Fixed Income Markets

At a turning point ?
Key factors affecting interest rates
• Inflation
– Commodity prices
– Currency
– Base effect

• Fiscal Deficit
– Subsidies – Oil, Fertilizer
– Elections - Farm loan waiver
– Sixth Pay Commission

• Liquidity
– Money supply, elections

2
Outlook in summary

• We expect the fiscal deficit (including the off balance

sheet items), the current account deficit and the
inflation to peak out in the current financial year (FY
‘09)

• In the short term, the markets are always uncertain and

will continue to react to newsflow

• However, over medium term, yields are likely to fall

• Similarly, over the medium term, Corporate spreads

should also moderate

3
Inflation to moderate significantly in
FY10
• US / Euro region / Japan – all major economies are
slowing down. This should lead to lower commodity
prices. Oil, Steel & Chemicals constitute 27% of the WPI
basket. (refer slides 28 - 32 in Annexure)
• Monsoons have been close to normal and should have a
soothing effect on agri-commodity prices
• With the Indian story still intact, FII flows likely to
improve by next year. FDI inflows are strong. Along with
lower oil, INR likely to appreciate from current levels
• Base effect to moderate inflation sharply in the next six
months

4
 Currency/BOP should peak in the
FY09
• INR has sharply depreciated against the USD (24.76%)
in the current year till date*
• Some of the reasons for the above are:
– High oil prices, resulting in current account deficit likely to
touch 2.5% of GDP in FY09
– FII outflows
• However we expect INR to start appreciating soon due
to:
– Likely lower oil prices
– From FY10-11, all increase in domestic oil consumption
would be met through domestic production by CAIRN and
Reliance (excluding gas)
– Given higher domestic capacities and some demand
compression locally, current account deficit should
improve to below 1% of GDP by FY11
* As on November 24, 2008.
5
 Fiscal Deficit
• Due to coincidence of multiple factors, centre’s fiscal
deficit (including off balance sheet items) is likely to
exceed 6%?
Exceptional Items (Rs crs) FY09E FY10E FY11E
Farm Loan Waiver 22900 13600 27900
Sixth Pay Commission
Arrears 11760 17640
Tax on Full Arrears @ 30.99% -9111
Salary Increase 15700 15700 15700
Oil Bonds 66000 15000 15000
Fertiliser subsidy / Bonds 55000 0 0
Total 162249 61940 58600

Est. Nominal GDP (growth 15%) 4949202 5691582 6545320

Exceptional items as a % of GDP 3.28% 1.09% 0.90%
Source:
Source: Finance
Finance Ministry,Ministry, HDFC
In-House Research AMC est., press articles
E – Estimates

6
Fiscal Deficit – likely to peak in FY09
Fiscal Deficit and Off–Balance–Sheet Items – How do they stack up?

Fiscal Deficit may be mitigated to an extent by 3G license fee / special

dividend and sale of assets
7
Liquidity

• RBI has adopted tight liquidity policy due to the high

inflation and also due to high sensitivity of inflation
(impending elections next year)

• In the remaining part of current financial year and next

financial year, as inflation eases and elections get over,
liquidity should ease

• FII flows, as and when they resume, should add to the

liquidity

8
Corporate spreads

• Factors affecting the corporate spreads

– High absolute levels of interest rates
– Tight liquidity
– High SLR (24%) and CRR (5.5%) are resulting in “crowding
out” of private sector by the banking sector. It is also
increasing the cost of borrowing of the banking sector
– Off balance sheet funding of the fiscal deficit in the form of
buying oil bonds, giving loans to oil and fertiliser
companies is aggravating the problem
– Corporate sector has undertaken large capex and needs
huge funding. The poor equity market sentiment as well
as the restriction on ECBs is increasing the need for debt
financing

9
 -0.50
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
31-Dec-01

31-Mar-02

30-Jun-02

30-Sep-02

31-Dec-02

31-Mar-03

30-Jun-03
peaking?

30-Sep-03

31-Dec-03

Source: Bloomberg. As on November 24, 2008.

31-Mar-04

30-Jun-04

30-Sep-04

31-Dec-04

31-Mar-05

30-Jun-05

30-Sep-05

31-Dec-05

31-Mar-06
Spread for 5yr Corp Bond (%)

30-Jun-06

30-Sep-06

31-Dec-06

31-Mar-07

30-Jun-07
5 year Corporate Bond Spread –

30-Sep-07

31-Dec-07

31-Mar-08

30-Jun-08

30-Sep-08
10
 -0.50
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
31-Dec-01

31-Mar-02

30-Jun-02

30-Sep-02

31-Dec-02

31-Mar-03

30-Jun-03
peaking?

30-Sep-03

31-Dec-03

Source: Bloomberg. As on November 24, 2008.

31-Mar-04

30-Jun-04

30-Sep-04

31-Dec-04

31-Mar-05

30-Jun-05

30-Sep-05

31-Dec-05

31-Mar-06
Spread for 10yr Corp Bond (%)

30-Jun-06

30-Sep-06

31-Dec-06

31-Mar-07

30-Jun-07
10 yr Corporate Bond Spread –

30-Sep-07

31-Dec-07

31-Mar-08

30-Jun-08

30-Sep-08
11
Optimal Investment Strategy over
medium term
 Basis for indicative optimal portfolio*
• Over the medium term, inflation should stabilise around
5%. The fiscal deficit should also come down as also laid
in the Fiscal Responsibility and Budget Management
(FRBM) Act.

• Over the medium term, the absolute yields as well as

corporate spreads should also fall

• Over the medium to long term, India is fast catching up

with the bigger economies of the world due to the
higher growth rates and may soon be the ninth largest
economy in the world. Hence the inflation and interest
rates should also align with the larger economies at
some point. (refer slides 34 and 35 in Annexure)
*Portfolio of Investor and not Mutual Fund.

13
 Indicative optimal portfolio*
• In such a scenario, we think it is time to add duration to
portfolios

• An indicative optimal portfolio, based on current G-sec

yields and corporate spreads is as follows:

G-sec – 20%, Corporate bonds – 80%

Modified Duration of 6.40
Portfolio yield of 9.75%

*Portfolio of Investor and not Mutual Fund.

14
 Indicative optimal portfolio* performance – over
1 year

This table is for illustration purpose only. HDFC Mutual Fund is not guaranteeing, promising or
forecasting any returns on investments. All the above returns have been annualised.

Assumption:
• Expenses have not been considered in the above analysis
• Green cell indicate the most likely scenarios to investors in our
opinion
*Portfolio of Investor and not Mutual Fund.

15
 Indicative optimal portfolio* performance – over
2 year

This table is for illustration purpose only. HDFC Mutual Fund is not guaranteeing, promising or
forecasting any returns on investments. All the above returns have been annualised.

Assumption:
• Expenses have not been considered in the above analysis
• Green cell indicate the most likely scenarios to investors in our
opinion
*Portfolio of Investor and not Mutual Fund.

16
 Indicative optimal portfolio* performance – over
3 year

This table is for illustration purpose only. HDFC Mutual Fund is not guaranteeing, promising or
forecasting any returns on investments. All the above returns have been annualised.

Assumption:
• Expenses have not been considered in the above analysis
• Green cell indicate the most likely scenarios to investors in our
opinion
*Portfolio of Investor and not Mutual Fund.

17
Summary of most likely returns
It appears that irrespective of whether the yields and
corporate spreads fall over 1 , 2 or 3 years, the returns
for the indicative optimal portfolio* are quite attractive.
The most likely scenarios in our opinion are summarised
below:

This table is for illustration purpose only. HDFC Mutual Fund is not guaranteeing, promising
or forecasting any returns on investments. All the above returns have been annualised.

Assumption: Expenses have not been considered in the above analysis.

*Portfolio of Investor and not Mutual Fund.
18
 HDFC Income Fund – Current
Strategy
• HDFC Income Fund shall aim to adopt the indicative
optimal portfolio strategy with 20-30% in G-secs* and
70-80% in corporate bonds
• The Fund would aim to keep the modified duration in
the range of 6-7
• Trade on spreads across asset class, ratings sectors and
maturities
• With high quality issuers available for longer tenors
(10yrs and above) at high absolute yields, the Fund
shall endeavour to keep credit risk to the minimal.

*subject to availability of instruments at the time of investments and in line with the investment objective of the scheme.

19
 HDFC Income Fund - Product
Features
Type of An open-ended Income Scheme
Scheme
Investment To optimize returns while maintaining a balance of
Objective safety, yield and liquidity
Inception Date September 11, 2000
Investment Growth and Dividend. The Dividend Option offers
Plan / Options Dividend Payout and Reivestment facility
Minimum Purchase:
Application • Rs. 5,000 and any amount thereafter
Amount Additional Purchase:
• Rs. 1,000 and any amount thereafter
Benchmark CRISIL Composite Bond Fund Index
Index

20
 HDFC Income Fund – Product
Features*
Entry / Sales Direct Applications & Applications routed through
Load any Agent / Distributor / Broker: Nil
(Non–SIP/STP)

Exit Load • In respect of each purchase / switch-in of units

(Non-SIP/STP) less than Rs. 1 crore in value:
– An exit load of 2.00% is payable if units are redeemed / switched out
within 6 months from the date of allotment
– An exit load of 1.00% is payable if units are redeemed / switched –
out after 6 months but within 1 year from the date of allotment

• In respect of each purchase / switch-in of units

equal to or greater than Rs. 1 crore in value:
– An exit load of 0.50% is payable if units are redeemed / switched out
within 3 months from the date of allotment
– An exit load of 0.25% is payable if units are redeemed / switched out
after 3 months but within 6 months from the date of allotment

*The aforesaid change will be applicable on a prospective basis from December 15, 2008 in respect of investments
made in HDFC Income Fund. The Trustee reserves the right to change / modify the load structure at a later date on
prospective basis. All other terms and conditions of the scheme will remain unchanged.
For details on load structure on SIP / STP refer SIP / STP enrolment form available on the website, Investor Service Centres (ISCs)
www.hdfcfund.com or with the distributors / agents.
21
Why HDFC Income Fund?

• Exposure to a diversified portfolio of debt securities

• Strong emphasis on risk control – credit, interest rate and

liquidity risk

• Emphasis on superior credit quality; no investments in

instruments below investment grade

• Flexibility to invest in the entire range of debt and money

market instruments to take advantage of various interest rate
scenarios

• Units of HDFC Income Fund are declared as “Public Securities”

under the Bombay Public Trust Act, 1950

• No entry load
22
 HDFC High Interest Fund – Current
Strategy
• HDFC High Interest Fund shall aim to adopt the
indicative optimal portfolio strategy with 25-40% in G-
secs* and 60-75% in corporate bonds
• The Fund would aim to keep the modified duration in
the range of 5-8
• Trade on spreads across asset class, ratings sectors and
maturities
• With high quality issuers available for longer tenors
(10yrs and above) at high absolute yields, the Fund
shall endeavour to keep credit risk to the minimal.

*subject to availability of instruments at the time of investments and in line with the investment objective of the scheme.

23
 HDFC High Interest Fund - Product
Features
Type of Scheme An open-ended Income Scheme

Investment To generate income by investing in a range of debt and

Objective money market instruments of various maturity dates with a
view to maximise income while maintaining the optimal
balance of yield, safety and liquidity

Inception Date April 28, 1997

Investment Plan / Growth plan, Dividend Plan offers Quarterly, Half Yearly and
Options Yearly Dividend Options. All the Dividend Options offer
Dividend Payout and Reinvestment facility
Minimum Purchase:
Application • Rs. 5,000 and any amount thereafter
Amount Additional Purchase:
• Rs. 1,000 and any amount thereafter

Benchmark Index CRISIL Composite Bond Fund Index

24
 HDFC High Interest Fund - Product
Features
Entry / Sales Direct Applications & Applications routed through
Load any Agent / Distributor / Broker: Nil
(Non–SIP/STP)

Exit Load • In respect of each purchase / switch-in of units

(Non-SIP/STP) upto and including Rs. 10 lakhs in value:
– An exit load of 0.50% is payable if units are redeemed / switched out
within 6 months from the date of allotment

• In respect of each purchase / switch-in of units

greater than Rs. 10 lakhs in value:
– No exit load is payable

For details on load structure on SIP / STP refer SIP / STP enrolment form available on the website,
Investor Service Centres (ISCs) www.hdfcfund.com or with the distributors / agents.

25
Annexures
 7.50
8.00
8.50
9.00
9.50
10.00
10.50

200.00
220.00
240.00
260.00
280.00
300.00
320.00
Dec-05
1-Sep-06

1-Nov-06 Mar-06

1-Jan-07
Jun-06

1-Mar-07

Sep-06

Source: Bloomberg, IIP – Index of Industrial Production

1-May-07

Dec-06
1-Jul-07

Mar-07
1-Sep-07
IIP
Slowing Real economy

1-Nov-07
GDP Qtrly yoy

Jun-07

1-Jan-08

Sep-07

1-Mar-08

Dec-07

1-May-08

Mar-08
1-Jul-08

1-Sep-08
27

Jun-08
India’s vulnerability to oil

High Oil prices

Higher Current Higher Fiscal High Interest

Account Deficit Deficit rates, Inflation

Slower Growth

We feel all these have peaked and Markets will start discounting the same
28
 Impact of oil
India’s vulnerability to oil has been a major concern, particularly for
the FIIs
• Oil consumption = ~7% of India’s GDP
– World average ~5%, US = 5%, China = 7%

• Oil Imports - 30% of India’s total imports in FY08

– Gross Oil imports = $77bn in FY08 (net imports (E) - $58bn)
– FY08 avg price = $85/bbl
– At avg $110, FY09E oil imports to rise $20bn (2% of GDP)

• Large subsidy bill

– FY08 – Rs.770bn ($19bn)
– FY09e – Rs.1.7trillion ($38bn) @ $1105, ($1/bbl = $600mn of
subsidy)

• Fuel & Light - 14% weight in WPI

Source: Media, Merrill Lynch, World Bank, British Petroleum

29
 Sharp Correction in Crude & other
Commodities
Crude Oil Zinc Lead

900.00

800.00

700.00

600.00

500.00

400.00

300.00

200.00

100.00

0.00
5-Jan-98

5-Jan-99

5-Jan-00

5-Jan-01

5-Jan-03

5-Jan-04

5-Jan-05

5-Jan-06

5-Jan-07

5-Jan-08
5-Jan-02
5-Jul-99

5-Jul-00

5-Jul-01

5-Jul-02

5-Jul-05

5-Jul-06

5-Jul-07
5-Jul-98

5-Jul-03

5-Jul-04

5-Jul-08
Slowing global growth, stability in USD, suggest best of
commodity prices are behind
Source: Bloomberg. As on November 24, 2008.
30
 0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
10-Nov-07

24-Nov-07

8-Dec-07
WPI
22-Dec-07

5-Jan-08

19-Jan-08

2-Feb-08

16-Feb-08

1-Mar-08

Source: Bloomberg. WPI – Wholesale Price Index

15-Mar-08

29-Mar-08

12-Apr-08

26-Apr-08

10-May-08
WPI

24-May-08

7-Jun-08

21-Jun-08

5-Jul-08

19-Jul-08

2-Aug-08

16-Aug-08

30-Aug-08

13-Sep-08

27-Sep-08

11-Oct-08

25-Oct-08
31

8-Nov-08
 10.00
11.00
12.00
13.00

4.00
5.00
6.00
7.00
8.00
9.00
25-Nov-98
25-Mar-99
25-Jul-99

25-Nov-99
25-Mar-00

25-Jul-00
25-Nov-00
25-Mar-01

25-Jul-01
25-Nov-01

Source: Bloomberg. As on November 25, 2008.

25-Mar-02
25-Jul-02

25-Nov-02
25-Mar-03
25-Jul-03

25-Nov-03
10 year G-sec Yields

25-Mar-04
25-Jul-04
10 Yr G-Sec (%)

25-Nov-04
25-Mar-05
25-Jul-05

25-Nov-05
25-Mar-06
25-Jul-06

25-Nov-06
25-Mar-07
25-Jul-07

25-Nov-07
25-Mar-08
25-Jul-08
32

25-Nov-08
India transitioning to a large economy
2006 GDP 5 year 2011GDP
(US$bn) CAGR (US$bn)

(Estimates)
USA 13,202 3.0 15,313
Japan 4,340 1.8 4,746
Germany 2,907 1.1 3,063
UK 2,345 2.5 2,647
France 2,231 1.5 2,406
Italy 1,845 0.7 1,907
Canada 1,251 2.7 1,433

Mexico 839 2.8 963

Brazil 1,068 3.2 1,252
0
China 2,668 10.0 4,301
India 906 7.8 1,318

India is fast catching up with the bigger economies of the world due to
the higher growth rates. The Indian economy will be one of the biggest
among developed and developing countries, nearing that of Canada in
the coming years.

Source: Based on recent data from Bloomberg 33

 0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
1-Nov-98

1-Mar-99

1-Jul-99

1-Nov-99
Euro
1-Mar-00

1-Jul-00

1-Nov-00

1-Mar-01

1-Jul-01

Source: Bloomberg. As on October 31, 2008.

1-Nov-01

1-Mar-02

1-Jul-02

1-Nov-02

1-Mar-03

1-Jul-03
India - US

1-Nov-03

1-Mar-04

1-Jul-04

1-Nov-04
India - Euro

1-Mar-05

1-Jul-05

1-Nov-05

1-Mar-06

1-Jul-06

1-Nov-06

1-Mar-07

1-Jul-07

1-Nov-07
10yr G-sec yield spread of India with US and

1-Mar-08

1-Jul-08
34
• Disclaimer: This presentation is for information purposes only. These views alone are not sufficient and should not be used
for the development or implementation of an investment strategy. It should not be construed as investment advice to any
party. All opinions, figures and estimates included in this presentation are as of the latest available date and are subject to
change without notice. The opinions, figures and other charts, etc. are sourced from publicly available information, other
sources like Bloomberg, in house research and/or are just internal interpretation/analysis of reports/data sourced from the
aforesaid sources. The statements contained herein may include statements of future expectations and other forward-looking
statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties
that could cause actual results, performance or events to differ materially from those expressed or implied in such
statements. Neither HDFC Asset Management Company Limited (HDFC AMC), nor any person connected with it, accepts and
liability arising from the use or in respect of anything done in reliance of the contents of this information /data. While utmost
care has been exercised while preparing the presentation, HDFC AMC does not warrant the completeness or accuracy of the
information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient of this
material should rely on their investigations and take their own professional advice.

• Risk Factors: All mutual funds and securities investments are subject to market risks and there can be no assurance that
the Scheme’s objectives will be achieved and the NAV of the Scheme may go up or down depending upon the factors and
forces affecting the securities market. Past performance of the Sponsors and their affiliates / AMC / Mutual Fund and its
Scheme(s) do not indicate the future performance of the Scheme of the Mutual Fund. There is no assurance or guarantee to
unit holders as to the rate of dividend distribution nor that dividends will be paid regularly. Investors in the Scheme(s) are not
being offered any guaranteed / assured returns. The NAV of the units issued under the Scheme(s) may be affected, inter-alia
by changes in the interest rates, trading volumes, settlement periods, transfer procedures and performance of individual
securities. The NAV will inter-alia be exposed to Price / Interest Rate Risk and Credit Risk. HDFC Income Fund (an open-
ended income scheme; the objective of the scheme is to optimize returns while maintaining a balance of safety, yield and
liquidity) and HDFC High Interest Fund (an open-ended income scheme; To generate income by investing in a range of
debt and money market instruments of various maturity dates with a view to maximise income while maintaining the
optimal balance of yield, safety and liquidity) are only the name of the Scheme(s) and does not in any manner indicate
either the quality of the Scheme(s), their future prospects and returns. Please read the Offer Document of the Scheme(s)
before investing. Investment Pattern: HDFC Income Fund: Debt Instruments (including securitised debt): 80% - 100%.
Money Market Instruments (including cash/call money): 0%- 20%. HDFC High Interest Fund: Debt and Money Market
Instruments (including Securitised debt): 100%. Load Structure: HDFC Income Fund: Entry Load: Direct applications and
applications routed through any agent / distributor / broker: Nil. Exit Load: In respect of each purchase/switch-in of units less
than Rs. 5 crore in value an exit load of 2.00% is payable if units are redeemed / switched – out within 1 year from the date of
allotment. In respect of each purchase/switch-in of units less than Rs. 5 crore in value an exit load of 1.00% is payable if units
are redeemed / switched out after 1 year but within 2 years from the date of allotment. In respect of each purchase / switch
– in of units equal to or greater than Rs. 5 crore in value an exit load of 0.50% is payable if units are redeemed / switched out
within 3 months from the date of allotment. In respect of each purchase / switch – in of units equal to or greater than Rs. 5
crore in value and exit load of 0.25% is payable if units are redeemed / switched out after 3 months but within 6 months from
the date of allotment. HDFC High Interest Fund: Entry Load: Direct applications and applications routed through any
agent / distributor / broker: Nil. Exit Load: In respect of each purchase/switch-in of units upto and including Rs.10 lacs in
value, an exit load of 0.50% is payable if units are redeemed / switched – out within 6 months from the date of allotment. In
respect of each purchase/switch-in of units greater than Rs.10 lacs in value, no exit load is payable. Statutory Details:
HDFC Mutual Fund has been set up as a trust sponsored by Housing Development Finance Corporation Limited and Standard
Life Investments Limited (liability restricted to their contribution of Rs. 1 lakh each to the corpus) with HDFC Trustee
Company Limited as the Trustee (Trustee under the Indian Trusts Act, 1882) and with HDFC Asset Management Company
Limited as the Investment Manager.
35
Thank you