December 2008

Fixed Income Summary and View

Summary

• 2 contrarian forces – one inflationary and the other deflationary have been in play
since last year
– Strong demand from emerging economies leading commodities higher and fuelling
inflation worldwide
– Housing led credit crisis in the US starting to exert a ‘deflationary’ force

• The first force was dominant till early July 2008 leading commodity prices to fresh
peaks and inflation to multi year highs. Since then, however, the second force has
conclusively taken hold

• As a result commodity prices have fallen 50% from the top, growth and inflation
numbers are toppling worldwide, and central bankers have shifted focus to
achieving financial stability and protecting growth
Inflation Is Falling Across The Globe…
500 150
COMMODITY PRICES
140
450
• Commodity prices peaked in July 2008
130

120
400
and are down by more than 50% since 110

350 100
then 90
300
80

• The intensity of the fall indicates the

70
250
60

strength of the ongoing de-leveraging 200 50

Oct-08

Nov-08
Jun-08
Jan-08

Feb-08

Jul-08

Aug-08
Apr-08

May-08

Sep-08
Mar-08
process GENERIC COMMODITY INDEX CRUDE PRICE
Source: Bloomberg

• In line with the above, inflation is falling 10.5

PRODUCER PRICE INDEX
10

at a sharp pace in almost all major 9.5

9

economies across the world 8.5

8
7.5

• Recent data has sparked serious threat 7

6.5
6
of deflation in the US 5.5
5
4.5

31-Oct-08
29-Feb-08
31-Jan-08

30-Jun-08

31-Jul-08

31-Aug-08
30-Apr-08

31-May-08

30-Sep-08
31-Mar-08

US EUROZONE UK CHINA

Source: Bloomberg
…As Growth Collapses
13 5
GDP
12.5 4.5

12 4

• Major economies like the US, UK, Euro 11.5

3.5
3
11
Zone, Japan, Hong Kong and Singapore 10.5
2.5
2
are witnessing a significant slowdown in 10
1.5
9.5
1
growth 9 0.5
8.5 0

• Lead indicators are pointing towards 8 -0.5

Jun-07

Dec-07

Jun-08
Sep-07

Sep-08
Mar-07

Mar-08
further contraction around the world CHINA US EUROZONE

Source: Bloomberg
(including in China)
64
PURCHASING MANAGERS' INDICES
62
60
58
56
54
52
50

31-Oct-07

30-Nov-07

31-Oct-08

30-Nov-08
31-Jan-07

28-Feb-07

30-Jun-07

31-Jul-07

31-Aug-07

31-Dec-07

31-Jan-08

29-Feb-08

30-Jun-08

31-Jul-08

31-Aug-08
30-Apr-07

31-May-07

30-Sep-07

30-Apr-08

31-May-08

30-Sep-08
31-Mar-07

31-Mar-08
48
46
44
42
40
38
36
34
US EUROZONE UK CHINA

Source: Bloomberg
Policy Response Has Been Unprecedented

• The US Fed has been proactive in

8
POLICY RATES
7.5
7
cutting rates given that the US has been 6.5
6

the epicenter of the current crisis 5.5

5
4.5

• Inflation targeting Central Bankers of

4
3.5
3
Europe have also shifted stance. UK has 2.5
2

cut drastically recognizing the catching 1.5

1

31-Oct-07

30-Nov-07

31-Oct-08

28-Nov-08
31-Jan-07

28-Feb-07

29-Jun-07

31-Jul-07

31-Aug-07

31-Dec-07

31-Jan-08

29-Feb-08

30-Jun-08

31-Jul-08

29-Aug-08
28-Sep-07

30-Sep-08
30-Apr-07

31-May-07

30-Apr-08

30-May-08
30-Mar-07

31-Mar-08
up required
US EUROZONE UK CHINA

• Most Asian central bankers, most

Source: Bloomberg
notably the Peoples Bank of China, have
started cutting aggressively as well
A Similar Theme is Underway In India…

13.0%

• Wholesale Price Index (WPI) inflation

12.0%
11.0%
10.0%
has fallen drastically over the past few 9.0%
8.0%
weeks in line with global trends 7.0%
6.0%
5.0%

• We expect it to fall to below 3% levels by 4.0%

Projected
Inflation
3.0%
March 2009 2.0%
1.0%

May-02

May-03

May-04

May-05

May-06

May-07

May-08
Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09
Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08
• GDP growth is decidedly slowing despite
support hitherto from the services sector Source: Bloomberg &
HSBC AMIN research
11
GDP
10.5

10

9.5

8.5

7.5

7
30-Jun-05

30-Jun-06

30-Jun-07

30-Jun-08
31-Dec-05

31-Dec-06

31-Dec-07
30-Sep-05

30-Sep-06

30-Sep-07

30-Sep-08
31-Mar-06

31-Mar-07

31-Mar-08
GDP
Source: Bloomberg
…With Further Weakness Ahead
50
48 TRADE
46
44
42

• Relative freeze in domestic credit

40
38
36
34
32
markets has happened starting October 30
28
26

2008 24
22
20
18
16
14

• Monthly growth indicators like trade data

12
10
8
6

and purchasing managers’ index point to

31-Oct-07

30-Nov-07

31-Oct-08
30-Jun-07

31-Jul-07

31-Aug-07

31-Dec-07

31-Jan-08

29-Feb-08

30-Jun-08

31-Jul-08

31-Aug-08
30-Apr-07

31-May-07

30-Sep-07

30-Apr-08

31-May-08

30-Sep-08
31-Mar-07

31-Mar-08
sharply lower prints in incremental GDP EXPORTS IMPORTS

numbers Source: Bloomberg

60
PURCHASING MANAGERS' INDEX
58

56

54

52

50

48

46

44

31-Oct-08
30-Jun-08

31-Jul-08

31-Aug-08
31-May-08

30-Sep-08
PURCHASING MANAGERS' INDEX
Source: Bloomberg
Policy Has Been Proactive
11
RATES
• Policy makers have been quite proactive so 10

far with monetary as well as other 9

administrative tools 8

• However, while bank lending rates have

7

6
been cut in response, flow of credit is still to
5
resume fully

31-Oct-07

30-Nov-07

31-Oct-08

28-Nov-08
31-Jan-07

31-Aug-07
28-Feb-07

29-Jun-07

31-Jul-07

29-Aug-08
31-Dec-07

31-Jan-08

29-Feb-08

30-Jun-08

31-Jul-08
31-May-07
30-Apr-07

28-Sep-07

30-May-08
30-Apr-08

30-Sep-08
30-Mar-07

31-Mar-08
• We expect more rate cuts ahead given the
REPO RATE 1 YEAR OIS 10 YEAR GOVERNMENT SECURITY

Source: Bloomberg
need to anchor overnight rates at much lower
levels in order for banks to ‘feel the
steepness’

• The 1 yr swap rate is already pricing in

overnight rates of below 5%

• Government security yields have fallen but

still look lucrative as rate cuts should
continue
Excess Supply Is No Longer A Worry

• Government will breach its fiscal target for the year, in line with our long held view

• However, given rising delinquencies on loan books and trader appetites already whipped by
a sharp rally so far, the additional supply will be comfortably absorbed

• RBI is already committed to providing liquidity for incremental borrowing through

simultaneous buy-back of market stabilization bonds

• The opening up of spread between government securities and the swap curve partly reflects
expectation of additional supply.

• The government securities curve still provides a lucrative entry point as it might gear up for
the next leg of rally when fears around absorption of incremental excess supply are
decidedly eliminated.
Credit Spreads May Still Compress Reluctantly

500000 14

• India has had a phenomenal credit cycle 475000

450000
INDIA'S PHENOMENAL CREDIT CYCLE
13
425000 12
with the stock of credit having doubled over 400000
375000 11
350000
10
325000
last 3 years 300000
275000
9

250000 8
225000
7

• A sustained current account deficit during

200000
175000 6
150000
125000 5
this time has meant we have consistently 100000
75000
4
50000 3
relied on external funding

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08
NON FOOD CREDIT (INR CRS) CREDIT TO GDP RATIO (%)

• The current risk aversion (as reflected in Source: Bloomberg

rising emerging market bond spreads and 118

117 ASIAN CURRENCIES AND EMERGING MARKET BOND SPREADS
800
750
116 700
weakening currencies) has led to severe fall 115
114
650
600
113
in external sources of funding 112
111
550
500
110 450
109 400

• With equity markets being weak and banks

108 350
107
300
106
250
105
less willing to lend, the process of 104 200
150
103

channeling domestic savings into 102 100

Nov-07

Nov-08
Oct-07

Oct-08
Jan-07

Feb-07

Jun-07

Jul-07

Aug-07

Dec-07

Jan-08

Feb-08

Jun-08

Jul-08

Aug-08
Apr-07

May-07

Sep-07

Apr-08

May-08

Sep-08
Mar-07

Mar-08
investments has been disrupted as well ASIA DOLLAR INDEX EMERGING MARKETS' BOND SPREADS

Source: Bloomberg
Credit Spreads May Still Compress Reluctantly (cont)

• All this means that demand for funds far outstrips supply as of now. As long as this is the
case, it is unlikely that there will be any meaningful compression in spreads

• Some stability in international risk appetite (and in turn currency) may lead stabilization in
corporate spreads domestically since it may open window for external funds again

• A sustained contraction in spread will, however, only happen once demand versus supply of
credit finds a better balance than currently

• Consequently, current strategy favors government securities in building duration. At

some point, however, as triggers mentioned above begin to fructify we will go
overweight corporate bonds
Income Fund returns during the last cyclical bull run

• The last secular bond bull run lasted approximately 3 years beginning October
2000

• Average returns of of 17 income funds which were in existence over this full
period were: Year 1 = 16.9%, Year 2 = 16.6% and Year 3 = 7.9% (all returns
post expenses)*

• Average returns over the 3 years was 13.8% (post expenses)

• There are 2 inferences to be made:

– Duration play can potentially be much more powerful than play on credit risk

– One needs to stay invested over the period of a cycle in order to benefit fully
from a fall in interest rates

*Source: MFIE, HSBC AMIN Research

Disclaimer
This document has been prepared by HSBC Asset Management (India) Private Limited (HSBC) 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 HSBC, the third party believes to be reliable but which it has not independently verified and HSBC, 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 HSBC only and are subject to change without 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. Mutual fund investments are subject to
market risks. Please read the offer documents carefully before investing.

© Copyright. HSBC Asset Management (India) Private Limited 2008, ALL RIGHTS RESERVED.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC
Asset Management (India) Private Limited.

HSBC Asset Management (India) Private Limited; 314, D. N. Road, Fort, Mumbai 400 001. Tel: 6614 5000.
Risk Factors
Investors may obtain Offer Documents/ Scheme Information Document/Statement of Additional Information and Key
Information Memorandums along with application forms from the office of HSBC Mutual Fund, 314 D. N. Road, Fort,
Mumbai 400 001. Tel: 022-6666 8819.

Statutory Details: HSBC Mutual Fund has been set up as a trust by HSBC Securities and Capital Markets (India)
Private Limited (liability restricted to the corpus of Rs 1 lakh). The Sponsor / associates of the Sponsor/ Asset
Management Company (AMC) are not responsible or liable for any loss or shortfall resulting from the operation of the
Schemes. The Trustees of HSBC Mutual Fund have appointed HSBC Asset Management (India) Private Limited as the
Investment Manager.

Risk Factors: All investments in mutual funds and securities are subject to market risks and the Net Asset Value (NAV)
of the Scheme(s) may go up or down depending on the factors and forces affecting the securities markets. There can
be no assurance that the objectives of the Scheme(s) will be achieved. Past performance of the Sponsor, AMC, Mutual
Fund or any associates of the Sponsor/AMC does not indicate the future performance of the Scheme(s) of the Mutual
Fund. Please read the Offer Documents/ Scheme Information Document/Statement of Additional Information
carefully before investing.
Thank You