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Valuation & Forecast of SREI Infrastructure Finance Ltd

TABLE OF CONTENTS

Page No.

Executive Summary 03

PART ONE

Introduction 08

Introduction to the Project

Introduction to NBFCs

Introduction to SREI Infrastructure Finance Ltd

PART TWO

Analysis 33

Economy Analysis

Industry Analysis

Company Analysis

SWOT Analysis

Ratio Analysis

PART THREE

Valuation 141Firm valuation: DCF Approach

Asset Based Method

Income based Approach

Equity valuation: DDM Approach

Relative methods

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Economic Value Added (EVA)

Market Value Added (MVA)

PART FOUR

Forecasting 174

Forecasting of Profit & Loss A/C

Forecasting of Balance Sheet.

PART FIVE

Conclusion 186

Annexure 187

Bibliography 202

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EXECUTIVE SUMMARY

Non Banking Financial Companies (NBFCs) have come a long way from the

era of concentrate regional operations, lesser credibility and poor risk

management practices to highly sophisticated operations, pan-India presence and

most importantly an alternate choice of financial intermediation (not an a lternate

choice of banking as NBFCs still operate with lots of limiting factors, which

make them non-comparable to banks).

It is true that the difference between commercial banks and NBFCs is getting

increasingly blurred as NBFCs are today present in almost all the segments of

financial sector save cheque issuance and clearing facility. NBFCs are now

recognized as complementary to the banking system capable of absorbing shocks

and spreading risks at times of financial distress. The Reserve Bank of India

(RBI) also recognizes them as an integral part of the financial system and is

trying to improve the credibility of the entire sector.

Today, NBFCs are present in the competing fields of vehicle financing, hire

purchase, lease, personal loans, working capital loans, consumer loans, housing

loans, loans against shares, investments, distribution of financial products, etc.

More often than not, NBFCs are present where the risk is higher (and hence the

returns), reach is required (strong last-mile network), recovery has to be the

focus area, loan-ticket size is small, appraisal & disbursement has to be speedy

and flexibility in terms of loan size and tenor is required.

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The key differentiating factor working in favour of NBFCs is service. Today, a

borrower is looking for more convenience, quick appraisal & decision-making,

higher amount of loan-to value and longer tenor. Though banks are not behind on

the service aspect, they are largely limited to urban centers. When it comes to

semi-urban and rural centers, particularly where the banking culture still not

fully developed, NBFCs enjoy an edge over banks. However, even in the urban

areas, NBFCs have created niches for themselves, which are often neglected by

banks e.g. non-salaried individuals, traders, transporters, stock brokers, etc, and

all these categories are growing at a rapid pace.

New opportunities like home equity, credit cards, personal finance, etc, are

expected to take NBFCs to a new level. Growth in all these segments is

sustainable at a higher rate than before given the low penetration and changing

demography in the country. Secondly, 100% cover for public deposits would

ensure higher credibility to the sector. Thirdly, capital had always been a limiting

factor for the sector. In a booming economy and the capital market, we expect

that these companies are now in a better position to raise capital at competitive

rates to fuel their future growth plans. Fourthly, better risk management and

regulatory practices, NBFCs enjoy a higher credibility today. Last but not the

least, due to an established reach and network,

NBFCs could be the favorites of the foreign financial giants to make an inroad in

the country. The RBI has proposed to open the domestic market for foreign banks

after FY2009 and some of the foreign banks would not hesitate to shake hands

with NBFCs to hit the ground running.

SREI is one of Indias largest private sector infrastructure and

construction equipment financial institutions. The company began its operations

in 1989. It is headquartered in Kolkata, and has a pan-India presence with a

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network of 37 offices. It also has an international footprint, with operations in

the Russian Federation and Germany.

SREI operates in the infrastructure financing segments of infrastructure

equipment, infrastructure projects and renewable energy. It is the market leader

in the segment, managing an asset base of Rs 33931 mn (USD 762.48 mn) as on

31 st March 2006.

SREI is a widely held company, listed on the Kolkata, Mumbai, National and

London Stock Exchanges with a market share capitalization of Rs 5624 mn as on

22nd May 2006. During the year, SREI raised RS 1530 mn (USD 35 mn) through

the GDR programme with its securities being listed on the London Stock

Exchange, becoming the first NBFC to do so.

The project report basically aims at the valuation and forecast of SREI

Infrastructure Finance Ltd. The project starts with the introduction to the project,

NBFC sector and the company. It proceeds with the detailed analysis of the

firm,i.e the SWOT analysis and ratio analysis. Ratio analysis undertakes the

calculation and finding the trend of the company in respect of ratios related to

liquidity, leverage, market and profit for the last five years. The next step in the

project is valuation. A business valuation determines the estimated market value

of a business entity. A valuation estimates the complex economic benefits that

arise from combining a group of physical assets with a group of intangible assets

of the business as a going concern. The valuation, which is part art and part

science, estimates the price that hypothetical informed buyers and sellers would

negotiate at arms length for an entire business or a partial equity interest. The

value of the firm for the last five years has been calculated and compared by

using the Discounted Cash Flow method. In this method the cash flows for the

respective years are calculated and then discounted by the cost of capital. Income

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Based Methods, i.e. the Net Income Approach and the Net Operating Income

Approach are also used to find the value of the company. The next step in

valuation is finding the intrinsic value of equity for the year 2006 and 2007 using

the Dividend Discount Model. The Net Asset per share is also calculated to

estimate the worth of net assets per equity share. Relative methods like P/E ratio,

PEG ratio, Price to cash flows and many others are used to estimate the value of

equity as at 31/03/2007. After valuation the Balance Sheet and the Profit and

Loss account has been forecasted using ratios, total income and growth rate.

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PART 1

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INTRODUCTION

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INTRODUCTION TO THE PROJECT

OBJECTIVES BEHIND THE PROJECT

Primary objective :

Compute the value of SREI INFRASTRUCTURE FINANCE LTD.

Compute the intrinsic value of SREI INFRASTRUCTURE

FINANCE LTD.

Secondary objective :

To do the financial statement analysis

To do the fundamental analysis for the determination of intrinsic

worth of the firm

To do the Economic analysis

To do the Industry analysis

To do the Company analysis

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INTRODUCTION TO NBFCs

The financial system comprises of financial institutions, financial instruments

and financial markets that provide an effective payment and credit system and

thereby facilitate channelising of funds from savers to the investors of the

economy. In India considerable growth has taken place in the Non-banking

financial sector in last two decades. Over a period of time they are successful in

rendering a wide range of services. Initially intended to cater to the needs of

savers and investors, NBFCs later on developed into institutions that can provide

services similar to banks. A non-banking financial company (NBFC) is a

company registered under the Companies Act, 1956 and is engaged in the

business of loans and advances, acquisition of

shares/stock/bonds/debentures/securities issued by government or local authority

or other securities of like marketable nature, leasing, hire-purchase, insurance

business, chit business, but does not include any institution whose principal

business is that of agriculture activity, industrial activity,

sale/purchase/construction of immovable property.

A non-banking institution which is a company and which has its principal

business of receiving deposits under any scheme or arrangement or any other

manner, or lending in any manner is also a non-banking financial company

(residuary non-banking company).

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According to Reserve Bank (Amendment act, 1997) A Non Banking Finance

Company (NBFC)means-

a financial institution which is a company;

a non banking institution which is a company and which has as its

principal business the receiving of deposits under any scheme or

arrangement or in other manner a lending in any manner;

Such other non banking institution or class of such institutions as

the bank may with the previous approval of the central government

specify.

The definition excludes financial institutions which carry on agricultural

operations as their principle business. NBFCs consists mainly of finance

companies which carry on functions like hire purchase finance, housing finance,

investment, loan, equipment leasing or mutual benefit financial operations, but

do not include insurance companies or stock exchange or stock broking

companies.

NBFCs are doing functions akin to that of banks, however there are a fewdifferences:

(i) a NBFC cannot accept demand deposits (demand deposits are funds

deposited at a depository institution that are payable on demand --immediately or within a very short period -- like your current or savingsaccounts.)

(ii) it is not a part of the payment and settlement system and as such

cannot issue cheques to its customers; and

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(iii) deposit insurance facility of DICGC is not available for NBFCdepositors unlike in case of banks.

To encourage the NBFCs that are run on sound business principles, on July 24,

1996 NBFCs were divided into two classes:

Equipment leasing and hire purchase companies (finance

companies), and

Loan and investment companies.

In India several factors have contributed to the growth of NBFCs. They provide

tailor made services to their clients. Comprehensive regulation of the banking

system and absence or relatively lower degree of regulation over NBFCs has

been some of the main reasons for the growth momentum of the latter. It has been

revealed by some research studies that economic development and growth of

NBFCs are positively related. In this regard the World Development Report has

observed that in the developing counties banks hold a major share of financial

assets than they do in the industrially developed countries. As the demand for

financial services grow, countries need to encourage the development NBFCs and

securities market in order to broaden the range of services and stimulate

competition and efficiency. In India the last decade has witnessed a phenomenal

increase in the number of NBFCs. The number of such companies stood at 7063

in 1981, at 15358 in 1985 and it increased to 24009 by 1990 and to 55995 in

1995. The main reasons for deposits with NBFCs are greater customer orientation

and higher rate of interest offered by them as compared to banks. With such adramatic growth in the numbers of NBFCs it was thought necessary to have a

regulatory framework for NBFCs. Slowly the RBI came out with set of

guidelines for NBFCs.

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The salient features of this guideline are given below.

The acceptance of deposits has been prohibited for the NBFCs having

net owned fund less than Rs.25 lakhs.

The extent of public deposit raising is linked to credit rating and for

equipment leasing and hire purchase companies it can be raised to a

higher tune.

Interest rate and rate of brokerage is also defined under the new

system.

Income recognition norms for equipment leasing and Hire purchase

finance companies were liberalized for NPA from overdue for six

months to twelve months.

Capital adequacy raised 10% by 31/3/98 and 12% by 31/3/99.

Grant of loan by NBFCs against the security of its own shares is

prohibited.

The liquid assets are required to be maintained @ 12.5% and 15% of

public deposits from 1/4/98 and 1/4/99 respectively.

Modifications also came to these norms over a period of time. The provisioning

norms for hire purchase and lease companies were changed. Accordingly, credit

was to be given to the underlying assets provided as security. The risk weight for

investment in bonds of all PSBs and FD/CD/ bonds of PFI is reduced to 20%. By

monetary and credit policy for 1999-2000 the RBI has raised the minimum net

owned funds limit for new NBFCs to Rs. 2 crores which are incorporated on or

after 20/4/99. According to the guideline issued on 8/4/99 the company is to be

classified as NBFCs if its financial assets account for more than 50% of its total

assets i.e. net of intangible assets and the income from financial assets should be

more than 50% of the total income.6 By June 1999 RBI had removed the ceiling

on bank credit to all registered NBFCs which are engaged in the principle

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business of equipment leasing, hire purchase, loan and investment activities.

From above brief summary regarding steps taken by RBI for managing NBFC it

is apparent that RBI assigns the priority for proper management of NBFCs

keeping in view the investors protection. In the light of the above regulatory

frame work one should like to examine various parameters of different groups of

NBFCs.

The NBFCs that are registered with RBI are:

(i) equipment leasing company;

(ii) hire-purchase company;

(iii) loan company;

(iv) investment company.

With effect from December 6, 2006 the above NBFCs registered with RBI have

been reclassified as

Asset Finance Company (AFC)

Investment Company (IC)

Loan Company (LC)

AFC would be defined as any company which is a financial institution carrying

on as its principal business the financing of physical assets supporting productive

/ economic activity, such as automobiles, tractors, lathe machines, generator sets,

earth moving and material handling equipments, moving on own power and

general purpose industrial machines.

Principal business for this purpose is defined as aggregate of financing

real/physical assets supporting economic ac tivity and income arising therefrom is

not less than 60% of its total assets and total income respectively.

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The above type of companies may be further classified into those accepting

deposits or those not accepting deposits.

Besides the above class of NBFCs the Residuary Non-Banking Companies are

also registered as NBFC with the Bank.

The NBFCs accepting public deposits should furnish to RBI:

Audited balance sheet of each financial year and an audited profit and loss

account in respect of that year as passed in the general meeting together

with a copy of the report of the Board of Directors and a copy of the

report and the notes on accounts furnished by its Auditors;

Statutory Annual Return on deposits - NBS 1;

Certificate from the Auditors that the company is in a position to repay the

deposits as and when the claims arise;

Quarterly Return on liquid assets;

Half-yearly Return on prudential norms;

Half-yearly ALM Returns by companies having public deposits of Rs 20

crore and above or with assets of Rs 100 crore and above irrespective of

the size of deposits ;

Monthly return on exposure to capital market by companies having public

deposits of Rs 50 crore and above; and

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rates to fuel their future growth plans. Fourthly, better risk management and

regulatory practices, NBFCs enjoy a higher credibility today. Last but not the

least, due to an established reach and network,

INTRODUCTION TO THE COMPANY

SREI is one of Indias largest private sector infrastructure financial

institutions. The company began its operations in 1989. It is headquartered in

Kolkata, and has a pan-India presence with a network of 37 offices. It also has an

international footprint, with operations in the Russian Federation and Germany.

SREI operates in the infrastructure financing segments of infrastructure

equipment, infrastructure projects and renewable energy. It is the market leader

in the segment, managing an asset base of Rs 33931 mn (USD 762.48 mn) as on

31 st March 2006.

SREI is a widely held company, listed on the Kolkata, Mumbai, National

and London Stock Exchanges with a market share capitalization of Rs 5624 mn

as on 22nd the may 2006. During the year, SREI raised RS 1530 mn (USD 35 mn)

through the GDR programme with its securities being listed on the London Stock

Exchange, becoming the first NBFC to do so.

CORE VALUES

Customer partnership

Respect for people

Stakeholder value enhancement

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Integrity

Passion for excellence

Professional entrepreneurship

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OPERATIONAL OVERVIEW

1. INFRASTRUCTURE EQUIPMENT FINANCE

CORE ACTIVITIES

Financing construction equipment like heavy and light excavators, loaders,

earth moving equipment, dumpers, tippers, cranes among others.

HIGHLIGHTS 2005-06

Contributed Rs 23030 mn to business.

Securitised assets to increase availability of finances to fund new

projects.

Non-performing assets as a proportion of total assets declined from

1.43% in 2004-05 to 0.92% in 2005-06.

Increased market share to 30% in 2005-06.

With the government increasing i ts focus on implementing new

infrastructure projects and improving the existing ones, the requirement for

quality equipment has increased. These equipments enable the delivery of

projects in internationally comparable timeframes.

SREI realized the potential of the sector and capitalized on the first mover

advantage. As a result the Company has achieved a pre-eminent position in the

industry and is the leader in the segment. SREIs disbursement grew from Rs

16099.70 mn in 2004-05, representing a growth of 54%.

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2. INFRASTRUCTURE PROJECT FINANCE

CORE ACTIVITIES

Projects financed by the Company include bridges, approach bridges,

bypasses and roads, independent power projects, captive power projects and

small-to-medium sized power projects and equipment in the power sector,

port equipment, private berths and container handling jetties in the port

sector.

HIGHLIGHTS 2005-06


Non-performing assets as a proportion of total assets remained same at

0.05% in 2005-06.

Forayed into new sector- civil aviation, financing projects worth Rs

1080 mn.

Since the early nineties, India has been experiencing a consistently high GDPgrowth rate. This has been achieved through the first generation of economic

reforms in 1991. However the rapid economic growth has put the existing

infrastructure under tremendous pressure. Specifically, the country has not

deployed enough funds for building the necessary power plants, transmission

lines, distribution networks, roads, ports, airports, water and sanitation

infrastructure since Independence.

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3. RENEWABLE ENERGY EQUIPMENT FINANCE SREU

CORE ACTIVITIES

SREI Renewable Energy Unit (SREU) finances only eco-friendly green

energy systems of various sizes and specifications on easy and affordable

lease/hire-purchase terms to suit the varied needs of customers, both for

domestic and commercial use. The financing period is normally between one

to five years and funding is sourced by the company primarily from domestic

and international financial institutions.

HIGHLIGHTS 2005-06


Tie-ups with leading vendors.

Increasing awareness and extending reach by building relationship

with reputed NGOs/Co-operatives/Self Help Groups.

Being a responsible corporate citizen, we set up SREU in may 1999 with theobjective of promoting the use of renewable sources of energy and in doing so

became the first private sector company in the country to finance renewable

energy products.

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EXCITING SERVICE PORTFOLIO

As a part of its strategy to deliver superior value to all stakeholders, SREI

has expanded its services, forayed into allied business to offer holistic solutions

to cater to customer needs. These activities are primarily in the domains of

venture capital funding, capital markets, insurance broking, foreign exchange,

asset disposal, equipment rentals and deposits.

SREI Subsidiaries :-

SREI Venture Capital Limited:

This is a SEBI registered venture capital fund operating four schemes that

focus on high growth sectors of the economy.

Schemes Target Size Target Sector

Medium and SmallInfrastructure Fund (MASIF)

Rs 1000 mn(USD 22mn)

Road, Power, Port & UrbanInfrastructure Projects.

India Global Competi tive

Fund (IGCF)

Rs 10000 mn

(USD 220 mn)

Globally competitive

companies.

Prithvi Infrastructure Fund Rs 5000 mn

(USD 110 mn)

Infrastructure & Realty Sector.

Infrastructure Project

Development Fund

Rs 100 mn

(USD 2.2 mn)

Infrastructure Sector.

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SREI Capital Markets Limited:

SREI Capital Markets Limited is a SEBI registered Category I merchant

banker. It offers services from infrastructure advisory, investment banking,

infrastructure project conceptualization, development, implementation and

management to financial structuring, resource mobilization and capital issues. It

also offers financial advisory services as well as services in the domain of

privatization to government enterprises and departments.

SREI Insurance Services Limited:

This is a unique, all encompassing insurance services and brokerage

company. Registered with the Insurance Regulatory Development Authority

(IRDA), it is a composite broker offering services in the domains of Life

Insurance, General Insurance and Reinsurance, as well as risk management

advisory services. The company provides consultancy and risk management

services for insurance/reinsurance and undertakes other related activities. The

primary objective with which the Company has been established is to educate the

customer about the equipment and to provide holistic insurance solutions under

one roof. It also helps negotiate for better rates with insurance companies.

SREI Forex Limited:

SREI Forex capitalizes on Indias fast growing foreign trade and increased

business and leisure travel undertaken by Indians. The company is a full fledged

money changer. It deals in 44 currencies and travellers cheques besides having a

tie up with Western Union to facilitate money transfer.

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Global Investment Trust Limited:

Global Investment Trust Limited (GITL) is a wholly owned subsidiary of

SREI Infrastructure Finance Limited. The Company has been set up with the

objective functioning as trustees for various funds and to offer related services. It

currently acts as trustee company for few capital and private equity funds being

managed by SREI Venture Capital Limited.

SREI Joint Ventures:-

Bengal SREI Infrastructure Development Limited:

Bengal SREI Infrastructure Development Limited is a joint venture

company floated by West Bengal Industrial Development Corporation Limited

and SREI Capital Markets Limited with a view to create, expand and modernize

infrastructure facilities in West Bengal and other states of India. It offers

services in the domains of project advisory, policy advisory and industrialcapability building. It is actively involved in projects relating to roads, industrial

and agricultural infrastructure.

IIS International Infrastructure Services GmbH:

IIS International Infrastructure Services GmbH (IIS) has been

incorporated in Bonn, Germany. The business of IIS is leasing of infrastructure

equipment and rendering advisory services, apart from acting as a holding

company for SREIs investment in other countries.

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SREI Associate:-

Quipo Infrastructure Equipment Limited:

QIEL has been sponsored by SREI and supported by the Construction

Industry Development Council (the apex industrial body formed by the Planning

Commission and the Ministry of Surface Transport, Govt. of India). The company

provides high value, multi-purpose, special ized and general-purpose

infrastructure equipment on rental. In addition, it also provides auxiliary value

added services such as trained operators to run and service the equipment and on

site repairs and maintenance with a high uptime of the equipment to the

contractor. This enables the contractor to focus on his core competence-

construction and project management, and allows him to access such

infrastructure equipment without blocking his limited capital resources.

Quipo- equipment bank:

Quipo was set up to cater to the needs of construction companies and

contractors, who cannot afford high technology equipment due to capitalconstraints. Quipo acts as an equipment repository renting out equipment based

on need, creating a level playing field in the process. Additionally, it ensures

uniformity and productive deployment of idle equipment thus effectively

conserving scarce capital resources.

Quipo- oil and gas:

First Indian company to provide comprehensive equipment and services

solutions with specialized services for drilling.

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Quipo- telecom:

First Indian company providing passive infrastructure sharing for mobile

telecom companies.

Henry Butcher International Valuers & Auctioneers Pvt. Ltd.

This is a 50:50 Joint venture between Quipo and GoIndustry Henry

Butcher. GoIndustry group is one of the largest asset management companies in

the world, providing industrial equipment disposal and consultancy services.

Through this joint venture we provide services for auctions asset disposal and

valuation services- a first time offering for the Indian markets. This format for

disposal of assets has been adopted to optimize their realizable value.

NAC Infrastructure Equipment Limited

SREI is a joint sponsor of NAC Infrastructure Equipment Limited

alongwith the National Academy of Construction, IIEL, L&T Finance Ltd. and

Nagarjuna Construction Company Ltd. The Company operates on the similar

lines of quipo. It acts as an equipment bank and focuses on the high-growth

South Indian market, which includes the states of Andhra Pradesh, Karnataka,

Tamil Nadu and Kerala.

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FINANCIAL OVERVIEW

The Company has reported excellent results for the financial year ended 2005-

06. During the year the Company's disbursement went up by 54% per cent to

reach a level of Rs 24807.60 mn. This has been achieved on the back of the huge

investments lined up for enhancing and expanding the country's infrastructure.

Along with the increase in disbursements, there has been an equally robust

growth in our assets managed. The assets under management have increased from

Rs 20921.10 mn to Rs 33930.60 mn. SREI continues to operate in a market

requiring first-hand knowledge and expertise. This has aided the Company to

maintain its leadership position in financing of infrastructure equipment. The

Company has been focusing on lending to SME (small and medium enterprises)

customers. The Company has been able to maintain low levels of NPAs through:

robust appraisal system de-risking the Company from possible defaults

strong collection and repossession capabilities

prudent selection of assets

PROFIT AND LOSS STATEMENT OVERVIEW:

Financial income and expenditure:

The total income increased from Rs 1299.30

mn in 2004-05 to Rs 2272.50 mn in 2005-06. The income is derived from the

core activities of infrastructure equipment financing, infrastructure project

finance and renewable energy equipment finance. With rising interest rates theCompany's cost of interest increased from Rs 558.30 mn to Rs 1067.30 mn.

Income from other sources comprised of write back of provision for diminution

in value of long term investments, dividend on trade investments and others. The

write back of provision was to the extent of Rs 0.50 mn, dividend amounted to Rs

0.60 mn, while others accounted for Rs 3.60 mn.The administrative and other

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expenses increased by almost 36 per cent. Personnel expenses increased by 48

per cent as the Company has been steadily increasing its business, it is essential

to have adequate number of people to steer operations. The other expenses

increased by 29 percent. The profit before tax has recorded a growth of over 71

percent, rising from Rs 398.00 mn in the last financial year to Rs 682.00 mn at

present. The profit after tax increased by 71.10 per cent from Rs 283.00 mn to Rs

484.20 mn in 2005-06.

BALANCE SHEET OVERVIEW

SOURCES OF FUNDS :

During the year the Company raised Rs 1530 mn

through the GDR route and in the process became the first Indian NBFI to be

listed on the London Stock Exchange. Post issue of GDRs, the Company's equity

share capital stands at Rs 1090.9 mn, comprising of 109.09 mn shares of face

value Rs 10 each. The Company leverages its resources in the most productive

manner and deploys excess funds to generate and increase business. Reserves and

surplus increased by 173 per cent from Rs 1104.80 mn to Rs. 3014.30 mn. This

was largely on account of the premium received through the issuance of GDR. As

per the RBI guidelines, the Company increased its provision for special reserves

from Rs. 264.70 mn to Rs. 362.70 mn. The term loans increased by 253 per cent.

The company accessed Rs 4256.50 mn from domestic financial institutions and

banks and Rs 1951.80 mn from foreign financial institutions. Working Capital

increased by 13.93 per cent. During the year under review, six banks - HDFC

Bank, Yes Bank, Kotak Mahindra Bank, Indian Overseas Bank, Corporation Bank

and Bank of Rajasthan - joined the consortium lending to the Company,

enhancing the total s trength of consort ium bankers to 33, the largest

suchconsortium among NBFCs in India. The Company raised Rs 1300 mn by way

of debentures to meet the increased demand for funds. The Company has

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been focusing on reducing its reliance on public deposits. As a result, it accounts

for only 0.86 per cent of the total funds at the Company's disposal. The public

deposits went up marginally from Rs 144.70 mn to Rs 144.90 mn. During the

year the Company redeemed commercial papers amounting to Rs 300 mn,

bringing down the total from Rs 450 mn to Rs 150 mn. The total amount

securitised by the Company increased from Rs 8447.5 mn to Rs 11381.9 mn

providing it access to greater funds.

APPLICATION OF FUNDS:

The Company's base of financial assets increased from Rs 10452.5 mn in

2004-05 to Rs 16848.2 mn in 2005-06, recording a growth of 61 per cent. The

project finance division of the Company has recorded impressive growth. This

can be attributed to the hectic activity being witnessed in the country and SREI's

understanding of the sector. The Company leverages its strong relations with the

small and medium enterprises and customises its disbursals. This has led to the

divisionrecording a growth of 26 per cent. During the year the fixed asset base

grew by 1157 percent from Rs 178 mn to Rs 2237.50 mn. This was largely a

result of the innovative practice of beginning operating leases in this year. Under

this mechanism, the ownership of the asset financed rests with SREI, and

therefore the company avails of the depreciation benefit. It also results in a

quantum increase in the fixed assets base. During the year, assets financed under

the operating lease mechanism amounted to Rs 2114.00 mn. The provisioning for

assets increased by 34 per cent, from Rs 22.20 mn in 2004-05 to Rs 29.80 mn,

even as our asset base grew by 1157 per cent.

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OPERATIONAL OVERVIEW

Disbursements

Total disbursements of the Company grew from Rs 16099.7 mn in 2004-05

to Rs 24807.6 mn in 2005-06, recording a remarkable growth of 54 per cent.

Treasury operations

SREI sourced its funds from numerous financial institutions including

banks, domestic institutions, foreign financial institutions and multilateral

agencies. SREI's dynamic treasury team helped mobilise resources from

the domestic and international markets to meet i ts extensive funding

requirements. Active management of cash surpluses, stiff negotiations for

obtaining funds at lower interest rates and hedging exposure to prevailing

market risks aided access to greater resources.

Capital adequacy ratio

The capital adequacy of the Company was 19.75 percent as on 31st March

2006, which is well above the minimum level of 12 per cent prescribed by the

ReserveBank of India.

The Company has complied with all the norms prescribed by the Reserve

Bank of India including the newly introduced Anti money laundering and Know

your customer (KYC) guidelines and all the mandatory accounting standards

issued by The Institute of Chartered Accountants of India. It has adopted a sound

and forward looking accounting policy of providing for non performing assets in

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terms of the guidelines laid down by the Foreign Financial Institutions, which are

more stringent than the guidelines of the Reserve Bank of India.

Interest rates

SREI's average rate of interest increased from 6.23 percent in 2004-05 to

7.97 per cent in 2005-06 through competent cash management, raising additional

resources by issuance of GDRs, MIBOR linked bonds/debentures and the use of

longer tenure foreign loans (7-10 years) and redemption of commercial papers.

Credit rating

SREI's credit ratings have been consistently improving. Improved credit

ratings are important as it allows SREI to raise resources at competitive rates.

The lenders, to ensure that their funds are safe, attach significant weight to it.

Non performing assets

The Company's NPAs stood at 1.43 per cent of total assets in 2004-05 and

further decreased to 0.92 per cent in 2005-06 which was amongst the lowest in

the industry. On a net basis, the Company's NPA is nil.

SREI carries out a due diligence before any loan is disbursed to assure

itself of the quali ty and safety of the asset and is complemented by a

conservative treatment of non performing assets on the Company's books. NPA

provision norms followed by SREI conform to thestandards set by Indian

regulatory authorities, foreign lending institutions and credit rating agency

parameters.

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PART 2

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ANALYSIS

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ECONOMIC ANALYSIS

Overview of recent macroeconomic developments:

The year 2006-07 marks the fourth consecutive year of vibrant economic growth,

thus producing an average growth of 8.5 per cent. But the major issues are still

the same, infrastructure development and slow growth in agricultural sector. The

Eleventh Five-Year Plan is likely to aim at rising growth scenario in two-digit

figure over the five year period between 2007-08 and 2011-12. Despite several

bottlenecks, steady improvements in the domestic saving and investment rates

would possibly sustain the high growth expectation. In the coming years, the

outlook for the Indian economy remains bullish. The CSOs advance estimates of

a 9.2 per cent real GDP growth for 2006-07 as well as the expectations of

continuing this high growth during 2007-08, seem realistic

The economy appears to be heated up as inflationary pressures are on the rise

which may require for policy changes on the economys expansionary plans.

While agricultural sector is expected to show only minor improvement, good

industrial performance including improvement in core infrastructure industries,

and a vibrant services sector continuing to lead the economys growth momentum

backed by a booming information technology industry, justifies the expectations

for high growth for the current year(2006-2007) as well as the next year(2007-

2008). The supply-side has been impressive; the demand-side is too exuberant

raising concerns of heating up. Money supply expansion has been considerably

higher till date (30th march 2007) during the current year with each of its

components displaying accelerated increases. The growth in bank credit, too, has

been at a high pace. These monetary developments in recent years have resulted

in high liquidity in the economy.

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And coupled with supply-side constraints in some essential commodities as also

pressures from global commodity prices, the demand pressures have led to a rise

in average inflation to 5.2-5.4 per cent in 2006-07 so far as against 4.4 per cent a

year ago. The central bank has adopted instruments like increases in the reverse

repo rate and cash reserve ratio in order to curtail liquidity while the government

has initiated several measures like changes in the customs duty structure and

restrictions on trade in commodities markets to deal with the influence of

demand pressures as well as that of supply shortages. In the latest Union Budget

for 2007-08, the past trends for macro-level reforms has been replaced with

concerns regarding the structural changes in the economy; on the taxation side,

substantial concessions have been made both in direct and indirect taxes for

small and medium enterprises (SMEs), even as measures have been proposed to

reduce indirect tax burdens on commodities for fighting inflation. On the

expenditure front, substantial increases in government spending on social sector

areas, particularly health and education, as well as agriculture and physical

infrastructures have been announced. In the external sector, the REER (real

effective exchange rate) shows an appreciation of nearly 7-8 percentage points

while the nominal value of the rupee has moved up close to the base level of

2004-05. This has implications for the economys export competitiveness,

particularly at a time when export growth is slowing, but it also has positive

effects on the imports of capital goods in which the economy is facing a shortage

of installed capacities.

Inflation analysis:

The annual inflation as measured by movements in the wholesale price

index (WPI) on a point-to-point basis has risen by 6.1 per cent in the month

ending February 24, 2007 contrasts with the r ise of 4.2 per cent in the

corresponding period of the previous year However, the inflation rate after

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reaching a peak of 6.7 per cent in the first week of February 2007 slipped in the

subsequent next three week period to register the above 6.1 per cent rate. This

respite in the upward movements during the month is mainly brought about by

falling prices of wheat, pulses, substantial lowering of prices of vegetables and

sugar and, to some extent, the decline in prices of petrol and diesel. The annual

increases in different consumer price indices (CPIs) all for January 2007 have

ranged between 6.7 per cent and 9.5 per cent compared with the range of 4.4 per

cent to 5.0 per cent increases in the previous year. Specifically, in the current

year, the CPI for agricultural labourers has shown a faster rate of increase than

the rate of inflation of other CPIs.

The inflation rates on an average basis, too, have been depicting obvious

increases 5.3 per cent during April-February 2006-07 as against 4.5 per cent

during April-February 2005-06 in WPI, though less than the 6.7 per cent recorded

in the corresponding period of 2004-05. A similar, though at a higher level, trend

has also been witnessed in the movements of all CPIs

Sources of Inflationary Pressures

A number of commodities and commodity groups have faced price

pressure during the current year so far. The primary articles index has shown a

11.1 per cent rise over the past 12-month period as against a 5.7 percent rise in

the preceding 12-month period. Manufactured Products, another major group

has experienced a higher rate of price rises of 6.2 per cent during the current year

as against 2.1 per cent last year. On the other hand, the third major group, fuel,

power, light and lubricants has shown a considerably lower price rise of 1.4 per

cent this year as against 8.6 per cent in the previous 12- month period because of

reduction in the prices of petrol and diesel.

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Supply shortages of a large number of primary articles have been reflected

in their sharp price increases: cereals (8.3 per cent in the last one year as against

5.2 per cent a year earlier), pulses (16.8 per cent against 28.7 per cent), fruits

(13.7 per cent against a decline of 3.8 per cent last year), milk (7.9 per cent as

against 1.9 per cent ), condiments and spices (30.8 per cent against 2.4 per cent)

and other food articles (12.0 per cent against 18.1 per cent). Oilseeds have faced

acute supply shortages due to hampered kharif output and hence their price index

has risen sharply by 23.5 per cent as against a large fall of 9.1 per cent in the

preceding 12-month period.

Fiscal Year Price Movements

During the current fiscal so far (April 2006 to February 2007), the prices

of all commodities have risen by 5.9 per cent as against a comparatively lower

increase of 3.9 per cent last year. Prices of primary articles have accelerated to

register an increase of 10.7 per cent and contributed about 40 per cent to the

overall price level rise as compared to an increase of 5.0 per cent and a 28 per

cent contribution during the last fiscal year. The prices of manufactured

products have risen by 6.2 per cent during the review period as against a

nominal rise of 1.7 per cent last year. The groups contribution works out to be

58 per cent as against 25 per cent last year. The third major group fuel, power,

light and lubricants, however, has recorded a lower increase of 0.9 per cent

during the fiscal year so far as against a larger rise of 8.4 per cent during the

corresponding period last year mainly due to stable international oil prices.

Among primary articles, pulses, vegetables, fruits, condiments and spices,

oilseeds and minerals have registered double-digit inflation during the review

period. Among manufactured products the prices of grain mill products, edible

oils, iron and steel, and nonferrous metals have recorded double-digit increases.

The sub-group, sugar, khandasari and gur is the lone sub-group to record a

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decline within in the major group manufactured products. This group has

recorded a double digit fall of 10.5 per cent due to a fall in sugar prices which

can be attributed to substantial increase in sugar cane production and their

crushing for higher sugar production.

Consumer Price Indices

The inflation this year arising from shortages of essential commodities has

also been reflected in consumer prices. The CPI for industrial workers (CPI-IW)

has risen by 6.7 per cent year-on-year in January 2007 as against a rise of 4.4 per

cent in January 2006 or on an average basis, the increase has been 6.7 per cent

during the first 10 months of the current fiscal year as compared to 4.0 per cent

during the corresponding period last year. A similar, but at a higher level,

increase has occurred in CPI for non-manual employees. However, among the

CPIs, the highest rise has occurred in CPI for agricultural labourers an annual

rise of 9.5 per cent in January 2007 as against 4.7 per cent last year or on an

average basis, the current fiscal year rise has been 7.5 per cent in contrast to a

rise to just 3.6 per cent last year. The prices of food index, a major group in

agriculture labour index has recorded a double-digit inflation rate of 11.2 per

cent during the current fiscal so far as against a lower growth of 5.8 per cent last

year.

Global Inflation Rate

A worrisome aspect of the world inflation scene is that India is

experiencing a relatively high inflation rate (CPI-IW) at 6.7 per cent during the

current year among the comparable groups of countries like China (2.2 per cent),

South Korea (2.1 per cent), Thailand (2.3 per cent) and Malaysia (3.2 per cent).

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However, among Asian countries, Pakistan and Indonesia have recorded

higher inflation rates of 6.6 per cent and 6.3 per cent, respectively, in the review

period. Inflation has been stable in the advanced economies. Inflation in the euro

area remained below the European Central Banks 2 per cent ceiling as fuel

prices declined. Consumer prices in euro area have risen by 1.9 per cent from a

year earlier. Oil prices in these areas have recorded a 24 per cent drop from July

level which pushed down the prices of transport fuel by 0.22 per cent in February

from a year earlier.

Money and Banking Analysis

During the financial year 2006-07, the monetary and banking variables

have begun to further speed up, essentially as a result of taxation and other year-

end considerations. During the past one month ending March 2, 2007, all

components of M3, except demand deposits, have shown higher rates of

expansion than in the comparable month of the previous year. M3, except demand

deposits, have shown higher rates of expansion than in the comparable month of

the previous year. M3 expansion of Rs 77,837 crore (or by 2.5 per cent) during

the latest month has been indeed high as compared with the expansion of Rs

55,780 crore (1.8 per cent) during the corresponding month of the previous year.

Continued expansion in bank credit and rise in foreign exchange assets, have

contributed to the accelerated monetary expansion. The largest increase in

monetary expansion has occurred under time deposits: an increase of Rs 53,718

crore (2.4 per cent) as against Rs 30,764 crore (1.4 per cent) in the corresponding

period of the previous year . Currency expansion too has been of a higher order

this year: Rs 11,170 crore (2.4 per cent) as against Rs 8,107 crore (1.7 per cent).

Higher tempo of financial activities supported by increased capital market

activities as well as industrial activities have resulted in higher levels of currency

expansion during the recent period as well as during the current fiscal

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year so far. An expansion of Rs 458,241 crore in M3 (16.8 per cent) during April-

March 2, 2007 as against an increase of Rs 277,448 crore (11.9 per cent) during

the comparable period of the previous year is indeed noteworthy. While currency

with the public has shown a higher rise [Rs 70,954 crore (17.2 per cent) against

Rs 58,195 crore (16.4 per cent) last year], the largest increase has occurred under

time deposits: Rs 357,223 crore or 18.8 per cent as against Rs 175,736 crore or

10.6 per cent. Demand deposits have grown at a considerably slower rate of 7.9

percent (Rs 31,869 crore) in contrast to the expansion of 13.9 per cent (Rs 44,768

crore) in the previous year.

Banking Operations

The higher tempo of banking activities in the recent period is reflected in

the data on scheduled commercial banks. All variables show an accelerated

growth in the latest month as compared with the growth in the month a year ago.

While banks deposit growth has been faster almost continuously since the

beginning of the current financial year, higher investments and bank credit,

particularly non-food credit expansion, are a recent phenomenon. Banks

investments in government securities have expanded phenomenally Rs 44,414

crore during the latest month period in contrast to an absolute fall of Rs 7,727

crore in the corresponding month of the previous year.

Hike in Lending Rates

State Bank of India, the countrys largest bank, has raised its prime

lending rate (PLR) for the second time in less than three months, but at the same

time has decided to spare existing home and educational loan borrowers from the

hike. SBI has raised its PLR by 75 basis points to 12.25 per cent with effect from

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February 20 and also announced that it will be offering the highest interest rate

of 9.5 per cent among commercial banks for deposits with maturity of 4 years to

less than 5 years. Centurion Bank of Punjab has increased its prime lending rate

(PLR) by 100 basis points to 14.50 per cent per annum from March 1, 2007.

ICICI Bank, the countrys second largest bank, has hiked its lending rates for

fresh loans to individuals by 50 basis points, following a 50 basis point increase

in CRR by the RBI. So we may expect the banks to announce increase in interest

rates on loans to corporates, which would definitely a negative news for the

bonds as well as the equity markets. The bond prices would crash down, and

higher interest rates would hurt the corporate profit margins.

External sector analysis

With the base effect coming into play, export growth in Jan-07 remained

in the single-digit range for the second consecutive month up 5.5% (US$9.6bn).

It is expected this trend would continue for the next few months given that export

growth during the period Jan06-Aug06 averaged was closed to 30% YoY. On the

import front, due to lower oil prices, it is expected a moderate import growth and

hence a narrowing in the trade deficit. The full-year estimates of exports

touching US$120.7bn (20%) and imports up US$177bn (26.2%) resulting in the

customs trade deficit widening to US$56.3bn in FY07 as compared with

US$39.8bn in FY06. Composition of trade comes out with a two-month lag.

Export growth in the current fiscal has been led by engineering goods and

petroleum products. As regards imports, besides oil, over 70% of the rise in non-

oil imports is due to capital goods, industrial raw materials all of which support

the investment story.

The current account deficit of the county has stood at $ 3 billion for the

third quarter ended December 31, 2006, according to statistics put out by the

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Reserve Bank of India compared with $ 4.7 billion in the corresponding period in

the previous fiscal. For the nine-month period covering (April-December 2006),

the current account deficit has stood at about $12 billion, at the same level as in

the previous corresponding period.

The foreign exchange reserves of India have surged by $1.789 billion to

touch $197.746 billion in the week ended March 23, 2007. The reserves have

increased by over $3.3 billion in two consecutive weeks. During the week ended

March 16, the reserves had touched $1.547 billion to $ 195.957 billion.

According to the RBI's Weekly Statistical Supplement, foreign currency assets

increased by $1.789 billion to $190.392 billion.

The country's external debt stock has shot up by $6.19 billion in the

quarter ended December 2006 to $142.66 billion on the back of a sharp increase

in commercial borrowings by corporate sector and also due to rise in non-

resident India (NRI) deposits. While long-term debt outstanding for the quarter

ended December 2006 increased by $6.80 billion to $132.64 billion, short-term

debt declined by $610 million to $10.02 billion at end-December 2006.

The rupee-dollar exchange rate touched a high of Rs 42.90 on April 4 but

dipped to Rs 43.15 on April 5. The six-month forward premia closed at 5.41 per

cent (annualized) on April 05, 2007 vis--vis 4.40 per cent on March 30, 2007.

Industrial growth analysis

Industrial growth rose 10.9% in Jan 2007 lower than the November and

December data, but higher than the consensus expectations and the 8.5% growth

seen in the same period last year. This is positive and bodes well for the govts

9.2% GDP estimate for FY07.

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Growth on a sectoral basiswas led by manufacturing up 11.6%, electricity

and mining up 8.5% and 6.0%; (2) Continued buoyancy across the use-based

classification led largely by basic goods (11.6%), intermediate goods (12.7%)

and consumer goods especially non-durables; (3) However, capital goods

production came in at 8.6%, which can be attributed partially to the base effect

(27% in Jan06).

Interest Rate Implications

On the back of the strong IIP data coupled with the fact that we expect

inflation to remain in the 5.5-6.5% range until March/April, we expect policy

rates to rise by 25bps in April. While concerns on overheating in sectors remains,

we do not anticipate policy rates to rise much further as significantly higher rates

could result in more dollar inflows and thus make currency management difficult.

Infrastructure sector analysis

Railway

Indian Railways has witnessed a 9.12 per cent growth in freight loading

during April 2005-February 2006 to 655.35 million tonnes (mt) from 600.58 mt.

It has also registered a 14.89 per cent increase in freight earnings touching Rs

37,589.03 crore from Rs 32,716.59 crore during the period. Passenger earnings

have risen by 13.61 per cent to Rs 15,371.93 crore from Rs 13,530.19 crore. The

integral coach factory and rail coach factory has produced 1,110 and 1,164

coaches, respectively, during the period, exceeding the target by 26 and 4

coaches each. The rail wheel factory has produced 1,22,339 wheels and 52,537

axles during the same period compared to the target of 1,18,126 wheels and

52,528 axles.

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Shipping

The union shipping ministry is considering an action plan for the next fiveyears to increase the draught in the major ports in the country up to 18 m to

handle larger vessels. In this context, the ministry has prepared an action plan to

increase the draught in major ports such as Kolkata from the present 7 to 9 m,

Haldia Dock Complex from 8.5 to 9 m, Visakhapatnam from 17 to 18 m, Ennore

from 13.5 to 16.5 m, Chennai from 17 to 17.5 m, Tuticorin from 10.7 to 14.7 m,

Kochi from 12.5 to 14.5 m, New Mangalore from 14 to 17 m, Goa from 13.3 to

14.3 m, Mumbai from 9.1 to 14 m, JNPT from 12.5 to 14 m and Kandla from 11.7

to 14.5 m. The ministry is also planning to set up a deep-sea port off the coast of

West Bengal . The new port will be like that of Shanghai Port far away from the

coast with a draught of 20 m to cater to vessels with a capacity of more than 1.5

lakh TEUS.

In 2006-07, the 12 major ports have handled a total of 463.84 million

tonnes (mt) of traffic, up by an estimated 9.51 per cent over 423.56 mt handled in

2005-06, according to tentative figures released by the Indian Ports Association.However, there has been a marginal shortfall of 0.4 per cent from the target of

465.7 mt. Visakhapatnam port is the largest cargo-handling port with a total

traffic throughput of 56.38 mt, followed by Kolkata port (including Haldia) 55.05

mt and Chennai 53.4 mt. In terms of growth, Mumbai port has topped the list

with an 18.5 per cent growth at 52.36 mt (44.19 mt in 2005-06), followed by

Jawaharlal Nehru port 18.45 per cent at 44.81 mt (37.83 mt), Ennore 16.86 per

cent at 10.71 mt (9.17 mt) and Paradip 16.33 per cent at 38.51 mt (33.10 mt).

Kolkata Dock System (excluding Haldia) has also posted 16.56 per cent growth

at 12.59 mt (10.80 mt). But traffic throughput at Haldia remained virtually

stagnant at 42.45 mt (42.33 mt), or a mere 0.28 per cent rise. Together with

Haldia, Kolkata port has, thus, posted a meager growth of 3.59 per cent. Other

ports that posted double digit growth during the year are Kandla, 15.41 per

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Bond markets analysis

Bond markets were relatively less impacted by the global financial turmoil

with the benchmark ten-year yield closing marginally higher at 7.94% from

7.93%.Though budget estimates were in line with the FRBM targets and

measures to ease inflationary pressures continued, the RBI announced a series of

measures earlier this month to absorb excess liquidity to contain inflation.

Measures include: (1) Capping the amount of money they will absorb through

revere repos to Rs30bn on a daily basis which possibly was done to discourage

banks to fulfill their SLR requirements by borrowing G Secs in repo; and (2)

Modifying the market stabilisation scheme (MSS scheme) which would now

use a mix of T-Bills and dated securities to and T-bills under the (MSS).

Implication: These measures are likely to divert short-term liquidity to the

inter-bank money market thus bringing down the overnight call money rate. The

reverse-repo window being limited to Rs30bn could see increased demand for

bonds in the short tenors upto 1 year and in excess liquidity conditions could

result in a steepening of the curve. Moreover, greater shifting of sterilisation

money to MSS would mean that the government pays the cost for MSS while

reverse repo window cost is borne by RBI.

Note : for the actual data refer to the key indicators table in annexure 1

(source latest economic and political weekly)

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ANALYSIS OF MACRO ECONOMIC INDICATORS (as per the latest

economic survey 2006-2007)

India's real GDP has attained an average growth rate of 8.1% between

2003- 2006 as compared to that of 4.6% in the three years preceding this period.

It is believed that this above 8% growth achieved in the last three years is

cyclical in nature and does not reflect a long-term structural growth.

It is expected the Indian economy's growth to fall by 50-100bps in FY07E

and FY08E compared to the last three year's average growth of 8.1% led by

rising inflation and interest rates, soaring crude oil prices and a likely slowdown

in the domestic capital markets.

Table 1

Years 2003 2004 2005 2006 2007

Real GDP

growth in

%

3.8 8.5 7.5 9 9.2

Figure A

48

Real GDP growth rate %

0

2

4

6

8

10

2004 2005 2006 2007 2008E

years

Real

GDPGrowth

rate%

real GDP


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compared to that of 5.2% between 2001-03. Agricultural growth in the last three

years has however been erratic reflecting the sector's continued dependence on

monsoon. Although the average agriculture sector growth at 4.9% in the last

three years has been above the trend growth rate of 4% and significantly higher

than the negative growth rate of 0.2% between 2001-03, the higher growth

mainly emanated from a strong 10% growth in FY04 and a 3.9% trend growth in

FY07.This helped to average out the dismal performance of the agriculture sector

in FY06 when it grew by a mere 0.7%

It is believed that this above 8% growth achieved in the last three years is

cyclical in nature and does not reflect a long-term structural growth. An

environment of excess global liquidity during 2003, given the ultra loose

monetary policy in major developed countries, has helped fuel a robust yet

unsustainable growth in most of the emerging market countries in the last three

years. In India, a credit boom - led by a fall in the domestic real interest rates

since end-2003 and a soaring capital market - reflecting the increase in the global

risk appetite of investors have helped to sustain the robust growth momentum in

the last three years. However, currently real interest rates are on the rise both

globally and domestically to curb inflationary pressures. Given the likelihood of

a slowdown in the capital markets owing to drying up of global liquidity

exacerbated by rising international oil prices on the face of mounting geo-

political risks, India's growth is most likely to slow down by 50-100bps in

FY07E and FY08E than the last three year's average growth of 8.1%. RBI's

projection of 7.5-8% growth for FY07 is on the optimistic side and there would

be some slippage in the growth numbers as the lagged effect of rising interest

rates on credit growth would start to manifest itself, especially in the second half

of FY07E. it is expect GDP growth to be in the range of 7-7.5% in FY07

depending on the performance of the South-West monsoon.

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Services sector - fuelling India's growth engine

India has relied on a services-led growth model to reach a higher growth

trajectory unlike its Chinese counterpart, which relies heavi ly on a

manufacturing-led growth strategy. As a result the services sector contribution to

GDP has kept on steadily increasing from an average 51% between FY93-FY03

to 60.7% in FY06.The stupendous performance of the services sector leading to

an average growth of 9.1% in the last three years has acted as the main catalyst

behind India's rising GDP in this period. Lead indicators of services sector

performance for 2006 suggest continued buoyancy. Going forward, it is expected

the services sector growth momentum to be maintained but at lower levels

compared to the double-digit growth recorded in the last two years. It is

expected that the services sector would grow at 9% in FY07E.

Table 4

Services

Growth% 2004 2005 2006 2007 2008E

8.5 9.6 9.8 11.2 10.9

Figure D

51

Services Growth%

0

2

4

6

8

10

12

2004 2005 2006 2007 2008E

Years

Servicesgrowth%

Services Sector


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MONETARY INDICATORS

In a widely expected move, the RBI increased both the Reverse-Repo and

the Repo rate by 25bps in the latest Monetary Policy Review, taking the key short

term interest rates to 6% & 7% respectively.

It is not expected that RBI will hike interest rates any more in this

calendar year although it would definitely continue to maintain its hawkish

stance on interest rates and keep a close vigil on global macroeconomic

conditions.

As against the RBI's projection of 7.5-8% real GDP growth in FY07E, it is

expected to have slightly lower growth at 7-7.5% mainly due to an expected

slowdown in economic conditions in the latter half of the current fiscal.

RBI raises the Reverse-Repo rate by 25bps taking it to 6.25%

In a widely expected move, the Reserve Bank of India increased the

Reverse-Repo rate by 25bps in the 2007(3 rd Quarter) Monetary Policy Review,

taking the key short-term interest rate to 6.25%. It increased the Repo rate by

25bps, taking it to 7.25% - thereby maintaining 100bps spread between the two

rates. Bank Rate and Cash Reserve Ratio have been kept unchanged.

The 2007 interest rate hike is the seventh rate hike since Oct'04 when the

RBI first embarked on a monetary tightening cycle.However it would definitely

continue to maintain its hawkish stance on interest rates and keep a close vigil on

global macroeconomic conditions..The RBI has retained both its GDP growth

projection and inflation forecast for FY07E at 7.5-8.0 % and 5.0-5.5%

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respectively. Although economic conditions are robust at this moment, we expect

the economy to slow down in the second half of FY07E leading to a lower GDP

growth estimate of 7-7.5% in FY07E.

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MACROTREND

Very low real interest rates helped to create the present credit boom

It is believed that the fall in the real interest rates (10-Yr G-Sec WPI

Inflation) from a high of 6.5% in Feb'02 to abnormally low levels in FY03 and

FY04 has helped to trigger the current credit cycle which has been sustained for

almost two years now. The US had cut down its key short-term interest rate - the

Fed-Fund rate - to as low as 1% in 2003 and this led to the building up of global

excess liquidity which manifested itself in the form of low real interest rates in

most parts of the world and India was no exception. In a series of rate cuts, the

Reverse-Repo rate was brought down from 6.5% in Feb'02 to 4.5% in Sept'04.

Since then the RBI has however embarked on a monetary tightening cycle in an

effort to rein in inflationary pressures by increasing nominal interest rates and

rationalizing the real interest rates.

The current credit cycle is nearing its end

The current credit cycle was an offshoot of rising consumer demand

fuelled by abnormally low real interest rates. It started from June'04 and has

almost lasted for two years. However the lagged effect of interest rate hikes (in

India it takes 15 months for a monetary policy to have effect on the economy)

which started since Oct'04 is expected to weigh down on the credit growth in the

latter half of the current fiscal, slowing it down from last year's 30% growth to

25% levels in FY07E.

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Mismatch between the deposits and credit growth

The current credit cycle, which is nearing its end, is characterized by a

huge divergence in growth between aggregate deposits and bank credit. While the

bank credit has grown at an average 30% in the last two years, aggregate deposits

have grown at a much lower rate of 16-17%. Such a huge divergence in growth

rates is unsustainable and carries the risk of triggering inflation. As a result the

RBI has been increasing interest rates aggressively to narrow the gap between the

two growth rates. It should be borne in mind that monetary policy works with a

lag and it takes at least 15 months before the effect of a rate hike starts kicking

in. Therefore, the monetary tightening cycle, which the RBI embarked on since

Oct'04, will start taking effect now, helping to bring down the divergence

between the credit and deposits growth rate.

Table 5

Bank credit 2004 2005 2006 2007 2008E

15.3 30.9 30 23 20

Figure E

05

101520

253035

Bank Credit

Growth (%)

Bank

credit

2004 2006 2008E

Years

Bank Credit Growth(%)

credit growth

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Table 6

Deposit growth 2004 2005 2006 2007 2008E

17.5 13 17 15 15

Figure F

Deposit Growth(%)

17.5

13

1715 15

0

5

10

15

20

2004 2005 2006 2007 2008E

Years

DepositGrowth(%)

deposit growth

Widening gap between the C/D & I/D ratio

The high credit growth in the last two years have been sustained by the

commercial banks liquidating their investments in G-sec's (as it is unprofitable to

stay invested in the bond markets in a rising interest rate scenario) and using the

resources to fund the credit growth. As a result, the Credit-Deposit ratio has

increased from an average of 55% in 2004 to 71% currently and the Investment-

Deposit ratio has steadily fallen from an average of 46% to 35% currently thus

widening the gap between the two ratios considerably.

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Inflation

It is believed that inflation is purely a monetary phenomenon and is not

caused by either "demand side factors" or "supply side factors" - the most

common example being oil price shock. They are of the view that inflation is

caused when money supply or credit grows in excess of the nominal GDP growth.

The effect of money is non neutral and when injected in the economy affects

specific areas first setting in a motion of relative price changes, which causes

distortion in the structures of production and ultimately leads to a general rise in

price level. The WPI and CPI indices used to measure inflation are based on the

faulty assumption of neutrality of money i.e. the effect of newly injected money

would affect all prices in a neutral way. General goods price rises, which are

captured through price Indexes such as WPI & CPI are only one of the many

symptoms of inflation - they cannot explain either the true cause or depict the

correct level of inflation.

Table 7

Years 2003 2004 2005 2006 2007

Inflation

WPI in %

3.4 5.4 6.5 4.5 5.3

Figure G

High money supply and bank credit growth main threat to inflation

57

Inflation WPI chart

3.4

5.4

6.5

4.55.3

0

1

23

4

5

6

7

2003 2004 2005 2006 2007

2003-07

Inflation

WPIin%

WPI


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The real fear of inflation stems from the fact that broad Money Supply

(M3) and Bank Credit are growing at a faster rate than nominal GDP. This has no

doubt created inflation which has flowed into asset prices, commodity prices,

equities and goods and services. Just because the inflation has not shown up in

narrowly defined price indexes such as WPI does not mean that inflation is not a

concern. RBI seems to have recognized this risk and has openly shown

discomfort about the way asset prices and credit growth have been soaring up.

Money supply presently growing at 18.8% against RBI's target of 15% for

FY07E

Broad money supply (M3) and bank credit growth are currently growing at

18.8% and 31% respectively - much higher than RBI's target of 15% and 22% for

FY07E.Therefore some more tightening may be warranted to bring down the

money supply and bank credit growth. However we can expect to see more rate

hikes in Jan'07 Monetary Policy Review if the bank credit and money supply

continues to grow at a fast pace.

Fed about to pause rate hikes but BOJ and ECB to continue

It is expected the US Federal Reserve to increase the target Fed-Funds rate

by another 25bps on 8th Aug'06 taking the key short-term interest rate to 5.5%.

From this stage onwards there is an uncertainty whether the Fed would prefer to

raise rates further or not. The decision would depend on the Fed's outlook on

core inflation, which is presently at 3% - much above the Fed's comfort zone of

2%. However the BOJ and ECB are expected to tighten interest

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Interest Rate-PLR year end

9.7 9.8 9.9 10 10.1 10.2 10.3 10.4 10.5 10.6

2004

2006

2008E

years

Interest Rate -PLR year end PLR

FISCAL INDICATORS

India's public finance is expected to deteriorate in the coming months due

to the effect of increasing interest rates, reduction in the import duties of

transport fuel from 10% to 7.5% on 16th June'06 and finally the government's

decision to put on hold all divestment decisions and proposals until further

notice.

It is expected the fiscal deficit to have a slippage of Rs.120bn in FY07E

thus pushing it up to 4.1% of GDP - same as last year's headline fiscal deficit.

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EXTERNAL SECTOR INDICATORS

The trends are bullish on INR and expect the INR to be around Rs.

42.5/US$ by Mar'07- end primarily led by a weak dollar. However certain factors

such as continued rise in international oil prices, a reversal of capital flows and

political risks may pose to be major threats to our projections.

In the worst-case scenario it is expected INR to depreciate to Rs. 45/US$ by

April '07 end.

Table 10

RS/US$ 2004 2005 2006 2007 2008E

45.9 45 44.3 44.9 43.2

Figure J

Rs/US$ annual avg.

45.945

44.344.9

43.2

41

42

43

44

45

46

47

2004 2005 2006 2007 2008E

years

Rs.US$annuala

Rs/US$

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weighted exchange rate leads to the same long-run impact of a 18-20bp increase

in interest rates.

Moreover the shifts in exchange rate have an effect on the inflationary

conditions in just two months whereas the impact of an interest rate hike works

with a lag of 15 months in India. Therefore, given the scenario of high crude oil

prices and rising inflationary pressures the RBI may opt for using the exchange

rate route to tighten liquidity and control inflation rather than using the interest

rate route.

Reasons against INR appreciation:

Concerns about widening CAD

India's Current Account Deficit (CAD) has widened in the last year to

US$10.6bn (1.3% of GDP) from US$5.4bn (0.8% of GDP). This was mainly due

to a deteriorating Trade Deficit, which touched US$51.5bn (6.5% of GDP) in

FY06 as compared to US$36.6bn (5.3% of GDP) in FY05 led by a higher oil and

non-oil imports growth. Most of the Trade Deficit was financed by a strongly

growing invisibles which stood at US$40.9bn (5.1% of GDP) in FY06 compared

to last year's US$31.2bn (4.5% of GDP) thus containing the CAD at a lower level

of 1.3% of GDP.

Oil prices remain a major threat for the widening Trade Deficit

Apart from a higher non-oil imports growth due to a fast growing domestic

economy, the main reason for the deteriorating Trade Deficit has been high

international crude oil prices. WTI oil prices are currently hovering around

US$74/bbl amidst intense geo-political risks leading to supply shortages from oil

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exporting countries. If the oil prices remain at these levels or worsen in the

remaining part of FY07E, it would lead to a further widening of the Trade Deficit

and CAD even after assuming a buoyant invisibles trend. Given the likelihood of

a global slowdown by the end of 2006 driven by hardening of interest rates, it is

expected oil prices to come down from its current high level and average around

US$70/bbl in FY07E. In such a scenario, the Trade Deficit will not deteriorate

substantially in FY07 and remain under manageable limits. It is expected Trade

Deficit to be around US$60bn in FY07 (6.9% of GDP). However if the political

tension in the Middle-East heightens leading to a war at some stage, oil prices

may skyrocket, which would substantially worsen the Trade Deficit.

CAD may widen substantially if invisibles flow slows down

Given a manageable Trade Deficit and an expected buoyant trend in invisibles,

the Current Account Deficit is expected to be slightly higher than last year at

US$15bn (1.7% of GDP). It is believed that the flows in the capital account will

be sufficient to finance the CAD without dipping into the forex reserves though

the capital flows will slow down compared to last year leading to less accretion

to forex reserves. However if the invisibles flow slows down considerably

triggered by a fall in the repatriation of remittances and software services as a

result of rising interest rates in other parts of the world and an impending global

slowdown, this will widen the CAD even further leading to a depreciating

pressure on the INR.

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Performance of Equity Markettill third quarter (2006-2007)

Primary Market

Resources raised through the public issues segment picked-up during the

quarter ended December 2006 vis--vis the previous quarter. Cumulative

resources raised through public issues during April-December 2006 increased by

33.0 per cent to Rs. 25,365 crore, even as the number of issues came down from

88 to 78 . The average size of public issues increased from Rs.217 crore during

April-December 2005 to Rs.325 crore during April-December 2006. Except one

issue, all public issues during April-December 2006 were in the form of equity.

Out of 78 issues during April-December 2006, 41 issues were initial public

offerings (IPOs), accounting for 78.7 per cent of resource mobilisation.

Mobilisation of resources through private placement increased by 55.5 per

cent to Rs.71,038 crore during April-September 2006 over the corresponding

period of the previous year . Resources mobilised by private sector entities

increased by 67.0 per cent, while those by public sector entities increased by 43.8 per cent during April-September 2006. Financial intermediaries (both from

public sector and private sector) accounted for the bulk (70.2 per cent) of the

total resource mobilisation from private placement market during April-

September 2006 (61.1 per cent during April-September 2005).

The resources raised through Euro issues - American Depository Receipts

(ADRs) and Global Depository Receipts (GDRs) - by Indian corporates during

April-December 2006 at Rs.8,841 crore were almost the same as in the

corresponding period of previous year.

During April-December 2006, net mobilisation of resources by mutual

funds increased substantially by 190 per cent to Rs.79,708 crore over the

corresponding period of 2005. Bulk of the net mobilisation of funds was under

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income/debt-oriented schemes (73.0 per cent of total), while growth/ equity-

oriented schemes accounted for 25.8 per cent of the net mobilisation of funds.

Interpretation : This shows the buoyancy in the primary markets, the amount of

funds mobilized has been increasing over the years. It is indeed a positive factor

for financial services firms like Religare Securities as managing IPO investments

is one of their key services offered to the clients. Further it also provides an

opportunity to list itself as other brokerage firms have already done in the recent

past.

Secondary Market

The domestic stock markets remained buoyant and recorded further gains

during the third quarter of 2006-07. Continued buying by FIIs on the back of

strong domestic fundamentals, robust corporate results, upward trend in the

international equity markets and decline in global crude oil prices provided

support to domestic stock markets. Domestic stock markets declined during May-

June, 2006 in consonance with global trends increased risk aversion over

concerns of slowd

seri valuation

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