market strategy of icici bank

8/13/2019 Market Strategy of ICICI Bank

1/17

Executive Summary

Global outlook: Global economy under transition

The global economy is in a transition phase, as the US economy prepares to shift from an extremely low

interest rate regime. The surge in volatility suggest that the Fed QE tapering is coming sooner (i.e. September)

rather than later (i.e. December). Sharp surge in US interest rate will have negative implication for US growth

while at the same time ramification for EM economies. EM economies are presently exposed to sudden sharp

capital outflows as external sector vulnerability has increased over the last few years. EM central banks now

faced with a trade-off between growth objectives and stability in bond and currency markets. We believe that

the Fed policy makers will adjust the QE tapering program such that the rate normalization cycle is gradual.

State of the Indian economy: Economy in a crucible of uncertainty and volatility

The Indian economy has gone through a watershed period during the past two months, which will structurallyalter the way policymakers grapple with macroeconomic decision making. The RBI undertook interest rate

defense for a sharply depreciating currency but we should keep in mind the core structural reasons, which has

caused this crisis and which require credible and sustainable commitment to long term on ground reforms and

not just short term palliatives.

Currency: Rupee remains under tremendous pressure

The depreciation pressure on Indian Rupee persisted through the month of August. The normalization of the

US yield curve has led to the significant capital outflows from EM economies including India. To prevent the

depreciation pressure in the Indian Rupee, RBI tightened liquidity conditions by raising the short term interest

rate. The previous episodes of monetary tightening suggest mixed impact on INR. Indias rising external sector

vulnerability too is weighing on Rupee. Creating an enabling environment key to stability in the Indian Rupee.

Rates: Markets under severe stress as RBI strives to save the Rupee

The bond markets have witnessed heavy volatility primarily on RBI's measures as part of the interest rate

defense policy strategy to save the Rupee. The yields are likely to remain elevated tracking the Rupee with its

fate linked to Fed policy stance and hence the September 17-18 FOMC meeting will remain in focus. Moreover,

the extent of inversion of the yield curve will increase with expectations of continued liquidity tightening with

the RBI likely to continue with the measures to address FX volatility.

Inflation: Upside risks to inflation from weak Rupee and rising food prices

Inflationary concerns have re-emerged as clearly signaled by the upward surprise in the July WPI inflation print.

Going forward, the sharp Rupee depreciation, rising global crude prices and up tick in metal prices, togethermake a case for upside risks to inflation. Overall, we expect WPI inflation to average 5.7% in FY2014, with an

average of ~5.2% in H1-2014 and a sharp rise to average 6.1% YoY in the second-half of the fiscal.

Feature: Analyzing risks to crude oil supply on account of Syria

Although Syria itself is not a major producer of crude oil, however any potential conflict in the country could

easily spill over to two major OPEC oil producers - Iraq and Iran. Besides, possible involvement of Iran in any

potential conflict could lead to disruptions in oil tanker flow through the Strait of Hormuz (which accounts for

20% of worlds oil trade). In a pessimistic scenario, oil production from Gulf countries (Saudi Arabia, Kuwait,Qatar and UAE) is also likely to be affected, especially if the Strait of Hormuz is disturbed. The future trajectory

of oil prices would depend on unfolding events in Syria in particular and the Middle East region in general.

Market Strategy MonthlyTreasury Research Group

For private circulation only

August 29 2013


2/17

Market Strategy

Global OverviewSamir Tripat

The global economy is in

a transition phase, as the

US economy prepares to

shift from an extremely

low interest rate regime

The surge in volatility

suggest that the Fed QE

tapering is coming

sooner (i.e. September)

rather than later (i.e.

December).

Sharp surge in US

interest rate will have

negative implication for

US growth

Normalization of yield

curve will have

ramification for EM

economies

Global economy in transition

The global economy is in a transition phase, as the US economy prepares to shi

from an extremely low interest rate regime which will have a major implication f

global growth prospects as well as financial markets.

In light of gradual improvement in economic activity in the US, the consensu

view seems to be evolving that the ultra easy policy is not sustainable and the

are unintended consequences in terms of distorted asset price signals and hig

inflation down the line. In this regard, it should be noted that the key genesis fo

the US house price bubble during last decade and the subsequent credit crisis

2008-09 was led by the prolonged period of easy monetary stance adopted sinc

2000-01.

With gradual recovery in US, the focus has shifted to when and how the Fe

would begin the policy normalization process. The surge in volatility in th

financial market tends to suggest that the tapering of quantitative easing (QE)

coming sooner (i.e. September) rather than later (i.e. December).

The expectation that Fed will taper its asset purchase program, has led to a shar

reversal in US interest rates. As the Fed rhetoric on unwinding its monetary easin

stance gained traction in early May, the US Treasury bond market witnesse

significant sell off, with 10 year bond yield moving from 1.62% to 2.82% presentl

Given the sharp spike in US interest rate since May, a major part of the Fed Qtapering is already there in the price. Also the fact that further rise in US intere

rate will have negative implication for growth, the Fed policy makers will take no

of the rising macro risk of any such eventuality, especially for an econom

growing at a moderate pace. In this regard, it should be noted that US real GD

grew at a stronger-than-expected 1.7% QoQ (ann.) rate in Q2 against consensu

expectation of 1.0% QoQ (ann.) rise. Component wise, private consumption an

investment sector contributed 2.6 percentage points to growth while extern

sector/government spending were the key drag on growth, subtracting aroun

0.88 percentage points from overall growth. The US economy grew by 1.4%

an annualized rate in H12013. In the last FOMC meeting, the Fed expected U

GDP growth to be 2.3%-2.6% in 2013. To attain that kind of growth for full yeaUS economy will have to grow by 3.2%-3.8% in H2'2013. At this point this seem

highly unlikely. Further rising yields in the US has also led to a sharp increase

mortgage rates, which may set back the nascent housing market recovery that w

have seen so far.

On the other hand, the implication of normalization of interest rate cycle in US w

have significant ramifications for the EM economies, especially given the fact th

these economies were the key beneficiaries of the capital inflows during th

monetary easing cycle of 2008-2013.


3/17

Market Strategy

EM economies are

presently exposed to

sudden sharp capital

outflows

The external sector

vulnerability has

increased in many EM

economies, especially

the ones running current

account deficit

The exchange rates

volatility will have

negative implications for

EM corporates with

unhedged FX exposures.

EM central banks now

faced with a trade-off

between growthobjectives and stability in

bond and currency

markets

We believe that the Fed

policy makers will adjust

the QE tapering program

such that the rate

normalization cycle is

gradual

With US interest rates rising, interest rates in EM countries have also gone u

significantly. The strong capital inflows" to EM economies in the past few year

expose these to large sudden reversals if markets expect an exit from

unconventional policies.

Normalisation of yield curves in core economies on the backdrop of narrowin

growth differentials in the EM-DM space and talks of moderation of stimulus in U

have put pressure on EM assets. Further evidence suggests that cross ass

correlations have significantly risen during the last five years and therefore there

scope of significant spillover impact on EM equities, currencies, and bon

markets.

Particularly, the external sector vulnerability has increased in many emergin

market economies, especially the ones running current account deficit, resulting

sharp depreciation in EM currencies. Brazilian Real, Indian Rupee, South Africa

Rand and Turkish lira are the key currencies that have depreciated by 15-18%since May 1st 2013.

This is further reflected in significant capital outflows from the EM economies

the last few months. For instance, India has witnessed capital outflows to the tun

of USD 11.6 bn since May 2013, out of which USD 9.0 bn is from the deb

segment and the remaining from the equity markets. Similar trend is witnesse

across other EM Asian economies.

To accentuate the problem further, the exchange rates volatility has led

pressures on EM debtors and will have negative implications for EM corporate

with unhedged FX exposures. Along with this, rising global interest rate scenar

will have adverse implications for debt servicing requirements of EM countries.

The rise in core economies yield curve have also led to the change in stance

Central Banks in the EM region where they are now faced with a trade-off betwee

growth objectives and stability in bond and currency markets.

To conclude, the global economic is in a transitionary phase and the reversal

easy monetary policy stance by the Fed will have implications for both the US a

well as global economies especially the EM economies. Rising rates in US has th

potential to slowdown growth in general and housing sector in particular. Th

spillover impact will also be felt in the EM economies, through capital outflow

and rising rates, at a time when growth is already adjusting at a lower leve

Amidst this backdrop, we believe that the Fed policy makers will adjust the Q

tapering program such that the rate normalization cycle is gradual and nodisruptive as has been the case during the last few months.


4/17

Market Strategy

State of the Indian EconomyKamalika Das

This month witnessed theprecipitous fall in the

Rupee where it is now

within striking distance of

the 70 to a Dollar mark

and has seen a near

monotonic depreciation

trajectory for the past

few weeks.

The RBI chose to adopt

the interest rate defense

to stem the sharp fall in

the currency

Although short termmeasures are important

to check the first wave of

volatility and to shore up

sentiment and in the

process arrest capital

outflows but we must not

lose sight of the core

issues that caused the

deceleration in the first

place

Indian economy in a crucible of uncertainty and volatility

The Indian economy has gone through a watershed in the past two months,

which is likely to structurally alter the way policymakers view themacroeconomic landscape.

This month witnessed the precipitous fall in the Rupee where it is now within

striking distance of the 70 to a Dollar mark and has seen a near monotonic

depreciation trajectory for the past few weeks. This has predictably shaken the

foundations of all theories which are used to come to grips with the scenario.

In a snapshot, the most important consequence that we saw in the backdrop

of a falling Rupee was that the RBI adopted some form of interest rate defense

of the currency. Prima facie, there are broadly a few things that policy makers

can resort to in times of a sharp fall in the currency. They are viz. direct

intervention through the forex reserves channel, institute growth oriented

structural reforms or raise interest rates so that speculating against the home

currency becomes costlier.The RBI chose the latter option as it was likely to be the most effective given

that structural measures take a few quarters to pan out and our forex reserves

do not permit a sustained onslaught on market forces. As a result, we saw the

short term bank funding costs raised (read MSF hiked to 10.25%) and the LAF

channel curtailed. The RBI has also announced other forms of liquidity

withdrawal such as auction of cash management bills every week.

However, what came to pass was not a convincing amount of currency

stability as the Rupee continued to depreciate and other markets such as

equities and bonds reacted very violently in the negative territory. Taking into

cognizance these developments, especially on the bond markets, the RBI

capitulated a bit recently and made provisions that banks could make

accounting changes in lieu of their fixed income portfolio and that the RBI

would consider tapering its tightening action as and when required.

Since then there has been some degree of calm in the markets and most likely

positioning will be ranged in the run up to the crucial Federal reserve meeting

due later this month, which is likely to decide the fate of QE tapering.

Be that as it may, it stands to reason that although short term measures are

important to check the first wave of volatility and to shore up sentiment and in

the process arrest capital outflows but we must not lose sight of the core

issues that caused the deceleration in the first place. Our external sector has

increasingly become more vulnerable over the years and as a case in point,

our current account balance has gone up from being roughly balanced during

2004-05 to USD 88 bn last year. This sharp deterioration accompanied with an

equally sharp increase in short term debt obligations over the same period of

time is a significant cause for concern and needs to be addressed.

GDP growth has declined sharply in FY2013 IIP stagnates for Q1 FY2014

0

2

4

6

8

10

12

Q2FY2

006

Q4FY2

006

Q2FY2

007

Q4FY2

007

Q2FY2

008

Q4FY2

008

Q2FY2

009

Q4FY2

009

Q2FY2

010

Q4FY2

010

Q2FY2

011

Q4FY2

011

Q2FY2

012

Q4FY2

012

Q2FY2

013

Q4FY2

013

GDP at factor cost(% YoY)

-8

-3

2

7

12

17

Jun-12

Aug-12

Oct-12

Dec-12

Feb-13

Apr-13

Jun-13

Mining Manufacturing Electricity IIP

(% YoY)


5/17

Market Strategy

The Q1 GDP data for

FY2014 is due to be

released end August and is

unlikely to show any

substantial improvement

in economic activity as

compared to Q4 FY2013,

which ended at 4.8% YoY

With the sharp

depreciation in the Rupee,

inflationary pressures are

likely to keep mounting in

the economy and are a

source of a parallel

macroeconomic concern

Fiscal arithmetic to be

adversely affected by food

and oil subsidies but

FinMin reiterates that

target will not be breached

The Finance Minister in his recent communication has reiterated that the

Government is well aware of the problems on the external front and that the

current account deficit has to be controlled as soon as possible. To this end, he

has committed to a target of CAD at USD 70 bn and has also announced

measures on the export front and hiked import duties on mainly precious

metals etc. While, this is an important step to begin with but care must also betaken that more deep rooted concerns such as raw material availability,

provision of core infrastructure, boosting productivity and enhancing skill

component etc are very important for the economy to take the next leap

forward to break out of the current vicious cycle and achieve the 8-9% growth

rates seen until recently.

In this context, we note that the Q1 GDP data for FY2014 is due to be released

end August and is unlikely to show any substantial improvement in economic

activity as compared to Q4 FY2013, which ended at 4.8% YoY. As far as high

frequency data is concerned, the scenario is fairly dismal as industrial

production as measured by IIP has averaged -1% YoY for April-June and the

services PMI component has gone into contraction territory in July for the first

time since 2011.

The only comfort seems to be on the agriculture front, where crop sowing data

shows that the Kharif crop is well on track and given fairly normal Monsoons

we should see some fillip on the farm output side. Apart from this, Government

spending in this quarter has also been fairly robust and the Government

balance with the RBI steadily decreased over Q1. This may provide some

respite to the community, social and personal expenditure front. However, the

two more important constituents of services, viz. trade, hotels and financial

services are likely to show weak growth. As a consequence, Q1 GDP is also

likely to be sub 5% and close to what we ended FY2013 with.

With the sharp depreciation in the Rupee, inflationary pressures are likely to

keep mounting in the economy and are a source of a parallel macroeconomic

concern. In other important developments, the Lok Sabha passed the Food

Security Bill, which is set to cover a population of around 82 crores and will

entail procurement of around 62 mn tons of grain. The fiscal impact in the

current year is however minimal and the full effect will only kick in next year

onwards. Given the current rate of sharp increase in oil prices globally, our

fiscal arithmetic will be adversely impacted through a rise in oil under

recoveries as well. In light of this, there are talks by the Oil Ministry of a INR

5/litre one off hike in diesel prices soon. Although, the fiscal looks to be under

stress from food and oil subsidies but the Finance Minister has reiterated firmly

that the budgeted estimate will not be breached.

Inflation showing a sharp uptick Short term rates to remain high for the moment

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

Jan-12

M

ar-12

M

ay-12

Jul-12

Sep-12

Nov-12

Jan-13

M

ar-13

M

ay-13

Jul-13

WPI(% YoY)

Source: CEIC, ICICI Bank Research

7.0

8.0

9.0

10.0

11.0

12.0

Jan-13

Feb-13

Mar-13

Apr-13

May-13

Jun-13

Jul-13

Aug-13

3m T bill(%)

Source: Bloomberg, ICICI Bank Research


6/17

Market Strategy

Forex StrategySamir Tripath

The depreciation pressure

on Indian Rupee persisted

through the month of

August

The normalization of the

US yield curve has led tothe significant capital

outflows from EM

economies.

To prevent the

depreciation pressure in

the Indian Rupee, RBI

tightened liquidity

conditions by raising the

short term interest rate

Rupee remains under tremendous pressure

The depreciation pressure on Indian Rupee persisted through the month ofAugust and the currency has been one of the worst performers in the EM

currency basket. Though a part of the sell off in the currency markets reflect the

weak domestic fundamentals in some of these EM economies, the timing of the

selloff (i.e. May2013- present) suggest that expectation of the normalization of

yield curve in the US is the key trigger for the capital outflows from the EM

economies.

What is driving EM currency markets?

The normalization of the yield curve i.e. the unwinding of the monetary policy

stance in the US has led to the selloff in the US bond market, with the 10 year

treasury yield rising from a low of ~1.65% in April end to ~2.72% presently.The reversal in the US treasury market has acted as the trigger for the rotation

out of bond funds both in US and EM economies. This is reflected in significant

capital outflows from the EM economies in the last few months. For instance,

India has witnessed capital outflows to the tune of USD 11.6 bn since May 2013,

out of which USD 9.0 bn is from the debt segment and the remaining from the

equity markets. Similar trend is witnessed across other EM Asian economies. As

a result, since early May the correlation between 10 year US Treasury yield and

the EM currency basket has increased sharply.

Previous episodes of interest rate defense has mixed success in

combating INR depreciation

To address the capital outflows and thereby prevent the depreciation pressure

in the Indian Rupee, RBI has announced a series of measure to tighten liquidity

conditions by raising the short term interest rate. In this regard, we looked at the

three previous episodes (i.e. East Asian crisis (1997-98), Tech Bubble (2000-01)

and Global financial crisis (2007-08)) where in the RBI has raised interest rate

Out of the three episodes, during the East Asian crisis and Tech bubble episode

RBI measures were aimed toward addressing the Rupee volatility, during the

Credit crisis of 2008-09, RBI aimed to check inflation by tightening monetary

policy.

Reversal in US Treasury market has acted as

the trigger for rotation out of bond funds

thereby weighing on Emerging Market currencies

1.5

1.9

2.3

2.7

3.1

Jan-13

Feb-13

M

ar-13

Apr-13

May-13

Jun-13

Jul-13

Aug-13

US 10 year bond yield(%)

Source: Thomson Reuters, ICICI Bank Research

-0.6

-0.2

0.2

0.6

1.0

USDBRL

U

SDMYR

USDTRY

USDINR

USDZAR

USDIDR

Jan-April 2013 May 2013 -present

Correlation with US Treasury 10 year yield



7/17

Market Strategy

The previous episodes of

monetary tightening

suggest mixed impact onINR

The previous episodes

depreciation pressure was

led by external factors.

Indias rising external

sector vulnerability too is

weighing on Rupee

Creating an enablingenvironment key to

stability in the Indian

Rupee

The key takeaways from the previous episodes of monetary tightening

measures:-

The duration of monetary tightening measures announced during theprevious three episodes lasted between 2-6 months

The impact of monetary tightening on USDINR is mixed. During theTech bubble episode, INR appreciated in the aftermath of the policy

reversal, in the other two episodes, INR continued to depreciate in the

~10-16% range, even after the reversal of the policy measures.

Monetary tightening measures partly led to growth slowdown duringthe Tech bubble episode (2001) and the more recent credit crisis of

2008-09. During these periods, monetary tightening lasted for ~6

months.

Indias growth during 2001 and 2008-09 was also impacted by overall slowdown

in global economy.

Takeaways for the presentAs a caveat, the past three episodes of heightened uncertainty discussed above

were primarily on account of external factors. In the present episode, although

Fed QE tapering triggered the depreciation in INR, worsening domestic

fundamentals and rising external sector vulnerability too is weighing on Rupee

sentiment.

The external vulnerability has worsened in the last few years, in light of the

rising current account deficit. In terms of financing the current account deficit,

though the stable sources of capital (i.e. FDI and ECB) has played a crucial role

in financing a part of the deficit, in the recent years i.e. 2010 onwards, reliance

on portfolio related flows have a key role in financing the CAD. This has

increased Rupees vulnerability in the recent years.

Creating an enabling environment for stability in FX market

Any policy announcement towards providing stability in FX market will require

a.) Encouraging stable capital flows in the near term and b.) Initiating urgent

structural reforms. Though the outlook for the capital flows will to an extent

depend on external development i.e. Fed policy meeting scheduled for

September 18th, the creation of enabling environment will go a long way in

attracting the stable source of flows i.e. FDI in the medium to long term.

USD/INR performance in previous episodes ofmonetary tightening measures

External vulnerability has worsened in the last fewyears, in light of the rising current account deficit

Qrt prior During the period QrtpostEast Asian financial crisis 8.6 -0.4 9.9

Tech bubble 2.7 4.7 0.8

Global Financial crises -2.2 9.8 16.4

USDINR performance during the period

Source: Reuters, ICICI Bank Research-20

-15

-10

-5

0

5

10

Mar-

00

Mar-

01

Mar-

02

Mar-

03

Mar-

04

Mar-

05

Mar-

06

Mar-

07

Mar-

08

Mar-

09

Mar-

10

Mar-

11

Mar-

12

Mar-

13

Financing the CAD (CAD+FDI+ECB)(USD bn)

Growing external sector vulnerability



8/17

Market Strategy

Fixed Income StrategyKanika Pasricha

Bond markets arewitnessing heavy volatility

as the RBI has adopted an

interest rate defense for

the Rupee

Rupee under pressure on

domestic fiscal, growth &

inflation issues coupled

with Fed QE tapering

concerns

RBI has tightened liquidity

and increased cost of

liquidity to harden yields

and support debt flows

Yield curve has inverted

sharply since July 15th

Markets under severe stress as RBI strives to support the Rupee

The bond markets have witnessed heavy volatility over the last two months aspart of the global EM debt sell off amidst concerns regarding tapering of its

quantitative easing (QE) program by the US Fed later this year and more

importantly, on RBIs measures as part of the interest defense policy strategy to

save the depreciating Rupee.

Since early May, the Rupee has depreciated more than 20%, while the 10-year

bond yield has risen more than 150 bps to trade above a new threshold of 9%.

The slew of measures announced by the policymakers to stabilize the Rupee and

address the hardening of yields at the longer-end of the yield curve have shown

limited effect amidst weak investor sentiment.

RBI has adopted an interest rate defense for the Rupee and kept gilts

under pressure

The Indian currency has been the worst affected on account of concerns over

tapering of QE program by the US Fed, given our elevated current account

deficit and weak domestic fundamentals amidst slowing growth and rising

inflationary concerns. Against this backdrop, the RBI decided to adopt an

interest rate defense for the Rupee by increasing the cost of Rupee liquidity and

support debt flows amidst rise in yields especially for the shorter tenure.

Since 15thJuly, the RBI has adopted a slew of liquidity tightening measures as

highlighted in the section above. The liquidity tightening measures were

introduced in various tranches amidst persistence of depreciation pressure on

the Rupee and in order to ensure that the call rate trades consistently at the

higher end of the policy corridor at 10.25%.

The measures have led to a rise in systemic liquidity deficit to `1100 bn currently

as against ` 630 bn as of end-June. Our projections show that the liquidity deficit

is likely to increase beyond `1.5 trillion in September amidst advance tax

outflows, if the RBI continues with the liquidity tightening measures to support

the Rupee.

The consequent tightening of the liquidity situation has led to an inversion of the

yield curve, with the 3-month and 10-year yields rising by ~3% and ~1.5% since

15thJuly. The heavy supply pressures in August (`790 bn) have put an additiona

upward pressure on the yields. This led the authorities to announce some

measures to address the market conditions.

Yield curve has inverted sharply Gsec demand-supply dynamics reflect need forOMO buybacks

Yield curve

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

3M

6M2

Y3Y

4Y

5Y

6Y

6Y

8Y

9Y

10Y

11Y

12Y

13Y

14Y

15Y

19Y

24Y

30Y

23-Jul 15-Jul 27-Aug(%)


Supply FY2013 FY2014Dated securities 4675 4840

Tbills 280 198

Net SDL issuance 1453 1453

Total 6408 6491

Demand FY2013 FY2014SLR demand by banks 2360 2630

Demand from PFs & insuance companies 1803 1830

Demand from Mutual funds 350 200

Demand from FIIs 210 0

Demand from RBI 1685 1831^

Total 6408 6491

Excess demand/(supply) - -

Demand and Supply for G-secs ( bn)

^Depending upon RBI policy objectives at various points of time assuming 29% of NDTL and 14% deposit growth

Source: RBI ICICI Bank Research


9/17

Market Strategy

To limit the hardening of

yields at the longer end of

the curve, the RBI has

announced variousmeasures to address

market conditions

The steps taken to protect

the Rupee have led

various banks to raise

base rates and have

affected liquidity invarious market segments

like CPs, CDs

However, credit growth

has spiked given the

relatively cheap funding

available through banks

Yields to remain elevated

amidst persistence of

depreciation pressure on

the Rupee

The RBI has decided to conduct OMOs to ease the pressure at the longer-end

of the yield curve. The RBI has been a key buyer of duration in the last few

fiscal years, with the OMO purchases worth more than `1600 bn in FY2013.

Our Gsec supply-demand projections also reflect the need for ~`2000 bn

worth demand from the RBI to match the heavy supply requirements.

Moreover, the pace of liquidity tightening through cash management bill salesis likely to be calibrated and scaled down as and when stability is restored in

the Rupee market. Further, the banks have been allowed to limit the accounting

losses on Gsec investments by transferring a part of trading portfolio into HTM

up to 24.5% of NDTL.

Various implications of liquidity tightening measures

The interest rate defense for the Rupee has helped reduce the pace of FIIoutflows from the debt markets to USD 1.2 bn in August versus USD 7.6 bn

cumulative in June and July. Nevertheless, the extent of FII debt utilization

has slipped from 55% of the limits in early May to 37% currently.

Rise in cost of borrowing has led various banks to raise base rates over thelast fortnight. This has increased downside risks to our FY2014 growth

projection as it would delay the recovery in investment cycle.

Gsec trading volumes have declined sharply with the average grossvolumes declining to `160 bn in August-2013 versus `550 bn in April.

Market liquidity has reduced sharply in various market segments like CPsand CDs, with the issuances in CP and CD market slipping to `66.0 bn and

`32.4 bn respectively in the second fortnight of July versus ` 277.2 bn and

`105.9 bn in the last fortnight of April.

Mutual funds as market participants have shifted their funds deploymenttowards CBLO markets from CD market. The latest data for the month of

July-2013 shows that the funds have reduced their investments in CDs by `

350 bn, while their CBLO market exposure has been increased by `380 bn.

Despite the rise in downside risks to growth, the credit growth has surgedto 16% levels as per the latest data. This is possibly attributable to thesubstitution of CP issuances with the relatively cheap bank credit by the

corporates. A similar trend is being witnessed in case of NBFCs. Moreover,

mutual funds witnessing heavy redemption pressures are taking the OD

facility against FD from the banks, to meet the demand for funds.

Yields to remain elevated amidst a pressured Rupee

Bond markets remain under intense pressure tracking the Rupee with its fate

linked to Fed policy stance. In this context, the September 17-18 FOMC

meeting is in focus. Moreover, the extent of inversion of the yield curve will

increase with expectations of continued liquidity tightening with the RBI likely

to continue with the measures to address FX volatility.

Credit growth above 16% on market disruptions FII debt utilisation has dropped to sub 40%

11

13

15

17

19

21

Aug-11

No

v-11

Feb-12

Ma

y-12

Aug-12

No

v-12

Feb-13

Ma

y-13

Aug-13

70

72

74

76

78

80

credit-deposit ratio (RHS) Aggregate deposits Credit

(% YoY) (%)


S.No as onUpper Cap Debtutilization Upper Cap

Debtutilization

(USD bn) ( ) (USD bn) ( )1 Government Debt 30.0 43.8 25.0 76.4

(i) 25.0 52.5 25.0 76.4(ii) ^^ 5.0 6.4 0.0 0.0

1(a) Treasury Bills 5.5 60.7 5.5 93.82 Corporate Debt 51 33.0 51.0 43.6

2(a) Commercial Papers 3.5 69.5 3.5 81.5 Grand Total 81.0 37.1 76.0 54.7

FII debt Utilisation Status27-Aug

Type of Instrument

10-May

^^Investments by long-term investors such as SWFs, multilateral agencies,pension & insurance funds and foreign central banks

Source: NSDL ICICI Bank Research


10/17

Market Strategy

InflationKanika Pasricha

WPI inflation provided a

sharp upward surprise in

the July print

There was a broad based

spike in sub-components

Core inflation increased as

manufacturers decided to

pass on the rising costs

due to Rupee depreciation

Going forward, Rupee

depreciation, rising global

crude prices and up tick in

metal prices, pose upside

risks to inflation

We expect WPI to average

5.7% in FY2014, with core

inflation likely to surge

past 3% mark in H2

FY2014

Upside risks to inflation from weak Rupee and rising food

prices

Inflationary concerns have re-emerged as clearly signaled by the sharp upward

surprise in the July WPI inflation print that came in at 5.79% YoY versus

consensus estimate of 5% YoY and a full percentage point higher compared to

4.7% average inflation in Q1 FY2014.

Looking at the details of the July inflation print, the food inflation spiked to

11.9% YoY versus 9.7% YoY in the previous month. This is primarily attributable

to a 46.6% YoY rise in vegetables prices amidst a 144.9% YoY increase in

inflation in onions. Further, fuel inflation increased to 11.31% YoY versus prior

reading of 7.12% YoY. The sequential momentum of the fuel index jumped to

3% MoM as against 1.1% MoM, with a contribution of 8.2% MoM from the non-

administered component while the administered prices increased by 1.36%MoM. Moreover, the non-food manufactured products inflation rose to 2.33%

YoY after slipping to a 3 year low of 2.1% YoY in June. The sharp Rupee

depreciation has pressured the manufacturers to raise prices in spite of weak

pricing power, with the sequential momentum of core inflation increasing to

0.53% MoM, highest since April-2012.

Going forward, the sharp Rupee depreciation, rising global crude prices and up

tick in metal prices, all together make a case for upside risks to inflation in the

near term. The core inflation component is 55% of the WPI basket and 50% of

this basket is composed of metals and chemicals, with their domestic prices are

determined by the import parity prices (in INR terms). Hence, Rupee

depreciation is likely to have a significant impact on core inflation.

The authorities are also considering a one-time hike in diesel prices by ` 5/Lgiven that the rising global crude prices amidst geopolitical tensions in the

Middle East has led to a rise in diesel under-recovery to `10/L from `3/L in late-

April. The 20% depreciation in the Rupee coupled with rise in crude and meta

prices is likely to feed into core and non-administered fuel inflation.

Overall, we expect WPI inflation to average 5.6-5.8% in FY2014, with an average

of ~5.2% in H1-2014 and a sharp rise to average 6.1% YoY in the second-half of

the fiscal. We also expect the core inflation to surge past 3% levels in H2

FY2014, with rising upside risks to this component.

Non-administered price increases amidst

elevated global crude prices driving fuel inflation

INR depreciation poses upside risks for core

inflation

-10

0

10

20

30

40

Ju

l-10

Oct-10

Jan

-11

Apr-11

Ju

l-11

Oct-11

Jan

-12

Apr-12

Ju

l-12

Oct-12

Jan

-13

Apr-13

Ju

l-13

0

2

4

6

8

10

12

14

16

18

Non-admin istered Admin istered (RHS)Fuel inflation

(% YoY) (% YoY)

So ce Bloo be g ICICI Ba k Resea ch

-30.0

-15.0

0.0

15.0

30.0

Au

g-12

Se

p-12

Oct-12

No

v-12

De

c-12

Ja

n-13

Fe

b-13

Mar-13

Apr-13

Ma

y-13

Ju

n-13

Jul-13

Au

g-13

0.0

2.0

4.0

6.0

8.0

CRB index CRB (INR adjusted) WPI-core (RHS)

(% YoY)



11/17

Market Strategy

Feature: Analyzing risks to oil supply on account of escalating tensions in SyriaTadit Kundu

Brent crude oil pricebreached the USD 117/bbl

level on Wednesday for

the first time in six

months

Recent statements by US

officials have raised

speculation of possible

military action

Crude oil prices hovering around the highest levels in six months

The Brent oil price on Wednesday breached the USD 117/bbl level for the firsttime in six months, as speculation rose that the US might conduct military

strikes against the Syrian Government (over the episode of an alleged chemica

weapons attack in Syria). The Brent price is currently hovering around USD

116/bbl, while WTI is hovering around USD 111/bbl. Recent statements by US

and UK Government officials have raised speculation of possible military action

Meanwhile, US reportedly moved four warships in the Mediterranean Sea, close

to the Syrian coast.

The analysis below tries to put in context the risks to oil supply emanating from

any potential conflict around Syria.

A confluence of geopolitical issues Syria, Libya and Egypt have raised risks to oil supply from

the Middle East and North Africa region


12/17

Market Strategy

Syria per se is not a major

oil producer

However, Syria risks

engulfing the entire region

Iraq has shown rise in

political violence in recent

days, tied to happenings

in Syria

A. Why is Syria important for oil supply?Syria per se is not a major oil producerSyria currently produces around 28,000 barrels of oil per day (bpd), which is

only 0.03% of global oil output. Even at its peak, before the outbreak of the Civi

War, Syrian oil output was around 360,000 bpd (0.4% of global oil output).

Syria is not even a major oil transportation route:Unlike Egypt, which controls the important Suez canal, Syria cannot claim to

control any important oil supply route. The Kirkuk-Baniyas oil pipeline, which

used to transport oil from Iraq to Syrian coast, has remained out of operation

since 2003.

In short, Syria, p r s , is not important for the global oil market.

However, Syria risks engulfing the entire region

Owing to history and demographics, any potential Syrian conflict is very likely to

affect the neighbouring countries of Iraq and Lebanon, besides Iran. Of them,

Iraq and Iran are major oil producers and OPEC members.

A.1. Possible effect on oil supply from Iraq

Iraq has shown rise in political violence in recent days, tied to happenings in

Syria. According to the UN, the Iraq conflict death toll in July 2013 topped the

1000-level, the highest since April 2008. Consequently, there remain concerns

that oil facilities in Iraq might be disrupted if the Syrian conflict escalates and

Iraq becomes a proxy battleground.

Meanwhile, a conflict in Syria can also threaten the crucial 335,000 bpd Kirkuk-

Ceyhan pipeline, which transports oil from Iraq to Ceyhan oil terminal in Turkey

and runs close to the Turkey-Syria border.

Syrias crude oil output, even at its pre-War

levels, amounted to only 0.4% of global outputConflict poses risks to 335,000 bpd Iraq-Turkey

oil pipeline that runs along Turkey-Syria border

0

50

100

150

200

250

300

350

400

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Jul-13

Syria crude oil output('000 bpd)

Source: Bloomberg, CICI Bank Research Source: News reports, ICICI Bank Research


13/17

Market Strategy

Iran has diplomatically

supported the Assad

Government in Syria

There remain concerns

that the Syrian conflict

might engulf Iran, thereby

prompting disruptions to

oil tanker flow through

the Strait of Hormuz

Continued political unrestin Egypt and Libya have

added to concerns over

stability of oil supply from

the region

In a pessimistic scenario,oil production from Gulf

countries (Saudi Arabia,

Kuwait, Qatar and UAE) is

also likely to be affected,

especially if the Strait of

Hormuz is disturbed

A.2. Possible effects on Iran

Iran has diplomatically supported the Assad Government in Syria. Various

reports have alleged that the Iranian Government is also materially supporting

the Assad Government. Involvement of Iran in the conflict could further reduce

its oil exports, already strained under US-EU sanctions.

A.3. Possible effects on the Strait of Hormuz

The Strait of Hormuz is a narrow waterway between Oman and Iran. It is an

important oil transit route, transporting around 17 mbpd of oil from the Middle

East region. Iran had previously threatened to close the Strait in case of

hostilities. There remain concerns that the Syrian conflict might engulf Iran

thereby prompting disruptions to oil tanker flow.

B. Other geopolitical issues in the Middle east region

B.1. Libya: strikes disrupt oil export terminals

Persistent political unrest and strikes by workers/security guards has led to

intermittent shutdown of the countrys export terminals. Therefore, Libyas oil

output fell to 0.8 mbpd in July from 1.4 mbpd in March.

B.2. Egypt: Continued unrest could endanger Suez oil flow

Egypt remains in a state of flux since a Government change in early July. There

remains possibility that tanker movement across the Suez canal might be

disrupted. However, the probability of such an event is as yet minimal

Moreover, Suez canal shutdown would only impose manageable hurdles to

global crude oil movement.

C. Overall picture: A confluence of factors has significantly increased

geopolitical risks

Thus, we already see conflict in Syria, Libya and Egypt along with concerns ofconflict quickly engulfing Iraq and Iran In a pessimistic scenario, oil production from Gulf countries (Saudi Arabia,

Kuwait, Qatar and UAE) is also likely to be affected, especially if the Strait of

Hormuz is disturbed

US military presence in both the Mediterranean Sea and the Persian Gulfadds to tensions

Consequently, oil prices are likely to climb even higher in the next few daysand could touch USD 120/bbl.

The future trajectory of oil prices would depend on unfolding events in Syriain particular and the Middle East region in general

In a pessimistic scenario, the Syrian conflictposes risks to oil supply from the Middle East consequently crude oil prices have spiked inrecent days

Saudi Arabia Iraq

Iran Outside ME*

Other ME* nations

World July crude oil production (% of world total)

Outs ideM idd le

East(74%)

M idd leEast*(26%)

ME*: Middle East (Egypt & Libya included for calculation purposes)

Source: Bloomberg ICICI Bank Research

100

104

108

112

116

120

3-Jul

10-Jul

17-Jul

24-Jul

31-Jul

7-Au

g

14-Au

g

21-Au

g

28-Au

g

Brent WTI(USD/bbl)

Source: Bloomberg ICICI Bank Research


14/17

Market Strategy

Unit Period Latest Previous FY13 FY12Real GDP % YoY Q4 FY13 4.8 4.7 5.0 6.3

Agriculture % YoY Q4 FY13 1.4 1.8 2.0 3.7

Industry % YoY Q4 FY13 2.7 2.5 2.1 3.5

Services % YoY Q4 FY13 6.6 6.7 7.1 8.2IIP % YoY Jun-13 -2.2 -2.8 1.2 3.1

PMI Index Jul-13 50.1 50.3 53.7 54.5

WPI inflation % YoY Jul-13 5.8 4.9 7.4 9.0

CPI inflation % YoY Jul-13 9.6 9.9 10.2 8.4

Unit Period Latest Previous FY13 FY12Exports % YoY Jul-13 11.6 -4.6 -2.7 24.7

Imports % YoY Jul-13 -6.2 -0.4 0.8 32.8

Trade balance USD bn Jul-13 -12.3 -12.2 -194.7 -183.4

Current Account USD bn Q4 FY13 -18.2 -31.8 -88.2 -78.3

Capital Account USD bn Q4 FY13 20.5 31.5 89.3 67.9

BOP USD bn Q4 FY13 2.7 -0.2 3.8 -12.8

FX reserves USD bn 16-Aug-13 278.8 278.6 0.3 0.0

Unit Period Latest Previous FYTDCorrespondingperiod last year

Auto Sales % YoY Jul-13 -1.3 -4.3 0.9 12.3

Passenger Cars % YoY Jul-13 -2.5 -12.1 -4.9 5.1

Commercial Vehicles % YoY Jul-13 -16.9 -23.1 -22.3 2.6

Cellular Subscribers % YoY May-13 -6.4 -5.9 25.3 45.0

Railway freight % YoY Jul-13 6.3 7.9 18.7 14.7

Unit Period Latest Previous FYTD avgCorrespondingperiod last year

INR bn 15725 15637 14429 11717

% YoY 7.1 7.1 23 103

INR bn 55091 54053 46050 39380

% YoY 16.6 13.5 17 19

INR bn 71037 70869 60786 52995

% YoY 14.1 13.7 15 15

INR bn 87697 87390 76134 66467

% YoY 12.2 12.5 15 16INR bn 21871 22167 21701 19356

% NDTL 28.3 28.8 28.8 29.0

Reserve Money 16-Aug-13

9-Aug-13

9-Aug-13

Credit outstanding

Aggregate Deposits

9-Aug-13Money Supply

SLR investment 9-Aug-13

Key macroeconomic Indicators

External Sector Indicators

Monetary Indicators

Leading indicators


15/17

Market Strategy

Unit Period Latest Previous FY13 FY12Fiscal Deficit as a% of

budgeted % June FY2013 48.4 33.3 94.0 98.9Total Expenditure as % of

budgeted % June FY2013 23.0 13.1 98.5 98.9

Total Rece pts as a % ofbudgeted % June FY2013 10.6 3.3 101.1 98.9

Policy Rates Unit Period Latest PreviousCumulativechange in

FYTD (bps)Cumulative change

in FY13Repo rate % 28-Aug-13 7.25 7.50 -25 -100

Reverse Repo % 28-Aug-13 6.25 6.50 -25 -100

CRR % 28-Aug-13 4.00 4.25 0 -75Auctions Unit Latest Previous FYTD FY13Dated security auction INR bn 28-Aug-13 150 150 2,840 5460

OMO Purchase INR bn 28-Aug-13 62.3 96.6 227 1550SMO Purchase INR bn 28-Aug-13 0 0 0 0MSS buyback INR bn 28-Aug-13 0 0 0 0

Unit Period LatestLast month

avg last month FYTDBSE Sensex Index 28-Aug-13 17852.10 18899.77 -9.86 0.90

Exchange Rate (USD/INR) - 28-Aug-13 68.16 61.90 15.31 53.36

364-day T-Bill % 27-Aug-13 9.98 9.92 5.51 91.9410-yr GOI bill % 27-Aug-13 8.88 8.77 4.72 13.55

OIS (5-year) % 28-Aug-13 9.07 8.57 9.02 31.85MIFOR (5-year) % 28-Aug-13 7.60 7.44 4.11 19.69

MIBOR (NSE) % 28-Aug-13 10.31 9.63 42.21 177.90

Unit Period LatestLast month

avg last month CYTDEuro - 28-Aug-13 1.3370 1.3322 0.69 -6.7

British Pound - 28-Aug-13 1.5517 1.55 0.88 -3.9

Japanese Yen - 28-Aug-13 97.45 97.81 -0.77 4.7Swiss Franc - 28-Aug-13 0.919 0.93 -1.01 -11.2

DOW - 28-Aug-13 14776 15307 -5.0 41.7

FTSE - 28-Aug-13 6415 6544 -2.1 18.5

Nikkei - 28-Aug-13 13338 13804 -5.6 26.5

Global PMI - Jul-13 50.8 50.6 0.2 0.2USD Libor 3mth % 27-Aug-13 0.26 0.26 -1.9 2.0Ted Spread bps 27-Aug-13 19.9 23.7 24.2 23.2

change since

Currencies

Fiscal Indicators

Equities

Others

RBI Action

Market Indicators change since

Global snapshot


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