Dear Shareholders,
 
 ''Steady Always. Cruising Ahead'' is the theme of our Annual Report
 this year.  To many the theme may appear incongruous in an environment
 where global economic recovery has remained elusive. Markets have been
 short on confidence with the prolonged Eurozone debt crisis and the
 resultant looming recession. In the US, housing and employment data
 have remained weak, undermining hopes of a sustained recovery. Averting
 a hard landing for China depends on how effectively it reduces export
 dependence and boosts domestic demand without triggering inflation. As
 for India, unfortunately, most of its problems in the recent period
 have been self induced - lack of fiscal rectitude, uncompromising
 coalition partners, inability to gain consensus on crucial legislation,
 stalled reforms, corruption scandals and a sense of apathy towards
 foreign investment. Despite this, India has managed a GDP growth rate
 of 6.5% in FY 2012. In relative terms, compared to most countries,
 India''s growth rate is still impressive.
 
 The disappointment is that India''s performance is significantly below
 its potential. Alarm bells have been ringing with deteriorating
 macro-economic parameters. Inflation has remained stubbornly high and
 the rupee has been volatile, having depreciated sharply in the recent
 period. Muted capital flows and higher oil and gold imports has widened
 the current account deficit. An increasing entitlement and subsidy
 driven regime has resulted in a ballooning fiscal deficit. With reforms
 having come to a grinding halt, there is a sense of wariness in the
 investment climate. Globally too, the economic outlook is grim. In
 short, investors are forced to cope with volatility.
 
 In such an environment, there is a tendency to be blinkered by
 pessimism.  No doubt, business confidence in India has sunk to a low
 ebb. Fortunately, the same is not the case with consumer confidence. It
 is ironic to see the coexistence of falling business confidence but
 rising consumer confidence.  But herein lies India''s vibrancy and
 perhaps its true strength. India''s demographics have always been a
 strong attraction for investors. This unique advantage, however, may be
 lost if sufficient jobs are not created.
 
 The most radical, structural change in recent times in India is the
 growing power of its middle class. Better job opportunities, higher
 disposable incomes, a ''wanting-more'' consumer mind-set and an
 ambitious and optimistic outlook on life characterises this group. The
 middle class is consuming most of what India produces and is demanding
 more at a frenetic pace. India''s future lies in how effectively it
 can push households upwards into the middle class segment.
 
 The rapid growth in consumer goods, housing and other retail loans,
 mobile phones, cars and budget hotels amongst several other sectors —
 all point towards the voracious consumption of the middle class. India
 and China are markets rightly termed as ''the buying power by the
 billion''. Given the sheer size of these two markets, companies with
 global aspirations recognise they cannot afford to bypass these
 markets.
 
 As a result of the self-inflicted traumas that India has brought upon
 itself, some companies are caught in the dilemma of giving up the
 ''billion opportunity''. India has always been a country where
 investors need patience, but the rewards have been visible. Though
 there are deepening doubts about India''s ability to manage its
 future, companies with a long-term vision still believe that the risk
 of not being in India is greater than the risk of being in India.
 
 Economic hardships can always be overcome. What India needs to do to
 set itself back on course is known to all. Legislations that can
 re-instill confidence into the markets are ready and waiting for the
 requisite nod from parliament. The only thing holding India back at
 this juncture is lack of political will to ensure a better future for
 the country.
 
 Investors can no longer be placated by saying that the long term
 fundamentals of the country are still intact. It is equally important
 for investors to recognise that India is not a ''top-down'' story -
 it never was and perhaps never will be. From an investor''s
 perspective, India has always been a ''micro'' story. It is a select
 group of companies that have constantly strived to meet world class
 standards which has attracted global investors. For us, it is an honour
 that HDFC along with its group companies are amongst this privileged
 group.
 
 HDFC @ 35
 
 ''Steady Always. Cruising Ahead'' is a mirror image of what we have
 done during the past thirty-five years of our existence. We have
 consciously grown at a pace we believe is sustainable to ensure that
 there is no compromise on our asset quality. There have been many
 instances where irrational competition invaded the Indian housing
 finance market. Yet through all these years, HDFC has always maintained
 that market share has never been its priority, but being profitable is.
 In a country where mortgage penetration is so low, gaining market share
 is perhaps the easiest thing to do. Earning the goodwill of a customer
 requires much greater effort, and this was the very premise on which
 HDFC was set up.
 
 Through various economic and business cycles, HDFC has realised that a
 steady pace of growth has held it in good stead. Perhaps we may have
 foregone some short-term upside on growth, but in the long run, our
 cautious approach has been our rudder. This is also reflected in our
 consistently low non-performing assets.
 
 Many bad financial decisions are made in good times and it is easy to
 succumb to market exuberance. It is, however, important to recognise
 that a housing loan is different from other loans - it is long-term, it
 is the single largest investment a person makes in his or her lifetime
 and while the asset acquired per se does not generate any income, a
 home creates a deep sense of security and well being. A responsible
 home loan lender has to ensure that a customer not only acquires a home
 but is also able to remain in that home. Since inception, HDFC has
 taken its role of being a responsible lender very seriously. The global
 financial crisis which had housing at the epicentre also reaffirmed
 that being conservative pays in the long run.
 
 Urbanisation: The Next Implosion?
 
 Growing economic prosperity and urbanisation are inextricably linked.
 Rising urbanisation generally translates into better jobs, increased
 incomes and a higher standard of living. India''s urban population is
 projected to increase from 31% presently to 40% by 2030 and by 2050,
 more than two-thirds of Indians will be living in urban areas. The key
 question is: are we at all prepared to manage India''s urban
 transition? Evidently the answer is no.
 
 A comparison of BRIC nations, (Brazil, Russia, India and China) reveals
 that India''s pace of urbanisation ranks the lowest. Cities are
 centres of growth, employment generation and innovation, and yet India
 spends barely 0.1% of its GDP on urban development, whereas the minimum
 requirement is 0.25% of GDP per year. The Report on Indian Urban
 Infrastructure and Services (2011), estimates that India will require Rs
 39.2 lakh crore (~US$ 700 billion) for investment in urban
 infrastructure over the next 20 years. The government presently has
 just one key flagship programme on urbanisation and its seven year
 track record has been dismal.
 
 70% of India''s GDP and 7 out of every 10 jobs are expected to be
 created in urban India in the next 20 years. This should be a
 compelling enough reason for the government to give more thought on how
 future urban infrastructure requirements may be funded. It is certainly
 not enough to say that the PPP model will take care of all funding
 needs. Even municipal and urban local bodies have not been provided
 with a conducive environment to make them financially autonomous and
 raise their own resources.
 
 The skewness of urban lands is evident in these current statistics:
 
 - The top 10 Indian cities are estimated to produce 15% of the GDP
 with 8% of the population who occupy just 0.1% of the land area; and,
 
 - The top 100 largest Indian cities produce 43% of the GDP with 16% of
 the population, occupying just 0.24% of the land area.
 
 Unfortunately, the Land Acquisition, Rehabilitation and Resettlement
 Bill, has turned into a long saga, having lapsed twice and gone through
 umpteen committees. The underlying principles are clear - land has to
 be acquired for development, the compensation has to be fair and the
 role of the government cannot be eliminated given that the land markets
 in India are not sophisticated.  Collusion and vested interests of a
 few have distorted our land markets, but it is inaction and uncertainty
 that is most detrimental for investment projects.
 
 Urban living conditions are abysmal. The inevitable urban influx will
 only exacerbate the situation. Where are these people going to live and
 how many more slums will spring up? We hear of plans but no
 implementation of rental housing schemes for slum dwellers. Further,
 without transit accommodation existing slums cannot be rebuilt into
 formal housing units. With such a looming crisis, it is inexplicable
 why authorities are not giving serious attention to urban planning. If
 cities are allowed to decay and more people are homeless, it gives rise
 to civil strife.
 
 If any headway is to be made on affordable housing then some rethinking
 has to be done on the Floor Space Index (FSI). Given the pace of growth
 of Indian cities, there is no option but to go vertical. Yet, we
 consider it sacrosanct to restrict FSI.  Certainly, prudent norms are
 necessary when raising the FSI, but this can easily be done by ensuring
 strict building code standards and ring fencing funds to be utilised
 only for the upgradation of the surrounding infrastructure. Similarly,
 there has to be a mindset change on land reclamation. Globally, world
 class cities have been expanded through reclamation and without damage
 to the environment.  Affordable housing projects have to be fast
 tracked through a single window approval mechanism - only then will
 developers be sufficiently incentivised to build for this segment.
 Lastly, bringing in order, discipline and transparency through a real
 estate regulator must not be allowed to be thwarted by lobbies with
 vested interests. Time and again solutions to urban housing problems
 have been given, only to fall on deaf ears.
 
 To conclude, we have to work towards creating new cities. Yes, there
 are many roadblocks but the risk of inaction is far greater. The late
 Prof. C. K. Prahalad had rightly said, India needs to create 500 new
 cities to accommodate a better quality of life, otherwise every
 existing city will become a slum when India turns 75 in 2022.
 India''s defining moment has arrived and we should not miss out on the
 economic opportunities that urbanisation brings. A few bold policy
 measures will go a long way in changing the lives of a billion Indians.