A brave new world - HSBC...A brave new world Outlook 2017 2 Content Global economy India - A bright spot Reforms pave way for growth Catalyst at work Indian fixed income Global economy

January 2017

A brave new world Outlook 2017

2

Content

Global economy

India - A bright spot

Reforms pave way for growth

Catalyst at work

Indian fixed income

Global economy

4

What happened in 2016?

Source: Bloomberg, HSBC Global Asset Management, as of 30th December 2016.

Investment involves risks. Past performance is not indicative of future performance.

Total returns, USD (%)

2015 was a tough year for asset allocators. But 2016 was a much better scenario, with occasional episodic

volatility (China worries, global growth concerns, Brexit)

Variability in asset performance reminds us that “what” we buy and “when” we buy is the key investment

decision

1.6 1

-4.3 -4.7

1.3

-0.3

1.4

-5.45

-7.9-9.1

-14.6

1.1

4.0 4.4

14.8

10.3

8.2

12

-0.1

0.94

7.05

11.6

-18

-13

-8

-3

2

7

12

17

US 10YBonds

GlobalAggregate

Global IG Global HY EM Debt DM Equities US Equities DM (ex US)Equities

ChinaEquities (H-

shares)

Asia ex JapanEquities

EM Equities

2015 2016

5

Trumponomics and US equities

Source: HSBC Global Asset Management, Global Investment Strategy, November 2016.

Investment involves risks. Past performance is not indicative of future performance.

2

2.5

3

3.5

4

600

700

800

900

1000

1100

2014 2015 2016

% US 30Y Total Return Index, LHS

US 30Y Yield, RHS

1

2

3

4

5

2003 2005 2007 2009 2011 2013 2015

yoy, % Average Hourly Earnings, Total

Employment Cost Index, Total

Atlanta Fed Wage Growth Tracker

Within our Fragile Equilibrium framework, market perceptions of risk has shifted towards the scenario of a

“strong demand recovery”

This is driven by expectations that Trump will try and implement more growth-friendly policies: (i) USD500bn

infrastructure spending, (ii) lower corporate and personal tax rates, (iii) deregulation, anti-trust laws etc.

These policies also reinforce our theme of the “end of fiscal austerity”. The prospect of pro-cyclical fiscal policy

has increased the odds of reflation and this environment is less bond-friendly

Corporate tax reform gives some upside risk to earnings. But the US profits outlook remains under pressure

Margins are being squeezed as wage costs intensify

Low nominal growth continues to weigh on the top-line

Employment costUS 30-year total return index and yield

6

Fiscal and monetary policy co-ordinationThe end of austerity

*Fiscal boost calculated as the inverse change in the cyclically adjusted primary balance. 2017 estimated using IMF forecasts.

Source: HSBC AMG Global Investment Strategy, IMF Fiscal Monitor, October 2016. Any forecast, projection or target contained in this presentation is for information purpose only and is not guaranteed in any way. HSBC Global Asset

Management accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purpose only.

Concerns about the sustainability of high gross debt levels and therefore the need for austerity have dominated

thinking in most advanced economies since the crisis

But (i) a new populist political agenda, (ii) the lacklustre recovery and (iii) the perceived limits of monetary policy

are now forcing a reconsideration

An “arsenal” of monetary tools and measures (negative rates, QE, direct financing) still means that global liquidity

conditions remain highly supportive for reflation

But central banks’ focus is now shifting away from the “size of balance sheet” toward “yield curve control”

(BoJ bond yield caps, Fed “dot plot”)

Fiscal boost*, % of potential GDP

7

Emerging market equities outperformed

Source: Bloomberg, HSBC Global Asset Management, as of November 2016

Emerging market equities – MSCI Emerging Markets Index, Developed Market Equities – MSCI World Index

85

90

95

100

105

110

115

120

Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16

Emerging Market Equities Developed Market Equities

MSCI Emerging Markets Index vs. MSCI World Index in 2016

Emerging market equities outperformed developed market equities in 2016 YTD

Interest rates remain high in many markets. There is potential for a secular equity market re-rating

This was logical given the relative valuations and prospects of emerging markets versus the developed

markets although the absolute difference was relatively small

8

Emerging market vs. developed market equities

EM equities have lagged DM peers in the last decade

Source: HSBC Global Asset Management, DataStream as at 30 September 2016. For illustrative purposes. Any performance information shown refers to the past and should not be seen as an indication of future returns.

.

-20%

-10%

0%

10%

20%

30%

De

c-0

4

De

c-0

5

De

c-0

6

De

c-0

7

De

c-0

8

De

c-0

9

De

c-1

0

De

c-1

1

De

c-1

2

De

c-1

3

De

c-1

4

De

c-1

5

EM equities have been a major laggard over the last decade, as disappointing earnings growth, multiple

contraction and depreciating currencies have all weighed on total returns

9

The case for emerging market equities

Source: HSBC Global Asset Management, DataStream as at 30 September 2016. For illustrative purposes only.

.

Contribution to global GDP growth

-2%

0%

2%

4%

6%

19

81

19

86

19

91

19

96

20

01

20

06

20

11

20

16

Emerging markets Developed markets

Emerging markets now contribute about a third of global GDP and half of global GDP growth

In the short to medium term, we expect economic fundamentals to be supportive for EM equities

Continued, rapid, industrialisation will boost growth while potential moves up the value chain could

improve corporate earnings in some economies

10

Looking ahead – 2017 and beyond

Going into 2017, global economy remains in a state of fragile equilibrium with a low growth/inflation

mix

Combination of reflationary policies, corporate fundamentals and compelling valuations form a

supportive backdrop for equities in the year ahead

Equity premiums look attractive in a low return world, especially when compared with government

bonds

Emerging market equities, particularly in Asia, continue to stand out in terms of growth prospects,

positive earnings revisions and valuations

2017 will see an overhang from many of the risks that materialised in the previous year and new ones

including de-globalisation and potential policy missteps

On a longer time perspective, geopolitical events play much less important role than fundamentals and

economic and market development

India - A bright spot

12

We have come a long way in 2016…

Source: Kotak Institutional Equities – December 2016

Key events and performance of the Indian market (Nifty-50 Index) in CY2016

13

GDP – Onus is on government to revive investmentsExpect growth to be a slow recovery path

Source: CEIC, HSBC Global Asset Management, LHS: data as of September 2016, RHS: data as of November 2016. Any forecast, projection or target contained in this presentation is for information purposes only and is not

guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purpose only

Industrial production and manufacturing PMIGDP growth (y-o-y): expenditure components

-6

-4

-2

0

2

4

6

8

10

12

45

46

47

48

49

50

51

52

53

54

55

Au

g-1

3

Nov-1

3

Fe

b-1

4

Ma

y-1

4

Au

g-1

4

Nov-1

4

Fe

b-1

5

Ma

y-1

5

Au

g-1

5

Nov-1

5

Fe

b-1

6

Ma

y-1

6

Au

g-1

6

Nov-1

6

Manufacturing PMI Industrial production

-10

-5

0

5

10

15

3Q12 3Q13 3Q14 3Q15 3Q16

% yoy; ppt

Private consumption Government consumption

GFCF Change in stocks

Net exports Discrepancies

GDP growth

14

Decline in oil prices – Potential savings of USD61bn

Source: CEIC, Morgan Stanley Research as of December 2015. Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. HSBC accepts no liability for any failure

to meet such forecasts, projections or targets. For illustrative purpose only

12-month trailing peak

net oil imports as of

Dec 12 USD 108 bn

Current reduction in oil

burden USD 61 bn

12-month trailing net

oil imports as of

Nov-16

US$ 47 bn

Government budget

USD 35 bn

Household sector

USD 8.5 bn

Corporate sector

USD 17.5 bn

Every US$ 10/bbl increase

in oil prices will increase

annualised net oil import

bill by ~US$ 10bn

Lower oil subsidy

USD 14 bn

Higher tax revenue

USD 20.5 bn

State Govt

lower oil sales tax

- No change

How is the reduction in oil burden distributed?

15

5.2

5.5

6.0

5.7

4.3

3.94.0

3.3

2.5

6.0

6.5

4.8

5.7

4.8

4.5

4.13.9

3.5

3.0 3.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

FY 00 FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 FY 17 FY 18 FY 19

Fiscal deficit – On track as per roadmap

Note: Any forecasts, projections or targets contained in this presentation is for information purpose only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. For

illustrative purpose only

Source: Budget documents, CEIC, HSBC, as of February 2016

Govt’s fiscal

consolidation path

% of GDP

Central government fiscal deficit

16

Fiscal deficit – Reduction in subsidies allows government to reallocate to capital investments

0

500

1,000

1,500

2,000

2,500

3,000

2000-0

1

2001-0

2

2002-0

3

2003-0

4

2004-0

5

2005-0

6

2006-0

7

2007-0

8

2008-0

9

2009-1

0

2010-1

1

2011-1

2

2012-1

3

2013-1

4

2014-1

5

2015-1

6

2016-1

7 (

BE

)

Note: RE = Revised Estimate, BE = Budget Estimate; Any forecasts, projections or targets contained in this presentation is for information purpose only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet

such forecasts, projections or targets. For illustrative purpose only

Source: Nomura, Ministry of Finance, Budget documents, CEIC, HSBC, as of May 2015

INRbn

11%

12%

12%

13%

13%

14%

2012-13 2013-14 2014-15 2015-16 (RE) 2016-17 (BE)

Fertiliser, food and fuel subsidies Capital expenditure as % of total expenditure

17

Fiscal deficit – Supply in 2H FY2016-17 reasonably revised downwardsBetter technical backdrop overall

FY 17 FY 16

(INRbn) Gross issuance Net issuance Gross issuance Net issuance

October 450 450 750 676

November 740 740 450 450

December 420 420 440 440

Q3 1,610 1,610 1,640 1,566

January 550 (previous 700) 75 560 560

February 110 (previous 140) 110 140 140

March - - - -

Q4 660 (previous 840) 185 700 700

H2 2,270 (previous 2,450) 1,795 2,340 2,266



Source: RBI, Bloomberg and HSBC Research, as of January 2017

FY 14 FY 15 FY 16

FY 17

(budgeted)

Fiscal deficit (% to GDP) -4.6 -4.1 -3.9 -3.5

Fiscal deficit (INRbn) 5,245 5,311 5,351 5,339

Gross borrowings (INRbn) 5,486 5,857 5,842 6,000

Net borrowings (INRbn) 4,536 4,469 4,406 4,252

% financed by market borrowings 86.4 84.1 82.3 79.6

Q4 net supply truncated due to larger tax revenues; provides a favourable technical backdrop

18

Current Account Deficit (CAD) – Improving and structurally resilient

Note: Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. For


Source: LHS – IMF, data as of October 2016, RHS- CEIC, Bloomberg, HSBC Global Asset Management, data as of 31 December 2015

Expected

CAD (% of GDP)

Gold imports contracted on

y-o-y basis for third

consecutive month

Oil imports decline to 2.5% of GDP

Oil and gold imports (y-o-y%)

Lower oil and gold imports supportive of CADCAD – Structurally sustainable

-6

-5

-4

-3

-2

-1

0

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

19

CAD – FX reserves provide a reasonable cushion

0

2

4

6

8

10

12

Q2 11 Q1 12 Q4 12 Q3 13 Q2 14 Q1 15 Q4 15 Q3 16

Import cover (months of imports of goods and services)

FX reserves over short-term external debt (times)

250

270

290

310

330

350

370

390

50

52

54

56

58

60

62

64

66

68

70

Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16

INR/USD exchange rate (LHS) FX Reserves (RHS)

Source: IMF, CEIC, Bloomberg, HSBC Global Asset Management; LHS: data as of 23 December 2016; RHS: data as of 30 September 2016

USDbn

FX reserves – RBI to stay on the bid FX reserves to imports and short term external debt

20

CAD narrowed considerably while funded by growing net FDI inflows

Source: LHS and Upper RHS: RBI, Bloomberg, HSBC Global Asset Management, data as of December 2016; Bottom RHS: CEIC, HSBC Global Asset Management, data as of 17 June 2016

Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in anyway. HSBC accepts no liability for any failure to meet such forecast, projections or targets. For illustrative

purpose only.

FDI inflows picked up significantly over the last 10 years CAD is well financed by FDI inflows

2013 2014 2015

Year to

Sep 2016

Net FDI

(US bn)+26.3 +21.5 +36.3 +28.1

CAD

(US bn)-49.2 -27.5 -22.5 -4.0

0

5

10

15

20

25

30

35

40

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Sep2016

USDbn

21

Inflation – Down from historical highs

Source: CEIC, Bloomberg, HSBC, November 2016

Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative

purpose only.

% y-o-y% y-o-y

RBI target: 4% +/- 2%

RBI’s inflation target is achievable Core inflation remains sticky

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Dec-13 May-14 Oct-14 Mar-15 Aug-15 Jan-16 Jun-16 Nov-16

Core WPI Core CPI

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

Nov-02 Nov-04 Nov-06 Nov-08 Nov-10 Nov-12 Nov-14 Nov-16

CPI WPI RBI Target of 4% - 2% RBI Target of 4% +2%

22

Food inflation – Remains under control through supply side measures

Source: CEIC, Bloomberg, RBI, December 2016

300

320

340

360

380

400

420

440

460

480

Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16

CRB FOOD Index

0%

2%

4%

6%

8%

10%

12%

Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16

Food inflation remains under control Minimum support prices kept flat over past two years

Global food prices have levelled off

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Rice Coarse cereals Wheat Pulses (urad) Oilseeds (groudnut)

Rs/quintal

23

Food Inflation – Good monsoon and Govt’s supply measures keep prices under control



Source: Indian Meteorological Department, BofA Merrill Lynch Global Research, HSBC Global Asset Management, Department of Consumer Affairs, PMC, 20 September 2016

Weight in

CPI Jan Feb Mar Apr May Jun Jul Aug 16 Sep

Cereals 7.1 0.87 0.14 0.53 -0.51 0.18 0.15 0.80 1.80 1.12

Pulses inflation 2 52.9 45.55 40.16 39.40 34.96 30.91 30.86 22.72 6.60

Oilseeds inflation 3 5.7 4.1 3.6 3.3 4.4 5.0 4.6 4.8 3.4

Vegetables

inflation2.2 -6.6 -15.3 -16.5 -5.9 3.1 14.4 7.7 -18.7 -32.1

Sugar 1.1 -2.4 1.1 5.4 17.4 25.0 29.5 34.8 38.3 35.8

Milk 6.4 2.1 2.4 2.0 2.2 2.0 2.7 2.3 1.9 1.2

Tea loose 1 -0.3 -1.2 -3.7 -3.1 -3.9 -3.8 -4.6 -3.7 -4.0

Salt pack 0.2 2.1 2 2.2 2.6 1.7 3.1 -0.1 -0.3 -0.7

CPI food inflation 45.9 6.66 5.52 5.19 6.29 7.20 7.46 7.96 5.83 -

Good monsoon has started to have a salutary impact on food prices

Government measures include importing vegetables and banning hoarding / stocking of pulses

Pulses inflation remains high but has started to head lower on increased farming and Government’s INR 9 billion buffer for pulses

in Budget 2016-2017

Agflation remains under control thanks to food supply management

Reforms pave way for growth

25

The government’s big initiatives

Higher public investment

– Higher outlays for rural India

– New mechanisms for ‘crowding in’ private investment

Making “Make in India” possible

– Ease of doing business; Bankruptcy code

– Skilling India

Decentralising decision-making…and spending

– Untied funds to states

Better targeting of subsidies

– The JAM trinity

– Direct transfer for fertilisers as well

Tax reforms

– GST bill has been approved

New institutions

– Inflation targeting via new Monetary Policy Committee

– Public debt management office

26

20

30

40

50

60

70

80

'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

India’s competitiveness is accelerating at its fastest pace

Source: World Economic Forum, data as of 2016

71st

39th

The gauge of productivity and long-term prosperity

Areas considered:

– Institutions

– Infrastructure

– Macroeconomic environment

– Health and primary education

– Higher education and training

– Goods market efficiency

– Labor market efficiency

– Financial market development

– Technological readiness

– Market size

– Business sophistication

– Innovation

The Global Competitiveness Index

27

2010 2011 2012 2013 2014 2015

Dec 12

250 million

Nov 13

500 million

Jan 15

750 million

Apr 16

1000 million

Reforms pave way for growth: Aadhar

Source: Motilal Oswal, data as of September 2016

Latest available data updated in the slide

World’s largest dual biometric citizen identification scheme

Improved transmission of subsidies, wages and pension proceeds as the individuals can link their bank accounts and other utility

accounts to Aadhar

More Aadhar-linked schemes and benefits in the works

Rapid ramp up in Aadhar enrollments

28

Reforms pave way for growth: GST

Note: Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets

Source: Nomura data as of August 2016

GST - The Constitution Amendment Bill for Goods and Services Tax (GST) has been approved by The President of India post its passage in the Parliament on 3 August 2016. The Government of India is committed to replace all the

indirect taxes levied on goods and services by the Centre and States and implement GST by April 2017

Running time40%

Check posts16%

Other official stoppages8%

Repairs5%

Fuelling6%

Rest and meals13%

Traffic hurdles9%

Other halts3%

Successful implementation of GST should:

Support fiscal stability

Bring down cost of doing business, including logistics costs

Help companies deliver better margins

Pass along some of the gains to consumers

Average time spent by truck during a trip

29

Roadmap to GST implementation

Source: Credit Suisse estimates, as of 31 December 2016

GST Council Formed Actions in parallel

GST Rate Structure Finalised

Synchronisation and Mapping of

final rates to categories

Centre to pass GST Act and a

separate IGST Act; States to pass

GST Act

Implementation

GSTN software

Commercial ERP systems

Training and implementation of

software

Rules for implementation (eg dual

control, valuation of interstate

stock transfers, dispute resolution

etc)

Colour code: Decreasing difficulty

and time taken

30

Reforms pave way for growth: Bankruptcy Law

Note: Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets

Source: Credit Suisse, data as of December 2016

0 1 2 3 4 5 6

Japan

HK

Australia

Malaysia

UK

Germany

US

China

SA

Pakistan

Brazil

India

Vietnam

Time to resolve insolvency (No of years)

0 20 40 60 80 100

Singapore

UK

HK

Malaysia

US

Thailand

China

Indonesia

India

Vietnam

Recovery Rate (cents on the Dollar)

India lags in bankruptcy resolution

New law to establish a transparent and time bound process for bankruptcies

Help improve confidence in India as an investment destination

South Africa

31

1.7

3.1

2.0

1.1

2.7 2.7

2.0

1.1

3.3

1.9 2.1

1.1

1.9 2.12.6

1.9 2.02.5

8.4

11.0

3.2

2.42.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1Q

FY1

2

2Q

FY1

2

3Q

FY1

2

4Q

FY1

2

1Q

FY1

3

2Q

FY1

3

3Q

FY1

3

4Q

FY1

3

1Q

FY1

4

2Q

FY1

4

3Q

FY1

4

4Q

FY1

4

1Q

FY1

5

2Q

FY1

5

3Q

FY1

5

4Q

FY1

5

1Q

FY1

6

2Q

FY1

6

3Q

FY1

6

4Q

FY1

6

1Q

FY1

7

2Q

FY1

7

3Q

FY1

7E

RBI’s asset quality review led to banks’ clean up of bad loans

Source: MOSL, company, data as of December 2016

Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets

Source: Credit Suisse, data as of December 2016

Net slippage ratio spiked

as banks redefined more

loans as non-performing

under RBI review

Net slippage ratio (%)

32

Change in rates since December 2014

Source: Credit Suisse, as of 31 December 2016

Investment involves risks. Past performance is not indicative of future performance

Percent change since January 2015

Repo Rate -1.5%

Bank Base Rate -1.0%

(%)

33

Impact of Demonetization - Good Intent but Short Term Pain

Source: Bank of America Merrill Lynch, December 2016.

Over, longer term demonetization coupled with GST will nudge the shadow economy to formalize itself thus

boosting efficiencies and growth.

However, four negative impacts of demonetization:

Near term ‘halt’ as physical cash had disappeared. This is a ‘logistical’ problem; the Govt./RBI will eventually replace old

notes

‘Loss of income’: Services account for 61% of India’s GDP. For this part, the current disruption is not a postponement of

income, but is lost revenue (no haircut today doesn’t imply two haircuts tomorrow)

Large negative wealth effect: This could impact 60% of Indian household assets (physical savings). Propensity to

consume – both in the black and the formal economy – will fall

Body blow to the shadow economy: The black economy is estimated to be 25-30% of GDP

Consumers: ST pressure but LT consolidation gains to accrueAutos: Rural demand may get disrupted in the near term

Maruti’s rural volumes

Unbranded share of total

Catalysts at work

35

MSCI India PE against its historical average

Source: Bloomberg, as of 31 December 2016


20.8

15.5

5.0

12.0

19.0

26.0

33.0

Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

MSCI India PE (x) MSCI EM PE (x)

MSCI India Avg: 19.2x

MSCI EM Avg: 13.6x

0

25

50

75

100

Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

MSCI India Vs EM PE Premium (%)

Average of 42%

36

Cyclicals’ valuations starting to normalise

Global Financial Crisis

Taper tantrums

Source: Credit Suisse, as of 31 December 2016

37

MSCI India PE relative to MSCI EM and MSCI Asia ex Japan

Source: Bloomberg, as of 1 January 2017


0%

10%

20%

30%

40%

50%

60%

70%

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

Prem to MSCI EM fwd PE Prem to MSCI Asia Ex Japan 12m fwd PE

38

Source: Bloomberg, as of 31 December 2016


ROE of Indian stocks trending up

(%)

0

2

4

6

8

10

12

14

16

18

20

Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Aug-16

India EM Asia Ex Japan BRIC World

India Fixed Income

40

Indian bond market – Large, liquid domestic market

Source: RBI, Ministry of Finance, New Delhi. Chart 1: *1Q2016 is based on best estimate, data as of January 2016, Chart 2: data as of September 2016

The market has rapidly grown in the past few years

A market still dominated by government issuance

Corporate market is still underdeveloped, but likely to grow strongly in the coming years

% GDPUSDbn

Bonds outstanding Ownership pattern of Indian government securities

40.00

0.1422.68

2.13

2.470.84

1.09

3.82

6.25

14.80

5.79

Commercial Banks Non-Bank PDs Insurance Companies

Mutual Funds Co-operative Banks Financial Institutions

Corporates Foreign Portfolio Investors Provident Funds

RBI Others

50%

52%

54%

56%

58%

60%

62%

0

200

400

600

800

1,000

1,200

1,400

2010 2011 2012 2013 2014 2015 1Q 2016*

Government bonds Corporate bonds % GDP

41

Indian bond market – Broad and deep structure

Indian Debt Market is broadly classified in three segments:

– Government Securities comprising the Central and State Government securities and treasury bills

– Public Sector Undertaking (PSU) bonds, generally treated as surrogates of sovereign paper, often due to the comfort of

Government ownership of the PSUs

– Corporate securities comprising debentures/corporate bonds and commercial papers

Indian Debt Market is predominantly wholesale market with dominant institutional investor participation which

includes

– Banks

– Insurers

– Retirement funds

– Mutual funds

– Financial Institutions

India’s central banking authority – The Reserve Bank of India (RBI), regulates transactions in sovereign

securities

Exchange-listed debt securities come under the concurrent purview of the Stock Exchange where they

are listed

All transactions of FPI’s in the debt market are governed by Securities Exchange Board of India (SEBI)

42

Indian bond market – Access for FPI’s

FPI’s can access Indian market by securing an FPI license from Designated Depository Participant (DDP)

FPIs can invest in

– Debentures of Indian Companies

– Units of domestic mutual funds

– Exchange traded derivatives

– Dated Government Securities

– State Development Loans

Coupons and capital gains are taxed

Investment limit for FPI’s are as follows:

– Debt limit in respective category is freely available till the aggregate FPI investments reaches 90% of the limit, after which the

auction mechanism will be triggered for the balance limit

– FPIs can invest in dated government securities and corporate bonds having residual maturity of three years or above

– Depositories will monitor the different thresholds

– Switching (buying/selling) within the quota limit is allowed for the same day

– The USD10bn limit in sovereign segment is available for investments only to specified FPIs

– Total FPI government securities limit is at 5% of total outstanding bonds, denominated in INR terms. The quota is reviewed

every 6 months and released every quarter

43

Indian bond market – Recent changes to FPI Investments Policy

In the policy meeting on 29 September 2015, RBI announced significant changes to the FPI investments

policy:

– Total FPI government securities limit has been adjusted to 5% of total outstanding bonds, implying an additional INR1.2 trillion

in quota

– The limit was previously set in absolute dollar terms; the quota has also now been redenominated into INR

– The quota will be reviewed every 6 months and released every quarter, adding much more transparency to the system

RBI has opened up State Development Loans (SDL) to foreign investors

– SDLs are issued by states as opposed to the central government

– SDLs were previously inaccessible for foreign investors

– 2% of outstanding SDL will be opened up to foreign investors

RBI introduced Masala bonds which are bonds issued by Indian companies offshore, denominated in INR and

settled in USD

– Not subject to FPI license

– Subject to 5% withholding tax

44

Indian bond market – Recent market reforms

In August 2016, RBI announced a series of measures to develop the onshore fixed income and currency

markets. Some of these include:

– Allowing banks to raise capital through Masala bonds in the overseas market

– Allowing both residents and non residents to maintain large open positions (up to limit of USD 5 million)

– Proposed to permit listed companies to lend money to banks through repo market mechanism

– Granting direct access to foreign portfolio investors (FPIs) to bond trading for both government and corporate bonds

To further develop the corporate bond market, the following measures have been put in place:

– Permitting brokers to repo in corporate bonds

– Allowing FPIs to trade directly in corporate bonds

– Accepting corporate bonds under the liquidity adjustment facility of the RBI

– Introduction of the Electronic Dealing Platform for repo in corporate bonds

These measures are intended to:

– enhance market participation

– facilitate greater market liquidity and

– improve communication & transparency

45

Indian government bond yields are attractive relative to emerging market peers, but especially so against developed markets

Yield curve is flat, which means we don’t give up yield irrespective of our duration view

Indian bond market – Attractive absolute and relative yields

Years to maturity

Source: Bloomberg, data as of 30 December 2016

Yield to maturity (%)

Selected 10 year government bond yields Indian government yield curve

0

1

2

3

4

5

6

7

8

9

10

So

uth

Afr

ica

Indo

nesia

Me

xic

o

India

Ph

ilipp

ines

Ma

laysia

Hun

ga

ry

Chin

a

Th

aila

nd

US

Sp

ain UK

Ge

rma

ny

Yield (%)

6.50

6

6.5

7

7.5

8

8.5

1Y 2Y 3Y 5Y 6Y 7Y 8Y 9Y 10Y 11Y 12Y 13Y 14Y 15Y 30Y

Dec-16

2014

46Source: IMF World Economic Database number as of October 2016. Spot rate as of 30 December 2016. Investment involves risks. Past performance is not indicative of future performance

INR – Appreciation potential over the long term

Performance of Indian rupee % under/over valued versus USD on PPP

40

45

50

55

60

65

70

75

De

c-1

1

Ma

y-1

2

Oct-

12

Ma

r-1

3

Aug-1

3

Jan-1

4

Jun-1

4

No

v-1

4

Apr-

15

Sep-1

5

Feb

-16

Jul-1

6

De

c-1

6

USDINR exchange rate

-80% -60% -40% -20% 0% 20% 40%

CHF

JPY

EUR

GBP

HKD

KRW

SGD

CNY

TWD

PHP

THB

VND

MYR

IDR

INR

Indian rupee is among the most undervalued major currency on PPP in the world

47

Yields – Look attractive vis-à-vis policy rate and inflation

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16

10y yields Policy rate

Source: Bloomberg, data as of December 2016

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

10y vs policy rate Real rates (Policy rate – CPI inflation)

48

RBI’s Monetary Policy – MPC maintains accommodative stance



Source: HSBC Global Asset Management, data as of January 2017

The Monetary Policy Committee (MPC) held the 5th Bi-Monthly Monetary Policy meeting on 7 December 2016

– Policy rate put on hold due to the following factors:

– Rise in prices in some items and uptick in inflation expected due to base effects and oil prices;

– Global developments especially the monetary and fiscal policy stance by the US Federal Reserve;

– Withdrawal of Specified Bank Notes (SBN) expected to have temporary effect on inflation

MPC maintains its accommodative stance

– Neutral liquidity stance continues

– The inflation expectation for Q4 2016-17 is retained at 5%, given the improvement in food inflation, with a minor upside bias

Key decisions at the meeting:

– Repo rate kept unchanged at 6.25%

– Cash Reserve Ratio left unchanged at 4.00%

RBI continues to follow developments on:

– CPI data which is expected to be in the range of 5% with upside risk lower than last time

– Imminent tightening of monetary policy in the US triggering high volatility

– Supply disruptions due to currency replacement may drag down growth this year

49

Interest rate view – Further easing dependent on inflation trajectory



Source: HSBC Global Asset Management; data as of January 2017

MPC believes the upside risks to the 5% inflation target for Jan-Mar 2017 have diminished

– Acknowledges the possibility of risks to inflation from the implementation of the 7th Pay Commission and GST bill

– However, declining food inflation momentum should guide headline CPI lower

Stance of policy continues to be accommodative

– Fiscal prudence, lower inflation, lower neutral real rate with focus on growth should keep rates on an easing bias

– We see scope for the MPC to cut rates further by at least 25bps before Mar 2017

Bond supply

– The government has revised the supply in the remainder part of H2 2016-17

– revised downwards to 66,000 crore from 84,000 crore previously due to larger tax revenues

– provides a favourable technical backdrop for bonds

– Statutory demand from insurers, pensioners and retirement funds to drive demand for yield

– Slow credit growth leads to demand from banking system

Expect 10Y government bonds to trade between 6.30-6.60% with softening bias to yields given improved

liquidity

50

Macroeconomic factors supportive of INR:

– Accommodative monetary policy positive in medium term

– Investment reform to be positive for FDI/divestment programme/equity capital flows

– Current account deficit has narrowed and sustainable

– Capital flows cover current account deficit adequately

– Higher real rates imply move from gold to financial assets

Expect INR to move in line with USD vs Asian currencies, but with greater resilience given:

– Healthy FX reserves

– Improving fundamentals

– Foreign investor appetite for Indian debt appears to remain healthy

Currency – Expect a rangebound rupee in the medium term



Dawn of a brave new world

52

Interest rates in India down sharply, improving outlook on the banking sector and a revival in external

demand can pave the way for a sustained rally in the Indian markets

A world which will return to a growth orientation, away from the stagnation seen in the past few years

We feel, Indian equity markets are reasonably valued and offer an attractive alternative to other

emerging markets, much more challenged by the new world order at this time, especially China.

Increasing propensity for sustained discretionary spending, reduction in the asset quality problem with

banks and a stable increase in discretionary spend in the US points to some beneficiaries in the local

stock markets

A revival in investment demand fueled by government spending, may also throw up interesting

opportunities in Industrials and basic manufacturing

Our asset allocation prefers an overweight stance in equities and intermediate debt duration

Dawn of a brave new world

53

Important information

Specific risks to the Indian equity market include: government inaction, high oil prices, pressure on current account, INR weakness and sticky inflation

investors should be reminded that investment in some of the developing Asian countries may involve special considerations and risks. Below could affect adversely

the economies of such countries or the value of the investment:

Political changes

Government regulation

Social instability

Diplomatic development

Global economic development, etc

Emerging markets can be significantly more volatile than developed markets, so that the value of investments may be subject to larger fluctuations

Currency movement and market condition may affect the value of investments

Risk Considerations. There is no assurance that a portfolio will achieve its investment objective. In addition, there is no guarantee that any investment strategy will

work under all market conditions, and each investors should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline. Accordingly, you can lose money

investing in any of these strategies. Please be aware that these strategies may be subject to certain additional risks, which should be considered carefully along with

the strategy’s investment objectives and fees before investing. Equity. In general equity securities’ values also fluctuate in response to activities specific to a

company. Foreign and emerging markets. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of

investing in emerging-market countries are greater than the risks generally associated with foreign investments. Derivative instruments. Derivatives can be illiquid,

may disproportionately increase losses and may have a potentially large negative impact on performance. Non-diversification. Focusing investments in a small

number of issuers, industries, foreign currencies or particular countries or regions increases the risks associated with a single economic, political or regulatory

occurrence. Sector concentration. When a strategy will invest more than 25% of its total assets in securities issued by companies in the financial services group of

industries. Accordingly, a strategy will be more susceptible to developments that affect such industries, such as economic cycles, interest rate changes, business

developments and regulatory changes, than other strategies that do not concentrate their investments. Commodity-related investments. Exposure to commodities

markets, including investments in companies in commodity-related industries, may subject a strategy to greater volatility than investments in traditional securities.

The value of commodity-related investments may be affected by overall market movements and factors specific to a particular industry or commodity.

Gross performance information. Performance data is calculated gross of fees and assumes the reinvestment of dividends, income and any capital gains and is net

of transaction costs. The results are shown before the deduction of investment advisory fees and other expenses, which would reduce a return. Information about

investment advisory fees is available in our Form ADV Part 2A, which is available upon request. The following hypothetical illustrates how investment advisory fees,

compounded over time, could impact performance. Assuming a portfolio’s annual rate of return is 15% for 5 years and the annual investment advisory fee is 50 basis

points, the gross cumulative five-year return would be 101.1% and the five-year return net of fees would be 96.8%.

54

Disclaimer

This document has been prepared by HSBC Asset Management (India) Private Limited (AMIN) for information purposes only and

should not be construed as an offer or solicitation of an offer for purchase of any of the funds of HSBC Mutual Fund. All information

contained in this document (including that sourced from third parties), is obtained from sources, which AMIN/ third party, believes

to be reliable but which it has not been independently verified by AMIN/ the third party. Further, AMIN/ the third party makes no

guarantee, representation or warranty and accepts no responsibility or liability as to the accuracy or completeness of such

information. The information and opinions contained within the document are based upon publicly available information and rates

of taxation applicable at the time of publication, which are subject to change from time to time. Expressions of opinion are those of

AMIN only and are subject to change without any prior intimation or notice. It does not have regard to specific investment

objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should

seek financial advice regarding the appropriateness of investing in any securities or investment strategies that may have been

discussed or recommended in this report and should understand that the views regarding future prospects may or may not be

realized. Neither this document nor the units of HSBC Mutual Fund have been registered in any jurisdiction. The distribution of this

document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this

document are required to inform themselves about, and to observe, any such restrictions.

© Copyright. HSBC Asset Management (India) Private Limited 2017, ALL RIGHTS RESERVED.

HSBC Asset Management (India) Private Limited, 16, V.N. Road, Fort, Mumbai-400001 Email: [email protected]

Mutual fund investments are subject to market risks, read all scheme related documents

carefully.

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