IN PERSPECTIVE: OUTLOOK FOR 2012

This is for investment professionals only and should not be relied upon by private investors.

December 2011

2012: GLOOM vs. OPTIMISM: WHATS IN THE PRICE?

2011 has been an intense year for equities globally, with one consistent theme volatility. Through the tsunami in Japan to unrest in the Middle East, concerns of slowing US and emerging market growth to the survival of the euro region, most equity markets have fallen notably. Would 2012 be any different or does the uncertainty spill over into the next year as well? Alexander Treves, Head of Investments, Fidelity Worldwide Investments, India feels that while the year could be challenging, it also presents an opportunity to build positions in top quality companies that have a long term competitive advantage.

Alexander Treves is Head of Investments at Fidelity, India. Alexander joined Fidelity in 2006 as Director of Research in London having gained over 11 years of extensive experience in Research and Portfolio Management across Asia and the UK. Before moving to India in April 2010, he was the Head of Research at Fidelity in Tokyo. He is a Chartered Financial Analyst and holds a Bachelor of Arts degree from Kings College, Cambridge.

Globally, three key factors that played out this year were the ongoing eurozone sovereign debt crisis, fears of a slowing US economy, and a sharper than expected rise in inflation in emerging markets prompting higher interest rates. Apart from these, we witnessed events such as the surge in commodity prices in the first half of the year due partly to the political stability in Middle East and North Africa, and the Japanese earthquake and tsunami which disrupted the global manufacturing supply chain. Of these, fears over slowing growth in the US have eased with better than expected performance of the US economy recently. However, refocus on the fiscal / debt position in the US will begin to gain headlines as the presidential elections draw closer through the latter half of the year. Inflation in emerging markets could decline over the coming months and interest rates in many economies are currently on hold. The year could further test the resilience of the emerging market growth story to the economic slowdown in the developed world. However, it will be the eurozone that is likely to dominate headlines and the situation could worsen further before being contained. Some of the key themes for 2012 could be as below:

2012 COULD BE ANOTHER CHALLENGING YEAR FOR EUROPE 2011 has witnessed developments on the economic as well as financial front in the euro region and these have prompted reactive and temporary fixes by eurozone governments. The locus of the crisis has now moved from the periphery to the core economies and even France and Germany have not been spared. Our colleagues in Europe believe we are in the last leg of the sovereign debt crisis, and the closer the crisis moves to the core economies, the faster would be the move towards more decisive action. In that sense, whether the eurozone breaks up or moves towards a credible fiscal union, 2012 is likely to be a challenging year - albeit the challenges will act as catalyst for resolution. Recent political changes in Spain and Italy are significant and new governments are fully focussed on fiscal prudence. Having said that, we may see a general repricing of core, AAA rated sovereign debt. We have started to see the beginnings of this process and the markets are ahead of the rating agencies once again. The euro region could enter into recession in view of the constrained bank lending and austerity measures. The length and depth of the recession would be dictated by the policy response from the European Central Bank.

US TO AVOID RECESSION, BUT MAY BE IMPACTED BY CONTAGION FROM EUROPE Historically, US stock markets have had a high correlation with those in Europe. The US cannot be immune from its linkages with Europe, be it through exports or financial markets or consumer confidence. The US consumer is still burdened by debt and consumer sentiment is weak, mainly due to high inflation expectations and static growth in real income. Nevertheless, on a positive note, the release of upbeat economic indicators in the recent months, including better than expected growth numbers for the third quarter, have allayed fears of a recession in the

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US. Our colleagues tracking the US markets believe that corporate profits in the US are robust. This has historically been a reliable indicator of job creation, as confirmed by the latest jobs data, and a positive indicator for a rise in capital spending and industrial activity. Nascent signs of stabilisation in house prices, a decline in foreclosures and vacant house units, and a correction in housing inventory point to a brighter outlook.

ASIAN MARKETS RESILIENCE TO PROVIDE GROWTH Most Emerging Asia economies could not stay immune to the deteriorating situation in the eurozone and sluggish growth in the US, given export linkages to the west. Capital flows to the EM have slowed leading to a further sell-off in the equity markets, tightening of credit conditions, and pressure on some currencies. Some of the countries in the region also face domestic challenges such as a correction in Chinas property market, weaker investment sentiment in India, and high household debt weighing on consumption growth in Korea. Recent data releases on the growth front in China and India suggest that economic activity is losing momentum. The second half of the year could bring in a more optimistic economic tone, particularly if against a backdrop of easing inflation; there is the prospect of strong stimulus measures in EM economies. China has signalled the beginning of an accommodative monetary policy by lowering bank reserve requirement in December for the first time in three years, while the governments of Taiwan and the Philippines have unveiled fiscal stimulus measures. The contrast between emerging and developed economies is likely to become even more conspicuous in 2012. Investors should be alert to buying opportunities in emerging markets that allow them to increase exposure at attractive prices. The long-term case for emerging markets is intact and the existence of a two-speed world in economic growth terms is likely only to become more obvious.

REFORMS AGENDA AND DIVESTMENTS COULD BE CATALYSTS FOR INDIA Apart from global headwinds, India has also been impacted by a host of local factors due to which we have had one of the worst performing Asian markets this year. These include sustained inflationary pressures, a sharp rise in interest rates, and policy inaction on the part of the government. Added to this has been the significant decline in the Indian rupee later in the year due to a sell off in risk assets, the worsening current account deficit caused by a high import bill, and waning portfolio flows. On the fiscal deficit front, the government has had little success in reducing it since the financial crisis. Several social programs like the rural employment guarantee program (which gives 100 days of minimum wage to the rural unemployed) provided substantial impulse to rural demand while making the fiscal position worse. Furthermore, large subsidy programs for food, fuel, and fertilizer also added to the adverse fiscal position and inflated demand. Besides, the government has been able to raise only a small portion of the budgeted disinvestment target so far in the current fiscal year, although a revival in its divestment program could ease financing pressure. Consensus GDP growth expectations for India have declined in tandem with the fall in industrial production, high funding costs, and slowing global economic growth. Nonetheless, a slower growth rate in India will still be considerably in excess of growth achieved in the developed world. We are hopeful that the policy environment will improve in light of the marked deterioration in the growth outlook, as that has historically acted as catalyst for the government to push through tough reform measures. Even as industrial production data has disappointed, there are some bright spots of optimism in the economy. Meanwhile, even as underlying inflation will continue to present a challenge due to structural issues, and currency depreciation could offset the decline in commodity prices, a high base effect is likely to set in and result in a fall in the inflation rate in the coming months. This should be followed by monetary policy easing which could be supportive for equities. Amongst key performance drivers that wed look out for in 2012 could be a steady improvement in infrastructure spending, progress on goods and services tax (GST), range-bound crude oil prices, and reasonable capital flows. Meanwhile, Indias economy is domestic growth oriented which is likely to limit the impact of a slowdown in western economies. Furthermore, to some extent the policy challenges, high inflation and global risk are already priced into the market. In general corporate balance sheets are healthy and quite a few top quality companies are currently trading at attractive valuations. Many companies are entering 2012 in much better shape than they did the financial crisis of 2008. They have kept their cost bases under control, continue to have access to bank lending even if terms are tighter, and have actively managed their refinancing needs in the last two years to protect themselves. As always, when

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economic conditions get tough, strong companies get stronger and our investment team remains focused, despite the macro uncertainty, on picking individually attractive companies from a long term perspective. We are finding some attractive valuations which give us an opportunity to buy long term growth businesses at cheap levels. Notwithstanding the disappointment on the growth front, over time we expect India to continue to liberalise, offering a longer term supportive environment for the next round of economic expansion. Against this backdrop, the first half of 2012 is expected to present an opportunity to build positions in top quality companies that have a long-term competitive edge, whilst prudently managing portfolio risk. Recent hiccups notwithstanding, long term growth drivers remain intact. Favourable demographics, increasing urbanisation, low household debt, robust growth in domestic consumption, and a culture of entrepreneurship driven by a healthy corporate sector are all ongoing favourable trends which increasingly the market has chosen to ignore thereby offering opportunity.

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