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India:

New Government & Economic Outlook

Analysts:

Nilesh Sharma, Amresh Prasad

Vaibhav Tandon & Aniket Mittal

November 2014

India: New Government & Economic Outlook I November 2014 1

2 Improved decision making ends policy uncertainty; reforms on the anvil

Speedy decision-making process ends policy uncertainty; projects backlog worth over billions of dollars cleared by the new

administration

Government’s focus on infrastructure spending and expanding manufacturing activity by removing procedural bottlenecks

to boost investments

3

Strengthening external environment to boost investments and corporate sector performance

Corporate sector performance picking up; earnings growth increasing

Strict supervision and improving business environment reducing stress on asset quality of banks; credit growth likely to

revive 2015 onward

4 However, challenges persist…

At 142nd position among 189 countries, India languishing at the bottom half in the World Bank’s “Ease of Doing Business”

ranking; fares poorly on the “Global Competitiveness Index” ranking too

Higher non-planned expenditure and subsidies likely to derail fiscal consolidation; India’s sovereign ratings could be

negatively impacted

1 India on the brink of turnaround with the economy set to be back on high-growth trajectory

Real GDP growth set to bounce back after hitting a 10-year low in 2013; India to re-emerge as the second fastest growing

major economy

Falling crude prices easing inflationary pressure, paving the way for monetary easing

Key Takeaways

India: New Government & Economic Outlook I November 2014

After hitting a 10 year-low of 4.5% in 2013, real GDP growth set to pick up; India to re-emerge as the

second fastest growing major economy

2

INDIA REAL GDP GROWTH (%)

Source: Ministry of Finance, IMF World Economic Outlook October 2014 Estimates for 2015 & 2016

Economic growth

slows sharply with the

onset of the financial

crisis.

Sluggish external

environment

alongside policy

paralysis

accentuated the

slowdown.

3.9

8.0

7.1

9.5 9.6 9.3

6.7

8.6 8.9

6.7

4.5 4.7

5.6

6.4

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16


0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

-

10

20

30

40

50

60

70

2000-01 2003-04 2006-07 2009-10 2012-13

Consumer Spending (INR Trillion) YoY Growth (%) - RHS

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14

Exports (INR Trillion)

Rising consumer spending and exports to drive growth

3

GROWTH IN CONSUMER SPENDING

Source: Bloomberg, Reserve Bank of India (RBI)

GROWTH IN EXPORTS


Falling crude prices ease inflationary pressure

4

Source: Bloomberg, Reserve Bank of India (RBI)

80

85

90

95

100

105

110

115

120

125

130

Ja

n-1

2

Apr-

12

Ju

l-1

2

Oct-

12

Ja

n-1

3

Apr-

13

Ju

l-1

3

Oct-

13

Ja

n-1

4

Apr-

14

Ju

l-1

4

Oct-

14

0%

2%

4%

6%

8%

10%

12%

Ja

n-1

2

Apr-

12

Ju

l-1

2

Oct-

12

Ja

n-1

3

Apr-

13

Ju

l-1

3

Oct-

13

Ja

n-1

4

Apr-

14

Ju

l-1

4

Inflation - Wholesale Price Index Inflation - Consumer Price Index

Brent crude prices have

fallen by over 23% since

July 2014 India Inflation (September 2014)

WPI – 2.4%

CPI – 6.5%

CRUDE OIL PRICES (US DOLLAR PER BARREL) INFLATION (WHOLESALE & CONSUMER PRICES)


Interest rate cycle seems to have peaked; with inflation under control, Reserve Bank of India set to

adopt a pro-growth stance

5

Source: Reserve Bank of India (RBI)

6.50%

7.00%

7.50%

8.00%

8.50%

Jan-1

2

Feb

-12

Ma

r-1

2

Apr-

12

Ma

y-1

2

Jun-1

2

Jul-1

2

Aug-1

2

Sep-1

2

Oct-

12

No

v-1

2

De

c-1

2

Jan-1

3

Feb

-13

Ma

r-1

3

Apr-

13

Ma

y-1

3

Jun-1

3

Jul-1

3

Aug-1

3

Sep-1

3

Oct-

13

No

v-1

3

De

c-1

3

Jan-1

4

Feb

-14

Ma

r-1

4

Apr-

14

Ma

y-1

4

Jun-1

4

Jul-1

4

Aug-1

4

Sep-1

4

To arrest the fall in

economic growth,

the RBI cut interest

rates by 75 bps

Since taking over as the Governor of RBI in July

2013, Raghuram Rajan has increased interest rates

by 75 bps to rein in inflation.

REPO RATE


Boosted by the absolute majority in the lower house of the parliament, the new government kick starts

the reforms process

6

Source: Ministry of Finance, Aranca Analysis

SECTOR REFORMS PROPOSED BENEFITS

Raised the foreign direct investment (FDI) limit

to 49% from 26% under government approval

route

India largest weapons importer in the world (imports

totaled USD5.6 billion in 2013)

Transfer of technologies through joint ventures to

improve domestic manufacturing capabilities and reduce

burden on imports

About INR250 billion to be invested in the next 7–8

years

Allowed 100% FDI (earlier FDI allowed only in

mass rapid transport systems)

Proposed to raise FDI limit to 49% (earlier

26%)

Would increase life insurance penetration in India

(currently about 3.2% of GDP in terms of total premiums

underwritten in a year, much lower than nearly 6% in

Australia and more than 10% in Japan)

Increase in FDI limit may attract USD5 billion over the

next five years

Defense

Railways

Insurance

Foreign investment expected to generate much-needed

resources to introduce a high-speed rail corridor, build &

upgrade suburban corridors and add capacity through

speedy development of dedicated freight corridors

12th five-year plan earmarks INR5,129.2 billion

investment for railways by 2017

Identified projects (38) likely to attract FDI totaling

INR900 billion


Investor community responds positively to the change of guard; markets breach their all time highs as

portfolio inflows increase

7

Source: Bloomberg, Securities & Exchange Bureau of India (SEBI)

5,000

5,500

6,000

6,500

7,000

7,500

8,000

8,500

Jan-1

3

Ma

r-1

3

Ma

y-1

3

Jul-1

3

Sep-1

3

No

v-1

3

Jan-1

4

Ma

r-1

4

Ma

y-1

4

Jul-1

4

Sep-1

4

250 284

149

107

281

-442

-181 -157

74

21 21

214

133 127

317

4

338 307

360

221 210

Jan-1

3

Feb

-13

Ma

r-1

3

Apr-

13

Ma

y-1

3

Jun-1

3

Jul-1

3

Aug-1

3

Sep-1

3

Oct-

13

No

v-1

3

De

c-1

3

Jan-1

4

Feb

-14

Ma

r-1

4

Apr-

14

Ma

y-1

4

Jun-1

4

Jul-1

4

Aug-1

4

Sep-1

4

The benchmark Nifty50 index breached the 8,000

mark for the first time in history and has returned

over 34% to investors in 2014 YTD

NIFTY INDEX PERFORMANCE PORTFOLIO INFLOWS (INR BILLION)


Speedy decision making process ends policy uncertainty; projects backlog worth over billions of

dollars cleared by the new administration

8

May 2014

New government unveils 10-point

vision within just two weeks of

coming to power with an aim to

boost investments, complete

infrastructure projects in a time-

bound manner and ensure efficient

utilization of natural resources

June 2014

Passenger railway fare and

freight fare hiked 14.2% and

6.5%, respectively

Seven big-ticket investment

projects worth INR210 billion

cleared

Road-related projects worth

INR400 billion cleared

July 2014

Plans to build 100 smart cities

with an initial investment of

USD1.2 billion with additional

funding expected from private

investors

Aug 2014

Newly created National Board

for Wildlife cleared 133

proposals out of 160 proposals

Sep 2014

India China signed 13 MOUs,

with the latter committing

investments worth USD20 billion

over the next five years

Japan commits to doubling its

investments in India to USD35

billion in the next five years,

especially in the infrastructure

sector

Oct 2014

Crucial defense-related projects worth

INR800 billion cleared

Over 180 projects with a combined value

of INR6,500 billion cleared by Project

Monitoring Group

Nearly 88 infrastructure and industrial

projects worth INR3,000 billion

commenced operations over the last few

months



Government focus on infrastructure spending and boosting manufacturing activity by removing

procedural bottlenecks to boost investments

9

HIGHER ALLOCATIONS

Allocated INR379 billion to the Ministry of Road Transport and Highways for infrastructure development

Raised the corpus of Rural Infrastructure Development Fund (RIDF) to INR250 billion (from INR200 billion) to extend financial assistance to rural

infrastructure

Allocated INR176 billion for urban infrastructure and governance

Infrastructure development schemes include:

Developing 100 smart cities

Building 8,500 km of national highways

Developing 16 new port projects

Building metro rail in Tier-2 cities

Setting up 3P India at a cost of INR5 billion to provide support to mainstream PPP projects

Creating eBiz platform to provide information on all business and investment-related clearances

Encouraging banks to extend long-term loans to infrastructure companies, and have a flexible strategy to absorb potential adverse contingencies

Exempting the issuing of long-term bonds for financing infrastructure from reserve requirements

Creating Infrastructure Investment Trusts


STEPS TAKEN TO INCREASE INFRASTRUCTURE INVESTMENTS THROUGH …

IMPROVEMENT IN POLICY FRAMEWORK


Increasing foothold in state assemblies to strengthen the NDA-led central government’s position to

implement key reforms

10

NDA RULED STATES – 2009 NDA RULED STATES – 2014


Corporate sector performance picking up; growth in earnings gaining pace

11

Source: Bloomberg, Business Today, Aranca Analysis

REVENUE AND NET PROFIT NUMBERS OF TOP 500 LISTED COMPANIES IN INDIA

448.6

539.3

664.3

747.2

819.8

46.5

55.0 55.7

61.1

63.4

2010 2011 2012 2013 2014*

Revenue (USD bn) Net Profit (USD bn)

10.4% 10.2% 8.4% 8.2% 7.7%

Net Profit Margin (%)

Corporate performance seems to have bottomed out

after the long slump witnessed over FY2010–14.

Amid decreasing inflation-related concerns, likely

deduction in interest rates and improving business

confidence, corporate earnings are likely to bounce

back strongly.

Analysis of the earnings of 159 companies that

declared results for the July–September 2014 quarter

shows that net income grew 37.4% year-on-year,

almost twice compared to 19.7% year-on-year for the

April–June 2014 quarter.


Strict supervision and improving business environment helping banks reduce stress on asset quality;

credit growth likely to revive 2015 onward

12

CAR and Tier I CAR (%) Trend Gross NPA and restructured assets trend (%) Credit-deposit growth and liquidity (%)

2.79%

3.46% 3.26%

3.98% 3.85%

5.38%

6.13% 6.03% 6.47%

6.16%

Mar-12 Sep-12 Mar-13 Sep-13 Mar-14

Gross NPA Ratio

Restructured Assets to Advances Ratio

13.26% 12.59%

11.54%

9.45% 9.12% 8.86%

Mar-12 Mar-13 Mar-14*

Median CAR Median Tier I CAR

* Ratio computed as per Base III norms for Mar 2014; earlier

periods are based on Basel II

17.84% 16.64% 14.49%

15.25% 15.21% 14.53%

78.50% 79.48% 79.44%

Mar-12 Mar-13 Mar-14*

Advances Growth Deposit Growth

Credit-Deposit ratio

Source: Bloomberg, Reserve Bank of India (RBI), Aranca Analysis: Note: Analysis on 39 banks - 26 Public Sector Banks & 13 Private Sector Banks

ASSET QUALITY STRESS REDUCING… …CREDIT-TO-DEPOSIT RATIO FAVORABLE …ADEQUATELY CAPITALIZED…

Due to the central bank’s guideline on early

detection and resolution of bad loans and a

general improvement in the economic

environment, the stress on the asset quality of

banks is decreasing.

The banking system witnessed a marginal

improvement in the quarter ended March 2014.

Though the capitalization ratio decreased year-

on-year, Indian banks remain adequately

capitalized.

The median Tier I CAR of 8.86% in March

2014 was higher than the stipulated minimum

mark of 6.5%.

Due to slow credit pickup, the overall advances

of the banking system lag behind the growth in

deposit

Individual depositors seek ‘higher return –

minimum risk’ investment avenues

The liquidity (credit-to-deposit) ratio, however,

remains comfortably placed at nearly 80%


FDI inflows beginning to improve; momentum likely to gather pace in 2015

13

32.5 38.1

43.2

70.9

105.8

125.2

171.2

205.6 206.4

225.0 226.7

4.3 5.8

7.6

20.3

25.3

47.1

35.7

27.4

36.2

24.2

28.2

0

10

20

30

40

50

0

50

100

150

200

250

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

FDI Inward Stock (LHS) FDI Inflow

In USD billion

Source: UNCTAD

FDI INFLOWS SURGING AFTER BOTTOMING OUT IN 2012 SINCE THE PEAK OF 2008

For the first five months of FY14-15 (April–August 2014), FDI grew 42% year-on-year to USD12.0 billion.

FDI inflows expected to increase significantly in FY 2015.


Concerns over long-term growth persist with India languishing at the bottom half in the World Bank’s

“Ease of Doing Business” and World Economic Forum’s “Global Competitiveness Index” rankings

14

Source: The World Bank, World Economic Forum (WEF)

142

120

90

62

43

26

18

India

Brazil

China

Russia

South Africa

Thailand

Malaysia

71

57

28

53

56

31

20

India

Brazil

China

Russia

South Africa

Thailand

Malaysia

EASE OF DOING BUSINESS RANKINGS (2014) GLOBAL COMPETITIVESS INDEX RANKINGS (2014-15)


Higher non-planned expenditure and subsidies may derail fiscal consolidation; this could negatively

impact India’s sovereign ratings

15

Source: Ministry of Finance

3.9% 4.0%

3.3%

2.5%

6.0%

6.5%

4.9%

5.8%

4.5%

4.1%

2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2011-12 2012-13 2013-14 2014-15 e

Higher government

spending to revive economic

growth during the downturn

worsened the country’s

fiscal situation.

Threat of a ratings

downgrade pushed the

government toward medium-

term fiscal consolidation

(fiscal deficit is likely to reach

3.0% of GDP by 2017).

FISCAL DEFICIT (% OF GDP)


Concerns remain over big-bang labor and land acquisition reforms; once addressed, these measures

could usher in a new phase of growth

16


ISSUES POTENTIAL BENEFITS

LABOR LAWS

Major reforms to rigid laws likely to trigger a political and trade union backlash

Strictly regulated hiring and firing policy

‘Inspector raj’ rule of inspectors creating inconvenience for employers with loads of

paperwork

Politicization of trade unions and bad trade union laws

Strong segmentation between formal and informal employment a barrier to inclusive

growth as it leads to income inequality

Likely to create a conducive environment for growth

in trade and industry, and bring transparency in

social security benefits to aid workers

Expected to encourage job creation in the formal

sector

LAND ACQUISITION

Land titling and land record management systems leading to delays in land

acquisition

Complex land purchase procedures making acquisition difficult for industrial projects

Distortions in land prices due to large regulatory constraints and unfair process of

valuation

Rehabilitation and environmental issues

High transaction costs in land trade

Speeding up the process for buying land for

industrial use likely to increase investments

Would boost infrastructure projects that often suffer

due to delays in approval and acquisition

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