Dear Investors,

Although 2008 crisis showed that deleveraging balance sheets and prudent spending was important for households and corporate, the bygone year has highlighted the importance of deleveraging balance sheets and prudent spending for companies and nation states. The nation states which have high level of debt accompanied with high level of fiscal deficit saw significant pressures on their currencies, lowering of debt ratings and difficulty in raising short term and long term debt. This led to US credit rating being downgraded to lower than AAA for the first time by S&P. Various European nations, found raising short term and long term funds difficult. Inflation in emerging markets also rose to high levels driven in part by high food inflation and in part by high commodity inflation.

The year saw Indian macro-economic issues gaining importance with widening fiscal deficit, current account deficit and worsening balance of payment (BoP) getting attention. Inflation in Indian economy continued to remain high with wholesale price index (WPI) remaining at more than 9 per cent for most of the year although it has moderated to 9.1 per cent in November. High inflation forced the Reserve Bank of India (RBI) to continue with monetary tightening. RBI raised Repo Rates from 6.25 per cent at the start of the year to 8.5 per cent by the end. This along with slowing global growth led to moderation of Indian GDP growth with 1HFY12 growth coming in at 7.3 percent in 1HFY12 down from 8.6 percent a year ago. Since then, industrial performance has deteriorated further with a 5.1 per cent contraction in Index of Industrial Production (IIP) in October, the first contraction after June 2009. Corporate margins in Q2 of 2011-12 moderated significantly as compared with their levels in Q1. The decline in margins was largely on account of higher input costs, higher interest costs and declining pricing power. Slowdown in corporate growth is being further re-affirmed by slowdown of auto sales with four wheeler sales being muted and two wheeler sales slowing down to below 8 per cent growth for the month of December compared to more than 15 per cent growth in the preceding months. On the fiscal front, the central government has indicated that it might miss its budgeted fiscal deficit target of 460 bps of the GDP, by 75-100 bps driven by higher subsidies (oil, fertilizer, and others) and lower than estimated revenue collections. The deceleration in merchandise exports in October – November compared to 1HFY12 accompanied with continued strong imports has led to widening trade deficit and put pressure on current account. FIIs pulled out capital from Indian equity capital markets with USD 0.65 bn being withdrawn in CY11 compared with an inflow of USD 29.3 bn in CY10 and USD 17.64 bn in CY09. The deteriorating fiscal, current account and BoP situation has led to Rupee depreciating to 53.266 to one US Dollar as of 30th Dec 2011, a decline of 18.87 percent from `44.81 as of 31st Dec 2010.

However, by end of the year, most governments have recognized these issues and are working on finding solutions to these issues. Europe is working towards a tighter monetary and fiscal union. 6 central banks including US Fed, ECB took actions on 30th Nov to improve US Dollar liquidity support for European banks. China is working on keeping inflation in its economy under control. Further, the Chinese central bank has reduced its lending rates and cash reserve requirements. The US economic growth in Q3 was better than in Q2, although still substantially below trend, is showing signs of strength.

On the domestic front, in order to reduce the pressure on Rupee, RBI has taken several measures to attract capital inflows. Limits on investment in government and corporate debt instruments by foreign investors were increased. The ceilings on interest rates payable on non-resident deposits were raised. The all-in-cost ceiling for external commercial borrowings was increased. At the same time, government has allowed qualified foreign investors the flexibility of investing not just in Indian mutual funds but also in equities of Indian companies. Indian inflation momentum indicators show continuing signs of moderation. Primary article inflation for the week ending Dec 17 came in at 2.70. Commodity inflation is expected to remain muted as a result of low global growth. With inflation expected to ease, RBI has indicated that the balance between inflation and growth in its policy measures is expected to shift towards supporting growth. We expect this to result in a drop in interest rates in the Indian economy in the next 12 to 18 months.

The promising agricultural prospects, declining inflation (both commodity and agricultural), along with the expected easy monetary stand of RBI, and reasonable market valuations is laying the ground work for the next bull-run.