Market Review - May 2021

Macroeconomic Update

Global economy continues to grow at a healthy pace with strong data coming from major economies like US, China, UK, etc. The improvement was supported by demand recovery aided by fall in Covid-19 cases, fast roll out of vaccine, high savings in Advanced Economies (AEs), large fiscal stimulus, easing restrictions, sequential improvement in employment and manufacturing, etc. The recovery momentum in faltered on back of localised lockdowns by practically all major states. While the stringency of lockdowns is lower than one imposed last year but effect on demand and economic activities, especially discretionary ones was prominent. While the number of cases has fallen sharply from the peak seen during first half of May 2021, some State Governments took precautionary approach and have extended the lockdowns into June 2021, albeit with some relaxations. While it appears that worst is largely behind us, economic recovery is likely to be impacted in June 2021 as well, though to a lesser extent than May 2021.

Update on COVID-19: The total Covid-19 cases increased to over % of population 171 million as on 31 May 2021 from ~153 million a month ago with ~50% of the increase on account of India. New cases in Given 1+ dose Fully vaccinated Population (in million) advanced economies like US, UK, Europe etc. moderated Israel 60 57 8.7 significantly as the vaccination drive progressed at a healthy pace. U.K. 59 39 67.9 In many of the advanced economies, significant proportion of eligible population has been vaccinated and is likely to achieve Canada 51 5 37.7 herd immunity by end of this year. U.S. 51 41 331.0 China 47 NA 1,439.3 In India, the total cases rose to over 28 million as on 31 May 2021 from ~19 million as of end of last month as the new cases rose Germany 43 18 83.8 sharply during the first half of the month. However, the new cases EU 38 18 447.7 addition declined at rapid pace, in the second half of the month, as Brazil 22 11 212.6 the restrictions imposed by States helped to curb the spread. This along with strong recovery rate helped to reduce the active cases Mexico 17 10 128.9 from ~3.2 million as of 30 April 2021 to ~2 million as on 31 May India 13 3 1,380.0 2021. Further, the death rate remained low at 1.1% compared to Russia 10 7 145.9 global average of over 2%. Vaccination roll out in India was impacted by lack of availability of vaccines during the month. Indonesia 6 4 273.5 Supply is expected to ramp up over next couple of months as the Source: Bloomberg; JM Financials vaccine producers ramp up their capacity. By end CY21, also expected to have vaccinated significant proportion of their eligible population.

India's GDP growth recover strongly in Q4, lockdowns to slowdown the momentum: GDP in Q4FY21 rebounded strongly and grew at 1.6% YoY better than official estimate of Central Statistical Office (CSO). The improvement was driven by increased government spending which jumped over 28% YoY driven by clearance of dues against subsidies and acceleration in spending by both Central and State Governments. Private consumption (PFCE) also turned positive after 3 quarters of consecutive contractions. Interestingly, investment grew at healthy pace driven by strong execution and government thrust on capex. With domestic demand normalising, imports growth improved and outpaced growth in exports.

On the GVA side, while agriculture remained resilient in Q4FY21, manufacturing sector and services grew at a robust pace. Services sector growth turned positive driven by higher government spending and continued improvement in financial and real estate services, although trade, hotels, transport services continued to act as a drag.

Quarter ended (YoY, %) 31-12-2020 31-03-2021 Quarter ended (YoY, %) 31-12-2020 31-03-2021 GDP 0.5 1.6 GVA 1.0 3.7 Private Consumption -2.8 2.7 Agriculture, forestry & fishing 4.5 3.1 Government Consumption -1.0 28.3 Industry 2.9 7.9 Gross Capital Formation 3.0 13.8 Manufacturing 1.7 6.9 Gross fixed capital formation 2.6 10.9 Construction 6.5 14.5

Exports -3.5 8.8 Services -1.2 1.5 Imports -5.0 12.3 Trade, hotels, transport, etc. -7.9 -2.3

The recovery in economy will be impacted by lockdowns imposed by major states in India, however the impact is likely to be considerably lower than last year's lockdown. The economic impact is visible in last couple of months with recovery momentum slowing and there is rise in uncertainty on revival due to possible impact on consumer sentiments due to 2nd wave. In our view, given the low base, strong external sector, pent up demand and normalisation of activity, growth should recover strongly H2FY22 onwards. This is provided the Covid-19 situation does not deteriorate from here on and improves sequentially.

1/7 Market Review - May 2021

Macroeconomic Update (contd...)

Recovery momentum faces headwind due to 2nd wave: Economic revival was considerably impacted with most indicators deteriorating sequentially. While the goods movement through railway were relatively stable, manufacturing PMI was significantly lower than last month and just above the contraction threshold of 50. The impact of lockdowns was visible with key indicators like power demand, retail auto registration, E- way bills, unemployment, etc. significantly affected.

Indicators Units Apr-20 Sep-20 Dec-20 Mar-21 Apr-21 May-21 Retail registration - Auto@ 2W -52.5 -10.3 -2.1 -5.7 -19.1 -46.1 PV -68.5 7.2 12.4 16.6 -2.2 -37.6 MHCV -65.5 -49.9 -25.5 -9.7 -15.9 -46.2 LCV -51.8 -8.0 -13.7 -3.1 -15.8 -51.6 Tractors -60.8 38.7 18.7 21.8 3.1 -34.8 2year CAGR, Gross GST Collection -44.1 0.5 10.3 7.8 11.4 1.2 % Average E-Way bill generated -44.5 9.3 13.3 13.9 5.8 -14.2 Power demand -10.1 1.5 2.1 5.7 3.2 -4.7 IMPS Spending 8.9 40.7 41.1 36.2 33.1 21.5 Railway Freight Tonnage -18.3 3.9 6.5 4.4 5.0 4.6 Railway Freight Earnings -21.8 4.2 2.7 0.9 2.4 2.5 Manufacturing PMI* Index 27.4 56.8 56.4 55.4 55.5 50.8 Services PMI* Index 5.4 49.8 52.3 54.6 54.0 46.4 Unemployment % 23.5 6.7 9.1 6.5 8.0 11.9 Labour Force Participation Rate % 35.6 40.7 40.6 40.2 40.0 40.0

Given the favourable base effect because of nationwide lockdown during last year, 2year CAGR is used to assess the state of economic activities. Source: Raildrishti.com, MOFSL, gstn.org.in, www.icegate.gov.in, CMIE, PIB, RBI, vaahan.parivahan.gov.in, *Number >50 reflects expansions and number <50 reflects contraction compared to previous month @ - May 2021 figures are preliminary data and are subject to revision.

While the number of cases has moderated from the recent highs, states have extended the lockdowns for few more weeks to check the spread. The economy is likely to open in a phased manner and impact of consumer sentiments, higher health spending, etc. can result in economic revival facing some headwinds in the near term. The sectors like auto, contact intensive services, discretionary spending, etc. are likely to be impacted more than other sectors. Over time, we expect as the vaccination reaches a critical mass and restrictions are eased to a large extent, we may see recovery momentum improving. This is based on the assumption that the situation does not deteriorate significantly from hereon and things improve sequentially.

Centre's fiscal deficit widened further; to remain stretched: Fiscal deficit in FY21 widened to 9.3% of fiscal deficit, close to revised estimates of 9.5%. The improvement was driven by positive surprise in revenue collections during the last quarter as strong economic recovery resulted in buoyant tax collections. Despite YoY fall in GDP, strong indirect tax collections (mainly due to auto fuel taxes and higher GST collections) led to gross tax revenue growing by ~1% YoY. While capital receipts and non-tax revenue declined, it was still better than revised estimates. Government spending increased by 30.7% led by clearance of dues on account of food and fertilisers subsidies. Further, total spending on capex also increased driven by loans to Railways and higher spend on defence and roads.

FY20A FY21P Change (YoY)

Gross tax revenue 20,099 20,249 0.7% Total Direct Tax 10,372 9,264 -10.7% Total Indirect Tax 9,727 10,984 12.9% Less: Share of States & others 6,540 6,008 -8.1% Net Tax collection 13,559 14,240 5.0% Non-Tax Revenue 3,262 2,081 -36.2% Total Revenue Receipts 16,821 16,321 -3.0% Total Capital Receipts 686 576 -16.0% Total Receipts 17,507 16,897 -3.5%

Total Revenue Expenditures 23,496 30,864 31.4% Total Capital Expenditures 3,367 4,248 26.2% Total Expenditures 26,864 35,112 30.7%

Gross Fiscal Deficit -9,356 -18,215 94.7% Fiscal Deficit as % of GDP -4.6% -9.3% Source: CMIE. P - Provisional, A – Actual, YoY – Year on Year

Government estimates fiscal deficit to narrow to 6.8% in FY22 aided by normalisation of tax collections, higher divestment proceeds and lower subsidy payments. While government was conservative in its estimates when the budget was announced, but the 2nd wave and subsequent lockdowns has increased the risk of fiscal slippage. However, the situation is still evolving and fiscal deficit will depend on how the economy recovers post the unlocking.

2/7 Market Review - May 2021

Macroeconomic Update (contd...)

Retail Inflation moderates due to favourable base, likely to YoY, % Mar-21 Apr-21 Change in % remain rangebound: CPI declined closer to RBI target of 4% in April 2021 mainly driven by favourable base. The fall in CPI CPI 5.5 4.3 -1.2 was driven by YoY fall in food & beverages inflation mainly -2.6 because of fall in vegetable prices due to base effect Food & Beverages 5.2 2.7 (Vegetable CPI rose by 23.6% in April 2020). However, this Fuel and Light 4.4 7.9 3.5 was partly offset by elevated inflation in edible oil, eggs, meat and fish. Interestingly, CPI ex of vegetables declined modestly Housing 3.5 3.7 0.2 from 6.2% in March 2021 to 5.6% in April 2021. Further, Core Core CPI@ 5.9 5.4 -0.5 CPI was also lower for the month as the base effect kicks in for personal effects (like gold) and education. Even in core CPI Source: CMIE; @-CPI excluding food, fuel, transportation & housing certain components like health, tobacco, etc. continue to remain at elevated level. The momentum of Core CPI continues to remain strong indicating build-up of inflation pressure.

The base effect impact is likely to fade away from May 2021 onwards and CPI is likely to inch higher going forward. Further, the faster recovery in demand, supply chain disruption, rise in international commodity prices, higher inflation expectations, etc. can put upward pressure on CPI but it is likely to remain within upper bound of RBI's target range (6%).

WPI rises sharply driven by base effect, likely to inch higher Change (%) before moderating: Wholesale inflation climbed over 10.5% YoY, % Mar-21 Apr-21 due to base effect (April 2020 WPI: -1.4%) as well as strong WPI 7.4 10.5 3.1 momentum. The low price base of oil and food articles led to Primary articles 6.4 10.2 3.8 YoY increase in WPI as the prices have normalised to a large Food articles 3.2 4.9 1.7 extent. Increase in core WPI was on back of higher global commodity prices and higher prices in sectors like metals, Crude petroleum and gas 32.1 79.6 47.4 textiles, paper products, chemicals, rubber related items, etc. Fuel & power 10.3 20.9 10.7 Mineral oils 18.0 45.3 27.3 Going forward, the base effect should drive WPI higher in May Electricity 2.6 -2.5 -5.1 2021 as well. Further, rally in global commodity, squeezed producer margins, return of pricing power to producers etc. Manufactured products 7.3 9.0 1.7 could add to the upward pressure. However, the lockdown Core WPI (WPI ex food and fuel) 7.2 8.5 1.3 imposed by various states can negate the impact to a certain Source: CMIE extent. While there is risk to WPI trickling into CPI, given that WPI is more for good prices and CPI has higher component of services, the impact on CPI is likely to be limited.

Trade Deficit plummet in May-2021, likely to widen Change sequentially: Trade deficit plunged to USD 6.3 billion from Amount in USD billion Apr-21 May-21# USD 15.1 billion last month driven by fall in net oil and gold Trade Deficit / (Surplus) 15.1 6.3 -8.8 imports as the mobility restrictions, supply chain disruption Net Oil Imports 7.3 4.2 -3.1 and precautionary savings impacted the demand of oil and Net Gold Imports* 5.3 0.0 -5.3 gold. The NONG imports were largely flat month on month -0.4 with increase in imports of fertilizers, professional goods, etc. Deficit ex of oil and gold 2.5 2.1 offset by lower import of transport equipments. NONG Source: CMIE, Ministry of Commerce; # - preliminary data, * includes net imports of gold, exports were also flat month on month with higher exports of silver and precious stones adjusted for gems and jewellery exports. goods and chemicals, largely offset by lower agriculture goods and textile exports.

The impact of lockdowns is likely to persist in near term as the gradual recovery can impact domestic demand. However, as the restrictions are eased, pent up demand is likely to result in import demand normalizing at fast pace. Thus, trade deficit is likely to widen going forward assuming restrictions are eased starting in June 2021. Further, rise in oil and gold prices can also further widen the trade deficit as the volumes stabilize.

Commodity prices continue to trend higher: Strong recovery in global demand especially in US and China along with Change Market price (USD)* May-21 (m-o-m) FYTD22^ optimist outlook and ample global liquidity bode well for the Brent Crude (per barrel) 69.3 3.1 9.1 commodity prices and major commodities continued to rally in Gold (per ounce) 1,907 7.8 11.7 May 2021. Gold prices also increased on back of stable US Steel (per tonne) 935 (1.6) 23.0 Treasury yields and easing concerns over early roll back of Zinc (per tonne) 3,040 4.7 8.7 monetary stimulus by US Fed. INR appreciated by ~2% against Copper (per tonne) 10,160 2.1 14.8 USD during the month supported by buoyant capital flows. Aluminium (per tonne) 2,459 2.1 12.4 Lead (per tonne) 2,208 4.3 12.9 Source: Bloomberg; *Market prices as on May 31, 2021; ^ change in prices in FY21, m-o-m : Month on Month

3/7 Market Review - May 2021

Macroeconomic Update (contd...)

Summary and Conclusion

The second wave of Covid-19 has been significantly higher than first one and likely to hinder the pace of recovery. This is visible in economic activity indicators moderating over the past couple of months. While there is rising concern of impact on consumer sentiments and whether the recovery will be as quick as last year, we believe that fast pace normalisation will happen as the economic activity stabilizes. Further, a substantial proportion of population will be vaccinated in India by end of this year which is likely to support the rebound. On a full year basis, overall economic impact is not likely to be material provided Covid-19 related situation does not deteriorate significantly from hereon. The healthy investment growth in Q4FY21 and thrust of Central Government to push capital spending through higher budgetary allocation, improving access to infrastructure financing, etc. should also aid the revival. Considering the above, in our opinion, growth is likely to be strong in FY22 on back of favourable base effect, supportive fiscal and monetary policy and buoyant global environment. While the current account is likely to be worse off relative to FY21, but Balance of Payment (BoP) position remains comfortably supported by robust capital flows and large forex reserves.

Over the medium term, India is likely to gain from shift of global manufacturing from China to other emerging markets. Favourable Government policies and initiatives create a conducive environment to capitalise on this trend and thus, can provide a good growth impulse to the manufacturing sector and economy.

Equity Market Update

Indian equities were buoyant during the month and NIFTY 50 ended 6.5% higher than last month. Equity movement during the month were driven by considerable drop in new and active cases in India, better than expected Q4FY21 results, strong global recovery, rally in commodity prices, unveiling of large fiscal spending plan by US Government, receding concern on premature withdrawal of liquidity by US Fed and moderation in US treasury yields. While smallcaps outperformed, midcap returns were in line with largecaps during the month. Most major sector indices delivered positive returns with Power, Capital goods, Oil and Gas being best performing sectors while for Healthcare, IT, FMCG and Metal returns were relatively lower.

Global equities performance was strong with most major indices in key countries delivering positive returns. The tables below give the details of performance of key domestic and global indices.

% Change in Indices May-21 FYTD21^ % Change May-21 FYTD21^

S&P BSE India Auto 8.6 5.8 S&P 500 0.5 5.8 S&P BSE India Bankex 8.1 7.4 S&P BSE India Capital Goods 11.1 6.6 FTSE 0.8 4.6 S&P BSE India FMCG 5.0 2.0 DAX 1.9 2.8 S&P BSE India Healthcare 4.3 15.0 S&P BSE India Metal 5.9 31.5 CAC 2.8 6.3 S&P BSE India Power 13.5 13.8 Nikkei 0.2 (1.1) S&P BSE India Oil & Gas 9.8 11.1 S&P BSE India IT 4.9 3.9 Hang Seng 1.5 2.7

S&P BSE SENSEX 6.5 4.9 KOSPI 1.8 4.7 NIFTY 50 6.5 6.1 Shanghai 4.9 5.0 NIFTY Midcap 100 6.5 8.8 NIFTY Smallcap 8.2 14.2 MSCI Emerging Market 2.1 4.5

^ returns for FY21

FPIs were net seller during the first half but turned buyer during the second half of the month. FPIs sold net equity worth USD 0.4 billion during month of May 2021. On a cumulative basis, FPIs during the first 5 months of CY21 registered net inflows of USD 5.9 billion compared with net outflow of USD 5.4 billion (March 2020 alone witnessed net outflow of USD 8.3 billion) in the same period last year.

Domestic equity oriented mutual funds registered net inflows of INR 4,221 crore in April 2021 compared with a net inflows of INR 12,399 crore a month ago. In first 4 months of CY21, domestic mutual funds have recorded net outflows of ~INR 4,150 crores compared to net inflows of ~INR 11,300 crores last year.

Out of results declared so far for Q4FY21, results of sectors like Auto, (especially corporate banks), Insurance, Chemicals, Energy and Metals were better than expected whereas that of Utilities, Infrastructure and capital goods were in largely in line with expectations. Results of Consumer staples, consumer durables, NBFCs and Pharma sectors were relatively below expectations. In Q4FY21, the corporate profitability has improved significantly driven by better than expected recovery in demand, higher realisation, cost rationalisation, etc. Specifically, lower provisioning in banks, improvement in execution in Infrastructure, higher spreads in metals, etc. supported earnings.

4/7 Market Review - May 2021

Equity Market Update (contd...)

Market rally becomes broad based in CY21: After delivering healthy returns CY NIFTY50 Returns Top 5 contributors between Apr-Dec 2020, rally in equity markets continued in CY21. While 2005 39.1 48.9 NIFTY 50 has scaled new heights, one should view the same in context that over the past 10 years and 15 years, NIFTY 50 returns are largely in line with nominal 2006 46.2 45.8 GDP growth. Further, during the period CY18-CY20, the returns from NIFTY 2007 57.1 47.7 50 were polarised with top 5 stocks contributing bulk of the returns. However, 2008 (51.2) n.a. CY21 witnessed performance of the broader market improving 2009 77.9 38.1 (refer adjoining Table and Chart 1) 2010 19.5 53.5 2011 (23.6) n.a. 2012 29.9 49.8 Chart 1 2013 8.5 102.3 2014 33.4 38.8 2015 (2.8) n.a. 2016 4.5 72.8 2017 30.3 48.4 2018 4.6 152.2 2019 13.5 81.3 2020 16.1 81.7 5M2021 11.9 40.4 n.a. - not applicable

Source : Bloomberg

While rally has become broad based recently, there is still considerable divergence in valuations across sectors compared to their long term averages. The same has been presented in the table below:

Sector Valuations Consumer Consumer Oil and Private PSU Banks Electric Auto Cement IT services Pharma Metals Tobacco P/E# staples* Discretionary gas Banks P/B P/B utilities

Valuation multiple 24.4 53.1 68.3 15.4 30.8 25.6 27.7 2.7 8.3 15.3 1.0 8.1

10Y Average 16.5 40.9 45.0 11.2 23.1 17.9 22.6 2.5 10.2 24.2 1.1 10.6 Valuations Premium / 48.3 29.8 51.8 36.7 33.5 42.9 22.2 8.2 -18.2 -36.6 -2.8 -23.4 (discount)^

# - as on 31 May 2021. *ex tobacco; ^to Long term (LT) average Source: Kotak Institutional Equities. Stocks are part of Kotak Institutional Equities universe. Automobile and Oil & Gas valuations are high due to one company. Excluding these, the multiples are 21.8x for Auto & 7.1x for Oil & Gas vs 10 year average multiple of 19x & 9x respectively.

2nd Wave and Equity markets: The surge in Covid-19 cases in 2nd wave over the past couple of months has been significantly higher than last year. Further, strict lockdowns imposed by most states impacted the economic activity considerably. However, impact on equity markets has been relatively muted and NIFTY 50 has delivered over 6% returns since the end of March 2021. The key reason for this, in our view, is possibly the impact on corporate earnings of most major sectors is likely to be limited and that too transitory. Further, adaptation to lockdowns has been better than last time. Specifically, global cyclical sectors like metals, oil & gas, etc. are not materially impacted due to local conditions. Impact on FMCG / Pharma / Telecom / Utilities / IT etc. is also likely to be limited. Large players in financial services stand to gain from likely lower provisioning costs, technology is making them more competitive and possible increase in market share. While sectors like Auto and other discretionary spends might get impacted but their weights in NIFTY 50 are relatively low. Interestingly, ~50% of NIFTY 50 earnings is contributed by global linked sectors viz. IT, Oil & Gas, Metals and Pharmaceutical. Again, global experiences of equities in US, UK, etc. during the 2nd and 3rd wave also indicate lower impact of subsequent lockdowns on equity returns.

5/7 Market Review - May 2021

Equity Market Update (contd...)

Outlook Chart 2 As on 31 May 2021, NIFTY 50 was trading near 22x FY22E and 19.3x FY23E price to earnings ratio. In our view, these are reasonable multiples, especially given the low interest rate environment and healthy earnings growth. Further, the gap between 10Y Gsec and 1Y-Forward NIFTY 50 Earning yield* stood at 1.4, below its 10-year average of 1.7. *Earning yield = 1/(one year forward P/E). *Earning yield = 1/(one year forward P/E).

Further, though NIFTY 50 is trading near all-time highs, if one views the 10 year CAGR of NIFTY 50, returns are essentially similar to growth in nominal GDP.

In light of the above, in our opinion, markets hold promise over the medium to long term and there is still good value in select pockets of the market. Source: Kotak Institutional Equities Improvement in corporate profitability, fall in Covid-19 cases and relaxations in restrictions, easy financial conditions and low cost of capital, comfortable external sector, supportive monetary and fiscal measures, etc. also bode well for equities.

In view of the above, in our opinion, there is merit in increasing allocation to equities in a phased manner or in staying invested as the case may be (for those with a medium to long term view and in line with individual risk appetite). Resurgence of spread of COVID-19, premature unwinding of fiscal and monetary stimulus, surge in crude oil prices, higher than expected NPAs, etc. are key risks in the near term.

Debt Market Update

The fixed income markets moved within a narrow range during the month with 10-year Gsec yields ending the month at 6.02%, marginally lower than last month. Support measures announced by RBI during the month, receding of US treasury yields, rising concern of growth and ample global and domestic liquidity were the key driving factors. Further, higher than expected dividend by RBI, moderation in CPI and part rejections of bid in government auctions also kept the yields under check despite concerns over fiscal slippage and rising oil prices.

The table below gives a summary view of movement of key rates and liquidity:

Average net interbank liquidity surplus declined as the CRR was increased from Apr-21 May-21 Change (%) 3.5% to 4% of NDTL from early May 2021. 10Yr Benchmark G-Sec Yield^ (%) 6.03 6.02 -0.01 However, OMO purchases and acquisition AAA 10Year Corporate Bond Yields#& (%) 6.84 6.81 -0.03 under G-SAP by RBI and soft credit growth @ vis-à-vis deposit growth kept the interbank AAA 10Y corporate bond spread against 10Y benchmark (bps) 81 79 -0.02 liquidity in large surplus. Average net liquidity absorbed / (infused) by RBI* (INR billion) (approx.) 5,490 4,628 -15.7 Net FPI flows in debt were marginally MIBOR Overnight Rate (%) 3.43 3.39 -0.04 positive (USD 34 million only) during the month (April 2021: USD 29 million) .On a ^ - bi-annual yield; #-annualised yield; & - Average yield of 6.49% NABARD maturing on 30-Dec-2030 provided cumulative basis, in 5MCY21, FPIs net by Independent valuation agencies has been taken. @ - Spreads calculated by subtracting non-annualised Gsec inflows into debt has been USD 0.2 billion yields from annualised corporate bond yields. *Average net daily liquidity infused / absorbed through Liquidity Adjustment Facility, exports refinance, compared to net outflows of USD12.5 marginal standing facility and term repos/reverse repos; billion during the same period last year.

The Monetary Policy Committee (MPC) in its meeting concluded on 4th June 2021 unanimously voted to keep the policy Repo Rate and Reverse Repo Rate unchanged at 4.0% and 3.35% respectively. It also voted in favour of maintaining an accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. RBI also announced following measures to support financial conditions:

Ÿ Undertake secondary market purchase through G-SAP 2.0 of INR 1.2 lakh crore in Q2FY22. Further, it announced conduct of INR 40,000 crore secondary market purchases of government securities (including INR 10,000 crores SDLs) under G-SAP 1.0

Ÿ Liquidity facility of INR 16,000 crore was provided to SIDBI for on-lending/refinancing through novel models and structures including double intermediation, pooled bonds/loan issuances, etc. The facility will be available at repo rate for a period of up to one year.

Ÿ Liquidity window of INR 15,000 crore with tenor upto 3 years at the repo rates (till 31 March 2022) to banks for certain contact intensive sectors like tourism, hotels & restaurants, aviation ancillary services, etc. Banks are expected to create Covid loans portfolio under this scheme and can park surplus liquidity upto the size of this loan book with RBI at interest rate of 40 bps higher than reverse repo.

6/7 Market Review - May 2021

Debt Market Update (contd...)

Outlook

RBI monetary policy was largely in line with market expectations and yields remained in a narrow range. Monetary Policy announcement has potential of infusing additional ~INR 1.5 lakh crore liquidity in the system through G-SAP and other specially targeted liquidity facilities. Thus, financial and monetary conditions are likely to remain benign in the near term. Further, RBI and MPC statement reemphasised its focus on reviving and supporting growth and looking through the risk of marginally higher inflation. In a constrained demand environment as seen in the latest GDP data, RBI feels that the near term upside risks to CPI inflation emanate predominantly from supply side disruption.

Coming to outlook on yields, since the beginning of 2021, multiple domestic and international developments have resulted in overall environment turning adverse towards bond yields. Some of them are - surge in crude prices, increase in 10Y US treasury yields, higher than anticipated government borrowings, elevated Core CPI, etc. These have put upward pressure on yields, especially at the longer end of the curve. In our view, most of these factors are likely to persist in near future and could put further upward pressure on Gsec yields, especially at the longer end of the curve. Additionally, high SLR holding of banks and signs of broad based improvement in economic activity can also push yields higher. The risks to shorter end of the curve largely arise from use of longer tenure VRRR operations by RBI, thereby, reducing the term premia to a certain extent.

Despite the unfavourable developments, the rise in bond yields has been muted Chart 3 so far and 10Y yields have risen only ~15 bps since end of December 2020. This was mainly driven by continued RBI intervention through deployment of conventional and unconventional tools. The dovish commentary and future guidance coupled with systematic liquidity infusion done by RBI indicates that these interventions will continue in near future. This should cap any significant rise in yields. Further, comfortable external position, muted credit growth, ample global and domestic liquidity, weakness in growth due to 2nd wave of Covid-19, etc. can pull down the yields further.

In view of the above, we expect yields to trade with a marginal upward bias. Hence, we continue to recommend investments into short to medium duration debt funds, possibly, in a staggered manner in line with individual risk appetite.

While credit environment still warrants caution, measures by RBI have eased the spreads on AAA rated bonds significantly. However, opportunities exist in Long Term Average spread of AA over AAA over 10 years select pockets of non-AAA rated bonds as their spreads relative to AAA rated bonds are still trading at attractive levels. Hence, allocation to credit oriented schemes or funds with some non-AAA exposure can be maintained / increased in a phased manner, in line with individual risk appetite.

Source for various data points: Bloomberg, NSDL, CMIE, RBI, Kotak Institutional Research, Worldometers.info, World , Daily valuation provided by ICRA/CRISIL Glossary CPI Consumer Price Index NPA Non-Performing Assets CRR Cash Reserve Ratio OMO Open Market Operation FPI Foreign Portfolio Investment PMI Purchasing Managers’ Index GDP Gross Domestic Product PSU Public Sector Undertaking G-SAP Government Securities Acquisition Programme SDL State Development Loans GVA Gross Value Added SIDBI Small Industries Development Bank of India IMPS Immediate Payment System SLR Statutory Liquidity Ratio M-o-M Month on Month VRRR Variable Rate Reverse Repo MPC Monetary Policy Committee WPI Wholesale Price Index NBFC Non Banking Financial Company Y-o-Y Year on Year NDTL Net Demand and Time Liabilities

DISCLAIMER This document contains our views as on June 08, 2021. The views expressed herein are based on internal data, publicly available information and other sources believed to be reliable. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information contained in this document is for general purposes only and not an investment advice. The document is given in summary form and does not purport to be complete. The document does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. The information/ data herein alone is not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on our current views 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. Past performance may or may not be sustained in future. Stocks/Sectors referred above are illustrative and not recommended by HDFC Mutual Fund / AMC. The Fund may or may not have any present or future positions in these sectors. HDFC AMC / HDFC Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). Neither HDFC AMC and HDFC Mutual Fund (the Fund) nor any person connected with them, accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein. MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. 7/7