IFA GLOBAL SPECIAL REPORT Dated- 10 th May, 2017

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1 Risk Rally: Ahead of fundamentals, Short of a Bubble With several risk events behind us; and several queued up immediately ahead, it is the right time to take fresh guard. Following are the key takeaways from the recent events. 1. Stay United, Stay strong says Macron victory: Political election in Europe has been considered as a major market theme this year and until now anti- EU parties in Netherland and France have won the election. After these elections, Europe is proving to be more resilient to populism than Anglo- American economies. After unexpected outcome in Brexit and US presidential election poll, this time France result was in line with expectation. After France election on last Sunday, Macron's emphatic victory brought comfort to investors and European allies alike, who had been nervous about the risk of another populist upheaval. Moving towards another round of election in Germany, Chancellor Angela Merkel's conservatives won a decisive victory in a vote in Germany's northern state of Schleswig-Holstein on Sunday, boosting her prospects of winning a national election in September. We do not expect a significant move up in Euro from current levels as market had widely discounted the results. With the France election is

2 out of its way, investors are now focusing on when and how the ECB could scale back its quantitative easing. (Source:Reuters) EUR/USD 1M ATMS Vols collapse post 1st Round results 2. Landmark 100 days: Trump completed 100 days in the White house without any major legislative victory despite Republicans being in control of both the House and the Senate. On the contrary, the Trump administration barely managed to avert a federal government shutdown. The current US tax system is thirty years old and there are certain aspects of it that require an overhaul in order to ensure competitiveness. The details of the tax plan that the Trump administration outlines and the political strings its pulls to push the plan through the Congress will be keenly watched by the market. The passage of the healthcare bill in the house is a positive which could possibly clear way for bigger reforms ahead. The US has the highest marginal corporate tax rate (35%) among OECD nations. It is one of only 7 out of 34 OECD members that taxes corporations based on worldwide income instead of territorial income. As a result, US companies currently hold more than USD 3Tn in capital overseas. Many US companies do not repatriate overseas earnings in order to avoid paying high US taxes. It is also the only OECD member that does not have a Value Added Tax (VAT).While US has an income tax based model; most of its major trading partners have a VAT based tax system. Under WTO rules, whenever a foreign company manufactures domestically and exports, it receives a rebate on the VAT it has paid. As US state sales taxes are much lower than the VAT of trading partners, absence of VAT in US translates into an implicit export subsidy for foreign exporters.

3 Therefore in the tax reform plan to be tabled by Trump Administration in the second week of May, we may see: a) Announcement of lower corporate tax rate b) Move to a territorial system of taxation: This would partly offset the revenue loss due to lower corporate tax rate as corporates would start repatriating earnings from abroad c) Some form of border adjustment tax (BAT) Given the stiff opposition to BAT from US retailers and considering the market disrupting consequences of BAT (In the form of USD appreciation which in turn would have a negative wealth effect as it would lower the value of US holdings of foreign assets and overseas profits of US corporations), it is possible that the plan may propose a VAT instead of BAT. A VAT would be WTO compliant. It would level the playing field between US and foreign goods. It can be revenue neutral and can generate as much revenue as a 20% tax on imports. This would make reduction in corporate tax rate possible. If the above plan materializes we may see a significantly stronger US Dollar, higher real US interest rates and higher potential US GDP. 3. ECB April meeting:the ECB governing council kept rates unchanged, as expected and maintained its dovish, accommodative tone. It highlighted the possibility of asset purchase program continuing beyond December 2017 if economic situation warranted. It acknowledged that though downside risks to inflation were dissipating, downside risks to growth were still prevalent.

4 (Source:Bloomberg) Spread Between French and German Bonds Collapse post 1st Round French election result 4. UK Elections: Announcement of early elections scheduled for 8 th June did take the market by surprise. However the rally in Sterling had more to do with positioning, short covering and stop losses getting taken out. A labour party victory would reduce chances of a hard Brexit. Early polls however indicate that the Conservatives have a lead. A Tory victory would thus hardly alter status quo and the Sterling could correct back to levels. 5. May FOMC meet: The US Federal Reserve kept rates unchanged. Fed Fund futures now indicate a 90% probability of a hike in June. Markets are currently pricing in 2 more hikes this year. The Federal reserve acknowledged the strength in the labor market and maintained that pace of rate hikes would be data dependent. April NFP came in at 211k against expectations of 190k and unemployment rate further reduced to 4.4%. The average hourly earnings grew 2.5% YoY against expectations of 2.7%. The US Dollar and the US yields did not react to the strong headline number due to disappointing growth in average hourly earnings. Looking forward we have Federal Reserve monetary policy in the next month, unveiling of US tax plan and UK elections.

5 The 2 nd round of the French elections failed to throw up any surprises. The UK elections too are unlikely to alter the status quo. All eyes would therefore be on the tax plan that the Trump administration outlines. An aggressive tax reform plan coupled with balance sheet trimming by the US Federal Reserve could push US yields higher, which would be negative for EMs and risk in general. It seems at this point as though the entire rally in EM and DM is fuelled by liquidity rather than growth expectations. Lack of participation from commodities and commodity currencies is supportive of this. Though it appears that the valuations could have run ahead of fundamentals, it would be premature to call it a bubble. It would be important to track changing correlations (Broad USD strength and weakness V/s Risk on / Risk off theme). In case of broad USD strength or weakness, the USD strengthens or weakens against EM as well as DM currencies where as in case of risk on/risk off moves USD strengthens against funding currencies and weakens against currencies offering a higher carry (typically EM currencies) On the domestic front, though FPI inflows into equities showed signs of easing in April (USD 400 Mn), FPIs continued to pour money into debt (USD 2.6 Bn). Due to superior fundamentals, India is likely to be the biggest beneficiary of inflows out of all EM economies in case of a risk on scenario. Progress of Monsoon, pick up in rural demand, pick up in investment demand, corporate earnings, pick up in credit off take would be the key factors to watch out for. As far as the Rupee is concerned, appears to be a good support. A break and close above would qualify as a medium term reversal. It would be interesting to see if the May seasonality plays out for broader Dollar index as well as USD/INR. May is typically a month when Rupee tends to depreciate.

6 (Source:Bloomberg) USD/INR heat map indicating that Rupee tends to depreciate in the months of May, August and November. (Source:Bloomberg) The Bloomberg Dollar index (BBDXY) has risen in May on 10 out of past 12 occasions.

7 About us IFA Global is one of India's leading global Forex and treasury consulting company. We help companies explore extra-ordinary opportunities, manage and sustain growth, and maximize their revenue by minimizing the risks. Since 2005, we have been a trusted partner in Forex Consulting, Treasury Management and Forex Operational Excellence. We have always believed that every client needs a customized offering and we have a long history of serving mandate clients and tailoring the offering to their needs. We provide the right people and the right skill sets to ensure that our clients' solutions are specifically tailored and done right the first time. Disclaimer These views/ forecasts All are Interbank rates and do not include bank margins Copyright@ INDIA FOREX ADVISORS PVT LTD. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of India Forex Advisors Pvt Ltd. These views/ forecasts/ suggestions, though proffered with the best of intentions, are based on India Forex reading of the market at the time of writing. They are subject to change without notice. Though the information sources are believed to be reliable, the information is not guaranteed for accuracy. Those acting in the market on the basis of these are themselves responsible for any profits or losses that might occur, without recourse to us. World financial markets, and especially the Foreign Exchange markets, are inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved.