India Monthly Investment Outlook and Strategy

January 2013

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Contents
Macroeconomic Outlook
December Recap
Asset Classes- 12 Month Views

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India - Equities
India - Fixed Income
Currencies
Commodities

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Macroeconomic Overview Global

It would appear that economic policy-makers around the world are more confident about avoiding a crash in the global economy in
2013.

The consequences of continuing money-printing and debt build-up in the worlds richest nations does raise troubling questions about
the longer-term sustainability of current policies.

The possibility of a boom to bust economic cycle re-emerging in 2013 seems limited given the excess capacity and unemployment in
the West and Japan.

Both the US and China have seen definitive signs of a bottoming-out in their residential housing markets which bode well for the
future of the global construction and materials sectors.

The US economy continues to show signs of a measured recovery, with markets firmly focused on negotiations in Washington over
the fiscal cliff (although postponed by two months).

Growth in Europe is likely to remain sluggish in 2013. HSBC Global Research forecasts a mild recession in the Eurozone, i.e. growth
in 2013 of -0.1%. This is the result of fiscal austerity and knock-on effects such as credit squeeze, due to banking systems that have
not been properly recapitalized.

On balance, we expect a less volatile financial market environment in 2013, compared to 2012, but will be watchful for occasional
bouts of risk-off sentiment affecting risk asset markets.

The ongoing debate in the US about how its government will address the impending fiscal cliff issue will provide an interesting
pointer and set the tone for market activity in 2013.

Risks
In our view, the global economy remains vulnerable to a significant worsening of conditions in the Eurozone, a spike in oil prices or a
continued stand-off between US political parties on the issue of the fiscal cliff. However, none of these are our base case scenario.

Source: HSBC Global Research/Bloomberg

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Macroeconomic Overview India

Walking the straight and narrow: RBI on hold as expected
Facts:
The RBI kept the policy rate (the repurchase or repo rate) unchanged at 8.00%, in line with consensus and our call. Consequently,
the reverse repo and marginal standing facility rates were kept unchanged at 7.00% and 9.00%, respectively.
The cash reserve ratio (CRR) was also left unchanged, 4.25%, which was against expectations by us and consensus of a 25 bps cut
to cater to liquidity tightness.
However, the RBI was, as it turned out, satisfied that the stepped up OMOs (buy back of bonds) earlier in December had done
enough for now.
Implications:
The RBI again walked the straight and narrow by staying policy rates on hold. That was prudent given the still lingering inflation risks
and the need to ensure that sufficient progress on fiscal consolidation, structural policy reform, and infrastructure investment has
been achieved.
While the policy reform measures announced by the government are necessary to create the room for policy rate cuts, they are not
sufficient by themselves. A more fundamental problem is that inflation risks are still tilted to the upside. Cutting the policy rate under
these circumstances would have run the risk of unhinging inflation expectations as RBI could then have been seen as going soft on
inflation.
Moreover, given the supply-led nature of the slowdown, capacity remains relatively tight despite the slower pace of growth. A policy
rate cut now would, therefore, have run the risk of teasing up inflation while doing little to support growth on a sustained basis.
Furthermore, the current account deficit remains too wide for comfort as the October and November trade numbers clearly reminded
us. This is another constraint on monetary policy easing that the RBI could not easily ignore.
In terms of timing for rate cut, the January-March quarter now seems highly likely and it may come as soon as January. However, it
could get pushed back if inflation proves more stubborn than expected and the reform momentum fizzles out.
Bottom Line:
The RBI kept policy rates on hold in light of the persistence of inflation and lingering upside risks to inflation. However, it is gearing up
for potential policy rate cuts early 2013, assuming inflation risks recede and policy progress on other fronts is sufficient.
OMO: Open Market Operations is undertaken by the Reserve Bank of India to buy or sell government securities in the open markets.
Source: HSBC Global Research/Bloomberg

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Macroeconomic Overview India

Time for inflation celebration? November WPI inflation eased
Facts:
WPI inflation eased to 7.2% y-o-y in November (vs. 7.8% in October), below consensus expectations of 7.6% and our more bearish
estimate of 7.8%. On a sequential seasonally adjusted basis, however, inflation held steady at 0.3% m-o-m (vs. 0.3% in October).

The deceleration in headline inflation was mainly driven by energy (10% y-o-y vs. 9.8% in October) and manufactured products (5.4%
y-o-y vs. 5.9% in October). Manufactured food inflation picked up (10% y-o-y vs. 9.8% in October), but core inflation (manufacturing
excluding food, beverages, and tobacco) eased notably to 4.5% y-o-y (vs. 5.2% y-o-y in October). Sequentially, core inflation also
slowed a bit (0.2% on m-o-m sa vs. 0.3% in October).

Implications:

November inflation reading was another positive surprise, at least when it comes to WPI inflation. But, while it takes just two to tango,
it takes more than two data points to establish a clear trend. The bounce-back in food inflation was to a large extent a reflection of the
shifting timing each year of the Diwali, falling last year in October and this year in November. This pumped up the base for this year
as festive food demand picked up and, therefore, boosted the annual inflation print.

Moreover, the easing of core inflation was encouraging, although it was primarily driven by non-metallic minerals and basic metals.
However, there are also good reasons to remain concerned about inflation, with other gauges of inflation looking less encouraging.

All in all, the inflation picture is still not comforting enough for the RBI to let down its inflation guards.

Bottom Line:
Headline inflation eased unexpectedly led by fuel and core inflation, which should provide the RBI with some comfort. However, this
will not be enough to trigger a rate cut.
WPI: Wholesale Price Index an index that measures and tracks the changes in price of goods in the stages before the retail level.
Source: HSBC Global Research/Bloomberg

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Macroeconomic Overview India

Acronyms up: October IIP and November CPI rise
Facts:

Industrial production rose 8.2% y-o-y in October (vs. -0.7% in September); well above consensus expectation of 5.1% growth and our
5.3% estimate.
On a sequential bass, industrial production expanded 2.7% m-o-m (seasonally adjusted) following 2.6% m-o-m (sa) contraction in
September. On a 3m/3m (seasonally adjusted) basis, IP growth rose to +6.5% vs. -5.3% in September.
By industry groups, the index-heavyweight manufacturing jumped 9.5% y-o-y (vs. -1.5% in September). Electricity production (5.5% yo-y vs. 3.9% in July) also rose, but mining (-0.1% y-o-y vs. 2.3% in September) remain curtailed.

Implications:

The October IIP was a treat and offered a glimpse of hope. However, it should be borne in mind that the annual growth print was
flattered by the shifting timing of the Diwali, which was celebrated in October last year. This, therefore, boosted the annual growth
rate given this year's November timing of the Diwali. It also means that there will be some payback in November when the base effect
reverses.
Looking ahead and beyond November, a recovery in industrial production depends on progress on structural policies and
implementation of infrastructure related projects.
We, consequently, expect GDP growth to move, more or less, sideways in the near term and only recover very gradually hereafter as
it takes time to get traction on reforms and see their effect.

Bottom Line:

Industrial production rose more than expected, which partly reflected the favorable base effect due to last year's October timing of the
Diwali. While this base effect will reverse in November, there are signs that the underlying growth momentum is at least stabilizing.

IIP: Index of Industrial Production is an index which details out the growth of various sectors in the economy like mining, electricity, manufacturing and general.
CPI: Consumer Price Index is an index that measures changes in prices at a household level for various consumer goods and services.
Source: HSBC Global Research/Bloomberg

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Macroeconomic Overview India

On the rise: HSBC manufacturing PMI up in December
Facts:

HSBC's India manufacturing PMI picked up in December to 54.7 (vs. 53.7 in November) due to a strong rise in new orders (58.0 vs.
55.8 in November). The improvement was led by both domestic and overseas demand, with the new export order index rising to 56.4
(vs. 55.9 in November). In response to the pick-up in orders, output growth (57.7 vs. 55.4 in November) rose to a six-month high.

Implications:

The manufacturing sector is starting to show signs of a revival, helped by a pick up in both external and domestic demand.

On the external front, the lagged effect of the depreciation of the exchange rate may have helped fill the order books. Moreover,
global economic conditions have shown some signs of stabilization over the past few months, notwithstanding the looming US fiscal
cliff.

On the domestic front, policy progress is headed in the right direction. The winter session of parliament saw a number of key bills
passed and the government won a crucial vote on FDI in multi-brand retail. These developments have, in turn, helped lift sentiments
and demand. However, it will be important to sustain the reform momentum to bring about a more notable recovery in growth.

Bottom line:

The manufacturing PMI continued to pick up on the back of a sustained increase in new orders.

PMI: Purchasing Managers Index is an indicator of the economic health. The manufacturing PMI is based on new orders, inventory levels, production, supplier
deliveries and employment environment.
FDI: Foreign Direct Investment is the direct investment of one country into another country in their production or business.
Source: HSBC Global Research/Bloomberg

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December Recap
India - Equity
Post rally of 4.5% in November, Indian equity markets were up only 0.5% in month of
December, primarily due to concerns regarding fiscal cliff in US and its potential impact
on global economy. Also RBI did not cut the Repo and CRR rate.
In CY12, FIIs have invested USD 24.9 Bn in the Indian market (as compared to net
selling of USD 0.7 Bn for CY11). For the month of December 2012 alone, FIIs invested
USD 4.5 Bn, reflecting their continued interest in the country, given the slew of policy
measures announced by the Central Government and the increase in global liquidity.
Tactically, we look for risk on-risk off to continue. We expect the focus of the market to
shift to the earnings season, RBI policy review on 29 January and budget session of the
parliament in February.
India - Fixed Income
The longer end of the yield curve rallied towards the end of the month on account of the
RBI postponing an auction slated in the first week of January while it continued with its
buyback of bonds program to ease the tight liquidity scenario.
Systemic liquidity remained tight thereby causing the shorter end of the yield curve to
rise as the 1 month certificate of deposits rose by 28 bps, while the 3 to 12 months
segment of the curve rose by 5 to 6 bps.

Equity - India

MTD

YTD

Sensex

19,427

0.4%

25.7%

CNX Mid-cap

8,505

4.5%

39.2%

MSCI Emg Mkt

1,055

4.8%

15.1%

MSCI World

1,339

1.7%

13.2%

8.05%

12 bps

52 bps

55.0

-1.3%

-3.6%

Equity - World

Bonds & Currency

10 Yr Yield INR*

Currency
Concerns over the rising current account deficit impacted the INR during the month as it
weakened despite the equity market registering Foreign Institutional Investors inflows of
USD 4.5B in December. The USD weakened against the EUR due to concerns over the
impending US fiscal cliff.

USD/INR**

Commodities
Gold prices eased during the month due to profit booking ahead of the US fiscal cliff
decision. Oil prices gained during the month due to ongoing concerns in the Middle East.

Gold (USD)

1675

-2.3%

7.1%

Brent Crude (USD)

111

0.8%

7.8%

FII: Foreign Institutional Investor an investor or investment fund that is from or

registered in a country outside of the one in which it is currently investing.
DII: Domestic Institutional Investors a local institutional investor
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Commodities

* Arrow movement reflects impact on bond prices while numbers are in yield terms
** Arrow movements reflect impact on INR

As on December 31, 2012. Source Bloomberg

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Prev. Month =/+

India - Equity
Post rally of 4.5% in November, Indian equity markets were
up only 0.5% in month of December, primarily due to concerns
regarding fiscal cliff in US and its potential impact on global
economy. Also RBI did not cut the Repo and CRR rate in its
mid quarter policy review.

This Month =/+

Pick up in PMI due to firm increase in new orders

Nifty volatility index has eased in recent

months

In CY12, FIIs have invested a total of USD 24.9 Bn in the

Indian market (as compared to net selling of USD 0.7 Bn for
CY11). For the month of December 2012 alone, FIIs invested
USD 4.5 Bn. While in CY12, DIIs have sold USD 3.9 Bn in the
Indian market.
The recent rally has been largely led by risk-on trade on the
back of improving global sentiments, robust FII flows and
positive sentiments created by the government reforms.
We expect the focus of the market to shift to the earnings
season, RBI policy review on 29 January and budget session of
the parliament in February. Also we await clarity on fiscal roadmap by the Government (Telecom spectrum auction, PSU
disinvestment). Globally we look for the evolving US fiscal cliff
situation (postponed by two months). The near term outlook for
economic growth remains challenging and political
developments have the potential to increase volatility in the
short-term. On the flip side, continuation of reforms can act as a
further catalyst to the ongoing rally. Tactically, we look for risk
on-risk off to continue.

FII flows have been buoyant in the current year

Despite rally: valuations are attractive

In our view, valuations remains attractive, especially when

compared to history. SENSEX currently trades at a 13.4x FY14
earnings v/s average of 14x over the last decade.
We maintain neutral with a positive bias stance on Indian
Equities. Also we have increased CY13 SENSEX target from
20,000 to 21,700. In our view, a number of the key tails risks
facing the global economy have reduced, which has seen
global risk appetite recover.
We continue to recommend funds which have shown
consistent performance across cycles. In the current rally these
funds performed better than their peers. In our direct equity
model portfolio, we have added weight in cyclical and relatively
high beta stocks whilst sticking to companies with strong
corporate governance and attractive valuations.

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Source: Bloomberg;
All the views expressed in this document are 12 month views;
-ve means negative, = means neutral, +ve means positive

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Prev. Month: Duration =/+; Liquidity =/-;

India - Fixed Income

This Month: Duration =/+; Liquidity =/-;

Bonds initially during the course of the month witnessed volatility due to the tight systemic liquidity and on concerns
over inflationary pressures as indicated by the CPI and the PMI readings. Bonds however towards the end of the
month rallied due to the Government providing an indicative road map on its disinvestment program and on the RBI
postponing its weekly auction slated for the first week of January while it continued with its buy back of bonds
program.

Systemic liquidity tightened during the month

due to advance tax outflows and Government
curtailing its spending.

The Reserve Bank of India in its monetary policy review hinted at possible monetary easing in Q1-CY2013 as it
expects inflationary pressures to moderate as core inflation has started easing We believe that the room for the RBI
to cut policy rates is limited and we currently only expect 50 bps of rate cuts in the year.
We continue to believe that in the event the RBI cuts rates, this will lead to a shift in the yield curve downwards.
Furthermore, we expect the OMO announcement by the RBI to provide an upper cap to bond yields in the interim.
Moving forward the key risk for investors would be the reinvestment risk given the declining interest rate scenario.
Hence, we look to position portfolios to capture capital gains from a falling yield curve.
In the current environment therefore, we recommend a mix of dynamic bonds funds and long term debt funds (gilt
& income funds). Apart from maintaining attractive accruals, these schemes have registered capital gains through
active fund management and may continue to do so in an easing interest rate environment. Furthermore, these
schemes apart from having exposure to government securities and bonds have undertaken exposure to state
development loans as they are trading at relatively higher yields as compared to bonds.
However, investors need to be aware that the longer duration bonds will add to volatility in their portfolios as
witnessed in the past, especially in case of delay in the RBIs monetary easing, additional borrowing
announcements incase of a fiscal slippage. Hence, the investment horizon for such investments accordingly
therefore needs to upwards of 1 year.
We also recommend to our clients to selectively invest into tax free issuances by high quality public sector entities
as companies in this space have been allowed to raise upto INR 535Bn from such bond issuances during this
financial year. Presently select issuances have raised monies at the following levels: 10 year at 7.19-22%, 15 years
at 7.36 - 7.38% and 20 years at 7.50 - 7.41%.
Given the lower rates in the shorter end of the spectrum, clients may consider moving funds from the liquid/ ultra
short term schemes to the short term/ income funds, depending on the tenor of the investments and liquidity
requirements of clients as these schemes should be held with a time horizon upwards of six/twelve months,
respectively .

Tight systemic liquidity caused the shorter end of the

yield curve to edge higher. The longer end rallied on
account of the postponement of an auction and due to
the buy back of government securities by RBI.

INR Sovereign Curve Current

8.5
8
7.5
7
3M

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INR Sovereign Curve Prev Month

6M

1Y

3y

5Y

8Y 10Y 12Y 20y

Source: Bloomberg; All the views expressed in this

document are 12 month views; -ve means negative, =
means neutral, +ve means positive
10

Currencies

PrevMonth: USD -

GPB =

This Month: USD - GPB =

With reforms announced by the Indian government to boost investor confidence and
tackle the twin deficit problem, our degree of caution towards the INR has subsided to
some extent. These reforms have also coincided with the Feds latest QE as well as
calming tail risks in the Eurozone, suggesting that the time has come to be more
constructive on the INR. Additional reforms may be forthcoming in coming weeks and
months.

EUR +

USDJPY =

EM +

USD/INR +

EUR + USDJPY =

EM +

USD/INR +

INR weakened against the USD during the month

At the same time, we acknowledge that implementation risks and further political
obstacles could still emerge and could slow the momentum of additional reforms. If
India is unable to pass reforms to open up its investment sector and make it more
attractive to foreign funding, then the large twin deficits will continue to weigh on the
currency.
Our forex desk expects the INR to appreciate during the course of the quarter
predominantly aided by Foreign Institutional Investors inflows, interim volatility however
cannot be ruled out given the demand supply dynamics (oil companies requirements,
FDI measures etc).
Ongoing uncertainties with regards to the US fiscal cliff (Congress to decide in the
next two months) and the upcoming Italian elections are likely to keep major currencies
range-bound in the short term.

USD marginally weakened against the EUR and GBP during the
month due to concerns over the US fiscal cliff.

In the longer term, we believe that EUR will benefit from improving investor sentiment,
while USD suffers from ongoing accommodative monetary policies by the Federal
Reserve. GBP is likely to remain linked to EUR performance, although questions about
the UKs AAA credit rating may imply EUR will outperform.
We maintain our preference for emerging market currencies, which should benefit
from the ongoing search for yield and their healthier fundamentals and attractive carry.
As a result, reduced tail risk for 2013, in addition to less negative growth for the
Eurozone, should put a floor under the common currency. At the same time, continued
quantitative easing may lead to some de-basing of USD.

Source: Bloomberg; All the views expressed in this document are 12 month views;
-ve means negative, = means neutral, +ve means positive

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Prev Month: Gold +; Oil =; Agricultural +; Industrial =

This Month: Gold +; Oil =; Agricultural +; Industrial =

Commodities
We believe that the longer-term outlook for
commodities is improving, supported by the
recovery in Chinese economic data,
although it may take some time for higher
prices to materialise given some short-term
uncertainty.

Gold prices witnessed profit booking in Dec 12

Crude oil prices appreciated by ~0.8% in Dec 12

We maintain our positive view on gold,

which should continue to benefit from
accommodative monetary policy in the West,
purchase by Central Banks and on recovery
in EM demand.
In 2013 we expect Gold prices to remain
volatile and range between USD
1575/Ounce to USD 1950/ Ounce and
forecast an average price of USD
1760/Ounce.
Oil prices may remain range-bound given
softer demand and ongoing tensions on the
Middle East. In the longer term, we expect oil
prices to remain supported by emerging
market (EM) demand, but this may take
some time to materialise.

The agriculture index fell by ~5.7% in Dec 12

Industrial metal index rose by ~0.7% in Dec 12

In our view, industrial metal prices may not

rebound significantly until Chinese growth
shows signs of substantial and sustainable
improvement, but we believe that prices will
still somewhat benefit from recent central
bank actions.
We believe agricultural commodities
should benefit from changing eating habits in
the emerging markets in the very long term,
but this may take time to materialize.
Source: Bloomberg; All the views expressed in this document are 12 month views;
-ve means negative, = means neutral, +ve means positive

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