Will RBI rate cut keep inflation under check in 2015?

Dipankar Mitra ([email protected]); +91 22 3982 5405

2015: Era of low inflation and falling rates begin

RBI to get enough headroom to cut rates by 150-250bp While RBI has begun the rate cut cycle, plenty of headroom for

further cuts would be generated going forward as low inflation would

be the defining feature of 2015.

The sharper-than-anticipated fall in inflation seen already is not just a

statistical artifact but for ‘real’. The latest data indicate prevalence of

disinflationary trend is deeply entrenched at both retail and

wholesale level. Continuation of these trends would imply one of the

lowest CPI inflation in three decades and near zero WPI inflation in

FY16. This would lead to RBI’s target being overachieve by nearly

200bp. This would also mark the convergence of global and Indian inflation after a decade.

A decomposition analysis of inflation revealed relatively lower contribution of base effect (11% for CPI and 20% for WPI)

in the fall in inflation. However, nearly two third of decline in retail inflation is explained by moderation in food prices

while nearly half of decline of wholesale inflation is explained by meltdown in global commodities (including oil).

The meltdown in global commodities is now deeply entrenched due to the renewed fears of slowdown in advanced

countries and sector specific dynamics. On the other hand the clampdown on food prices by the government also seems

durable given the history of NDAs in tackling food inflation in the past and the medium term measures initiated by the

government to improve agricultural economy.

We expect 150bp cut to ensure, among other things and crucially, that real interest rates do not rise above GDP growth

rate. On the INR front, while low inflation lends a stability bias, RBI may proactively depreciate the rupee at a steady

pace to ensure export competitiveness and ward off future volatility.

Corporate sector as a whole would be a beneficiary of near term expansion of margin both on account of lower input

costs and expected pick up in activities that helps improve operating leverage. We model 120bp/190bp expansion in PAT

margins for FY16/FY17 for our universe companies.

20 January 2015

ECOSCOPE The Economy Observer 2015 low inflation

Rate cuts has begun but RBI to get more headroom as CPI set to overachieve RBI target by 200bp

Lower food prices and commodity crash led to the inflation decline

As these are durable factors, 2015 likely to be a year of low inflation

We expect policy rates to be cut by a total of 150 bp over 2015; INR may find a support too

Corporate margins to expand

Investors are advised to refer through disclosures made at the end of the Research Report.

20 January 2015 2

Period of low inflation begins As global factors and govt. tame inflation, rates and INR seen to benefit

The sharper-than-anticipated fall in inflation is not just a statistical artifact but for ‘real’. Quite contrary though the strong disinflationary impulse at the wholesale level and absence of a price rise at the retail level have caused this. Continuation of these trends would imply near zero WPI inflation for the first time in three decades and one of the lowest CPI inflation during this period. This would also mark the convergence of global and Indian inflation after a decade. 1. Inflation was meant to surprise… but the extent surprised us

too Inflation, both retail and wholesale, has rapidly winded down in a short period

of time of last six months. While we had expected that inflation would surprise on the downside, the

extent of decline was huge.

Exhibit 1: WPI inflation is falling sharply due to strong disinflationary trends and not just the base effect

Source: Government, RBI, MOSL

WPI inflation may fall to near zero if i) disinflationary conditions prevail for a few more months and ii) prices rise at half the rates of high inflation years

CPI inflation would fall to decadal low under similar conditions

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Wholesaleinflation (WPI YoY %) crashed to ground zero

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Strong disinflationary pressures seen for last four months (WPI MoM %)

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Retail inflation has crashed (CPI YoY%) and the may rise now only for base effect

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Now disinflation in retail inflation too (CPI MoM%)

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NREGA started with INR 113 b

Post crisis stimulus i) Debt waiver INR 720 b,ii) 6th Pay Commission INR200 b,iii) Tax and spend of INR 1 t

NREGA scaled up to INR 400 b

MSPhike of 27%

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Era of high commodity prices

ECONOMICS

20 January 2015 3

This concludes an era of high global commodity prices that kept the imported inflation high and got reflected in WPI measures.

On the other hand, it also reflected the cumulative measures on social welfare and crisis response undertaken by the previous UPA government, which percolated down on domestic retail inflation.

It is notable though that the decline in inflation is not a statistical artifact. Quite contrary, it comes on the back of rather deep disinflationary impulses that have engulfed the Indian economy. This is reflected at the retail level now with the Dec-14 CPI index witnessing MoM disinflation after three months of near no-growth in the index. At the wholesale level, disinflation is continuing for the fourth consecutive month now in Dec-14, signifying that the underlying index (or price) is actually falling.

Another supportive factor is the broad-based decline in all components of inflation and various analytical measures of inflation.

If the disinflationary trend continues for a few more months, or even if the increase in prices are half the rate of high-inflation years, we would arrive at near zero WPI inflation for FY16 (0.5%) -- the lowest in three decades. Similarly, CPI inflation is poised to reach below 4% level -- very near the lowest value in three decades.

This would mark the convergence of Indian inflation with global inflation in FY16. Notably, the two had diverged widely during the previous UPA regimes, while the NDA has a track record of maintaining low inflation, and we are likely headed in that direction again.

Exhibit 2: CPI and all of its components have more than halved from peak values (YoY, %)

Source: Government, MOSL

11

15

9

16

13 15

12 12 11

5 5 4

8

3

7 5 5 5

50% 26% 10% 9% 5% 41%

CPI-RU CPI-Food group

Services Housing Fuel group Clothing etc.

Rural CPI Urban CPI Core CPI

Recent peak Latest Weight

20 January 2015 4

Exhibit 3: FY16 retail inflation to crash to near three-decade lows

Source: Bloomberg, MOSL

Exhibit 4: Wholesale inflation is on course to be near zero


Exhibit 5: Indian and global inflation converging again after 10 years

Source: IMF, MOSL

2. Inflation decomposition - base effect, imported items and food price crash explains nearly all of inflation decline

A decomposition analysis of inflation revealed relatively lower contribution of base effect (11% for CPI and 20% for WPI) in explaining the decline in inflation. However, nearly two third of decline in retail inflation is explained by moderation in food prices while nearly half of decline of wholesale inflation is explained by meltdown in global commodities (including oil). Imported inflation mattered less for CPI inflation decline (only 13%) as the proportion of commodities directly affected by CPI is relatively less. For WPI, decline in food inflation however, did contribute a significant part (30%) of decline in overall inflation as food comprises a sizable 14% of the overall WPI basket.

As inflation declines it’s time to decipher what has led to such sharper than

anticipated inflation. A decomposition analysis reveals that three factors viz., base effect, decline in

imported inflation and moderation in food inflation is responsible for the decline in inflation.

However, the weight of these factors played different roles in CPI and WPI. While CPI declined mainly due to moderation in food price, meltdown in global commodities played a far greater role in moderation of WPI.

3.4 3.9 3.9 2

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E

CPI Inflation (YoY %) Third lowest CPI

inflation in 3 decades

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4

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12

16

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WPI Inflation (YoY %) Lowest WPI inflation

in 3 decades

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-3

0

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CPI (India - World) Period of convergence

Note: India's 2015 inflaton corresponds to FY16

NDA - I NDA-II UPA-II UPA-I

20 January 2015 5

Exhibit 6: Nearly two third of decline in CPI inflation is attributed to moderating food inflation


Exhibit 7: Nearly half of WPI crash is due to moderation in imported items


We have used separate methodology to isolate the impact of the three factors

in moderation of inflation. The base effect has been calculated by using a smoothened inflation index,

measuring the contribution of base effect as a residual of actual inflation and the smoothened series.

We have categorized the CPI and the WPI basket into commodity baskets that are influenced by global prices in to an index (with the combined weight of these components) and derived the imported inflation out of this index.

The contribution of food inflation was calculated directly by taking the weighted contribution of the food basket in each inflation indices.

Exhibit 8: Base impact calculated on a smoothened CPI index, account for only 10% of the decline in inflation

Exhibit 9: The impact of base effect is somewhat higher at 20% for WPI index

11.2

5.0

0.7 (11%) 0.8 (13%)

4.7 (76%)

Nov-13 Base effect Decline in imported inflation

Decline in food

inflaiton

Dec-14

7.5

0.1

1.5 (20%)

3.7 (50%)

2.2 (30%)

Nov-13 Base effect Decline in imported inflation

Decline in food

inflaiton

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CPI Inflation CPI inflation (without base effect)

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WPI-Inflation WPI inflation (without base effect)

20 January 2015 6

Most of the WPI basket is globally dependent while it holds for only a small part of CPI Inflation indicator Weight Inflation indicator Weight WPI 100.0 CPI 100.0

Primary articles 20.1

Food, beverages & tobacco 49.7 Food articles 14.3

Cereals and products 14.6

Non-food articles 4.3

Pulses and products 2.7 Minerals 1.5

Oils and fats 3.9

Fuel & power 14.9

Egg, fish and meat 2.9 Coal 2.1

Milk and products 7.7

Mineral oils 9.4

Condiments and spices 1.7 Electricity 3.5

Vegetables 5.4

Manufactured products 65.0

Fruits 1.9 Food products 10.0

Sugar etc. 1.9

Beverages, tobacco & tobacco products 1.8

Non-alcoholic beverages 2.0 Textiles 7.3

Prepared meals etc. 2.8

Wood & wood products 0.6

Pan, tobacco and intoxicants 2.1 Paper & paper products 2.0

Fuel & light 9.5

Leather & leather products 0.8

Clothing, bedding & footwear 4.7 Rubber & plastic products 3.0

Housing 9.8

Chemicals & chemical products 12.0

Miscellaneous 26.3 Non-metallic mineral products 2.6

Medical care 5.7

Basic metals, alloys & metal products 10.8

Education, stationery etc. 3.4 Machinery & machine tools 8.9

Recreation and amusement 1.4

Transport, equipment & parts 5.2

Transport and communication 7.6

of which import dependent transport 3.9

Personal care and effects 2.9

Household requisites 4.3

Others 1.1 Total global factor dependent WPI basket weight 66.2 Total global factor dependent CPI basket weight 13.4


Exhibit 10: Nearly two-third of decline in CPI inflation can be accounted for food alone


Exhibit 11: Decline in food inflation contributed in WPI moderation too; albeit to a lesser degree


2

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CPI Inflation Contribution of food in CPI inflation

0

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WPI inflation Contribution of food in WPI inflation

20 January 2015 7

3. Inflation to stay moderate as its backbone is crushed by global trends and govt’s firm hand

The meltdown in global commodities is now deeply entrenched due to the renewed fears

of slowdown in advanced countries and sector specific dynamics. On the other hand the

clampdown on food prices by the government also seems durable given the history of

NDAs in tackling food inflation in the past and the medium term measures initiated by the

government to improve agricultural economy.

i) Global commodity crash Indicative of the sharpness of disinflationary pressures prevailing in the global

economy, key commodity prices have retreated by three years. While INR’s depreciation has partly moderated this gain, commodity prices in

INR terms are still ruling at three years lows. In contrast, India’s inflation indices increased over these years at a steady pace.

Only recently, Indian prices have shown signs of a retreat. Global food prices (most crucial factor), after ending an era of extreme volatility,

now appear on the steadier course of a downturn. These developments have been highly beneficial for India’s imported inflation,

which nearly collapsed recently.

Exhibit 12: Global commodity prices have retreated by three years in INR terms


Exhibit 13: Crude oil prices fell by nearly 60% in the last six months to near levels prevailing six years ago


Exhibit 14: Coal prices have rolled back by five years


Exhibit 15: Other key input prices have crashed similarly


250,895

171,112

100,000

140,000

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260,000

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Rogers International Index (INR) 127

51 40

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ct-1

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r-12

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3 Se

p-13

D

ec-1

3 M

ar-1

4 Ju

n-14

Se

p-14

D

ec-1

4

Crude (USD/bbl)

128

63 50

70

90

110

130

Mar

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-12

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2 O

ct-1

2 Fe

b-13

Ju

n-13

Se

p-13

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n-14

M

ay-1

4 Au

g-14

D

ec-1

4

Coal - Richard Bay index (USD/MT)

761

479 450

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China HR Steel (USD/MT)

20 January 2015 8

Exhibit 16: In contrast, WPI index rose fairly steadily and has seen only moderate pushback recently


Exhibit 17: World food prices moderate too thus restraining domestic prices

Source: FAO, MOSL

ii) The iron hand of government The combination of post crisis stimulus measures, rural oriented schemes,

subsidies and proceeds from land sale had created a inflationary spiral during the previous UPA regimes.

Supply bottlenecks hindered a proportionate increase in food availability along with demand that was bolstered with higher rural income, wages and shifting terms of trade in favor of agriculture through higher MSPs. The rate of MSP hikes more than doubled during UPA regimes as compared with the first stint of NDA.

All these are being unwounded now. The new government has cracked the whip on the stubborn food inflation from all fronts, including price control measures, subsidy, ensuring food availability and ensuring appropriate response from states.

The measures had a salutary impact on food inflation that has subsided from as high as 19% during Aug 2013 to just 0.6% during Nov 2014.

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WPI index

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FAO food price index

A period of volatile food prices

A period of steady decline in world food prices

20 January 2015 9

Exhibit 18: The vicious cycle of inflation during post crisis period

Source: RBI, MOSL

Exhibit 19: Very low MSP hike by new govt. to contain food prices

Source: CACP, MOSL

Exhibit 20: Govt. has attacked food inflation from all fronts


Rural Schemes

Higher rural income

Higher rural wages

Higher MSP

Supply bottleneck

Higher rural inflation

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NDA-I Avg: 4%

UPA-I Avg: 10%

UPA-II Avg: 8%

NDA-I I

MSP hike (YoY %)

20 January 2015 10

4. Low inflation to ensure 150bp rate cut; INR to gain too

Low inflation would be the defining feature of 2015. While RBI has initiated the rate cut cycle, we expect ample headroom to be created during 2015 for a cumulative 150bp cut in 2015. Among other things this would ensure crucially, that real interest rates do not rise above GDP growth rate. On the INR front, while low inflation lends a stability bias, RBI may proactively depreciate the rupee at a steady pace to ensure export competitiveness and ward off future volatility.

i) See lower interest rates Due to continued tight monetary policy and rapid unwinding of inflation, real

interest rates have turned positive in FY15 itself. However, given the inflationary trajectory for FY16, if rates are not cut

proportionately, the real rates of interest would zoom to historically high levels. A cut in rates by 150-250bp in FY16 would thus be necessary to bring real rates

closer to RBI’s indicative real rate of 1.5% (for depositors) and the 0.6% long term real rate that has historically prevailed in India.

A critical problem associated with prevailing high real rates of interest though is that real lending rates have already reached unsustainable levels -- higher than the GDP growth rate. This would be accentuated in FY16, if rates are not cut proportionately, thus creating a strong deflationary bias.

Lower inflation and the inflation differential (with US) in the past have been associated with a narrowing of interest rate gap that presently is ruling at historically high levels. A rate cut is thus imperative to normalize the yield gap that may also narrow the arbitrage opportunities existing now.

Exhibit 21: In the past there existed a broad link between inflation and policy rates


Exhibit 22: This is more so for WPI inflation but the link now is

broken


Exhibit 23: Real interest rates have turned positive and may reach near the 16-year high in FY16 without matching cuts


Exhibit 24: Rates would need to be cut at least by 150-250bp by FY16 to normalize even with RBI's indicative real rates


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CPI Inflation (YoY %) Repo rate

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WPI Inflation (YoY %) Repo rate

4.7

3.4

1.8

1.1 1.7

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6

-1.0

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-2.2

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Real deposits rate (SBI 1yr deposits - CPI inflation)

RBI's indicative real rate of 1.5%

1.5

0.6

3.1

2.1

RBI's Indicative real rate

Real rate - Long period avg

Real rate with 150bp cut

Real rate with 250bp cut

Real rate (%)

20 January 2015 11

Exhibit 25: In a very unusual situation, real rates for corporates (WPI benchmark) would exceed GDP growth rate

Source: Government, Bloomberg, MOSL

Exhibit 26: Real lending rates in FY15 are much above GDP growth with adverse consequence on business viability

Source: Government, Bloomberg, MOSL

Exhibit 27: As inflation differential declines, historically high yield gap too needs to be brought down

Source: IMF, Bloomberg, MOSL

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Real AAA Corporate Bond rate (1-yr) GDP growth

1.2 1.5 2.2 1.7

8.0

5.6 5.0 5.3 6.0 5.5

11.8

5.6

Real Repo rate Real 10-yr Gsec Real CP rate 1yr Real term deposits 1-yr

Real SBI PLR GDP growth

CPI benchmark WPI benchmark RBI 1.5% benchmark for real rates

How much of real interest rate is too much ???

7.6

4.8 5.8

2.9 2.3 0.9 2.3 2.7 2.9 3.8 3.0 3.8 4.6 6.7 6.3 5.8 5.8 0

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10-yr Gsec Yield (India - US) CPI Inflation (India - US)

20 January 2015 12

ii) Expect INR stability but RBI intervention to ensure competitiveness Low inflation is expected to bring stability to INR. Notably, the period of NDA-I

that was marked by Indian inflation rate lower than global inflation, was also a period of static INR. However, inflation accelerated in the subsequent UPA regimes and INR too depreciated by a huge margin.

While low inflation would bring INR stability, we expect RBI to proactively lend a bias for steady INR depreciation to ensure competitiveness and ward off future volatility.

Exhibit 28: Higher inflation differential led to INR depreciation

Source: IMF, MOSL

Exhibit 29: RBI may still intervene to ensure competitiveness

Source: RBI, MOSL

iii) Government finance Inflation impacts government finance both from revenue and expenditure side. On the revenue side, corporate tax collections may be adversely impacted due

to lower inflation as also major indirect taxes that are collected on ad valorem basis.

However, on the expenditure side, government saves on the interest outgo and non-plan capital expenditure.

The net impact on government finance, especially headline deficit measures, are usually neutral.

However, if prices of particular commodities fall sharper than others where the government’s subsidy programme too is concentrated, it might mean more than the usual savings for the government.

Thus, the combined impact of oil prices fall, decline in food and fertilizer prices, better targeting of beneficiaries through the Direct Benefit Transfer (DBT) and reduction in scope of certain subsidies -- LPG and Kerosene -- is likely to aid the government stay on the fiscal corrective path along with improved fiscal accounting and practices.

However, there is a fairy strong and adverse impact of low inflation in public finance. The reduction in debt to GDP ratio may be slowed down as interest rates takes a longer time to adjust.

-0.7

2.5 5.6

2.3 7.1

36.1

1999-2004 2005-2009 2010-2014

CPI (India - World) (Yearly Avg) INR (% change over period)

-50

0

50

100

90

100

110

120

FY97

FY

98

FY99

FY

00

FY01

FY

02

FY03

FY

04

FY05

FY

06

FY07

FY

08

FY09

FY

10

FY11

FY

12

FY13

REER (WPI Based) (LHS)

RBI Intervention (USD b) (RHS)

20 January 2015 13

Exhibit 30: On revenue side, inflation has the strongest impact on corporate tax collections…


Exhibit 31: …this is followed by customs collection


Exhibit 32: Excise too seems positively impacted by inflation


Exhibit 33: On the expenditure side, interest burden has a strong relationship with inflation


Exhibit 34: Non-plan capital expenditure too is adversely impacted by high inflation


Exhibit 35: Fiscal deficit though is more stance driven and has nearly no correlation with interest rates


0

10

20

30

40

50

0

3

6

9

12

15

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

BE

WPI Inflation (YoY %) (LHS) Corporate tax receipt (YoY %, RHS)

-40

0

40

80

0

5

10

15

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

BE

WPI Inflation (YoY %) (LHS) Custom duties collection (YoY %, RHS)

-20

0

20

40

0

5

10

15

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

BE

WPI Inflation (YoY %) (LHS) Excise duties collection (YoY %, RHS)

0

5

10

15

20

25

0

3

6

9

12

15 FY

91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

BE

WPI Inflation (YoY %) (LHS) Interest payments (YoY %, RHS)

-20

0

20

40

0

5

10

15

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

BE

WPI Inflation (YoY %) (LHS) Excise duties collection (YoY %, RHS)

0

5

10

15

20

25

0

3

6

9

12

15

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

BE

WPI Inflation (YoY %) (LHS) Interest payments (YoY %, RHS)

20 January 2015 14

Exhibit 36: Low inflation however, would adversely impact the continued decline in debt burden by the government

Source: IMF, Bloomberg, MOSL

5. What not to expect from a low inflation

In popular perception, low inflation is expected to help GDP growth, saving (at least financial saving) or at the least inflation expectations itself. However, data suggests that these are fairly unlinked and inflation expectations, at the best would catch up with falling inflation with a lag.

i) GDP growth don’t go up in a hurry because of low inflation Economists have explored this ad infinitum, but the data at least in Indian

context, do not suggest any obvious conclusion of a link between inflation and GDP growth.

Indeed, we do not find any evidence of RBI’s assertion that beyond a threshold level, inflation is inimical to growth.

While long drawn statistical manipulations may find a result to the contrary, we simply note that there are just too many exceptions to this rule with many years 6%+ growth coexisting with even 8%+ growth.

While the conclusion may surprise many, but the fact is that growth requires many other favorable factors to come together beyond just low inflation.

Exhibit 37: Low inflation however, would adversely impact the continued decline in debt burden by the government


40

46

52

58

64

0

4

8

12

16

FY91

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

CPI Inflation (YoY %) Central govt. debt (% of GDP)

-6

-3

0

3

6

9

12

-5 0 5 10 15 20 25

GD

P gr

owth

CPI inflation

20 January 2015 15

ii) Saving, even private financial savings are not related to inflation Similarly, saving ratio is not influenced by inflation and the later is even

inconsequential for allocation of saving in financial instruments. This is because while GDP growth rate largely determine saving rate, financial

savings are indeed decided by many other structural factors such as banking and financial sector penetration; people’s habit, convenience and confidence; knowledge, etc.

Exhibit 38: There is nearly no link found between inflation and saving rate

Source: RBI, Government, MOSL

Exhibit 39: Inflation is also not found to influence the share of private financial savings


iii) Decline in Inflation expectations is not proportionate and may lag Finally while inflation expectations, as per RBI’s survey has come down to single

digit levels, there has not been a proportionate reduction in inflation expectations with falling inflation.

This is because the immediate past largely influence the survey response of the households and therefore may take time before moderation.

Besides, as the theory suggests, there may be an asymmetry of response between adjusting inflation in a falling inflation scenario vis-à-vis a rising inflationary situation. Typically the lag is longer in the former case.

Exhibit 40: Inflation expectations has come down but yet to adjust to realistic levels


Exhibit 41: The gap between expectations and current inflation is correcting after a lag


0

10

20

30

40

-5

5

15

25

35

FY62

FY

65

FY68

FY

71

FY74

FY

77

FY80

FY

83

FY86

FY

89

FY92

FY

95

FY98

FY

01

FY04

FY

07

FY10

FY

13

CPI Inflation (YoY %) Saving ratio

0

20

40

60

80

-5

5

15

25

35

FY62

FY

65

FY68

FY

71

FY74

FY

77

FY80

FY

83

FY86

FY

89

FY92

FY

95

FY98

FY

01

FY04

FY

07

FY10

FY

13

CPI Inflation (YoY %) Share of financial savings

4

8

12

16

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

Dec

-14

Inflation expectations (3-month ahead) Actual CPI Inflation (YoY %)

0.6%

3.3%

4

8

12

16

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

Dec

-14

Inflation expectations (12-month ahead)

Actual CPI Inflation (YoY %)

2.3%

3.9%

20 January 2015 16

Corporate India Interplay of dual factors turning favourable

Corporate earnings were impacted by dual force of ‘high inflation’ and ‘negative operating leverage’. With sharp correction in major commodity prices and expected rebound in GDP growth (and hence supportive operating leverage), both factors are turning favourable, in our view.

The combined forces of higher commodity prices and negative operating leverage (owing to sales de-growth) had led to a sharp correction in the reported EBIDTA margins since FY07. The margins fell 600bps/280bps from FY07/FY11 to a decade low of 19.0% in FY14.

Interest cost as percent of sales has increased significantly (to 2.1%) from the lows of FY07. As a result, PAT margins also witnessed contraction of 570bps/250bps from FY07/FY11 to decadal low levels of 9.8% in FY14.

Several sectors intrinsically linked to the domestic environment like Capital Goods, Cement and Real Estate reported a sharp decline in sales growth in this period; and severe margin erosion owing to negative operating leverage.

However, with sharp decline in inflation and expected rebound in growth (resulting from rate cuts and potential orderly depreciation of INR), margin expansion going forward will be the key drivers of earnings growth. We model 120bps/190bps expansion in PAT margins for FY16/FY17 for our universe companies.

Exhibit 42: Revenue growth impacted by constrained consumption demand and investment climate

Source: MOSL

Exhibit 43: RM cost-to-sales ratio increased due to increased commodity prices, poor demand environment

Source: MOSL, Company

Exhibit 44: EBIDTA margins at decadal lows (%), led by higher commodity prices and negative operating leverage


8.1 7.0 9.5 9.6 9.3 6.7 8.6 8.9 6.7 4.5 4.7 5.6 6.5

18.8

29.6

21.1 29.1

38.5

19.3

7.5

22.1 26.0

10.6 10.6 5.0

9.4

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

GDP growth (%) Sales Growth (MOSL Ex Financials & RMs) (%)

5.5 6.4 4.5 6.6 4.7 8.1 3.8 9.6 8.9 7.4 6.0

43.2

45.3 45.3 44.5 44.6

46.3 45.3

47.4 49.6 48.5

47.1

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

WPI (%) RM/Sales (MOSL Ex Financials & RMs) (%)

21.3 23.8 23.8 25.0 23.3

20.2 21.9 21.8 20.0 19.1 19.0 19.6 20.9

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

EBIDTA Margin (MOSL Ex Financials & RMs) (%)

INFLATION IMPACT

20 January 2015 17

Exhibit 45: Interest cost as % of revenues has increased significantly from lows in FY07…


Exhibit 46: … driving PAT margins to their decadal lows (%)


Sharp decline in inflation a positive for corporate margins Commodity prices, including both energy commodities (crude oil / coal, etc) and

industrial commodities (metals, rubber, chemicals, etc) had witnessed a sharp increase during FY04-09, and also during FY11/12 and FY13/FY14. WPI also increased from 5.5% in FY04 to 8.1% in FY09 and further to 9.6%/8.9% in FY11/FY12. The increase in commodity prices, especially during FY13/FY14, came on the back of a poor demand environment, impacting the ability of several corporates to fully pass on the pricing pressures.

In past, margins have reacted sharply to a sudden change in inflation as is evident during FY08-FY10. EBITDA margins shrank from 23.3% in FY08 to 20.2% in FY09 on the back of a sudden increase in inflation (WPI increased to 8.1% from 4.7%). Similarly, EBITDA margins expanded to 21.9% in FY10 from 20.2% in FY09 as inflation declined to 3.8% from 8.1%.

The sharp correction in key commodities (crude oil, coal, iron ore, China HR, palm oil) in 2HFY14 and resultant decline in inflation (WPI at zero in Nov-14, and expected to remain near-zero during rest of FY15 and FY16) bodes well for the companies that use commodities as input and would positively impact margins.

Margin expansion would start reflecting from FY16 onwards and would be ahead of the revenue growth, in our view.

Exhibit 47: In past margins have reacted sharply to sudden changes in inflation

Source: MOSL

3.0

1.9 1.5 1.3

1.6 1.9 1.7 1.6

1.9 1.9 2.1 2.1 2.1

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

Interest / Sales (MOSL Ex Financials & RMs) (%)

13.3 14.6 14.5 15.5

14.1 12.1 12.2 12.3

10.9 10.1 9.8 10.1 11.0

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

PAT Margin (MOSL Ex Financials & RMs) (%)

5.5 6.4 4.5

6.6 4.7

8.1 3.8

9.6 8.9 7.4 6.0 3.0

0.5

21.3 23.8 23.8 25.0

23.3 20.2 21.9 21.8

20.0 19.1 19.0 19.6 20.9

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

WPI (%) EBIDTA Margin (MOSL Ex Financials & RMs) (%)

20 January 2015 18

Operating leverage also turning favourable Indian Inc has gone through a prolonged period of slowdown during last five

years. GDP rate dipped from ~9% in 2010 to 4.5% in 2013. The steep decline had led to a near stagnation in manufacturing IIP over the last 3 years, leading to a collapse in the investment cycle.

During this period, the sales growth for our universe companies (excluding Financials & RMs) declined to just 10.6% in FY13/FY14 vs 38.5%/19.3% in FY08/FY09. EBIDTA margins have also shrunk significantly from peak levels of 25.0% in FY07 to 19.0% in FY14, and ROE has declined from 23.6% in FY07 to 14.7% in FY14.

Several sectors intrinsically linked to the domestic environment like Capital Goods, Cement, Real Estate, etc reported a sharp deceleration in revenue growth in this period. Sectors which witnessed acceleration in growth rates included IT and Pharma led by rising share in global markets coupled with INR depreciation; Consumer (stables / Discretion) managed to curtail the decline in revenue growth given the boost from increased rural spending.

We expect the growth cycle to rebound with expected cut in interest rates (on the back of low inflation) and potential orderly depreciation of INR (to ensure export competitiveness). GDP growth would bounce back to 6.5% by FY16 and further 7.2% by FY17 from 4.5% in FY14. Improved consumption activity will create congenial environment for a pick-up in industrial activity as well; translating into a period of strong revenue CAGR. We expect the corporate sales growth to rebound from FY17 onwards.

Exhibit 48: GDP Growth rates have declined significantly…


Exhibit 49: … impacting revenue growth (% YoY)


Thus, the combined forces of inflation and operating leverage that impacted EBIDTA margins in FY09-14 have started incrementally becoming supportive. Both these factors should drive expansion in EBIDTA margins.

0.0

3.0

6.0

9.0

12.0

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

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Sep-

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Sep-

07

Sep-

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Sep-

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11

Sep-

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Sep-

14

GDP Growth (%)

(15-year avg: 7%)

5.5 6.4 4.5

6.6 4.7 8.1 3.8

9.6 8.9

7.4 6.0 3.0 0.5

18.8

29.6

21.1 29.1

38.5

19.3 7.5

22.1 26.0

10.6 10.6

5.0 9.4

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E

WPI (%) Sales Growth (MOSL Ex Financials & RMs) (%)

20 January 2015 19

Sectors at their multi-year low/high margin Possible margin expansion across sectors, aided by lower commodity prices

There are a number of sectors (Auto, Capital Goods, Cement, Metals, PSU banks) which are at their multi-year low margin levels. Sectors such as Healthcare and Private Banks are at their multi-year high, while Consumer and Technology have current margins at average levels. We discuss below margin expansion possibilities across these sectors, given the dual force of ‘inflation/commodity prices’ and ‘operating leverage’.

Exhibit 50: Sectors at their multi-year high / low margins

EBITDA margin for all sector, except Banks where net margins are used Size of bubble represent 2014 margin

Source: MOSL

Auto Capital Goods

Cement

Consumer

Healthcare

Metals

Oil & Gas

Technology

Telecom

Utilities

Pvt Banks

PSU Banks -9.0

-6.5

-4.0

-1.5

1.0

3.5

6.0

8.5

-30.0 -20.0 -10.0 0.0 10.0 20.0 30.0 40.0 50.0

2014

less

10-

year

avg

mar

gin

(%)

Prem/disc to 10-year avg PE (x)

20 January 2015 20

Exhibit 51: Sectoral margin trend, key margin levers and best picks Sectors Margin trend Key margin expansion levers Best picks on margin theme

Auto Gross margins (-180bp) and EBITDA margins (-470bp) were under pressure during FY10-14, led by higher competitive pressures (reflected in increasing discounts) and negative operating leverage (~11% revenue CAGR)

Discounts moderation Favorable commodity prices Operating leverage

Maruti Suzuki TVS Motor Ashok Leyland

Capital Goods EBIDTA margins declined to decadal low levels of 10% in FY14, being impacted by muted revenue CAGR of 4% during FY11-14

Improved operating leverage Lower commodity prices

BHEL Thermax ABB

Cement EBITDA margins, which witnessed 25-31% range in FY07-10, plunged to ~20% in FY11-13 and further down to decades’ low of 16.2% in FY14

Volume and operating leverage Price (due to strong volume) Variable cost reduction

Ultratech Dalmia Bharat JK Cement

Consumer Gross margins and EBITDA margins of our FMCG universe has remained in a band of 50-54% and 15-16% during FY11-14

Demand uptick Input cost correction

Asian Paints Pidilite HUL Emami

Financials While return on asset (RoA) of PSU Banks are at decadal low (0.6% in 2014) primarily due to concerns on asset quality, RoA of Private Banks witnessed sustained improvement during FY09-14

Decline in short term interest rates Deleveraging of corporate balance sheet Comfortable liquidity conditions

SBI Axis Bank Yes PNB LICHF

Healthcare Combined forces of improved product mix in US, cost rationalization in domestic business and operating leverage in emerging economies had led to improvement in sector’s aggregate EBITDA margins from 21.4% in FY04 to 24.0% in FY14

Improved product mix Cost rationalization Operating leverage

Sun Pharma Lupin Divis Lab

Metals Metals witnessed decline in margins following sharp correction in commodities with the 2008 crisis. With gradual recovery following the crash, margins started to recover over FY10/11. Margins started declining again from FY12 due to China demand slowed down and over-capacity in major commodities

Price increase Demand recovery Cost optimization

Hindalco Nalco JSW Steel

Oil & gas Margins were impacted on two counts (a) lower net realization for PSU upstream companies led by higher under recoveries and (b) higher energy costs for all the refiners

Lower crude cost Lower energy cost Improved demand

OMC’s (HPCL, BPCL and IOCL) Castrol

Technology Growth in constant currency revenues has been the single largest determinant of operating profit margins for the industry

Currency Revenue growth Business mix

Infosys

Media There is clear trend of increase in ad spend to revenue ratio whenever there is a steep decline in RM/sales for FMCG sector. This was witnessed in FY05, FY10 and FY13. Similarly, sharp increase in RM cost in FY09, FY11 and FY12 led to lower ad spends.

Favorable demand environment led by increase in ad spend

Zee Entertainment

Telecom On average, telecom operators spend 7-9% of wireless revenue on energy. Increase in diesel prices in last few years have negatively impacted Telecom’s EBITDA margin

Network cost

Source: MOSL

20 January 2015 21

Macro Economic Indicators Annual FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15EI. National Income (Growth %)

Nominal GDP (USDb) 721 834 948 1,239 1,226 1,366 1,708 1,879 1,858 1,878 2,102Gross Domestic Product 7.0 9.5 9.6 9.3 6.7 8.6 8.9 6.7 4.5 4.7 5.6

Agricul ture 0.2 5.1 4.2 5.8 0.1 0.8 8.6 5.0 1.4 4.7 2.3Foodgra ins (M Ton) 198 209 217 231 234 218 245 259 250 263 265Rainfa l l (% of long period average) -9.1 -1.0 -5.2 -0.8 -10.0 -18.6 1.8 -7.2 -9.5 6.4 -13.0

Industry 9.8 9.7 12.2 9.7 4.4 9.2 7.6 7.8 1.0 0.4 3.4Services 8.1 10.9 10.1 10.3 10.0 10.5 9.7 6.6 7.0 6.8 7.2

II. Inflation (Y-o-Y %)WPI (Annual Averages)

Al l commodities 6.5 4.4 6.5 4.8 8.0 3.6 9.6 8.9 7.4 6.0 2.6Primary articles 3.7 2.9 9.6 8.3 11.1 12.7 17.8 9.9 9.8 9.8 4.2Fuel & power 10.1 9.5 6.5 0.0 11.6 -2.1 12.3 13.6 10.6 10.1 0.3Manufactured products 6.3 3.1 5.6 4.9 6.1 1.8 5.7 7.3 5.4 3.0 2.6

CPI-IW/CPI-RU (from FY12) 3.8 4.4 6.7 6.2 9.1 12.4 10.5 10.5 10.2 9.5 6.6III. Fiscal Situtaion (as % of GDP)

Tota l receipts 15.6 14.3 13.6 14.3 15.8 15.9 15.6 14.8 13.9 14.0 13.7Direct tax 4.1 4.5 5.4 6.3 6.0 5.8 5.8 5.6 5.5 5.6 5.9Indirect tax 5.3 5.4 5.7 5.6 4.9 3.8 4.5 4.5 4.7 4.6 4.8Net tax 6.9 7.3 8.2 8.8 7.9 7.1 7.4 7.2 7.3 7.4 7.7

Tota l expenditure 15.4 13.7 13.6 14.3 15.8 15.9 15.6 14.8 13.9 14.0 13.7Plan 4.1 3.8 4.0 4.1 4.9 4.7 4.9 4.8 4.1 4.2 4.3Non-plan 11.3 9.9 9.6 10.2 10.9 11.2 10.7 10.0 9.9 9.8 9.4

of which subs idies 1.4 1.3 1.3 1.4 2.3 2.2 2.3 2.4 2.5 2.3 2.0Fisca l defici t 3.9 4.0 3.3 2.5 6.0 6.5 4.9 5.9 4.9 4.6 4.1Revenue defici t 2.4 2.5 1.9 1.1 4.5 5.2 3.3 4.4 3.6 3.3 3.0Combined fi sca l defici t (centre + s tates ) 7.2 6.5 5.4 4.1 8.5 9.6 7.4 8.0 7.1 6.7 6.0Publ ic debt 82 79 75 71.4 72.2 70.8 66.0 65.6 64.0 65.0

IV. Money and Banking (Y-o-Y%) Reserve money 12.1 17.2 23.7 31.0 6.4 17.0 19.1 9.2 8.4 9.5 10.0Money Supply (M3) 12.3 21.2 21.3 21.4 19.3 16.9 15.9 13.0 13.6 13.5 12.0Depos i ts 10.8 23.4 23.8 22.4 19.9 17.2 15.8 13.4 14.3 14.3 13.0Bank credi t 26.2 38.0 28.1 22.3 17.5 16.9 21.4 17.0 14.1 14.6 15.0

V. External Sector(in USDb)

Exports 85 105 129 166 189 182 251 310 307 319 326Imports 119 157 191 258 309 301 381 500 502 466 488Trade Defici t -34 -52 -62 -91 -120 -118 -130 -190 -196 -148 -162Invis ible Surplus 31 42 52 76 92 80 86 112 107 115 126Current A/c defici t -2 -10 -10 -16 -28 -38 -44 -78 -88 -32 -36Net capi ta l flows 28 25 45 107 7 53 57 68 89 49 80Forex Reserves 142 152 199 310 252 279 305 294 293 304 348

(As % of GDP)Exports 11.8 12.6 13.6 13.4 15.5 13.2 14.5 16.8 16.5 17.0 15.5Imports 16.5 18.8 20.1 20.8 25.4 21.8 22.1 27.0 27.0 24.8 23.2Trade Defici t -4.7 -6.2 -6.5 -7.4 -9.8 -8.6 -7.6 -10.3 -10.5 -7.9 -7.7Invis ible Surplus 4.3 5.0 5.5 6.1 7.5 5.8 5.0 6.0 5.8 6.1 6.0Current A/c defici t -0.3 -1.2 -1.0 -1.3 -2.3 -2.8 -2.6 -4.2 -4.7 -1.7 -1.7External debt 18.5 17.3 18.2 18.1 20.5 18.9 17.3 18.7 21.4 23.2 24.2

VI. Financial Markets (Avg %)Cal l rate 4.7 5.6 7.2 6.1 7.1 3.2 4.5 8.0 8.0 8.1 8.01-yr AAA corporate bond 5.5 6.7 8.5 9.3 9.8 5.9 8.1 9.6 8.2 9.4 9.0Yield on 10-yr G-sec (%) 6.2 7.1 7.8 7.9 7.6 7.2 7.9 8.4 9.3 8.3 8.0Exchange Rate (INR/USD) 44.9 44.3 45.3 40.2 45.9 47.4 45.6 47.9 54.4 60.5 61.0BSE Sensex return 16.1 73.7 15.9 19.7 -37.9 80.5 10.9 -10.5 8.2 18.8P/E ratio (Tra l l ing) 14.4 21.6 18.2 18.8 11.8 21.0 19.0 15.6 16.0 16.8 18.7Market capi ta l i sation (as % of GDP) 52.4 81.8 82.5 103.0 54.8 95.2 87.7 69.0 62.9 65.4 77.1Oi l price (Indian Basket, USD/bbl ) 39.2 55.7 62.4 79.5 82.7 69.6 85.1 111.9 108.3 105.5 91.0

Figures in red are estimates

20 January 2015 22

Macro Economic IndicatorsQuarterly Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14I. National Income (Growth %)

Gross Domestic Product 5.1 4.5 4.6 4.4 4.4 4.7 5.2 4.6 4.6 5.7 5.3Agricul ture 2.0 1.8 1.8 0.8 1.6 4.0 5.0 3.7 6.3 3.8 3.2Industry 2.1 0.3 -0.4 1.7 2.1 -0.4 2.6 -0.4 -0.2 4.2 2.2Services 7.3 7.2 7.6 6.9 6.3 7.2 6.3 7.2 6.4 6.8 7.1

II. External Sector (USDb)Exports 80 75 73 74 85 74 81 80 84 82 85Imports 132 119 120 133 130 124 115 113 114 116 124Trade Defici t -52 -44 -48 -58 -46 -50 -33 -33 -31 -35 -39Invis ible Surplus 30 27 27 27 28 29 28 29 29 27 28Current A/c defici t -22 -17 -21 -32 -18 -22 -5 -4 -1 -8 -10Net capi ta l flow 17 16 18 31 21 21 -5 24 9 20 19Forex Reserves 294 290 295 297 293 285 276 296 304 316 314

Macro Economic IndicatorsMonthly Feb '14 Mar '14 Apr '14 May '14 Jun '14 Jul '14 Aug '14 Sep '14 Oct '14 Nov '14 Dec '14I. Growth and inflation (Y-o-Y %)

I IP -1.8 -0.5 3.7 5.6 4.3 0.9 0.5 2.8 -4.2 3.8WPI - Al l commodities 5.0 6.0 5.5 6.2 5.7 5.4 3.9 2.4 1.7 0.0 0.1

Primary articles 6.3 7.3 7.0 8.6 7.0 6.8 3.7 2.0 0.8 -1.0 2.2Fuel & power 8.7 11.8 9.3 10.5 9.0 7.4 4.5 1.3 0.5 -4.9 -7.8Manufactured products 3.4 3.7 3.7 3.9 3.9 4.1 3.7 3.0 2.5 2.0 1.6

CPI-RU 8.0 8.3 8.6 8.3 7.5 8.0 7.7 6.5 5.5 4.4 5.0II. Fiscal situation (as % of budgeted)

Tota l receipts 75.1 99.0 0.6 3.2 9.2 14.2 21.7 33.5 38.5 43.4of which tax revenue 75.0 97.6 0.1 2.9 10.1 15.0 19.0 33.1 37.7 42.3

Tota l expenditure 88.0 98.3 6.8 15.9 23.0 28.1 37.5 48.0 53.6 59.8Non-plan 88.9 99.6 8.1 18.3 24.7 30.5 40.6 50.5 57.0 64.0Plan 86.0 95.3 4.1 10.7 19.4 23.0 30.9 42.8 46.4 51.1

Fisca l defici t 114.3 96.9 21.5 45.6 56.1 61.2 74.9 82.6 89.6 98.9Revenue defici t 117.3 97.3 26.4 53.6 65.9 70.4 85.8 91.2 98.5 108.6

III. Money and Banking (Y-o-Y%) Reserve money 9.8 14.4 9.0 11.9 9.6 11.3 11.1 9.5 10.3 8.2 9.4Money Supply (M3) 14.6 13.2 13.8 13.1 11.7 12.2 12.6 12.8 12.7 11.0 11.1Bank Credi t (Y-o-Y %) 14.3 14.3 14.3 13.6 13.3 13.3 10.9 9.7 11.2 11.3 10.5Depos i ts (Y-o-Y %) 15.8 14.6 15.3 14.6 12.4 13.0 13.6 13.4 12.0 11.7 11.5

IV. External SectorExports (USD b) 26 30 26 28 26 28 27 29 26 26 25

Exports (Y-o-Y %) -3.7 -3.8 5.3 12.4 10.2 7.3 2.3 2.7 -5.0 7.3 -3.8Imports (USD b) 34 40 36 39 38 40 38 43 39 43 35

Imports (Y-o-Y %) -17.1 -1.1 -15.0 -11.4 8.3 4.3 2.1 26.0 3.6 26.8 -4.8Trade Defici t (USD b) -8 -11 -10 -11 -12 -12 -11 14 13 17 -9Forex Reserves (USD b) 294 304 310 312 316 321 319 314 316 316 320Real effective exchange rate 95.9 97.9 99.4 104.2 103.8 104.6 105.3 106.4 106.2 107.5 106.6RBI's net forex intervention -1.9 7.8 5.9 1.8 0.6 5.5 -0.5 1.4 2.7 3.1

V. Financial Markets (Avg %)Cal l rate 8.0 8.1 7.9 7.7 7.9 8.0 7.6 7.6 7.6 7.4 7.8Govt borrowing (% completed) 100.0 100.0 11.2 25.0 32.6 42.1 53.6 60.5 67.9 77.5 84.491-day T-bi l l 9.1 9.1 8.9 8.8 8.6 8.6 8.6 8.6 8.5 8.3 8.3Yield on 10-yr G-sec (%) 8.8 8.8 8.9 8.7 8.6 8.7 8.8 8.5 8.4 8.2 7.9SBI Base rate 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0CP - 3 month 10.0 10.0 9.4 9.2 8.9 8.9 9.1 8.9 8.7 8.6 8.7CD - 1yr 9.7 9.5 9.2 9.1 8.9 9.0 9.1 9.1 8.8 8.7 8.7AAA corporate - 1yr 9.9 9.8 9.5 9.3 9.0 9.2 9.2 9.1 8.8 8.6 8.6Exchange Rate (INR/USD) 62.3 61.0 60.4 59.3 59.7 60.1 60.9 60.9 61.3 61.7 62.8BSE Sensex return 3.0 6.0 0.1 8.0 4.9 1.9 2.9 0.0 4.6 3.0 -4.2P/E ratio (1 Year Forward) 14.5 15.2 15.0 16.0 16.5 16.5 16.7 16.5 17.0 17.2 16.3Mkt capi ta l i zation (as % of GDP) 62.3 61.0 60.4 66.3 71.2 71.0 72.8 73.8 76.3 78.3 77.1Oi l (Indian basket, USD/bbl ) 106.1 105.1 105.7 106.8 109.2 106.1 101.9 97.1 87.0 77.4 61.6

20 January 2015 23

ECOSCOPE Data Monitor Annual Quarterly/Monthly

GDP growth (%): Moderate recovery in growth suggested

GDP growth (%): First signs of pick up in growth

Inflation: Showing signs of sharp moderation

Inflation: CPI at 5%; WPI at near zero

Fiscal deficit (% to GDP): Consolidation continues

Fiscal trend: Year-end consolidation expected

Credit growth constrained by slowdown and tight money

Credit growth has slowed down

9.3

6.7

8.6 8.9

6.7

4.5 4.7 5.6

6.5

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

4.4 4.7 5.2

4.6 4.6

5.7 5.3

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

8.0

3.6

9.6

8.9

7.4

6.0

3.0

0.5

9.1

12.4

10.5

10.5

10.2

9.5

6.8

3.9

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E

FY16

E WPI CPI-IW / CPI-RU

5.1

5.0

6.0

5.5

6.2

5.7

5.4

3.9

2.4

1.7

0.0

0.1

8.8

8.0 8.3 8.6

8.3

7.5 8.

0

7.7

6.5

5.5

4.4 5.

0

Jan-

14

Feb-

14

Mar

-14

Apr-

14

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

WPI CPI-RU

6.5

4.9 5.

7

4.9

4.8

4.1

3.5

9.6

7.4 8.

0

7.1

6.9

6.1

5.5

FY10

FY11

FY12

FY13

FY14

E

FY15

E

FY16

E

Centre Centre + states

0

30

60

90

120

150

Apr-

12

Jun-

12

Aug-

12

Oct

-12

Dec

-12

Feb-

13

Apr-

13

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-

14

Jun-

14

Aug-

14

Oct

-14 As

% o

f ful

l yea

r bu

dget

Receipts Expenditure Fiscal deficit

16

13

14

14

13

14 16

13

14

14

13 15

21

17

14 15

14 16

FY11

FY12

FY13

FY14

FY15

E

FY16

E

Money Supply (M3) Deposits Bank credit

9

12

14

17

19

Apr-

13

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-

14

Jun-

14

Aug-

14

Oct

-14

Dec

-14

M3 Bank Credit Deposits

20 January 2015 24

ECOSCOPE Data Monitor Annual Quarterly/Monthly

External sector: CAD in control helped by oil price drop

External sector: Exports weak, deficit moderately up

Financial markets: Rates stable now while yield curve is flat

Financial markets: Interest rates displaying a downward bias

Market ended with good return in FY14

Markets are fairly valued now

INR depreciated; forex reserves static

RBI intervened to stabilize INR

-7.6

-10.

3

-10.

5

-7.9

-7.7

-7.7

-2.6

-4.2

-4.7

-1.7

-1.7

-1.7

FY11 FY12 FY13 FY14 FY15E FY16E

% o

f GD

P

Trade Deficit Current A/c deficit

-50

-30

-10

10

30

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Exports Imports Trade deficit (USD b)

2

4

6

8

10

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Call rate Yield on 10-yr G-sec (%)

8

9

10

11

12

Apr-

13

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-

14

Jun-

14

Aug-

14

Oct

-14

Dec

-14

CP - 3 month AAA corporate - 1yr

26 26 23 42 52 82 83 103

55 95 89 69 63 66

10

30

50

70

90

110

-80

-40

0

40

80

120

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Market capitalization (as % of GDP) (RHS)BSE Sensex return (LHS)

66

66

64

62

59

56

61

61

63

62

62

61

60

66

71

71

73

74

76

78

77

0

16

32

48

64

80

96

-8

-4

0

4

8

12

Apr-

13

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-

14

Jun-

14

Aug-

14

Oct

-14

Dec

-14

Market capitalization (as % of GDP) (RHS) BSE Sensex return (LHS)

050100150200250300350

3035404550556065

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Forex reserves (USD b, RHS)

Exchange rate (INR/USD, LHS)

42

48

54

60

66

-6

-1

4

9

14

Apr-

13

Jun-

13

Aug-

13

Oct

-13

Dec

-13

Feb-

14

Apr-

14

Jun-

14

Aug-

14

Oct

-14

Dec

-14

RBI's net forex intervention (USDm) (LHS) Exchange Rate (INR/USD) (RHS)

20 January 2015 25

N O T E S

20 January 2015 26

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Will RBI rate cut keep inflation under check in 2015?

Economy & Finance

Transcript of Will RBI rate cut keep inflation under check in 2015?