) 364 day T- Bills auction of Rs 50 bn (cut-off yld) M3 (YoY Chg) WMA (ways and means advance) - to central govt WMA (ways and means advance) - to state govts FX reserve (change on wk) Bank Deposit (YoY Chg) Bank Credit (YoY Chg) Bank Investment (YoY Chg) Bank Cash Deposit Ratio Bank Investment Deposit Ratio Bank Credit Deposit Ratio

Jan Jan Wk to Jan 25 Wk to Feb 1 Wk to Feb 1 Wk to Feb 1 Wk to Jan 25 Wk to Jan 25 Wk to Jan 25 Wk to Jan 25 Wk to Jan 25 Wk to Jan 25

Monthly Monthly Fortnightly Fortnightly Weekly Weekly Weekly Fortnightly Fortnightly Fortnightly Fortnightly Fortnightly Fortnightly

Technical Based View:

Daily USD/INR Chart: Reuters

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