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Market Strategy Monthly
Treasury Research Group For private circulation only

May 07, 2013

Executive Summary
Global outlook: Slightly better near term
The global economic outlook looks slightly better now, than was the case during the beginning of the year. In terms of key highlight, the economic recovery in US is on a slightly better footing, Eurozone policymakers have averted the tail risk through its Outright Monetary Transaction (OMT) program, while the BoJ has embarked on a very aggressive monetary policy stance. As a result of these developments, we expect risk assets to trade with a positive bias in the near term, after posting stellar performance during early 2013.

State of the Indian economy: Poised for a recovery but significant uncertainties remain
The Q4 FY2013 GDP print due at the end of this month is expected to show signs of recovery. Developments on the growth-inflation front will help to form policy expectations both on the monetary and fiscal fronts. Meanwhile, the Government’s reform agenda will be closely watched as this is an important input in investor sentiment currently.

Currency: Rupee remains a ranged story
The currency has seen a fair share of its ups and down but the existence of several offsetting factors has tempered the moves in INR, keeping it ranged in line with our expectations. Expected improvement in our current account deficit, some progress on the reforms front and continued monetary accommodation by major Central Banks have supported the Rupee. But cautious policy stance of the RBI, political uncertainty on the domestic front and global growth concerns have capped the gains.

Rates: Yields to trend downward on expectations of further rate cuts
Yields trading near 33-month lows and 1Y and 5Y OIS rates are in vicinity of 28 and 9 month lows after the RBI reduced repo rate in the May review. While the forward guidance was fairly cautious, we continue to maintain our policy call of 25 bps repo rate cut in June and hence, expect downward pressure on rate. Continued OMOs by the RBI to support the liquidity situation would support. With a new benchmark, 10Y yield likely to trade in a 7.50-7.80% range, with 7.50% target. HTM limit cut might possibly result in a steepening of yield curve.

Inflation: Inflation enters a benign territory though upside risks remain
WPI inflation slipped to a 40-month low of 5.96% YoY in March-2013, amidst a broad based decline across subcomponents. Meanwhile, elevated food inflation has led to the persistence of CPI-WPI wedge. We expect the inflation to remain benign in coming months, though upside risks remain from fuel price hikes and structural food inflation pressures. WPI likely to average 6.3-6.5% in FY2014 with further decline expected on a sustained drop in global commodity prices.

Feature: Analysing the recent trends in gold and oil prices
Global commodity prices have fallen in the last couple of weeks, led by a plunge in gold prices. The CRB index fell by around 3.7% in April. Gold has been the primary laggard in the commodity space, falling by around 7.5% in April. Meanwhile, oil and metal prices also fell amidst diminished investor confidence in commodities as a class. CFTC data showed a fall in net long positions for most commodities. In light of this we analyse the factors behind the recent plunge in gold and oil prices and pen down the outlook going ahead.

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Market Strategy

Global Overview
Samir Tripathi

Global outlook- Slightly better near term
The global economic outlook looks slightly better now, than was the case during the beginning of the year. This is especially true for the developed world, which has received significant support from the monetary stimulus provided by their respective central banks. The economic recovery in US is on a slightly better footing, Fed monetary easing program continues and though fiscal resolution debate is strenuous, it is less treacherous than it was earlier envisaged. Meanwhile, in Eurozone policymakers have averted the tail risk through its Outright Monetary Transaction (OMT) program, paving the way for structural reforms across the region and make progress on the long-term agenda to strengthen the monetary union. However, the key revolutionary policy announcement came from the new Japanese government, under the Prime Minister Shinzo Abe, who recently appointed Haruhiko Kuroda, to fight deflation. What followed next was a very aggressive monetary policy announcement by the Bank of Japan in its April policy meeting.

The global economic outlook looks slightly better now, than was the case during the beginning of the year

US economy is on the mend and the pace of recovery is improving
In the US, the GDP growth came at 2.5% QoQ annualized in Q1’2013 though better than Q4’2012 reading of 0.4% QoQ (annualized) growth, but weaker as compared to market expectation of a 3% growth. Within the broad category, the most encouraging data print is the robust support from the consumer sector. Consumer spending contributed 2.24 percentage points to overall US growth in Q1’2013, led by the services and the durable goods sector. Meanwhile, investment contributed 1.56 percentage points to overall growth in Q1’2013 (vs. 0.17 percentage point in Q4’2012, though the data doesn’t instill enough confidence, given the fact that the majority of the support came from inventory adjustment. Other segments, such as exports and the government expenditure were a drag on GDP growth, the latter more on account of the ongoing fiscal consolidation measures (i.e. sequestration). In other data prints, non-farm payrolls (NFP) increased by 165K in April'2013, higher than market expectations of an increase of 140K. Meanwhile, total job addition during February and March were revised to 332K (from 268K previously) and 138K (88K) respectively. As a result, employment growth averaged 180K/month in the first four months of 2013, broadly in line with 183K/month jobs addition in 2012 and pointing toward a gradual pace of recovery in labour market conditions. Also, the unemployment rate improved to 7.5% in April from 7.6% in the previous month and has declined by 0.4 percentage point since January'2013. Overall, the economic data points toward an incremental economic recovery as the drag from the budget sequestration is likely to be countered by the robust pace of recovery in the housing sector.

US economic growth is on a mend and the pace of recovery is improving

Better GDP data and improving labour market conditions points in that direction

Eurozone economies continue to muddle through.
Eurozone economic outlook continues to remain weak
Eurozone growth prospects continues to deteriorate and it seems there is more pain for the region going ahead as well. For instance, the unemployment rate across the Eurozone economies has hit 12.1% in March’2013 the record since the common currency was launched in 1999. Another concern for the region is the rising diversion between the core and the peripheral economies. While on the

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Market Strategy

one hand, Germany has the unemployment rate of 5.4% (in Feb’2013) Spain is marred by very high unemployment rate of 26.3%. Other indicators such as PMI data too points toward deepening recession in the region.

However, the tail risk has diminished in light of the proactive monetary policy stance

Besides the weaker growth outlook, the region is also affected by high deficit and debt levels, variance in competitiveness and a crisis of confidence. However, in this regard, the tail risk has diminished on account of decisive policy actions at the European level, including Outright Monetary Transactions (OMTs), the establishment of the European Stability Mechanism and Cyprus banking sector deal. Along with progress on economic adjustment by national governments, this has greatly improved financial conditions for sovereigns and banks alike.

Japan aggressive monetary policy positive on the margin
Japan has embarked on the path of aggressive monetary policy stance
In Asia, Japan continues to make headline news on account of aggressive monetary policy stance. Japanese PM Shinzo Abe, after returning to power in last December, has taken a very aggressive stance to end deflation in Japan. In this regard, the PM has appointed Haruhiko Kuroda as the new Bank of Japan governor, to fight deflation. Kuroda in his first monetary policy meeting, held on early April, surprised the markets by announcing a series of aggressive measures. His package includes a.) operating target for the money market operation changed from the uncollateralized overnight call rate to monetary base, b.) double the size of monetary base in the next two years at the rate of JPY 60-70 tn per annum c.) increase purchase of Japanese government bonds (JGBs) and other risk assets d.) increase the average maturity of JGBs from less than three years presently to about seven years and e.) achieve inflation target of 2% in the next two years. As a result of these measures, BoJ balance sheet is likely to increase from approximately JPY 160 tn at the end of 2012 to JPY 290 tn by end of 2014. Japanese aggressive monetary policy stance is likely to unleash significant amount of liquidity into the financial markets. Traditionally, Japanese liquidity has broadly remained inward in nature, with flows into JGBs predominating those into foreign currency denominated bonds and equities, both at the institutional and the retail level (indirectly through banks). On the margin, though there is scope for incremental flows to emerging market asset classes in general, it is unlikely to have an impact, similar to that announced by the US. However, the implication of aggressive monetary policy on the Japanese economy is yet to be seen.

On the margin, Japanese liquidity will have a positive impact on global financial market

The short term risk picture has improved and we expect risky assets to trade with a positive bias

Market outlook – Relatively benign in the near term
The short-term risk picture has improved considerably, mainly because policy action has lowered some major short-term risks, especially in the Eurozone. The recent rate cut by 25 bps by ECB will also help the Eurozone economy in the medium term. Meanwhile, the US and Japanese economies are likely to benefit from the ongoing monetary stimulus in the respective economies. As a result of these developments, we expect risky assets to trade with a positive bias in the near term, after posting a stellar performance during early 2013.

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Market Strategy

State of the Indian Economy
Kamalika Das

Poised for a recovery but significant uncertainties remain
The Indian economy is poised at an extremely crucial juncture at the moment and this month will decide whether we have finally convincingly bottomed out and some growth recovery is in the offing RBI in its policy decision delivered a 25 bps cut in repo rate but refrained from administering a CRR cut as well. The tone of the policy statement however continued to be fairly hawkish and the Central Bank continued to sound caution about the current account deficit and the possibility of reemergence of inflationary pressures
The Indian economy is poised at an extremely crucial juncture at the moment and this month will decide whether we have finally convincingly bottomed out and some growth recovery is in the offing. The Q4 FY2013 GDP print due by the end of May will be the acid test in determining the investor sentiment going ahead. The reform process in the country is still in its nascent stages and needs to be taken to a more robust conclusion. However, the line up of several state elections this year will only exacerbate the economic and political climate of the nation. In the meanwhile, the RBI in its policy decision delivered a 25 bps cut in repo rate but refrained from administering a CRR cut as well. The tone of the policy statement however continued to be fairly hawkish and the Central Bank continued to sound caution about the current account deficit and the possibility of reemergence of inflationary pressures. As far as its annual projections are concerned, GDP growth for FY2014 has been pegged at 5.7% YoY, which is significantly lower than the Government’s recent projections of around 6.4% YoY. The estimate reflects continued weakness in industrial activity, services growth and exports. The inflation projection is relatively more benign and is estimated to average 5.5% for this fiscal. The RBI also committed that it would use all instruments available to endeavour to bring inflation down to 5% YoY by the end of the year. The current account deficit continues to be highlighted as one of the key risks to the growth trajectory and emphasis remains on the fact that the Government will have to address supply bottlenecks and undertake more structural reforms to kick start the investment cycle and revive growth. While the monetary policy stance continues to remain accommodative for now, the stance is quite cautious and limited room for easing has been reiterated several times but we still believe some room still exists for supporting growth by way of another rate cut. What will be important to watch for going ahead is whether banks pass through these rate cuts.

As the focus of the RBI policy continues to remain on the need for structural reforms by the Government we take stock of the reform process implemented so far. A considerable amount of deliverables were expected from the Government over the past few months and the tally so far seems halfway there. As to what has gone right, fuel reforms (read LPG cap and partial decontrol of diesel), relaxing FDI and ECB norms, introducing sweeping measures for export promotion, attempts made towards fiscal consolidation etc are all positive scores for the Government. GDP growth has declined sharply in Q3 RBI continues policy accommodation
(% YoY) 12 10 8 6 4 2 0 Q1 FY2006 Q3 FY2006 Q1 FY2007 Q3 FY2007 Q1 FY2008 Q3 FY2008 Q1 FY2009 Q3 FY2009 Q1 FY2010 Q3 FY2010 Q1 FY2011 Q3 FY2011 Q1 FY2012 Q3 FY2012 Q1 FY2013 Q3 FY2013 GDP at factor cost
(%) 10 9 8 7 6 5 4 M ay-1 0 M ay-1 1 M ay-1 2 M ay-1 3 N ov -1 0 N ov -1 1 N ov -1 2 3 Repo Reverse Repo CRR

The focus of the RBI policy continues to remain on the need for structural reforms by the Government

Source: CEIC, ICICI Bank Research

Source: CEIC, ICICI Bank Research

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Market Strategy

Diesel price partial decontrol was a much needed step to rationalize our subsidy bill given the fact that the Government has to grapple with a considerable share of fuel under recoveries every year

It is also imperative that this momentum be continued for these to truly gain traction and have their desired impact. If we look at these reforms a bit more closely, then the diesel price partial decontrol was a much needed step to rationalize our subsidy bill given the fact that the Government has to grapple with a considerable share of fuel under recoveries every year. However, we must note that the space gained through fuel reforms may actually be conceded to social sector initiatives such as the Food Security Bill, which will inflate the food subsidy burden to some extent. In this regard, some reforms on the fertilizer front is also desirable and a phased increase in urea prices may greatly benefit the Government’s finances. The relaxation of FDI norms in sectors such as aviation and retail will also help to garner long term stable capital flows into the economy. Other reforms such as increasing FDI in pension and insurance sectors are also expected. On the investment front, several key reforms have been undertaken such as the establishment of the cabinet committee for investment, which is tasked with fast tracking big ticket projects. The 15% investment allowance provided in the budget is also a positive step forward. On the other hand, quite a bit of legislation is still on the anvil and this makes the ongoing budget session and the next Monsoon sessions of the Parliament, crucial to economic reforms in the months to come. As of now there has been some progress on the Land Acquisition Bill and most of the parties have been able to achieve some consensus about the broad modalities of the Bill. However, uncertainties about compensation continue to dominate the landscape. The Mining Bill is another bone of contention and unlike the Land Bill where some consensus among political parties has been achieved, the Mines Bill is yet to be cleared by the Parliamentary panel. As far as the macroeconomic scenario is concerned, industrial production still shows signs of weakness with the February IIP print at 0.6% YoY. WPI inflation turned out to be the wild card and came in at 5.96% YoY, much lower than market expectations. This has radically altered the perception of inflation in the country and the overall expectation of the inflation trajectory going ahead has become relatively more benign. CPI however, continues to remain in double digits although the trend is expected to soften in the near term.

On the other hand, quite a bit of legislation is still on the anvil and this makes the ongoing budget session and the next Monsoon sessions of the Parliament, crucial to economic reforms in the months to come

In this backdrop where global uncertainty persists with most major central banks continuing or further easing monetary accommodation, Indian policy makers will have to watch the economic situation closely and undertake policy initiatives so that the relatively nascent possibility of a growth recovery remains supported. IIP yet to show convincing signs of recovery WPI and CPI softening but wedge still a concern
Mining (% YoY) 17 12 7 2 -3 -8 Jun-12 Aug-12 Dec-12 Apr-12 Feb-12 Oct-12 Feb-13 Manufacturing Electricity IIP
(% YoY) 16 14 12 10 8 6 4 2 0 Jun-12 Aug-12 Dec-12 Jan-13 May-12 Sep-12 Nov-12 Apr-12 Feb-13 Jul-12 Oct-12 Mar-13 2 1 0 CPI - WPI (RHS) Food - WPI Food - CPI (pp) 5 4 3

On the macroeconomic front, Q4 GDP data due at the end of this month will be watched and policymakers will have to undertake initiatives to support growth going ahead

Source: CEIC, ICICI Bank Research Source: CEIC, ICICI Bank Research

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Market Strategy

Forex Strategy
Surbhi Ogra

Rupee remains a ranged story
Despite uncertain global and domestic environment, Rupee has defied expectations of large swings and continues to remain well within our forecasted range of 53.0 – 55.0. The currency has seen a fair share of its ups and downs but the existence of several offsetting factors has tempered the moves in INR. Looking at the key factors that have driven the currency this fiscal, the positives have clearly co-existed with the negatives, rendering Rupee to be ranged. • Expectation of lower current account deficit: Rupee gained on the back of a sharp correction in global commodity prices, especially oil and gold. This will help lower India’s current account deficit (CAD) as the two account for over 40% of our import bill. According to our estimates gold imports could be lower by around USD 10 bn, assuming average gold price of USD 1400/oz and some moderation in investment demand. Assuming an average Brent price of USD 105/bbl for FY2014 and a moderate rise in India’s oil demand, the oil import bill would be lower by around USD 4-5 bn. We thus expect CAD to ease to around 3.5% of GDP in FY2014 from an estimated 5.0% of GDP in FY2013. Reform measures by the Government: The Finance Bill was cleared by the Parliament recently, which included clarification on the Tax Residency Certificate (TRC) issue, making it a sufficient condition for availing tax benefits under the double tax avoidance agreement (DTAA). Further, the withholding tax for QFIs and FIIs was reduced to 5.0% from 20%. These would together provide a significant boost to FII inflows and help finance our CAD. The FDI proposal of IKEA was also approved recently and further liberalization in FDI norms is expected in the coming days. Earlier in the month, the Government had announced incentives for exporters as part of the foreign trade policy. It not only included measures to increase their cost advantage but also had a clear emphasis on export diversification, both products and markets. While retaining incentives given for regaining ground in traditional markets like US and Europe, newer markets in Latam and Africa were included. Special thrust was been given to labour intensive sector like engineering and textiles. A slew of measures were also announced to boost investment in newer SEZ facilities.

Despite uncertain global and domestic environment, Rupee continues to remain wellwithin our range forecast of 53.0 – 55.0

The positive drivers have clearly co-existed with the negatives, rendering Rupee to be ranged

Expectation of lower CAD, on the back of the sharp fall in global commodity prices, has supported the Rupee



Recent measures announced by the Government’s underscores their intent towards continuing with the reform process despite the political issues

All of these are positive developments, as they underscore the Government’s intent towards continuing with the reform process despite Rupee have remained largely range bound Oil and gold account for over 40% of India’s imports
USDINR 55.5 55.0 54.5 54.0 53.5 53.0 12-Feb 26-Feb 1-Jan 15-Jan 29-Jan 12-Mar 26-Mar 9-Apr 23-Apr

(USD bn) 140 120 100 80 60 40 20 0 Q4 FY2009 Q1 FY2010

Oil imports Non-oil non-gold imports

Gold imports Share of oil & gold in total (RHS) 50 45 40 35 30

Q2 FY2010

Q3 FY2010

Q4 FY2010

Q1 FY2011

Q2 FY2011

Q3 FY2011

Q4 FY2011

Q1 FY2012

Q2 FY2012

Q3 FY2012

Q4 FY2012

Q1 FY2013

Q2 FY2013

Source: Thomson Reuters, ICICI Bank Research

Source: Bloomberg, ICICI Bank Research

Q3 FY2013

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Market Strategy

the political issues. •

Continued monetary accommodation by major Central Banks is supportive of robust capital inflows

Continued monetary accommodation by major Central Banks supportive of robust capital inflows: After the Bank of Japan announced its aggressive bond purchase program, the Fed dampened any talk of an early exit from its ongoing accommodative monetary policy. While these two Central Banks continue to pump in liquidity, market sentiment received further support from the 25 bps rate cut by ECB yesterday as it has raised prospects of further easing from yet another major Central Bank. India has received healthy capital flows in FY2013 and the trend is expected to continue this fiscal. Both FII and FDI flows have been robust and given the expected easing in FDI norms and relaxations for FIIs, we can expect a good surplus in the capital account.

However, cautious monetary policy stance, political uncertainty and global growth concerns are some of the factors weighing on the Rupee

There are a set of factors that have weighed on the Rupee, offsetting some of the positives. • Cautious policy stance of the RBI: While the RBI cut repo rate by 25 bps, it said that the space for further rate cut is limited, given risks from reemergence of inflationary pressures and high CAD. The guarded policy guidance by the Central Bank does dampen sentiment given the prevailing growth concerns Political uncertainty: There has been a lot of choppiness in the Indian markets due to the uncertainties surrounding India’s political landscape. Although, fears of an early election have ebbed of late, market still remains cautious of further surprises on this front. Global growth concerns: The underlying reason for continued monetary accommodation by major Central banks is the weak growth outlook, which has been an important driver of global risk sentiment. Recent data from the US and China has surprised on the downside, adding to growth concerns.

Against the backdrop of uncertain global environment, domestic factors have become key drivers of the Rupee





The sentiment is cautiously optimistic as the market is eyeing further policy support in order to revive India’s growth

Currency outlook Against the backdrop of uncertain global environment, domestic factors have become key drivers of the Rupee. The sentiment is cautiously optimistic as the market is eyeing further policy support in order to revive India’s growth. Focus should also be on improving India’s CAD through a structural transformation, which includes enhancing export competitiveness and encouraging import substitution. This would help reduce India’s reliance on capital flows and thereby lower its vulnerability to external shocks, which is an area of key concern for India’s policymakers. The recent relaxation in norms is likely to attact more FII inflows
Net FII inflows (USD bn) 6 4 2 0 -2 Dec-12 Aug-12 Sep-12 Jan-13 May-12 Nov-12 Feb-13 Jul-12 Oct-12 Mar-13 Apr-12 Jun-12 Apr-13 Debt Equity

The recent drop in commodity prices should help ease the CAD
(USD/oz) 1900 1800 1700 1600 1500 1400 1300 Jun-12 Aug-12 Sep-12 May-12 Dec-12 Jan-13 Jul-12 Nov-12 Feb-13 Oct-12 May-13 Mar-13 Apr-13 Gold prices Brent prices (RHS) (USD/bbl) 125 120 115 110 105 100 95 90 85 80

Source: Reuters, ICICI Bank Research

Source: Bloomberg, ICICI Bank Research

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Market Strategy

Fixed Income Strategy
Kanika Pasricha

Yields to trend downward on expectations of further rate cuts
Benchmark bond yield has slipped ~20 bps since end-March on policy easing by RBI 1Y and 5Y OIS rates are trading in the vicinity of 28 and 9-month lows respectively Given our expectation of a repo rate cut in June, we believe rates are likely to come under pressure over next 2 months
The benchmark bond yields have slipped ~20 bps since end-March, as expectations of a rate cut were built in the run up to the May policy meeting, amidst easing inflation and current account deficit concerns. While the expectations were realized, the post policy session witnessed high volatility after the Central Bank reduced the banks’ HTM investment limit to 23% from 25% previously, to be effected by at least 50 bps every quarter starting from Q1 FY2014. However, given our expectations of another 25 bps repo rate cut in the June meeting and on resumption of OMOs this month, we expect the yields to trend downward with a 7.50% target for the 10Y bond yield over the next two months. The 1Y and 5Y OIS rates are trading in the vicinity of lowest levels in 28 months and since July-2012 respectively, at 7.23% and 6.95% levels. We expect the rates to decline further on expectations of continued policy easing by the RBI in the near term. RBI cautiously reduces repo rate by 25 bps in the May policy In the Annual policy review, the RBI reduced repo rate by 25 bps to 7.25% while keeping the CRR unchanged at 4%. The policy guidance was fairly cautious with the Central Bank highlighting limited room for easing, amidst upside risks to inflation from supply shortages and fuel price hikes and with CAD above sustainable levels. The FY2014 GDP growth has been projected at 5.7%, while WPI inflation to remain range bound around 5.5%. RBI has asserted that it will “endeavour to condition the evolution of inflation to 5% by March-2014 using all instruments at its command.” The money supply, deposit and non-food credit growth in FY2014 have been projected at 13%, 14% and 15% respectively. We continue to maintain our policy call for one more 25 bps repo rate cut by the RBI in the June meeting. Meanwhile, the macroeconomic data releases will be closely watched to form future policy expectations. Moreover, we expect primary liquidity injection of INR 1600-1700 bn in FY2014. On the monetary policy transmission, it has been limited, with the bankers finding it difficult to reduce the base rate amidst low deposit growth and rise in bank loan restructuring requirements. We believe though that the transmission will improve on expectations of a rise in deposit growth amidst recovery in growth and benign inflation trajectory that would lead to an increase in real interest rates.

In the May meting, RBI reduced the repo rate by 25 bps to 7.25%, though the guidance was fairly cautious Monetary transmission remains weak amidst low deposit growth We maintain our policy call of further rate cuts by the RBI, coupled with liquidity support

Liquidity deficit to rise though OMOs to support The average liquidity deficit as part of LAF has deteriorated to ` 895 bn in the Monetary transmission remains weak Benchmark yield trading near 33-month lows
LAF (RHS) (%) 12 11 0 10 9 8 7 6 -1500 5 4 -2000 -1000 1Y deposit rate Repo rate 1Y lending rate CRR 3M CD (` bn) 500

(%) 8.3 8.2 8.1

India generic 10Y yield

Yields have slipped on rate cut expectations

-500

8 7.9 7.8 7.7 A ug-1 2 S e p -1 2 D e c-1 2 Jan-1 3 N ov -1 2 F e b -1 3 Jul-1 2 M ay -1 3 O ct-1 2 M ar-1 3 A pr-1 3 7.6

J a n 1 1

J a n 1 2

J a n 1 3

J u l1 0

J u l1 1

J u l1 2

O c t 1 1

O c t 1 2

Source: Bloomberg, ICICI Bank Research

A p r 1 1

A p r 1 2

A p r 1 3

O c t 1 0

Source: Bloomberg, ICICI Bank Research

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Market Strategy

Rise in currency in circulation to weigh on liquidity deficit while government spending to provide support

Systemic liquidity expected to remain tight at ~`1300-1350 bn, with RBI support in form of OMOs at ` 250-300 bn

last two weeks versus ` 781 bn in first half of April-2013. The rise in currency in circulation by ` 350.4 bn during FY2014 has weighed on the liquidity situation. Meanwhile, the rise in Government spending and decline in CRR balances with the RBI has provided support. The liquidity situation is likely to continue to remain under pressure in May-2013 given the heavy auction schedule worth INR 750 bn. During Q1 FY2014, we expect currency in circulation along with banks’ CRR balances with the RBI to rise by 600-650 bn. Meanwhile, the situation will be supported by a decline in Government’s cash balances with the RBI by 700-750 bn. With March-end liquidity deficit at 1450 bn, we expect systemic liquidity to remain tight in Q1 FY2014, with deficit of ~`1300-1350 bn, with ` 250 bn funded through RBI’s export credit refinance facilities and balance using LAF borrowings. RBI is likely to inject primary liquidity in the form of OMOs to the tune of ` 250-300 bn in order to support the liquidity situation. Yields to trend downward on expectations of further rate cuts The benchmark bond yields are likely to continue to witness a downward trend in the near term, with expectations of a rate cut in the June meeting amidst benign inflation trajectory and persistent growth concerns. We will track the progress on the data front, in order to determine future monetary policy expectations. Moreover, continued OMOs by the Central Bank to support the liquidity situation, would also provide support to the gilts. Moreover, with a new 10Y benchmark likely to be issued this month, we expect the 10Y bond yield to slip to 7.50% levels over the next 2 months, while it is likely to trade in a broad range of 7.50-7.80% in the near term. With respect to the yield curve, we believe that the curve might possibly steepen gradually over the coming months on account of a variety of factors. The 2% reduction in HTM limit by the RBI, to be effected by the RBI would lead to a rise in banks’ demand for the shorter end of the yield curve (preferably 7 years and below). Moreover, the FII flows that usually are attracted by the short maturity gilts, are likely to rise, after the debt limits have been made fungible with a single basket worth USD 25 bn since the start of FY2014 and the Finance Ministry has sharply reduced the withholding tax on Gsec to 5% versus 1020% previously depending upon the country of residence of the FII investor. In fact, the flows have increased by USD 1.55 bn in the current financial year. Another factor that might contribute to the steepening of the curve is the bondswap program, worth INR 500 bn, in order to account for the heavy debt redemption over the next 3 fiscal years. The details of the same though are awaited and there is also a possibility that the program would be conducted with the RBI. Moreover, given our expectation of a 25 bps repo rate cut in the June meeting, we expect the OIS curve to bull steepen and recommend the 1s5s steepener trade over the next 2 months. OIS rates to ease on rate cut expectations
(%) 8.40 8.20 8.00 7.80 7.60 7.40 7.20 7.00 -80 -100 Feb-12 Jan-12 Jun-12 Aug-12 Sep-12 Mar-12 May-12 Nov-12 Dec-12 Feb-13 Jan-13 Apr-12 Jul-12 Oct-12 Oct-12 Mar-13 Apr-13 -60 Spread 5Y-1Y (RHS) 1Y OIS 5 Y OIS (bps) -20 -40

Bond yields and OIS rates are expected to witness downward pressure on expectations of rate cut in June and continued OMOs With a new benchmark, we expect 10Y yield to trade in 7.50-7.80% range, with 7.50% target Yield curve might possibly steepen post the 2% HTM cut and increased foreign interest in debt markets

OIS rates likely to ease, with expectation of bull steepening over the next 2 months

Yield curve to steepen further on HTM limit cut
(%) 8.4 8.2 8.0 7.8 7.6 7.4 90d 180d 720d 1080d 1440d 1800d 2160d 2520d 2880d 3240d 3600d 3960d 4320d 4680d 5040d 5400d 6840d 8640d 10800d Yield curve 6-May 4-Apr 6-Mar

6.80

Source: Bloomberg, ICICI Bank Research

Source: Bloomberg, ICICI Bank Research

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Market Strategy

Inflation
Kanika Pasricha

Inflation enters a benign territory though upside risks remain
WPI inflation slipped to a 40-month low in March2013, amidst a broad based decline in subcomponents
WPI inflation slipped to a 40-month low of 5.96% YoY in March-2013, lower compared to our projection of 6.2% YoY, amidst a broad based decline in the sub-components. The FY2013 inflation averaged at 7.3% YoY as against 8.9% YoY in the previous fiscal, primarily driven by a sharp drop in demand led core inflation component. Core inflation witnessed a declining trend from Octover2012 to 37-month low of 3.4% YoY in March-2013. Meanwhile, the administered fuel price hikes have kept the fuel inflation elevated in double digit levels. Moreover, food inflation continues to remain in double digits, notwithstanding the decline in March and is driven by structural factors like protein rich items coupled with high inflation level in food grains. Elevated food inflation has resulted in a wedge between WPI and CPI with the latter averaging 10.2% YoY during FY2013. While food inflation broadly follows a similar trend in CPI and WPI, the wedge between the two inflation measure sis created on account of a higher weight of food in CPI t 47.6% versus 24.3% in WPI and the higher level of CPI food inflation versus food WPI inflation possibly due to trade and transport margins and other supply chain inefficiencies. Moreover, there is a diverging trend in non-food and fuel inflation component, with the non-food and fuel CPI inflation (primarily reflecting the price changes in services sector) remaining stable in the 8.1-8.5% range for the last few months. Going forward, inflation levels are expected to decline on account of the recent sharp decline in global commodity prices. It should be noted that the global prices have a sharp impact on the non-administered fuel and the non-food manufactured products components, with ~60% weight contribution to WPI inflation. The forecast of a normal monsoon this year is expected to contribute to low food inflation. However, the inflation trajectory faces upside risks on account of suppressed inflation in diesel, electricity and coal prices. Further, MSP hikes and structural supply bottlenecks are likely to keep food inflation and hence, overall inflation expectations elevated. On balance, we expect WPI inflation to average 6.3-6.5% YoY in FY2014, with an average of ~6% YoY in H1 and a steep rise to average 6.9% YoY in the secondhalf on adverse base effects. There is further downside risk to our projection from a sustained decline in global commodity prices. We also believe that the CPI inflation is likely to decline to single-digit levels from April-2013 and FY2014 average is estimated at ~9%. Core inflation has eased to near 37-month lows
CRB index (adj INR) (% YoY) 40 20 0 -20 -40 -60 Aug-09 Aug-10 Aug-11 Dec-09 Aug-12 Dec-10 Dec-11 Apr-10 Dec-12 Apr-11 Apr-12 Apr-13 CRB index WPI core inflation (RHS) (% YoY) 10 8 6 4 2 0 -2 -4

Elevated food inflation has resulted in a wedge between CPI and WPI inflation measures

Recent decline in global commodity prices likely to weigh on inflation trajectory…

…though upside risks remain from fuel price hikes and structural food inflation pressures WPI expected to average 6.3-6.5% in FY2014, with further decline on a sustained drop in global commodity prices

Administered price hikes driving up fuel inflation
Fuel inflation (% YoY) 40 35 30 25 20 15 10 5 0 Sep-10 Dec-10 Sep-11 Dec-11 Sep-12 Mar-10 Mar-11 Mar-12 Dec-12 Jun-10 Jun-11 Jun-12 Mar-13 Non-administered Administered (RHS) (% YoY) 16 14 12 10 8 6 4 2 0

Source: Office of the Economic Advisor, ICICI Bank Research

Source: Office of Economic Adviser, ICICI Bank Research

10

Market Strategy

Feature: Analysing the recent trends in gold and oil prices
Tadit Kundu & Rupali Sarkar Global commodity prices have fallen in the last couple of weeks, led by a plunge in gold prices. The immediate factors leading to a 15% drop in gold prices were selling by ETFs and also speculation of gold sale by the Cypriot Central Bank. Meanwhile, oil and metal prices also fell amidst diminished investor confidence in commodities as a class. CFTC data showed a fall in net long positions for most commodities. The CRB index fell by around 3.7% in April. Gold: Prices to remain under pressure in the rest of 2013

Global commodity prices have fallen in the last couple of weeks

Gold prices have plunged by 15% to over a two year low of USD 1322/oz in mid-April

Gold prices have plunged over 15% to more than two year low of USD 1322/oz in intraday trade in April. Though prices have consolidated somewhat since then and are currently trading around USD 1470/oz levels, the year to date losses are still over 11%. Factors behind the recent price decline

Sharp sell-off in gold ETFs and increasing speculation over scaling back of asset purchase program by the Fed has weighed on gold





Increased speculation over scaling back of asset purchase program by the US Fed has significantly weighed on the bullion. Minutes of the Fed’s March FOMC minutes released in early April showed that several members were in favour of tapering the Fed’s asset purchase programme later this year Investment demand remains weak with continued trimming of position in gold backed exchange traded funds (ETFs). Assets in ETFs decreased to 2,262.67 metric tons on April 30th, the least since October 2011. They have shrunk 6.9% in Q1, the biggest reduction since at least 2004

Gold came under pressure amidst news reports that Cyprus was considering a plan to sell EUR 400 mn (USD 525-mn) worth of gold reserves to finance part of its bailout. At the prevailing prices, this would have been equivalent to a sell-off of around 10 tonnes of gold out of 13.9 tonnes of gold Cyprus holds (as per World Gold Council data). Following the news, speculation had also surfaced in some quarters that other European Central Banks might also follow Cyprus’s way to meet their respective bailouts needs. However, till now there has not been any official report of gold sell-off by Cyprus. • Weaker than expected China’s Q1 GDP reading released in early April also raised concerns over the demand outlook for the bullion in the world’s second largest gold consuming nation Gold has been the biggest laggard in the Investors pared long positions in gold and oil in commodity space in 2013 April
Commodity returns April Year to date Gold
('000 contracts) 280 250 CFTC net long non-commercial contracts WTI Gold

The immediate downside trigger has come from reports that Cyprus was mulling over selling its gold reserves to finance the bailout

Though the above factors have been weighing on gold prices for some time, the immediate trigger for the sharp decline came from the factors discussed below: •

Brent crude oil

220 190

CRB metals

160 130

CRB agri -14 -12 -10 -8 -6 -4 -2 0 2

100 Aug-12 Sep-12 Jun-12 Dec-12 Jan-13 Jul-12 May-12 Nov-12 Feb-13 Oct-12 Mar-13 Apr-12 Apr-13

Source: Bloomberg, ICICI Bank Research

Source: Bloomberg, ICICI Bank Research

11

Market Strategy

Speculative positioning also signals bearish investor sentiment

Investors have also been paring net long positions on gold, reflecting bearish market sentiment

Investors have been paring their net long position on gold significantly since October last year, which signals that markets are turning increasingly bearish on the yellow metal. Earlier, investors had sharply increased their net long position in gold since August 2012, in the run up to the announcement of QE3. However, there has been a steady decline in CFTC gold net long positions since mid October 2012, as the euphoria over QE faded. Outlook: Prices to remain under pressure this year

Value buying is likely to support the bullion, which is expected to trade around USD 1400-1450/oz in the near term Prospects of improving US growth, increasing speculation over unwinding of Fed’s balance sheet and likely strength in the Dollar to weigh on price in H2 2013 We expect gold prices to end 2013 in the range of USD 13301380/oz

Gold has chalked a downward trajectory so far this year, led by sharp sell-off in ETF gold holdings, which has largely offset the supportive fundamentals. Amidst continued trimming of ETF positions, reflecting bearish investor sentiment, further downside to gold prices from these levels cannot be ruled out. However, we expect some moderation in the pace of sell-off given the fact that ETF holdings are currently at near 1-1/2 year low. This coupled with some value buying at the dips is expected to provide support to the bullion, which is likely to hover around USD 1400-1450/oz in the near term. Increase in consumer (jewellery) demand from India, the world’s largest consumer of the bullion amidst the falling prices is also likely to provide a backstop to prices. Anecdotal sources suggest that there has already been a sharp rise in jewellery buying in India recently after domestic prices (NCDEX spot) fell to as low as INR 25,615/10 gms. Despite mild recovery expected in the near term, gold prices are likely to come under pressure in the second half of the year and trade in the range of USD 1330-1380/oz by the year end. Increasing speculation over unwinding of the balance sheet by the US Fed and likely strength in the Dollar in H2 2013 are expected to be a major drag on gold prices. However, accommodative policy stance by other major Central Banks and the recent aggressive easing by Japan are likely to provide some floor to the yellow bullion. Gold ETFs holdings have witnessed sharp selloff in 2013
(tonnes) 2700 2600 2500 2400 2300 2200 Total gold ETF holdings

Gold plunged to over two-year low earlier this month
(USD/oz) 1820 1720 1620 1520 1420 1320 Aug-12 Sep-12 Nov-12 Dec-12 Jan-13 Oct-12 Mar-13 Apr-13 Feb-13 Gold prices

Aug-12

Sep-12

Jan-13

Jul-12

Nov-12

Feb-13

Mar-13

Oct-12

Source: Bloomberg, CICI Bank Research

Source: Bloomberg, CICI Bank Research

Dec-12

Apr-13

12

Market Strategy

Crude oil: Expected to trade sideways in near-term

Crude oil prices fell in April amidst broad sell-off in the commodity space

Oil demand outlook remains subdued amidst growth concerns

Crude oil prices also fell last month amidst broad sell-off in the commodity space and weak macroeconomic data prints from US and China released in the first half of April. The Brent crude oil price fell to a 9-month low of USD 96.75/bbl in mid-April from levels of USD 110/bbl seen at the beginning of the month. Brent has since then recovered to currently trade around USD 104/bbl. Below, we discuss the outlook for crude oil prices. Demand side: The outlook for oil demand remains subdued amidst concerns over the pace of global economic growth. The International Energy Agency (IEA) revised down the world oil demand growth forecast for 2013 to 0.795 million barrels per day (mbpd) compared to earlier forecast of 0.82 mbpd, marking the third consecutive month of such downward revision. Supply side: Supply set to exceed demand; although OPEC might try to limit the size of the surplus Non-OPEC oil supply rose by 0.4 million barrels per day (mbpd) in March to 53.3 mbpd, posting the third consecutive MoM rise on the back of rising output from US, Canada and Norway. US oil output (at 7.15 mbpd) is currently at its highest level in 20 years and the output is slated to rise even further amidst use of new technologies to extract oil (and also natural gas) from shale formations. However, on the other hand, OPEC has curtailed its output by around 1.8 mbpd since August to currently 30.6 mbpd (in March) in response to rising supply elsewhere. OPEC’s production cuts have as yet been lesser than the rise in nonOPEC supply (+2.5 mbpd between August’12 and March’13). However, there remains a possibility that OPEC might lower its output target (currently at 30 mbpd), in their upcoming meeting on May 31st, if the oil prices decline further. Nevertheless, OPEC action is expected to at most reduce the quantum of excess supply rather than turn the market into deficit. IEA expects this year’s increase in non-OPEC oil supply (pegged at +1.1 mbpd) to alone exceed the rise in total world growth demand (pegged at +0.8 mbpd), thereby restricting OPEC’s ability to substantially raise global oil prices.

World oil market remains in surplus, with non-OPEC oil supply poised to rise going ahead, esp. in US

However, OPEC might curtail production and try to limit the size of the oil market surplus

Nevertheless, the rapid rise in non-OPEC output reduces OPEC’s ability to substantially raise global oil prices

Price view: Thus, world oil supply seems set to exceed oil demand in 2013, thereby weighing on prices. However, OPEC action is likely to limit the size of the oil market surplus, and hence provide some support to prices. Therefore, oil prices (Brent) are likely to trade ranged between USD 100-105/bbl in the nearterm. We expect Brent crude oil price to average USD 105/bbl for 2013 (current average for 2013 YTD at USD 110bbl). However, geopolitical tensions in the Middle East pose upside risks to the oil price forecasts. Oil demand outlook remains subdued Non-OPEC supply continues to rise while OPEC tries to curtail output
(mbpd) 34 OPEC oil output Non-OPEC oil output (RHS) (mbpd) 54 52 50 48 46 Jul-08 Jul-09 Jul-10 Jul-11 Nov-08 Nov-09 Nov-10 Nov-11 Jul-12 Nov-12 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

World oil demand growth (mbpd) 2013 forecast 2012 OPEC forecasts IEA forecasts Mar'2013 Apr'2013 Mar'2013 Apr'2013 forecast forecast forecast forecast +0.8 +0.84 +0.80 +0.82 +0.79

32 30 28 26

Source: OPEC, IEA, ICICI Bank Research

Source: Bloomberg, ICICI Bank Research

13

Market Strategy

Real GDP Agriculture Industry Services IIP PMI WPI inflation CPI inflation

Unit % YoY % YoY % YoY % YoY % YoY Index % YoY % YoY

Key macroeconomic Indicators Period Latest Previous Q3 FY13 4.5 5.3 Q3 FY13 1.1 1.2 Q3 FY13 3.3 2.7 Q3 FY13 6.1 7.2 Feb-13 0.6 2.4 Apr-13 51.0 52.0 Mar-13 6.0 6.8 Mar-13 10.4 10.9

FY12 6.2 3.6 3.5 8.2 3.0 54.5 8.9 8.4

FY11 9.3 7.9 9.2 9.8 8.3 57.4 9.6 10.5

Exports Imports Trade balance Current Account Capital Account BOP FX reserves

Unit % YoY % YoY USD bn USD bn USD bn USD bn USD bn

External Sector Indicators Period Latest Mar-13 7.0 Mar-13 -2.9 Mar-13 10.3 Q3 FY13 -32.6 Q3 FY13 31.1 Q3 FY13 0.8 26-Apr-13 296.4

Previous 4.2 2.7 -14.9 -22.8 23.6 -0.2 294.8

FY12 309.8 381.1 -189.7 -78.1 67.8 -12.8 307.5

FY11 250.5 499.5 -130.6 -45.9 62.0 13.1 289.1

Leading indicators Unit % YoY % YoY % YoY % YoY % YoY % YoY Period Mar-13 Mar-13 Mar-13 Feb-13 Mar-13 Mar-12 Latest -6.5 -18.4 -27.4 -5.4 7.9 6.7 Previous -3.1 -17.7 -35.4 -4.5 22.0 10.5 FYTD 2.0 -3.8 -23.9 25.3 23.0 6.1 Corresponding period last year 14.2 5.0 7.5 45.0 10.7 4.9

Auto Sales Passenger Cars Commercial Vehicles Cellular Subscribers Railway freight Cement

Monetary Indicators Unit INR bn % YoY INR bn % YoY INR bn % YoY INR bn % YoY INR bn % NDTL Period 26-Apr-13 19-Apr-13 19-Apr-13 19-Apr-13 5-Apr-13 Latest 15571 7.4 52899 14.5 68385 13.3 84674 12.4 20814 28.2 Previous 15550 7.5 53464 13.9 69049 13.2 85057 12.4 21498 29.5 FYTD avg 14268 10 45135 18 59709 15 74545 15 20110 29.2 Corresponding period last year 13015 106 38319 20 51813 16 64933 16 17237 28.7

Reserve Money Credit outstanding Aggregate Deposits Money Supply SLR investment

14

Market Strategy

Fiscal Deficit as a% of budgeted Total Expenditure as % of budgeted Total Receipts as a % of budgeted

Unit % % %

Period

Fiscal Indicators Latest 97.4 85.2 78.3

Previous 90.7 74.5 66.1

FY12 97.7 98.5 99.0

FY11 93.2 98.4 101.0

February FY2013 February FY2013 February FY2013

RBI Action Cumulative change in FYTD (bps) -125 -125 -75 FYTD 5,580 1546 0 0 Cumulative change in FY12 125 125 -125 FY12 5160 1342 0 0

Policy Rates Repo rate Reverse Repo CRR Auctions Dated security auction OMO Purchase SMO Purchase MSS buyback

Unit % % % Unit INR bn INR bn INR bn INR bn

Period 7-May-13 7-May-13 7-May-13 7-May-13 7-May-13 7-May-13 7-May-13

Latest 7.25 6.25 4.00 Latest 0 0 0 0

Previous 7.75 6.75 4.00 Previous 150 60 0 0

Market Indicators Unit Index % % % % % Period 7-May-13 7-May-13 6-May-13 6-May-13 7-May-13 7-May-13 7-May-13 Latest 19870.79 54.13 7.43 7.83 6.95 6.68 7.36 Last month avg 18965.47 54.31 7.58 7.89 7.04 6.85 7.64 % change since last month 4.36 -0.28 -4.74 -2.85 -3.84 -2.91 -4.54 FYTD 12.31 21.79 42.86 0.13 1.05 5.12 98.38

BSE Sensex Exchange Rate (USD/INR) 364-day T-Bill 10-yr GOI bill OIS (5-year) MIFOR (5-year) MIBOR (NSE)

Global snapshot Last month avg 1.3069 1.54 98.57 0.93 14728 6380 13514 51.1 0.28 20.1 % change since last month 0.69 1.33 1.55 0.74 2.8 4.6 10.5 -0.6 -2.5 14.0 CYTD -8.7 -3.8 6.5 -9.1 43.5 20.8 34.5 -0.4 8.1 -13.7

Unit Euro British Pound Japanese Yen Swiss Franc DOW FTSE Nikkei Global PMI USD Libor 3mth Ted Spread % bps

Period 7-May-13 7-May-13 7-May-13 7-May-13 7-May-13 7-May-13 7-May-13 Apr-13 3-May-13 3-May-13

Currencies

Latest

Equities

1.3080 1.554 99.08 0.9413 14969 6539 14180 50.5 0.28 23.0

Others

15

ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 400 051. Phone: (+91-22) 2653-1414 Treasury Research Group
Economics Research Sunandan Chaudhuri Surbhi Ogra Kamalika Das Kanika Pasricha Samir Tripathi Tadit Kundu Rupali Sarkar Pooja Sriram Senior Economist Economist Economist Economist Economist Economist Economist Economist (+91-22) 2653-7525 (+91-22) 2653-7243 (+91-22) 2653-1414 (ext 6280) (+91-22) 2653-1414 (ext 2260) (+91-22) 2653-7233 (+91-22) 2653-1414 (ext 2087) (+91-22) 2653-1414 (ext 2023) (+91-22) 2653-1414 (ext 2023) [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

Treasury Desks Treasury Sales Gsec Desk Interest Rate Derivatives Corporate Bonds
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