LIQUIDITY, VALUATIONS AND EVENTS Oct - Dec 2012

MOVEMENTS OF MAJOR INDICES Index30-sept-111-Jul-1230-Sept-12 3-month Returns 1-Year Returns BSE SENSEX16,45417,39918,7638%14% S&P CNX Nifty4,943 5,2795,703 8%15% Dow Jones10,91312,87113,4374%23% FTSE 1005,1285,5715,7423%12% S&P 5001,1311,3661,4415%27% Nikkei 2258,7009,0038,870-1%2% Shanghai Composite2,3592,2262,086-6%-12% Bovespa 52,32454,69359,1768%13% CAC 402,9823,1973,3555%13% Nasdaq2,4152,9353,1166%29% Hang Seng17,59219,44120,8407%18%

MOVEMENT OF SECTORAL INDICES Sectoral indexes 30-sept-112-Jul Sept month Returns 1-Year Returns BSE AUTO8,4989,40510,41311%23% BSE BANKEX10,85111,98813,13910%21% BSE Capital Goods10,74310,08610,9589%2% BSE Consumer Durables6,3616,2866,94010%9% BSE FMCG3,9104,8885,50713%41% BSE Health Care5,8686,9057,5289%28% BSE IT5,2755,7495,9233%12% BSE METAL10,99610,85110,528-3%-4% BSE OIL & GAS8,4948,0958,6627%2% BSE Power2,1252,0012,0492%-4% BSE PSU7,4047,3127,4161%0.2% BSE Realty1,7631,7071,8478%5% BSE TECk3,2523,3493,4172%5% *Our previous quarterly study prediction comes true with positive performance of Banking and Capital Goods sectors and negative returns by Metals.

FII FLOWS FII Flows in Equity FII Flows in Debt (in Rs. Million) Jul-12Aug-12Sep-12 Gross Purchases 495,574481,365667,525 Gross Sales 392,848373,325474,912 Net Purchase/Sale 102,727108,039192,613 (in Rs. Million)Jul-12Aug-12Sep-12 Gross Purchases179,622118,141162,169 Gross Sales145,707115,493155,945 Net Purchase/Sale33,9172,6526,224 Total Net FII Flows in Jul-Sep Rs. 446,172 Million September saw the highest monthly inflows in 7 months

CHANGE IN COMMODITY PRICES 30th Sept th June th Sept Month Returns 1 Year Returns Copper ($/MT) 6, , , %-6.3% Crude ($/MT) %-14.3% Aluminium ($/MT) 2, , , %-12.4% Zinc ($/MT) 1, , , %-8.9% Silver ($/ounce) %-20.4% Gold($/ounce) 1, , , %-10.0% Steel ($/MT) %5.4% Lead ($/MT) 2, , , %-18.8%

COMMENT The Sensex rally actually began on 26 th July. The quarter movement can be split into two phases: From 1 st July to 26 th July: % From 26 th July to 30 th September: % Between 2 nd July to 30 th September 2012: 8.36% Peak to bottom and retracement was a move of 17% in absolute terms

LEADERS IN THE RALLY (26 th July to 30 th September) Sectors which outperformed the Sensex in the upward phase Our June’12 prediction comes true with the outperformance of Capital Goods and Banking. SECTORRETURNS (%) Auto18% Capital Goods17% Realty17% IT15% Banking14% Sensex13%

LAGGARDS IN THE RALLY (26 th July to 30 th September) Sectors which underperformed the Sensex in the upward phase Metals was the worst performing sector. This is in line with our prediction in June’12 where we said we have a neutral outlook on Pharma and negative outlook on Metals. SECTORRETURNS (%) Metals4% Pharma7% Oil & Gas10% Sensex13%

DOMESTIC EVENTS

INDIAN MONSOON & INFLATION After making a delayed entry into the country, the rains where abnormally low in June and July, the two crucial months in its four- month journey over India. At the end of July, the overall southwest monsoon was around 20% deficient across the country with northwest India, Karnataka, parts of Gujarat and Maharashtra facing severe drought-like conditions. The overall rainfall deficiency in these parts of the country was around 60-80% below normal by end of July. However, a strong recovery was witnessed by the end of September reducing the seasonal deficit to 6%. Despite the monsoon revival, the country’s kharif food grain production is expected to fall by 9.8 per cent below last year’s level (which was high because of heavy and well-distributed rains). That would dim hopes of a significant drop in food inflation.

INFLATION India’s wholesale price index (WPI) rose to 7.55% in August 2012 in comparison to an unexpected 3-year low of 6.87% in July India's inflation based on the new Consumer Price Index (CPI) (Combined) rose to a three-month high of 10.03% in August from 9.86% a month ago. Prices of vegetables, sugar, and protein products such as pulses, eggs, fish and meat and milk products drove up retail price inflation.

RBI & MONETARY POLICY Inflation has stayed above 7 per cent for two-and-a-half years, restraining the central bank from easing monetary policy aggressively even as the economy slid in the January-March quarter to its weakest pace of annual growth in almost a decade. According to RBI, containing subsidy under 2% of Gross Domestic Product is key to managing demand-side pressures on inflation. RBI cut the cash reserve ratio (CRR) by 25 bps to 4.5% effective the fortnight beginning September 22, 2012; consequently, around Rs.17,000 crore of primary liquidity will be injected into the banking system.

REFORMS ANNOUNCED BY THE GOVERNMENT The appointment of P. Chidambaram as the Finance Minister in August has been followed by a drive to attract more foreign capital and control the fiscal deficit, which is most likely to breach the target of 5.1% of GDP. – The Cabinet Committee on Political Affairs approved a Rs. 5 hike in the price of diesel. It also decided to restrict the supply of subsidised cooking gas to six cylinders per household in a year. Government said that no customs or excise duty would be levied on non-subsidised cylinders for domestic use. – Aviation: India will permit foreign airlines to buy minority stakes of up to 49 per cent in Indian domestic carriers, a long-awaited move that could let some struggling airlines find new overseas partners to keep them aloft. Earlier all foreign investors except airlines could buy stake in Indian airlines. – FDI in multi-brand retail: Multinational retailers can invest up to 51 per cent in Indian retail companies. It has been left to state governments and union territories to decide if they wish to implement this in their states

Reforms… – Government allowed investments in exchange-traded funds and mutual funds to be eligible under the proposed Rajiv Gandhi Equity Savings Scheme, apart from direct investment in equities. – FDI in power exchanges up to 49 per cent. – Government notified the cut in withholding tax on interest payment of external commercial borrowings by Indian companies to 5% from 20%. These steps led to stiff opposition from various parties and eventually led to Trinamool Congress' noisy exit from UPA. Impact of Reforms: – FDI in Multi-brand retail: FDI in the next year will be a function of how many states open up. Benefits would accrue to farmers and SMEs as they will supply to international retailers. Agricultural states like Punjab, Haryana, Maharashtra and Uttar Pradesh will benefit.

GLOBAL EVENTS

US QE3: In its third such initiative in the last four years the US Federal Reserve on September 13 th announced the third round of Quantitative Easing that involves monthly purchases of an additional $ 40 billion worth of Mortgage-Backed Securities. Impact on US: – Inflation: Inflation problem does not exist as of now in the US but QE3 may lead to inflation and hence may force Fed to increase interest rates in the coming years. – Weakening dollar: The rise in prices of gold and silver could be further accentuated by an expectation that the dollar will decline. Impact on India: – Past experience of QE1 and QE2 suggests a tendency of the pumped money to pump up prices of financial assets including commodities. If crude prices go up it will adversely impact India’s import bill. – It may be positive for markets as we may see higher FII inflows

US EMPLOYMENT July: 163,000 jobs were added which was more than twice the job growth in June. The primary gain was in the service sector. However, the unemployment rate marginally increased from 8.2% to 8.3%. August: 96,000 jobs were added. The number was later revised to 142,000. The headline number fell from 8.3% to 8.1%. The number of people in the workforce is at the lowest level in last 31 years. The proportion of population that is working or looking for work fell to 63.5 per cent. September: 114,000 jobs were added. This took the unemployment rate below 8% to 7.8%.

USA….other data points US Consumer Confidence Survey: The survey is watched closely because consumer spending drives nearly 70 percent of economic activity. It rose to 70.3 in September from 61.3 in August and a revised 65.4 in July. The reading is still below 90, a level that indicates a healthy economy. The index hasn't been that high since December nd Quarter GDP: The growth figure was revised downward to 1.3 per cent on an annualised basis. US Fed now expects growth to be no stronger than 2% this year, down from June's forecast of 2.4% growth. The Fed expects growth to accelerate next year to 3%, up from its June forecast of 2.8%; for 2014, growth will range between 3-3.8%.

DEVELOPMENTS IN EUROZONE: WHAT HAS BEEN DONE On 6 th September, the European Central Bank agreed to launch a new and potentially unlimited bond-buying programme to lower struggling Eurozone countries' borrowing costs. The scheme focused on bonds with maturities within 3 years. ECB President Mario Draghi received overwhelming support in the governing council with only Bundesbank chief Jens Weidmann casting a negative vote. At a summit in June Eurozone leaders declared that it was “imperative to break the vicious circle between banks and sovereigns”. To do so, they would create a single banking supervisor urgently. This would help in using Euro-zone rescue funds directly to recapitalise troubled banks. It was meant to help Spain and Ireland.

DEVELOPMENTS IN EUROZONE: WHAT HAS BEEN DONE On 12 th September, European Commission presented proposals to set up a single supervisory mechanism (SSM). However, difference of opinion among nations started emerging. This disappointed investors who were expecting the oversight issue to be settled by the end of the year. Why was this proposal necessary? – There are currently vulnerabilities in the banking sector which have a negative impact on the sovereign debt crisis. – The single currency increases the likelihood of negative spill-over effects across borders. – The trend of financial institutions to increasingly focus on their national home markets significantly undermines the single market for financial services.

CHALLENGES It was proposed that the SSM will cover all the 6,000 banks in the Euro-zone. Germany opposes this and wants to exclude smaller banks, including its often-troubled regional lenders. Drafts of the Commission’s plan included a commitment to complement the new supervisor (ECB) with a Euro-zone resolution authority to wind up failed banks (known as Edira) and a European bank-deposit guarantee scheme (known as Edgar). Under German pressure, these were removed from the final version. Germany and others worry that with the removal of Edira and Edgar the ECB will be responsible for overseeing the banks but will lack the means to deal with the bad ones. They are concerned that deposit guarantees will put them on the hook for banks in Greece or Spain.

CHALLENGES It was proposed that the SSM will be in place by 1 st January, That has been slowed down by Germany on the grounds that such an important task should not be rushed. Even when it comes to the first step in the process - ECB supervision, which policymakers regard as a pre-requisite for the direct recapitalisation of struggling banks - there are differences over what steps need to be in place first.

EUROZONE EVENTS – Dutch Polls and German Court verdict Dutch Polls: An early general election was held in the Netherlands on 12 September 2012 after Prime Minister Mark Rutte handed in his government's resignation to Queen Beatrix on 23 April. The People's Party for Freedom and Democracy (VVD) received a majority of votes bringing Mark Rutte back to power strengthening the pro- European centre in a poll that had been expected to weaken it. German Court verdict: Germany was the only country in the 17- nation euro zone that was yet to ratify the European Stability Mechanism (ESM), which is meant to erect a €700-billion firewall against the spread of the sovereign debt crisis. Its much-awaited positive verdict was well received by markets.

DEVELOPMENTS IN EUROZONE: SPAIN Is a bailout imminent? – Government officials and euro zone partners have sent confusing signals over whether Spain would apply for and receive a precautionary credit line. Germany has said Spain does not require a bailout while France insists that Spain should avail itself of ECB help soon. – Spain plans to borrow billion euros ($266.5 billion) next year as the pressure builds on the Prime Minister Mr. Rajoy to ask for bailout. Spain’s debt will widen to 90.5 percent of gross domestic product in 2013 as the state absorbs the cost of bailing out its banks, the power system and euro- region partners Greece, Ireland and Portugal. – Austerity Measures: As per the 2013 draft budget the government will cut overall spending by €40 billion ($51 billion). The budget reduces funds available for unemployment payments by 6.3 per cent, and support for Spain’s royal house by 4 per cent with government ministry spending falling 8.9% and infrastructure spending to drop from 1.3% of GDP to 0.89%, among other things. Yields on Spanish bonds which had surged in anticipation of the draft fell after the announcement to below 6 per cent

Spain…festering issues – The EU has already committed up to €100 billion ($128.6 billion) to bail out its banks. The autonomous regions are all running out of cash, putting further pressure on Spain to request the bailout. Already five of the regions have taken about 90% of a regional liquidity fund, leaving less than €3 billion ($3.9 billion) for the rest. – Bank Stress Tests: The audit revealed a capital shortfall of €59.3 billion which means that it will not exhaust the €100 billion. – Troubles have multiplied as Catalonia, the rich and highly autonomous region where Barcelona is located, is on the verge of demanding independence from Spain. Long-standing resentment about what Catalans see as their unfairly high contribution to central government has been inflamed by Spain's economic woes. – As Spain has already complied with the strict conditionality laid out to avail of a formal bailout it is all set to request a bailout from ECB.

Spain…contd – Also German lenders have the highest exposure in Europe to Spain, at $139.9 billion, of which $ 45.9 billion is exposure to banks alone. German banks have largely hedged or disposed of their holdings of Spanish government debt but they still remain heavily invested in Spanish financial institutions, commercial real estate and in other businesses hit by the crisis. – These factors – Germany’s vulnerability, Spain’s commitment to austerity measures, stress in its banking system make a strong case for Spain to ask for a bailout.

CHINA: GROWTH FURTHER WEAKENS In July International Monetary Fund (IMF) said China's slowing economy faces significant downside risks and relies too much on investment, urging leaders to boost consumption and channel citizens' savings away from housing. China’s manufacturing contracted for the 11th straight month in September and export orders declined at the fastest pace in 42 months. Foreign direct investment (FDI) fell 1.4% from a year earlier to $8.3bn in August. China HSBC Purchasing Managers’ Index ticked up to 47.8 in September from 47.6 in August but remains below 50. In September, China approved $157 bn for infrastructure spending.

CHINA: MONETARY ACTION Chinese authorities have taken steps this year to stimulate growth by cutting interest rates twice - in June and July - and slashed the reserve requirement ratio thrice since late 2011 as ways to increase lending. Central Bank Dilemma: The People’s Bank of China (PBOC) injected the highest ever weekly cash of $ billion in the week ending 28 th September to prevent a short-term liquidity crunch at commercial banks. The PBOC has changed from a net buyer to a net supplier of cash as forex inflows have slowed. It faces the challenge of maintaining liquidity in the system without producing inflation and higher property prices.

EVENTS TO LOOK FORWARD TO -DOMESTIC Government action on policy reforms and political support from allies. Inflation and IIP numbers in Q4 of calendar year. Government borrowing : According to Budget estimate, the gross market borrowing is planned at Rs 5.69 lakh crore for The government has already exhausted 65 per cent of it. Outcome of state elections especially in Gujarat Winter session of Parliament and the ability of the Government to pilot legislation

EVENTS TO LOOK FORWARD TO – GLOBAL US Presidential elections, 2012 Mortgage demand & Unemployment data in the US Spanish bailout Progress on SSM in Euro-zone Agricultural commodity inflation across the globe

OUTLOOK FOR ASSET CLASSES Asset ClassPerformance in Q3CY12Start to End Value In Q3 Outlook for Q4CY12 Remarks Debt10-Year Gilt: Down 0.37% 5-Year Gilt: Down 0.12% AAA 10 Year: Down 4% 3-M T Bill: Down 2% 3-M CD: Down 7% 1-Year CD: Down 6% 3-M CP: Down 4% 1-Year CP: Down 5% 8.18 – – – – – – – – 9.51 Downwards RBI rate action or expectations Improved liquidity and positive sentiment EquitySensex : Up 8% Nifty : Up 8% 17,399 – 18,763 5,279 – 5,703 UpwardsContinued portfolio flows, Political stability

OUTLOOK FOR KEY SECTORS Sectoral IndicesQ3CY12 Returns 12 month returns Outlook for Q4CY12Remarks Auto 11%23% Positive Rate sensitives to attract buying interest, festive season should spur sales Banking 10%21% Positive Declining yields to generate treasury gains, asset quality to improve, 2QFY13 nos may surprise Pharma 9%28% Neutral Stock specific activity this qtr IT 3%12% Neutral Lack lustre results, rising rupee to weigh Capital Goods 9%2% Positive Order flows, declining interest rates, infra logjams to be smoothened FMCG 13%41% Neutral Positives already in the price. Shift from defensives to cyclicals Metals -3%-4% Neutral Muted outlook on commodity prices. May see some sparks due to rebound from lows

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