HDFC Standard Life Insurance

Debt markets Update – April, 2011

March Highlights

• RBI raised the Repo and Reverse Repo rates by 25 bps each to 6.75% and 5.75%
respectively, in its Mid-Quarter Policy review. All other Policy rates were maintained at
their respective levels.
o The tone of the Policy statement was clearly anti-inflationary
o RBI raised the March 2011 WPI inflation estimate to 8% from the 7% estimate
made in its previous Policy
o Growth momentum persists, with some threats to the momentum arising from
high commodity prices
o Liquidity in banking system seen in a range of 1% of deposits, surplus / deficit.
• WPI inflation for the month of February surprised on the upside at 8.31%y-o-y, against
expectations of about 7.60%. The February print was higher than the previous month’s
8.23% and broke the downward trend in inflation. Moreover, the December inflation was
was revised higher by almost a full percentage point, further accentuating market
concerns on trend in the price levels.
• IIP growth for the month of January, too, came in above market expectations, clocking a
3.7% growth over the same month of the previous year. Consumer durables sector
continued to show a robust performance as it expanded by 23.3% (7.8% growth mom)
and pulled up the index. Passenger car sales, which is a significant part of the consumer
durables, have shown steady growth over the past few months. This trend is expected to
continue into February with car sales having expanded about 22%.
• Bond yields were largely steady through the month. The rate hikes were well anticipated
by the markets after the RBI had resumed its rate hike cycle in January. The winding up
of the Government’s borrowing schedule for the year and lack of fresh supply during the
month lent an initial positive momentum to the markets. This direction reversed after the
inflation prints, and yields ended the month almost unchanged from the previous month
end. The benchmark 10-year bond ended the month at 7.98% from the 8.02% at the end
of the previous month.
• Short term yields went through the roof over the last fortnight, as the system liquidity
remained in deficit through the month and banks scrambled to roll over their maturing
CDs. Short term money market instruments traded above the 10% yield level.

Market Outlook
Bond markets will brace for fresh supply of GSecs as the Government’s borrowing programme for
the new financial year gets underway. The Government is scheduled to borrow Rs 2,500 bn in the
first six months of the year, breaking it down to an average of about Rs 120 bn per week. This
amount of supply is expected to be absorbed by the markets smoothly. However, concerns over
higher Government borrowing remain and will get more acute later in the year. The immediate
concerns are centered around Oil prices and the path of inflation. Oil prices are likely to stay
elevated, primarily due to fears of supply disruption caused by social unrest in the Oil exporting
countries. High Oil prices feed into higher inflation as well as push up the Government’s
expenditure on Fuel subsidies and Fertilser subsidies. India’s GDP is also expected to grow
around 8% over the next twelve months, a tad lower than the 8.6% estimated growth for the last
financial year. The robust growth, elevated inflation expectations and high Government borrowing
are expected to impart an upward bias to bond yields.
At the short end of the curve, an easing of the liquidity conditions is expected to soften the short
term yields in the near term. A pick-up in the Government spending at the start of the new year
and a seasonal slowdown in bank credit demand is expected to reduce the liquidity deficit in the
banking system. However, expectations of continued rate hikes by RBI will limit the fall in short
end yields.

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 HDFC Standard Life Insurance

April 2011

‘I never attempt to make money on the stock market. I buy on the assumption that they
could close the market the next day and not reopen it for five years.’
- Warren Buffet
Equity markets
Indices 28th February 31st March 1 Month Return 1 Year
2011 2011 (%) Return (%)
BSE Sensex 17,823 19,445 9.10 10.94
S&P CNX Nifty 5,333 5,834 9.38 11.14
BSE 100 9,259 10,096 9.03 8.55
BSE Mid Cap 6,373 6,873 7.85 0.99
BSE Small Cap 7,817 8,176 4.59 6.11
Source: Bloomberg

Indian markets recouped the losses of February and rallied in the month of March, not
withstanding inflation, interest rates and crude oil, which extended its strong rally in
March and was up by 10.1% month on month. Most global indices barring Hong Kong’s
Hangseng and US Dow Jones were down anywhere between 0% to 8% during the month.
SENSEX and NIFTY jumped by 9.1% and 9.4% respectively in March on the back of
~US$1.5bn FII inflows. The broader market in India underperformed the main indices
and mid cap index ended higher by 7.9%, while small cap index was higher by 4.6%
during the month. 
Foreign Institutional Investors (FIIs) were net buyers in the secondary market during the
month of March. FIIs bought net Rs.69.7 bn worth of Indian equities in cash market and
domestic mutual funds bought net Rs.28crs worth of stocks during the month of March.
For FY2011, FIIs have bought net Rs.1101.2 bn (US$24.4bn) worth of Indian equities,
while Domestic mutual funds were net sellers of Rs. 196.9 bn worth of Indian equities.
For the month of March sectors like Realty, Auto and Banking outperformed the key
benchmark indices, whereas sectors like FMCG, Healthcare, Metals, Capital goods,
Power and Oil & Gas underperformed. None of the sectors delivered negative returns.

For the financial year 2011 FMCG was the best performing sector delivering 27% returns
and Realty was the worst performing sector recording -27.6% returns.

Macro Economic Data

Inflation in Feb 2011 rose to 8.3% from 8.2% in Jan 2011 despite the sharp fall in food
inflation. The rise is attributed to the sharp increase in cotton and oil seed prices. While
there is some reciprocal rise in manufactured product inflation to 4.9%, the broader
assessment indicates intensifying margin pressure and declining pass-through coefficient.
The index of industrial production (IIP) grew 3.7% in Jan ’11 ahead of consensus
estimates of 2.8%. Low industrial growth in Jan ’11 was largely due to the base effect;
while the seasonally adjusted growth bounced back. The growth was backed by stronger
support from electricity generation which grew 10.5% with mining at 1.6% and
manufacturing at 3.3%. While capital goods sector contracted 18.6% YoY in Jan 2011 it
was more than compensated by stronger performance from consumer goods at 11.3%.

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 HDFC Standard Life Insurance

Metal products, machinery, transport equipment and other manufacturing segments

declined by 3.4% YoY.
Continuing with its calibrated monetary tightening cycle, the RBI on 17th March 2011 in
its monetary policy review meeting hiked the repo and reverse repo rates by 25bps each
as inflation continued to be nearly double the medium-term target of the RBI (since Jan
’10). RBI now projects WPI inflation at 8% by end-Mar ’11.
India’s exports in Feb ’11 rose 50% to US$23.6bn, the highest-ever monthly level while
imports grew 21% to US$31.7bn. The trade deficit widened to US$8.1bn (US$8bn in Jan
’11). During Apr-Feb FY11, exports rose 31% to US$208.2bn, imports grew 18% to
US$305.3bn and the trade deficit was US$97.1bn (US$100.3bn in Apr-Feb FY10). The
disaster in Japan is likely to have only a modest impact on India’s foreign trade as it is
not a significant trading partner. Japan contributed only 2% of India’s FY10 exports and
2.3% of India’s imports.
Liquidity growth has reduced with YoY M3 growth at 16.6% (as on 11th Mar’11)
compared to 16.9% in the same period previous month.
Commodities 1 Month One Year Commodities like Nickel, Zinc,
(USD) Return (%) Return (%) Copper and Tin traded lower
Gold 1.5 28.7 during the month of March.
Crude Oil 10.1 27.4
Copper -4.6 21.0
Primary Aluminum 1.8 14.0
Lead 5.2 25.5
Nickel -10.0 4.4
Tin -1.6 72.4
Zinc -6.3 -0.5
Source: Bloomberg

Due to the risk appetite coming back, the US dollar depreciated against most currencies
during March. Rupee appreciated by 1.5% against the US dollar during the month.
We expect manufacturing growth going forward to remain modest as lower base effect is
waning. We believe that reported inflation in India is likely to remain sticky in coming
months as the end consumer demand remains robust and outlook on most commodities
remain strong. Therefore, we feel that RBI will be forced to raise rates and keep tight
system liquidity. Banking credit growth is also robust and till mid-March year to date
credit disbursal reached almost Rs.6,157 billion up by 23.4% YoY.
The global situation remains mixed despite improvement in monthly data from USA.
Peripheral Eurozone continues to remain weak. We believe that high government debts
world over is complicating the outlook for the near and medium term growth in these
economies. This coupled with sluggish employment growth and the austerity measures to
contain the fiscal deficit are leading to muted outlook on these economies. Moreover,
political unrest in Middle East and Africa region is leading to higher crude price. Further
escalation in unrest could lead to higher crude prices and we could see some pressure on
risky assets in general and equity markets in particular. However, given higher
sustainable growth in emerging markets, the asset allocation will continue to favor
emerging markets like India and we continue to expect healthy FII flows in CY2011.

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The market valuations are at reasonable at about 16.2x FY12 estimated earnings for
SENSEX, which are building in about 21% EPS growth over FY11. We believe that
estimates are optimistic and could see downward bias going forward. The valuation gap
in mid cap and large cap stocks has widened as midcap stocks have underperformed the
large cap stocks during the month. We are now more comfortable with the valuations and
we remain positive on the earnings growth in the longer term and believe that growth in
India is secular. Barring the global risks especially crude prices, we remain optimistic on
the markets.