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India 2020: Consumption drivento investment led-Why and How?
India 2020: Consumption drivento investment led-Why and How?
Economy
Thematic | June 2016
Nikhil Gupta ([email protected]); +91 22 3982 5405
Economy
CONSUMPTION INVESTMENT
Savi
ngs
June 2016 2
Thematic | Economy
Contents Executive summary ............................................................................................................. 3
Info graphic: Indian economy from investors’ perspective .................................................. 5
Info graphic: Indian economy from Economist’s perspective .............................................. 6
How long can consumption drive economic growth? ......................................................... 7
Is political agenda supporting our thesis? ......................................................................... 10
Key economic projections for FY17-18 .............................................................................. 12
Info graphic: Indian economy from investors’ perspective ................................................ 13
I. Indian economy from Investors’ perspective ................................................................. 14
II. Indian economy from Economist’s perspective ............................................................. 20
Info graphic: Indian economy from Economist’s perspective ............................................ 22
II.1. Know your economy .................................................................................................. 23
II.2. Unique trends that make India the fastest growing economy .................................... 28
II.3. Remember the “Theory of Everything” ...................................................................... 38
II.4. Expectations for next two years ................................................................................. 45
III. Will India be ready to grow at 10% by 2020? ............................................................... 54
Conclusion ........................................................................................................................ 64
Appendix I: Data details .................................................................................................... 66
Appendix II: Understanding current account balance ....................................................... 67
Appendix III: Rational Investor Ratings Index (RIRI) .......................................................... 68
Appendix IV: Detailed Economic Projections..................................................................... 69
Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
June 2016 3
Thematic | Economy
Executive summary
This report aims to explain the framework with which we analyze the Indian economy. The intent is to share the lenses we use to look at an(y) economy. We have not seen other reports using this framework to explain the Indian economy.
Why should one read this report? Is this a report written by an Economist? “We know India’s real GDP growth and have heard the market forecasts…”, “India’s current account deficit is in control and inflation is likely to remain stable…”. Why should we read this report? If one believes that Economics is all about GDP growth, inflation, etc, one must read this report, because we show that (a) Economics is much more, and (b) Economics could be way more fun than it usually appears to be. Three things that differentiate this report are:
1. Covering an economy in one identity: “What if a large part of an economy couldbe explained by a single identity?” This is exactly what we have done here.Notwithstanding its vastness, we believe an economy could be explained by onesingle identity. We call this “The Theory of Everything”. This single identitycovers a large part of the economy by taking care of five facets – fiscal deficit,current account deficit, consumption, savings and investments. This identity alsohelps to understand the behavior of three participants in an economy –households, private corporate sector, and (consolidated) public sector.
2. Purely data-driven analysis, no airy talk: “In God we trust, all other must bringdata.” - W Edwards Deming. We are not God, and that’s why you will see onlydata-driven analysis here. If a finding cannot be backed by data, it comes with afair degree of uncertainty (especially in macroeconomics), which is why we haveresisted such analysis. Every conclusion in this report is supported by data fromreliable sources. There is a reason why we have more than 90 exhibits in a 70-page report. This, we believe, is our strength. We don’t make conclusions out ofthin air.
3. Independent analysis helps us challenge, if needed, market consensus: “Ifeveryone is thinking alike, then somebody isn't thinking.” – George S Pattron Jr.since our analysis is entirely data-driven, we are able to stick out our neck andmake conclusions, as you will see below, which may be in contrast to commonbeliefs.
Overall, while GDP growth and inflation are important, it is equally important to understand them in an appropriate manner. This is exactly what we intended to do. This report is divided into three parts. Part I analyzes the comparative performance of the Indian economy, which is what matters for investors. Part II covers the domestic fundamentals of the economy. We propound the KURE framework and explain the economy in a single equation. In Part III, we discuss the possible scenarios for India by 2020. We believe that the economy must address few challenges, if it wants to graduate to a sustainable high growth path.
Economy
ECONOMY
Economy India 2020: Consumption driven to investment led -
Why & How?
Mr Nikhil Gupta
Please click here for Video Link
June 2016 4
Thematic | Economy
Key conclusions 1. Consumption demand is not really weak…: Irrespective of the tag of “the
fastest growing economy in the world”, one keeps hearing about weakconsumption demand, as is reflected by the subdued topline of India Inc. Byincorporating the mid-level of the corporate pyramid with the (highly covered)top level, not only do we establish the sanctity of the new GDP series, but alsoconclude that the current slowdown is not as severe as the previous slowdownin the 2000s, primarily because of resilient consumption demand. In otherwords, we firmly establish that the current economy is driven by consumption,rather than investments.
2. …as reflected by falling savings, high inflation and wide external deficit:Notably, India’s consumption has been relatively resilient amid weak disposableincome growth. As a consequence, household savings in India have fallen to thelowest level in two decades. In fact, a comparison of the current slowdown withthat of the early 2000s shows that the combination of high consumption andweak investment has inevitably led to higher inflation in India. By creating ameasure of price gap (actual inflation – desired inflation), we find that India’sinflation is ~55% higher today. This makes us conclude that like the wholesaleprice index (WPI), retail inflation (based on consumer price index (CPI)) mustundershoot the medium-term target for at least a few quarters. Moreover, wefind that although current account deficit (CAD) has narrowed recently, it hasnot improved to a desired level.
3. Lower savings act as a structural constraint to higher investment rate…: As aresult of falling savings and narrower CAD, investment rate has also fallen. Using“The Theory of Everything”, we show that an increase in national savings is anecessary condition for investment rate to pick up again. This is primarilybecause the contribution of foreign capital to domestic investments, goingforward, will be limited due to incomplete adjustments in CAD. Further, weargue that the revival in investment rate has to be led by the private corporatesector, as higher household (or public) investments imply lower efficiency ofcapital, which must be avoided.
4. …which may make higher sustainable growth challenging: Overall, we believethat the current economic model could remain in place for the next few years,which will help India touch 8% real GDP growth. However, consumption-drivengrowth will increasingly become destabilizing (as inflation will continue to rise).India must replace consumption with investments as the key driver of growth(exactly opposite of what is recommended for China). The transformation, webelieve, would involve some sacrifice in terms of GDP growth, which impliesIndia could take a little longer (probably after 2020) to graduate to the next levelof economic growth (9-10%). We would not be surprised to see the Indianeconomy growing at 7-8% for a few years, as investments take overconsumption as the key driver of GDP growth. After the transformation,however, India could grow at 10% on sustainable basis.
Not only do we establish the sanctity of the new GDP
series, but also conclude that the current slowdown
is not as severe as the previous slowdown in the
2000s
An increase in national savings is a necessary
condition for investment rate to pick up again
Consumption-driven growth will
increasingly become destabilizing (as
inflation will continue to rise)
India’s consumption has been relatively resilient amid weak disposable income growth
June 2016 5
Thematic | Economy
Info graphic: Indian economy from investors’ perspective
June 2016 6
Thematic | Economy
Info graphic: Indian economy from Economist’s perspective
June 2016 7
Thematic | Economy
How long can consumption drive economic growth?
In the words of the Reserve Bank of India (RBI), the Indian economy is a beacon of stability. Indeed, it is. Irrespective of one’s (dis)comfort with the new GDP series, the Indian economy has turned corners in the past few years. Although the world economic growth has eased further from 3.5% in 2012 to 3.1% in 2015, India’s GDP growth has improved.
Growth being driven by consumption…: The tag of “fastest growing economy in the world”, however, needs some introspection. Notwithstanding the recent debate on actual GDP growth (whether 6% or 7%), there is no argument over the fact that consumption is the key driver of economic growth, while investments lag (Exhibit 1).
Exhibit 1: Average growth in key real GDP components (% pa)
* Consumption includes both private and government consumption Source: Central Statistics office (CSO), MoSL
In fact, growth in consumption has been resilient enough to make the recent economic performance look better than the economic performance in the previous slowdown in the early 2000s (Exhibit 2). What kind of introspection, then, are we talking about? (Please see Appendix I at the end of report for details on data used in this report.)
Exhibit 2: India’s real GDP growth has not slowed as much due to consumption (Index)
FY99=100 for ‘Early 2000s’, FY03=100 for ‘Boom period’ and FY12=100 for ‘Recent’ FY17 data MoSL’s forecasts
Source: Organisation for Economic co-operation and development (OECD), MoSL
5.6
13.3
8.4
4.1 3.2 2.8
(1.0)
6.0
Investments Exports Imports Consumtpion
2001-04 2013-16
Notwithstanding the recent debate on actual GDP growth
(whether 6% or 7%), there is no argument over the fact that
consumption is the key driver of economic growth in India,
while investments lag
June 2016 8
Thematic | Economy
…financed by household savings: Notwithstanding high economic growth, policy makers must not lose sight of the drivers of economic growth. Our analysis of India’s growth drivers makes us skeptical of the sustainability of the current economic model, in which consumption is doing all the heavy lifting, while investments are resting on their laurels. There are three key reasons, which make us believe so: 1. Consumption is financed by savings, rather than higher disposable income. It
implies consumption is replacing potential investments (Exhibit 3).2. Notwithstanding the recent sharp deceleration in CPI-based retail inflation, the
current inflation is still higher than the medium-term target of 4%. In fact,India’s inflation differential with major trading partners has risen further in thepast one year, hurting India’s competitiveness (Exhibit 4).
3. Related with the first reason, the share of consumption in India’s currentaccount deficit (CAD) has widened, while investment-led deficit has narrowedsubstantially. Ideally, India’s current account should have been in surplus.
Exhibit 3: Consumption growth has happened without proportionate growth in disposable income
Real disposable income is nominal income deflated by PCE deflator Data from FY15 onwards are our estimates/projections
Exhibit 4: Despite recent fall in India’s inflation, widening differential v/s trading partners has hurt competitiveness
Calculated using nominal and real effective exchange rate data Source: CSO, Bank for International Settlements (BIS), MoSL
Resilient consumption may continue driving growth for the next two years…: Regardless of our skepticism, we would not be surprised if the current economic model continues for the next few years. Accordingly, savings will fall further, CAD will widen and inflation will start reversing its current south-ward trajectory.
…unlikely to lead to sustainable growth: With these forces tightening their grip on the economy, policy makers will have to shift their focus back on containing these beasts. Not only might the economy then find it difficult to grow at 10% by 2020, but it might also find it challenging to maintain 8% growth. The four key changes necessary for the economy to move to a sustainable growth path, and then graduate to higher growth are: 1. Inflation must fall towards 2% at least for a few quarters2. National savings, driven by households, must witness an increase3. Domestic investments, driven by private corporate sector, must replace
consumption-driven growth4. Global environment has to be supportive
80
100
120
140
160
0 1 2 3 4 5Number of years
Real personal disposable income
Early 2000s Boom period Recent
80
100
120
140M
ar-1
0
Mar
-11
Mar
-12
Mar
-13
Mar
-14
Mar
-15
Mar
-16
Inflation differential with trading partners
China India Indonesia Philippines
(2010=100)
High inflation differential = Low competitiveness
Not only might the economy then find it
difficult to grow at 10% by 2020, but it might also find
it challenging to maintain 8% growth
Our analysis of India’s growth drivers makes us skeptical of the
sustainability of the current economic model, in which
consumption is doing all the heavy lifting, while investments
are resting on their laurels
June 2016 9
Thematic | Economy
What leads us to these conclusions: At a time when 4% inflation looks difficult, a recommendation of bringing inflation down to 2% may appear misplaced to our readers. The key difference between our research and the market participants could be the benchmark with which we compare the current economic environment. We believe that today’s Indian economy must be compared with the previous slowdown in the early 2000s rather than the boom period of 2005-08. This comparison not only tells us that the current environment is more buoyant than in the early 2000s, but also that (1) retail inflation is much higher, (2) national savings must rise for revival of the investment cycle, and (3) higher investments must be driven by the corporate sector rather than households.
A prolonged rural slowdown may be required…: To bring down inflation, rural wages may be a catalyst (Exhibit 5). We would not be surprised if the current episode of weak rural wages is prolonged. There are two key reasons for this: (a) the rural sector has high marginal propensity to consume, and (b) productivity of the rural sector is low, not justifying higher wage growth. Hence, the rural economy is unlikely to be as buoyant as it was between FY09 and FY13.
Exhibit 5: Rural wages have collapsed recently (% YoY)…
*Data for January-February 2016
Exhibit 6: …strongly correlated with inflation
CPI index for rural laborers (RL) Source: Labour Bureau, Reserve Bank of India (RBI), MoSL
…leading to lower consumption unless savings are rebuilt: If so, a fall in consumption growth, we believe, may be inevitable to bring down inflation. Further, consumption growth will have to moderate to a level where savings start to re-build. This may be unavoidable because we do not expect incomes to grow fast enough to support higher consumption and higher savings (like in FY04-FY08 period). As savings re-build, it will allow the investment rate to increase. Given limited gains due to capital efficiency, an increase in investment rate is necessary for India to increase its economic growth from 7-8% towards 10%.
Consumption must be replaced by investments: In short, lower consumption is necessary to help bring down inflation, re-build saving and keep CAD contained. The longer the current economic model continues, the more destabilizing it will become. The shift from consumption to investments, thus, will become inevitable for the economy. There could be some disturbances during the transition; however, this is an unavoidable to create a sustainable model of development.
(14)
(7)
0
7
14
21
4QFY
00
4QFY
02
4QFY
04
4QFY
06
4QFY
08
4QFY
10
4QFY
12
4QFY
14
4QFY
16*
Real rural wages
Avg growth was +0.1% between FY00 and FY10
Avg growth was +8.5% between FY11 and FY13
y = 0.4891x + 2.2216 R² = 0.7949
0
3
6
9
12
15
(5) 0 5 10 15 20 25
Reta
il in
flatio
n (C
PI-R
L)
Nominal rural wage growth (%, YoY)
Today’s Indian economy must be compared with the previous slowdown in the early 2000s rather than the boom period of 2005-08
We would not be surprised if the current episode of weak rural wages is prolonged
The shift from consumption to investments, thus, will become inevitable for the economy
June 2016 10
Thematic | Economy
Is political agenda supporting our thesis?
The government sector plays a critical role in determining the buoyancy of the rural economy, and thus, India’s inflation. Therefore, one must keep an eye on the government’s preferences.
Firstly, we must note that the current government, in its first stint, has shown its ability and experience in allowing the economy to adjust during the early 2000s. We believe that the domestic adjustments during that period – namely, lower inflation, current account surplus, high deposit rates, etc – created strong potential for the economy to grow sustainably at a faster rate. To grow at 10% in the 2020s, we believe the economy must create the same potential. This is unlikely without the government’s support.
Therefore, it is important to note how the central government has done in the past couple of years. To bring inflation down further, a key requirement is continued slowdown in rural wages, unless their productivity increases. The government’s core revenue expenditure (excluding interest) plays an important role in determining rural buoyancy. Core revenue expenditure growth was 4% in FY16, marking the lowest growth in 34 years. This, we believe, helped to keep rural wage growth contained (Exhibit 7). Since the correlation works with a lag of 18-24 months, we expect rural wages to remain subdued in the foreseeable future (Exhibit 8).
Exhibit 7: Core revenue expenditure* (RE) growth lowest in more than three decades in FY16…
*Excluding interest payments
Exhibit 8: …which is highly correlated (with lag) with real rural wages
RE growth is with a lag of 24 months Source: Union Budget documents, CMIE, Labour Bureau, MoSL
While the government has curtailed its consumption spending, it has pushed ahead its capital expenditure. In FY16, the central government’s capex grew more than 25%, marking its highest growth in six years. Nevertheless, unlike the CG’s high influence in driving consumption growth, we believe its influence in total investments is limited because (a) the share of the government (central + states) in the economy’s total investments is ~13%, and (b) like household investments, public investments are not as efficient as corporate investments. Notably, the share of the government has risen from 9.5% in FY12 to ~13% in FY15; however, higher public investments limit the gains in capital efficiency.
0
10
20
30
40
50
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
Revenue spending ex interest(% YoY)
(10)
(2)
6
14
22
0
15
30
45
60
Feb-
01Fe
b-02
Feb-
03Fe
b-04
Feb-
05Fe
b-06
Feb-
07Fe
b-08
Feb-
09Fe
b-10
Feb-
11Fe
b-12
Feb-
13Fe
b-14
Feb-
15Fe
b-16
RE ex interest (-24m) Real rural wages (RHS)(% YoY, 12mma (% YoY)
Unlike the CG’s high influence in driving
consumption growth, we believe its influence in total
investments is limited
Core revenue expenditure growth was less than 4% in FY16, marking the lowest growth in 34 years. This, we believe, helped to
keep rural wage growth contained
June 2016 11
Thematic | Economy
Exhibit 9: Key investors in the economy
* General government (Central + States) Source: Central Statistics Office (CSO), CMIE, MoSL
43.4
36.1
9.5
11.1
Households
Private corporate
Government*
Other public sector
FY12
33.9
43.3
12.8
9.9
Households
Private corporate
Government*
Other public sector
FY15
June 2016 12
Thematic | Economy
Key economic projections for FY17-18
Exhibit 10: Economic forecasts of key macro-economic parameters Economic variable Units FY13 FY14 FY15 FY16 FY17F FY18F
Real sector
Real GDP % YoY 5.6 6.6 7.2 7.6 7.8 8.1
Consumption* % YoY 4.5 5.8 7.2 6.6 8.1 9.0
Fixed investments % YoY 4.9 3.4 4.9 5.3 6.6 7.1
Real GVA % YoY 5.4 6.3 7.1 7.2 7.7 7.9
Industry# % YoY 3.6 5.0 5.9 7.4 6.2 6.9
Services % YoY 8.1 7.8 10.3 8.9 9.0 9.7
Nominal GDP % YoY 13.9 13.3 10.8 8.7 11.1 11.9
IIP % YoY 1.1 (0.1) 2.8 2.4 5.2 5.8
Real PDI % YoY 3.6 4.9 2.9 4.1 6.3 7.0
Total savings % of GDP 33.8 33.0 33.0 31.8 29.9 28.6
Total investments % of GDP 38.6 34.7 34.2 32.5 31.3 30.7
Prices & rates
CPI % YoY 10.1 9.3 5.9 4.9 4.7 5.0
WPI % YoY 7.4 6.0 2.0 (2.5) 1.9 2.9
GDP deflator % YoY 7.9 6.2 3.3 1.0 3.1 3.6
10-yr yield (year-end) % 7.96 8.80 7.74 7.47 ~7.00 …
INR/USD (average) Unit 54.5 60.5 61.2 65.5 68.0 69.8
M3 % YoY 13.6 13.4 10.8 10.4 11.3 12.3
Bank credit % YoY 14.1 13.9 10.4 9.9 11.1 12.0
Bank deposits % YoY 14.2 14.1 12.6 8.1 8.8 11.7
Balance of payments
CAD % of GDP (4.8) (1.7) (1.3) (0.8) (1.4) (2.0)
Capital & financial account % of GDP 5.0 2.5 4.4 2.3 2.4 3.0 Foreign exchange reserves (+(withdrawal)/-(accretion)) USD bn (3.8) (15.5) (61.4) (32.1) (21.4) (24.5)
Central government finances
Total receipts % YoY 16.7 14.8 9.1 8.4 15.5 14.1
Total spending % YoY 8.1 10.6 6.7 7.3 10.8 12.4
Revenue spending % YoY 8.5 10.3 6.9 5.5 11.8 12.8
Capital spending % YoY 5.2 12.5 4.8 20.9 3.9 10.0
Fiscal balance % of GDP (4.9) (4.5) (4.1) (3.9) (3.5) (3.4) * Private + Government consumption # Includes construction
Please see Appendix IV for detailed projections Source: CSO, RBI, CMIE, MoSL
June 2016 13
Thematic | Economy
Info graphic: Indian economy from investors’ perspective
June 2016 14
Thematic | Economy
I. Indian economy from Investors’ perspective
Unlike Economists, for whom absolute performance may be as important, comparative performance holds the key for investors. The key parameters that confirm India’s outperformance are: Economic resilience has helped India to rise from the world’s 12th largest economy in
2008 to 7th this year, increasing India’s dominance in the world economy. At a time when most major economies in the world are witnessing declining working
population, threatening to push them into stagnation, India’s demographic structure isan enviable asset.
In the past four years, India’s vulnerability matrix has improved markedly and rewardmatrix has also recovered. Hence, risk-reward matrix makes India the most attractiveinvestment destination.
Most importantly, the Indian economy has improved without increasing its leverage.The debt-to-GDP ratio has been stagnant since 2012 and the debt intensity of India’sGDP growth is one of the lowest among major emerging economies.
The Indian economy has come a long way from its weak fundamentals in 2012. While some of the long-term structural factors remain benign, the extent of improvement in other fundamentals vis-à-vis other major emerging market economies has been excellent in the past 3-4 years. We believe this is what matters most for global investors, who look at relative performance rather than absolute performance. In this part, we look at the comparative performance of the Indian economy vis-à-vis its counterparts in the developing world and some developed economies too.
I.1. Economic resilience has increased India’s dominance in world economy:Notwithstanding the Great Financial Crisis (GFC), which has rattled the developedworld for 7-8 years, growth of the Indian economy has been impressive. Exhibit 11shows the share of major developed economies (and India) in the world economy.Barring the US, major developed economies have lost share in the world economy.Exhibit 12 compares the share of major emerging and developing economies in thepast five years. While most emerging economies have lost share in the past fewyears, the dominance of China and India (Indonesia too to a lesser extent) hasincreased in the world economy.
Exhibit 11: Share of major advanced economies and India in the world economy (%)
Gross domestic product (GDP) at current prices in US Dollar terms
Exhibit 12: Share of major developing economies in the world economy (%)
Source: International Monetary fund (IMF), MoSL E=IMF’s estimates
16
24
32
0
3
5
8
2011 2012 2013 2014 2015 2016E
Germany India Italy USA (RHS)
0
5
10
15
20
0
1
2
3
4
2011 2012 2013 2014 2015 2016E
Brazil India Russia China (RHS)
While most emerging economies have lost share in the past few years, the dominance of China and India (Indonesia too to a
lesser extent) has increased in the world
economy
June 2016 15
Thematic | Economy
Owing to the relative resilience of the Indian economy in the past few years, its ranking in the world economy has improved dramatically. As Exhibits 13-14 show, India has moved up from the 12th largest economy in the world in 2008 to the 7th largest this year (as per IMF’s forecasts).
Exhibit 13: India’s ranking has improved from 12th in 2008…
2016 data is IMF’s forecasts
Exhibit 14: …to 7th in 2016 in the world economy (%)
Source: IMF, MoSL
I.2. India’s demographic structure an enviable asset: At a time when the developedworld is feared to be suffering from secular stagnation1, partly because of declining(or decelerating growth in) working population (aged 15-64 years), a vast youthpopulation (aged below 14 years) is an enviable asset for any economy. Exhibit 15shows that the growth in working population is decelerating at the global level;however, India’s working population continues to grow at 1.7% per annum againstthe global average of 1.1%. Notably, Eurozone (EZ), like Japan, is already witnessinga shrinking working population, while China is facing stagnant working population.
Exhibit 16 shows the share of youth population in major economies, reflecting the potential growth in working population after a decade or so. The lower the share of youth population, the higher is the risk of contraction in working population over the next decade. The share of youth population is the highest in India at 29.2% of total population and the lowest in Japan at less than 13% in 2014.
Exhibit 15: Working population (aged 15-64 years,% YoY)
Source: World Bank, MoSL
Exhibit 16: Share of youth population (aged 0-14 years)
Data for 2014
USA, 25.1
China, 15.4
Japan, 6.0 Germany,
4.7
UK, 3.7
France, 3.3 India, 3.1 Italy, 2.5 Brazil, 2.1
Canada, 2.0 Spain, 1.7
Russia, 1.5 Others, 29.0
2016E
0.0
0.5
1.0
1.5
2.0
2.5
2010 2011 2012 2013 2014
China India USA World
17.2 15.2
29.2
17.7 19.1
12.9
26.2
China EZ India UK USA Japan World
India’s working population continues to grow at 1.7%
per annum against the global average of 1.1%.
1 The concept was introduced by Lawrence H. Summers in late 2013, who is the Charles W. Eliot University Professor and President Emeritus at Harvard University. Read an ebook on secular stagnation here
2008 2016E
12
7
June 2016 16
Thematic | Economy
Exhibit 17 below, which shows the median age of the population, reinforces India’s favorable demographic structure vis-à-vis other large economies. The median age of population in India is 27 years, lower than the world median of 30 years. Notably, the median age in Japan is 47 years, which makes it the world’s oldest nation. Further, the old-age (aged 65+ years) dependency ratio in India is 9% against the world’s (and Asia’s) average of 13% (11%) in 2015 (Exhibit 18). India’s demographic structure gives it an enviable advantage, which, if utilized carefully, has the potential to take India to the next level in economic development.
Exhibit 17: Median age of population in 2015
Source: United Nations Population Division (UNPD), MoSL
Exhibit 18: Old-age dependency ratio in 2015
Old age dependency ratio is defined as the share of old-age (65+ years) as working population (15-64 years)
I.3. India’s vulnerability matrix has improved markedly…: Whether capital flows aredriven by investment model (arguing change in macro environment precedes andcauses investment flows) or liquidity model (capital flows precede and causegrowth) is an ongoing debate2 and beyond the scope of this report. There areenough experiences to validate both theories; however, as investors usually carryout fundamental research before making investment decisions, the investmentmodel dominates, at least conceptually. If macroeconomic risks increase in aneconomy, capital inflows would reduce (or capital outflows would increase). It is,thus, important to keep the domestic house in order (which is determined by thestate of other economies as well).
The government of India (GoI) introduced a macroeconomic vulnerability index3 (MVI) in its 2014-15 Economic Survey, comprising of inflation, fiscal deficit andcurrent account deficit. We replace fiscal deficit with the primary balance (fiscal deficit excluding interest payments) of the government and use the same structure to re-calculate MVI for several economies. The lower the MVI index is, the safer the economy is. A reduction (increase) in MVI over time reflects improvement (deterioration). Exhibit 19 on the next page compares the change in MVI for several emerging economies, for the entire group of emerging & developing Asia and all economies rated “BBB-” (India’s rating) by Standard & Poor’s. India is the second most improved economy in the past four years – between 2012 and 2016. On the other hand, the MVI index has increased since 2012 in its closest competitors – China and Indonesia (the deterioration in Brazil and Russia is obvious because of recession in these economies).
27 30 30 31 37 38 39 40 41 41 43 46 46 47
Indi
a
Wor
ld
Asia
Braz
il
Chin
a
USA
Russ
ia UK
Cana
da
Fran
ce
Spai
n
Italy
Germ
any
Japa
n
(Years)
9 11 11 13 13 19
22 24 28 28 31 32 35
43
Indi
a
Asia
Braz
il
Wor
ld
Chin
a
Russ
ia
USA
Cana
da UK
Spai
n
Fran
ce
Germ
any
Italy
Japa
n
(%)
India’s working population continues to grow at 1.7%
per annum against the global average of 1.1%.
2 Pettis Michael, “The Volatility Machine: Emerging economies and the threat of Financial collapse”, Oxford University Press (2001) 3 The concept is borrowed from The Government of India (GoI) introduced in Economic Survey 2014-15. See Appendix III for details.
India is the second most improved
economy in the past four years – between
2012 and 2016
June 2016 17
Thematic | Economy
Exhibit 19: Change in MVI for various economies (2012-2016)
* Emerging & developing Asia, as defined by IMF Average of all economies rated “BBB-“ by Standard & Poor’s Source: Economic Survey 2014-15, IMF, MoSL
...and reward matrix has also recovered: Gauging risk, however, is only one side of the balance sheet assessment for investors. The rewards are equally important, which could be measured by real economic growth. Consequently, we re-calculate another index, known as Rational Investors Ratings Index4 (RIRI), introduced in the same Economic Survey of 2014-15. Higher RIRI implies higher reward and lower vulnerability, which suggests better rating by investors. Exhibit 20 below compares the actual value of RIRI for the same set of economies in the past five years. While India’s RIRI has improved in the past five years, China, Philippines and Thailand have higher RIRI. Nevertheless, as financial markets react to incremental flow of information, what may matter more for investors is change in RIRI rather than the actual value of RIRI.
Exhibit 20: RIRI values for various economies
* Emerging & developing Asia, as defined by IMF Average of all economies rated “BBB-“ by Standard & Poor’s Source: Economic Survey 2014-15, IMF, MoSL
Risk-reward matrix makes India the most attractive investment destination: Exhibit 21 on the next page shows the change in RIRI for the same set of economies considered in this study. While several economies have improved on vulnerability index since 2012 (Exhibit 19), India and Turkey are the only two economies that have performed well on the entire risk-reward matrix, measured by RIRI. This, we believe, makes India a definite investment destination for global investors.
(11.4) (8.6)
(0.9) (0.8) (0.7) (0.6) (0.3)
1.1 1.3 3.9
5.6 6.0 6.7
Thai
land
Indi
a
S Af
rica
Mex
ico
Turk
ey
Phili
ppin
es
E&D
Asia
*
Indo
nesia
Chin
a
Mal
aysia
BBB-
Braz
il
Russ
ia
-5
-3
0
3
5
2012 2013 2014 2015 2016E
Brazil China India Indonesia Philippines
Russia Thailand Turkey E&D Asia* BBB-
While India’s RIRI has improved in the past five years, China, Philippines
and Thailand have higher RIRI
While several economies have improved on
vulnerability index since 2012, India and Turkey are
the only two economies that have performed well on the entire risk-reward
matrix
4 The concept is borrowed from The Government of India (GoI) introduced in Economic Survey 2014-15. See Appendix III for details.
June 2016 18
Thematic | Economy
Exhibit 21: RIRI values for various economies
* Emerging & developing Asia, as defined by IMF Average of all economies rated “BBB-“ by Standard & Poor’s Source: Economic Survey 2014-15, IMF, MoSL
I.4. Is Indian economy highly leveraged? The Indian economy is usually associatedwith high government debt, which is seen as a key concern. There is no doubt thatgovernment debt in India is one of the highest among emerging markets; however,the recent global financial crisis has taught us that what matters is total debt of thenon-financial sector (private + government), rather than just sovereign debt.Therefore, we look at total debt of the economy (excluding financial sector).
Exhibit 22 compares the total government debt of various emerging economies. In the emerging world, government debt as a percentage of GDP is one of the highest in India. However, as exhibit 23 shows, private debt in India is among the lowest in the sample considered for this study. Government debt is monitored closely by investors, but this does not make it more important than private debt. Several economies have witnessed slowdown (recession also) because of high private debt (Spain and Ireland are classic examples). Private debt is just as important as government debt; to get a holistic view of an economy, one should look at the total non-financial debt of the economy.
Exhibit 22: Comparison of government debt in 2015*
*For the first three quarters of 2015
Exhibit 23: Comparison of private non-financial debt in 2015*
Source: BIS, IMF, MoSL
(4.3) (3.9)
(1.2) (1.1) (0.9) (0.8) (0.8) (0.8) (0.4) (0.2) (0.2)
1.1
2.3
Braz
il
Russ
ia
Mal
aysia
BBB-
Chin
a
Indo
nesia
S Af
rica
Mex
ico
E&D
Asia
*
Phili
ppin
es
Thai
land
Turk
ey
Indi
a
4 16
25 30 31 33 38 41 49 53
63 66
Saud
i Ara
bia
Russ
ia
Indo
nesia
Thai
land
Turk
ey
Mex
ico
Arge
ntin
a
Chin
a
S Af
rica
Mal
aysia
Indi
a
Braz
il
(% of GDP)
16 38 38
56 58 69 70 73 73
120 133
193
Arge
ntin
a
Mex
ico
Indo
nesia
Indi
a
Saud
i Ara
bia
Russ
ia
S Af
rica
Braz
il
Turk
ey
Thai
land
Mal
aysia
Chin
a
(% of GDP)
Private debt in India is among the lowest in the
sample considered for this study
In the emerging world, government debt as a
percentage of GDP is one of the highest in India.
June 2016 19
Thematic | Economy
Exhibit 24 shows the total non-financial debt of the sample. India lies in the middle, implying neither too high nor too low debt. Again, investors are more interested in the trend (or flow) of total debt rather than the outstanding stock. “How is the debt-to-GDP moving?” is more pertinent for investors. The answer lies in exhibit 25, which shows that India’s total debt-to-GDP ratio has been largely unchanged in the past three years, while it has increased substantially in almost all other major emerging markets. This is what gives more confidence in the Indian economy.
Exhibit 24: Total non-financial debt in 2015*
* For the first three quarters of 2015
Exhibit 25: Trend in debt-GDP ratio since 2012
Source: BIS, IMF, MoSL
Finally, an important metric related to an economy’s debt is “debt intensity5 of GDP growth”. This measures “how many units of debt are needed to produce an additional unit of GDP in the economy?”. The lower it is, the better. Exhibit 26 shows the debt intensity for each of the 12 economies studied in this analysis. The exhibit shows the average of the three-year period ending 2015 to smoothen any one-time shocks. India features among the economies with low debt intensity – it needs 1.3 units of investment to produce one unit of GDP. This is in comparison to almost 4 units of debt needed by China, and an average of 2 units needed by the sample of 12 economies.
Exhibit 26: Debt intensity of economic growth (Unit)
Recent data as of 2015 Source: BIS, IMF, MoSL
55 62 63 71 85 104 119 119
139 150187
234
Arge
ntin
a
Saud
i Ara
bia
Indo
nesia
Mex
ico
Russ
ia
Turk
ey
Indi
a
S Af
rica
Braz
il
Thai
land
Mal
aysia
Chin
a
(% of GDP)
1 7 9 11 12 13
17 18 18 19 23
44
Indi
a
Arge
ntin
a
Indo
nesia
S Af
rica
Mex
ico
Turk
ey
Mal
aysia
Braz
il
Thai
land
Saud
i Ara
bia
Russ
ia
Chin
a
(percent points, pps)
0.6 0.9 1.2 1.3 1.5 1.7 1.7 2.3 2.4
2.9
3.9 4.3
Arge
ntin
a
Indo
nesia
Turk
ey
Indi
a
Mex
ico
Saud
i Ara
bia
S Af
rica
Russ
ia
Braz
il
Mal
aysia
Chin
a
Thai
land
India’s total debt-to-GDP ratio has been largely
unchanged in the past three years, while it has increased
substantially in almost all other major emerging
markets
5 Debt intensity of GDP growth = average change in debt in ‘t-1’ and ‘t’ period/change in GDP in ‘t’ period
India features among the economies with low debt intensity – it needs 1.3 units of investment to produce one unit of
GDP
June 2016 20
Thematic | Economy
We further discuss what has helped India become the “fastest growingeconomy in the world”.
The tag, we believe, has led to few changes in the economy, which, if notaddressed carefully and in time, have the potential to make the economyunsustainable.
Finally, we conclude Part II by giving our detailed expectations on the Indianeconomy for the next two years - FY17 and FY18.
We argue that India could touch 8% real GDP growth by FY18. We also giveour forecasts of the Indian Rupee (INR) against the US Dollar (USD) based onreal effective exchange rate (REER) model and our outlook for the bondsmarket in FY17.
U UNIQUE TRENDS THAT MAKE INDIA WORLD’S FASTEST GROWING ECONOMY
II. Indian economy from Economist’s perspective
To make projections, it is important to understand what happened in the recent past and how the economy is doing currently. We have explained our understanding of the Indian economy in this part of the report. We have analysed this part using the KURE theme. We define KURE as:
The first challenge presented to us is the divergence between new GDP dataand India Inc topline.
GDP data or India Inc topline – what to believe? Is consumption demand lowor high in India? How painful/serious has been India’s current slowdown?
These are the questions we have answered in Section I.
We follow Section II with an identity, which, according to us, covers a largepart of the economy.
We call it the “Theory of Everything” because the equation coversconsumption, savings, investments, fiscal deficit and current accountbalance.
In other words, the identity has the potential to explain a large part of aneconomy.
K Know Your Economy
R REMEMBER THE ‘THEORY OF EVERYTHING’
E EXPECTATIONS FOR NEXT TWO YEARS
June 2016 21
Thematic | Economy
KURE Theme
Source: MOSL
June 2016 22
Thematic | Economy
Info graphic: Indian economy from Economist’s perspective
June 2016 23
Thematic | Economy
II.1. Know your economy
We try to bridge the gap between resilient GDP growth and weak India Inctopline by incorporating the medium and bottom levels of the corporatepyramid.
We reckon that the listed corporate space may be losing market share to thenon-listed space, which continues to witness high sales growth and greatprofit margins.
In the recent past, resilient consumption demand has helped to mitigate theadverse pressure on real GDP growth, which is better than it was in theprevious slowdown in early 2000s.
II.1.1 What to believe? GDP data or India Inc toplineThere is a growing debate between the Central Statistics Office (CSO), whichreleases India’s national accounts data including GDP, and India Inc about the stateof India’s consumption. Net sales of India Inc have plunged from a healthy growth of9.5% in FY13 to a contraction of 3.5% in the first three quarters of FY16 (Exhibit 27).Such abysmal topline numbers have led India Inc to believe that consumptiondemand has declined dramatically in the country.
According to CSO, India’s nominal consumption (both private and government) growth has eased only gradually from 14.5 % in FY13 to 11.2% in FY16. Further, real consumption growth, as per CSO data, is estimated to grow 6.6% in FY16, much better than 4.5% in FY13 and 5.8% in FY14.
Exhibit 27: Growing divergence between GDP data and India Inc sales
Consumption includes private and government Source: RBI, CSO, MoSL
This is what makes the task of policymakers difficult. What to believe? This question has troubled us for almost a year from the time CSO published new GDP estimates. The question is of paramount importance to understand whether the economy needs policy support to boost consumption or not.
We believe both sides of the argument are correct. National consumption has been resilient; however, India Inc is not enjoying it. The unlisted or unincorporated corporate sector is flourishing and gaining market share6.
-10
0
10
20
30
Q1FY13
Q2FY13
Q3FY13
Q4FY13
Q1FY14
Q2FY14
Q3FY14
Q4FY14
Q1FY15
Q2FY15
Q3FY15
Q4FY15
Q1FY16
Q2FY16
Q3FY16
Q4FY16
India Inc sales GDP: Nom consumption GDP: Real consumption
(% YoY)
There is a growing debate between the Central
Statistics Office (CSO), which releases India’s
national accounts data including GDP, and India Inc
about the state of India’s consumption
We believe both sides of the argument are correct. National consumption has
been resilient; however, India Inc is not enjoying it
K II.1. Know your economy
6 Please refer to Appendix I for details on corporate data used in this analysis
June 2016 24
Thematic | Economy
Exhibit 28 shows that the share of RBI sample (2,700-odd companies) in national consumption (from CSO data) has fallen from 44% in FY13 to 36.6% in FY15.
Another interesting thing to note is that the share of companies covered by Ministry of Corporate Affairs (MCA) (~250,000 companies), but not by RBI in its quarterly data, has risen from ~11% in FY13 to over 14% in FY15. It implies that the share of the uncovered corporate sector, which could be called the unorganized (or informal or unregistered) sector, has also risen from ~45% in FY13 to 49% in FY15. (Please note the change in GDP base did not change this analysis.)
Exhibit 28: Share of different sample of companies in national consumption
Exhibit 29: Sales growth of different sample of companies in the past two years
RBI sample corresponds to companies covered by RBI quarterly data for 2,700 odd companies Ex-RBI MCA sample corresponds to expanded data covering 2,50,000 companies, which excludes RBI sample
* Others are companies not covered by MCA also (estimated as residual)Source: RBI, CSO, MoSL
Exhibit 29 shows that while the sales of RBI sample companies grew at low single digits (for changing set of companies) in FY14 and FY15, growth for the rest of the corporate sector was in high teens. Deceleration in case of ‘others’, companies not covered by MCA and which account for 49% of total consumption, was marginal – from 18.4% YoY in FY14 to 16.5% in FY15.
Expanded coverage of the corporate sector explains higher GDP growth: One of the key revisions in the GDP data released by CSO last year was the use of new data source – MCA database – for estimating the corporate sector’s contribution to the economy. Earlier, the corporate sector’s contribution was estimated using the RBI study on company finances, which was based on some 2,700-odd listed companies and Index of Industrial Production (IIP). The MCA database covers almost 500,000 companies. Not surprisingly, data for the manufacturing sector has witnessed a marked upward movement post revision.
This may represent a classic sample problem. The most-tracked listed companies in the country, captured by the RBI sample, may not be the real representative of the economy. To understand the stark difference, we have prepared Exhibit 30 for different sample of companies released by RBI. Since RBI releases data only for the past three years in a single press release, and MCA data was included in the recent data released by RBI for 2014-15, we have MCA data only for three years – FY13, FY14 and FY15. This data covers ~17,000 public limited companies against 2,700 companies covered in the RBI’s quarterly release. The exhibit is an eye-opener.
44.0 39.5 36.6
10.8 13.5 14.4
45.2 47.0 49.0
FY13 FY14 FY15
RBI sample Ex-RBI MCA sample Others*(%)
2.0 3.6
42.5
18.7 18.4 16.5
FY14 FY15
RBI sample Ex-RBI MCA sample Others*(% YoY)
The share of companies covered by MCA, but not by RBI in its quarterly data, has
risen from ~11% in FY13 to over 14% in FY15
The most-tracked listed companies in the country,
captured by the RBI sample, may not be the real
representative of the economy
June 2016 25
Thematic | Economy
If we just look at the ~2,700 companies’ data available on quarterly basis and include large companies, profit margin seems to have stabilized at low levels. However, with the CSO coverage quadrupling on inclusion of MCA database, the condition of the corporate sector shows dramatic improvement. The PAT margin of the limited coverage was ~6% in FY13 (~2,700 companies), which eased to ~5.5% in FY14 and 5.8% in FY15. On the expanded coverage, the PAT margin was more than double at 13.9% in FY13 and unchanged in FY15.
Exhibit 31 shows the PAT margin for the limited coverage, which gets most of the attention, and compares it with that for the expanded coverage. The difference is stark. The PAT margin for the companies not included in the limited coverage was as high as 24% in FY15, more than 4x the PAT margin for the limited coverage.
Exhibit 30: Net profit margin of different corporate samples released by RBI (%)
Exhibit 31: Comparison of PAT margin for different corporate samples (%)
RBI sample corresponds to 2,700-odd companies (and include only public companies) Expanded coverage is MCA sample implying coverage of ~17,000 public companies
Source: RBI, MoSL
Overall, the expanded coverage, which is now incorporated in CSO’s GDP data, shows that consumption has not slowed as much as is reflected by the weak position of the large corporates. Though the large corporates, which are not doing as well, receive most of the investor attention, policymaking decisions should be constructed on holistic analysis, which confirms resilient consumption in the economy, holding up real GDP growth at high levels.
0
5
10
15
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
Net profit margin
RBI quarterly data Expanded coverage
6.0 5.5 5.8
30.2
24.3 24.0
FY13 FY14 FY15
RBI sample Ex-RBI MCA sample
On the expanded coverage, the PAT margin was more
than double at 10.8% in FY13 and broadly
unchanged in FY15
The PAT margin for the companies not included in
the limited coverage was as high as 24% in FY15
Though the large corporates, which are not
doing as well, receive most of the investor attention,
policymaking decisions should be constructed on
holistic analysis
June 2016 26
Thematic | Economy
II.1.2. How painful/serious has India’s current slowdown been?In order to understand that, let us compare the economic performance in the recentperiod (FY12-17E) with that in the previous slowdown. Though liberalization beganin 1991, the economy actually opened up in 1995. An analysis of the Indian economyin the past two decades shows that the only episode of significant slowdown was inearly 2000, which coincided with the Dot-com bubble in the US. Accordingly, wehave compared India’s recent performance with that in the early 2000s (FY99-04)and the boom period (FY03-08).
Exhibit 32 compares India’s real GDP growth in the past five years with that of the early 2000s and the boom episode. India’s real GDP growth has averaged 6.8% per annum since FY12 as against 4.2% in the previous slowdown (early 2000s) and 8.8% during the boom period. The current slowdown is not as severe as the previous one. (Even if one believes that real GDP growth was 5.5% in FY15 and 6.0% in FY16, the average growth would be ~5.5%, better than in early 2000s.)
Exhibit 33 shows the key reason for the better-than-early-2000s real GDP growth. India’s consumption has grown ~6.5% in five years to FY17 (our projection for FY17), close to the 7% growth witnessed in the boom period of FY04-08. Consumption growth, however, averaged 4.5% in the early 2000s. The exhibit is in line with our conclusion from the first part of the current section, where we argued that consumption demand has not slowed dramatically in the current slowdown.
Exhibit 32: India’s real GDP growth has not slowed dramatically…
Data from 4QFY16 onwards are our projections
Exhibit 33: ….primarily because of strong consumption in the recent slowdown
Consumption includes both private and government consumption Source: OECD, RBI, MoSL
Reinforcing our conclusion in Exhibit 33, we also find that consumption demand (including private and government consumption) in India crossed 70% of GDP in FY16, up from 67% in FY12, marking the highest level since FY05 (Exhibit 34 on the next page). In other words, the share of consumption in GDP is at the highest level in the past 12 years. In fact, we believe it will increase further towards 72% in FY17, due to the continuation of consumption-driven growth in the economy.
Exhibit 35 on the next page compares the share of consumption across various Asian economies in 2014 (the recent period for which data is available). It is apparent that India has one of the highest shares of consumption, as against the lowest of 48% in Singapore and the average of 65% in the sample taken.
80
100
120
140
160
180
0 2 4 6 8 10 12 14 16 18 20 22
Number of quarters
Early 2000s Boom period Recent
(Index)
80
100
120
140
160
0 2 4 6 8 10 12 14 16 18 20 22Number of quarters
Early 2000s Boom period Recent
(Index)
India’s consumption has grown ~6.5% in five years to
FY17, close to the 7% growth witnessed in the boom period of FY04-08
The share of consumption in GDP is at the highest
level in the past 12 years.
It is apparent that India has one of the highest shares of
consumption
The current slowdown is not as severe as the
previous one
June 2016 27
Thematic | Economy
Exhibit 34: India’s consumption is at the highest level in more than a decade
Consumption includes both private and government consumption Data from FY16 onwards are our projections
Exhibit 35: Share of consumption in India vis-à-vis other Asian peers
Consumption includes both private and government consumption Source: World Bank
Box 1. What does potential output tell us about the recent slowdown? In a recent working paper7, Reserve Bank of India (RBI) attempted to estimate India’s potential GDP and output gap. Although the focus of the RBI’s paper was different and not related to our study, a look at the historical trend of the output
gap (actual output – potential output) presented in the RBI’s paper gives an interesting and relevant finding. The exhibit is shown below.
It is important to note that the negative output gap in the current slowdown is one of the lowest witnessed by the Indian economy in several slowdowns since 1980s. The negative output gap did not even touch 2%; in all the past three slowdowns since 1980, the negative output gas was close to 4%.
This implies that the fall in actual output below potential output is less severe than in the previous slowdown. This is exactlywhat we have concluded in our analysis.
Composite output gap estimate
Source: RBI
7 Bhoi, Barendra Kumar and Behera, Harendra Kumar, “India’s Potential Output Revisited”, April 2016, RBI Working paper series 05/2016
70.1
67.2
70.1
60
64
68
72
76
80
FY00 FY03 FY06 FY09 FY12 FY15 FY18F
48 50
66 66 66 69 70
83
Sing
apor
e
Chin
a
Kore
a
Mal
aysia
Indo
nesia
Thai
land
Indi
a
Phili
ppin
es
(%)
June 2016 28
Thematic | Economy
II.2. Unique trends that make India the fastest growing economy
Three key facts making India the fastest growing economy in the world: Consumption has replaced investments as the key driver of growth. The former is
financed by savings, not disposable income. Notwithstanding the fall in domestic inflation, the “price gap” remains as high as 54%.
Further, India’s inflation differential vis-à-vis major trading partners has increasedrecently, hurting India’s competitiveness. We argue that inflation must be allowed toundershoot the 4% target for at least a few quarters.
In comparison to the previous slowdown in the early 2000s, the recent adjustments inIndia’s current account deficit are highly incomplete. The economy probably needs asurplus on its external account to create the potential for high & sustainable growth.
Since 2008, real output growth has become rare. The developed world as a whole has grown only 1%, while the developing and emerging economies have grown at an average of 5.2%. India is the fastest growing economy in the world, estimated to have grown 7.6% in the recently concluded year and expected to grow ~8% this year. Our analysis shows that three unique but related factors have allowed the Indian economy to become the fastest growing major economy in the world. As discussed in the previous section, high consumption growth has helped India to maintain its GDP growth. However, high consumption, at a time when investments have slowed drastically, has come at the cost of higher inflation, lower savings and higher current account deficit (CAD). We have discussed these three factors in this section.
II.2.1. Higher consumption financed by savings, not higherincomeAs discussed in the previous section, India’s consumption growth has been resilientenough to make it the world’s fastest growing economy. Our first impression wasthat resilient household income (households account for 85% of total consumptionin the economy) has led to the resilience in consumption demand. However, asshown in Exhibit 36 on the next page, real personal disposable income (PDI) growthin the recent period has lagged the growth witnessed in early 2000s, let alone theboom period of FY04-08. Real PDI grew at a cumulative rate of 29% in the five yearsto FY04, 43% in the five years to FY08, and is expected to grow 23% in the five yearsto FY17.
U II.2. Unique trends that make India the fastest
Real personal disposable income (PDI) growth in the recent period has
lagged the growth witnessed in early 2000s, let alone the boom period
of FY04-08
June 2016 29
Thematic | Economy
Exhibit 36: Real personal disposable income growth has been lackluster…
Real disposable income is nominal income deflated by PCE deflator Data from FY15 onwards are our projections
Exhibit 37: …implying consumption growth financed by household savings
Household savings in absolute terms (INR) converted into index Source: CSO, RBI, MoSL
If income growth is weaker than it was in the early 2000s, how have the households maintained their consumption growth closer to the levels in FY04-08? The answer lies in household savings (Exhibit 37). Since FY12, Indian household savings have grown only 25% (in absolute INR terms) against ~87% growth in the early 2000s and ~98% growth in the mid-2000 period. As a percentage of GDP, household savings have collapsed from 23.6% in FY12 to 19% in FY15 and are projected to dip further towards 17% in FY17. This, as shown in Exhibit 38, is the lowest in the past two decades.
Exhibit 38: Household savings have collapsed in the past few years
FY16 is our estimate and FY17 is our forecast Source: RBI, CSO, MoSL
Households, thus, have financed their consumption out of savings rather than higher incomes. This strategy is unsustainable in the longer period. Falling household savings, which accounted for more than two-thirds of total savings in the economy, act as a serious constraint on the ability of the non-financial corporate sector to increase investments towards pre-crisis level. This is because savings are the key source of investments. Without domestic savings, an economy has to depend on foreign borrowings or current account deficit (CAD) for investments. As we discuss later, there is not sufficient room for CAD to help investment rate increase significantly.
80
100
120
140
160
0 1 2 3 4 5Number of years
Real personal disposable income
Early 2000s Boom period Recent
80
120
160
200
240
0 1 2 3 4 5
Number of years
Household savings
Early 2000s Boom period Recent
10
15
20
25
30
FY1996 FY1999 FY2002 FY2005 FY2008 FY2011 FY2014 FY2017F
Household savings (% of GDP)
Indian household savings have grown only 25% (in
absolute INR terms) against ~87% growth in the early
2000s and ~98% growth in the mid-2000 period
Households have financed their consumption out of
savings rather than higher incomes. This strategy is
unsustainable in the longer period
16.9%
June 2016 30
Thematic | Economy
It is also important to understand the behavior of Indian households vis-à-vis their counterparts in other economies. We take the US as a representative of the recession-hit economies. Exhibits 39 and 40 compare household savings and investments in India and in the US. Over FY09-13, while Indian households reduced their savings and increased their investments, their US counterparts did the reverse by building savings and cutting investments. The latter was a typical behavior of households in all economies hit by recession/slowdown. Indian households exhibited the opposite trend.
Exhibit 39: Household savings8 have collapsed in India…
We have calculated FY numbers for the US using quarterly data FY16 data for the US is for Apr-Dec 2015
Exhibit 40: ….while investments were strong till recently
Data for FY16 for India is MoSL’s estimate Source: US Bureau of Economic Analysis (BEA), RBI, MoSL
The diverse behavior of Indian households implies two things – either they believe that the slowdown in disposable income is fleeting or that the fall in savings is more structural in nature. Given India’s culture, demographic structure and the absence of social security net, the latter seems unlikely. If the former is true, then households’ perception of temporary slowdown could be challenged anytime, as real disposable income growth has remained subdued for five consecutive years.
4
5
6
7
8
15
18
21
24
27
FY06 FY08 FY10 FY12 FY14 FY16E
Household savings (% of GDP) (% of GDP)
India
USA (RHS)
2
4
5
7
8
6
9
12
15
18
FY06 FY08 FY10 FY12 FY14 FY16E
Households' investments (% of GDP) (% of GDP)
India
USA (RHS)
While Indian households reduced their savings and
increased their investments, their US counterparts did the
reverse by building savings and cutting investments
The diverse behavior of Indian households implies
two things – either they believe that the slowdown
in disposable income is fleeting, or that the fall in
savings is more structural in nature
8 Indian household savings = net financial savings + physical savings
June 2016 31
Thematic | Economy
II.2.2. Has inflation eased sufficiently?India’s retail inflation has fallen from double-digit levels in six consecutive yearsbetween FY09 (starting April 2008) and FY14 (ending March 2014) to ~5% in FY16.We expect retail inflation to average 4.7% in the current year (FY17) and undershootthe 5% target for January 2017. Considering this, one could assume that inflationhas fallen sufficiently. In this section, we look at inflation from various perspectivesand conclude that retail inflation at 5% is higher than it should have been. Webelieve inflation must be allowed to undershoot the medium-term target of 4% forat least a few quarters9.
“Price gap” is as high as 54%: Inflation is the rate of change in prices. Hence, the base matters. If inflation has averaged 10% in the past few years, 5% in the next year would imply much higher price level than in a scenario where inflation had averaged 5% in the past few years as well. To help grasp the difference between the rate of change in prices (inflation) and the price level (index), we introduce the concept of “price gap”. Just like “output gap” is the difference between actual output and potential output, we define “price gap” as the difference between actual price (or index) level and the optimal (or target) level. The logic is simple. If the authorities try to target zero output gap, the “price gap” should also be minimal - the actual price level should be closer to the optimal price index. If the actual index is higher than the optimal index, the economy will have a positive price gap. This happens when consumption demand is very high and producers have bargaining power. A negative price gap occurs when actual prices are lower than optimal, which happens when consumption demand is low and producers/sellers lose their bargaining power.
Price gap = Actual price index - Optimal price (or target) index
We derive the optimal price index through the desired (or targeted) inflation, which we take as 4%. Exhibit 41 compares the optimal index with the actual index level. From late 1990s to 2006, the actual index closely tracked the optimal index. In 2007, the “price gap” turned positive and has been rising consistently since then (Exhibit 42). The “price gap” scaled a peak of ~59% in April 2015. As per the recent reading in April 2016, it was 54%.
Exhibit 41: Comparison of optimal and actual price level
CPI for industrial workers (IW) is used to measure retail prices Optimal index is calculated assuming 4% inflation over the period
Exhibit 42: “Price gap” estimate for Indian economy
(Actual index - optimal price level)/Optimal level Source: CSO, MoSL
50
130
210
290
370
Oct
-98
May
-00
Dec-
01
Jul-0
3
Feb-
05
Sep-
06
Apr-
08
Nov
-09
Jun-
11
Jan-
13
Aug-
14
Mar
-16
Optimal price level Actual price level(FY99=100)
54%
(25)
0
25
50
75
Oct
-98
May
-00
Dec-
01
Jul-0
3
Feb-
05
Sep-
06
Apr-
08
Nov
-09
Jun-
11
Jan-
13
Aug-
14
Mar
-16
Price gap 18M MA(%)
If the authorities try to target zero output gap, the “price gap” should also be
minimal
From late 1990s to 2006, the actual index closely
tracked the optimal index. In 2007, the “price gap” turned positive and has been rising consistently
since then
9 Please note the entire analysis on inflation is conducted using Consumer Price Index for Industrial Workers (CPI-IW) for which a long historical time series is available
June 2016 32
Thematic | Economy
Box 2. How has WPI-based price gap behaved?
After reading the section on retail price gap, we realized that the readers could be interested in looking at the wholesale price gap, especially after the recent decline in wholesale price index (WPI).
We derive the WPI optimal price index through the desired (or targeted) inflation of 4%. WPI based price gap rose to its highest level of 34% in late 2013, when CPI based price gap was 45% (Exhibit 42 above).
As WPI-based inflation started easing from 2014 onwards and moved into negative territory in late 2014, the WPI price gap has fallen substantially to 20% by April 2016. In fact, as per our projection of WPI for the next two years, we believe the gap will narrow further toward 15% by the beginning of 2018.
Accordingly, as we have prescribed above, CPI also needs to undershoot the medium term target of 4% for at least fewquarters in order to bring the CPI index closer to the optimal price index.
Comparison of optimal WPI and actual WPI (FY99=100)
Optimal WPI index is calculated with 4% inflation over the period
WPI “Price gap” estimate for Indiasince late 1990s
(Actual index - optimal price level)/Optimal level Source: Office of Economic advisor (OEA), MoSL
Comparison of inflation in the previous slowdown: Another way to analyze if retail inflation has eased towards the desired level is to compare the current trajectory with those in the previous slowdowns. Taking forward our analysis from the first section of Part II, we have looked at the trajectories in three periods of five years each – early 2000s (FY99=100), boom period (FY03=100) and recent period (FY12=100). Exhibit 43 on the next page compares the inflation trajectories during these three episodes.
The average retail inflation (based on CPI-IW) during FY00-04 was 3.9%, while it averaged 5% during FY04-08. In comparison, retail inflation (based on CPI-IW) averaged 8% over FY13-16. Compared to the previous slowdown in the early 2000s, retail inflation is 20% higher (~17% higher than in the boom period).
For comparison purpose, we have also added the CPI-India series with our projections for FY17. Notably CPI-India tracks CPI-IW very closely with the new series only 2.5% lower than the old series of CPI-IW.
50
100
150
200
250
300
Oct
-98
May
-00
Dec-
01
Jul-0
3
Feb-
05
Sep-
06
Apr-
08
Nov
-09
Jun-
11
Jan-
13
Aug-
14
Mar
-16
Optimal WPI Actual WPI
(12)
0
12
24
36
48
Oct
-98
May
-00
Dec-
01
Jul-0
3
Feb-
05
Sep-
06
Apr-
08
Nov
-09
Jun-
11
Jan-
13
Aug-
14
Mar
-16
WPI-based price gap 18M MA(%)
Compared to the previous slowdown in the early
2000s, retail inflation is 20% higher
June 2016 33
Thematic | Economy
Exhibit 43: CPI trajectory during various episodes
FY17 numbers for CPI-India are our projections Source: RBI, CSO, MoSL
Has India’s ‘inflation differential’ fallen?: A key reason to track an economy’s inflation trajectory is the impact of inflation on the economy’s competitiveness. All other things equal, higher inflation reduces the competitiveness of an economy (one could argue the role of tradable and non-tradable in this discussion; however, it is beyond the scope of this study). Similarly, if the fall in inflation in ‘Economy A’ is lower than the fall in inflation in its trading partners, even lower inflation will not increase the competitiveness of Economy A, as the inflation differential (of Economy A vis-à-vis its trading partners) remains high(er). Therefore, one must look at the inflation differential of an economy vis-à-vis its trading partners.
Using the effective exchange rate data from Bank for International Settlements (BIS), we calculate inflation differential10 by dividing nominal effective exchange rate (NEER) and real effective exchange rate (REER). Exhibit 44 on the next page compares India’s inflation differential with other Asian peers. Notwithstanding easing domestic inflation, not only is India’s inflation differential with its major trading partners the highest among Asian economies, but has risen in the past one year. In other words, though India’s inflation has eased domestically, inflation in India’s trading partners has fallen more. Due to high and rising inflation differential, India, despite falling inflation, has not gained on competitiveness.
Exhibit 45 compares India’s inflation differential with the movement in nominal effective exchange rate (NEER). Though India’s NEER has weakened ~24% since 2010, higher inflation differential has offset the impact of weaker nominal currency. The INR has, thus, strengthened in real terms and this is hurting India’s competitiveness.
90
105
120
135
150
1 6 11 16 21 26 31 36 41 46 51 56 61 66 71Number of months
Early 2000s Boom period Recent CPI-India
20%
All other things equal, higher inflation reduces the
competitiveness of an economy
Notwithstanding easing domestic inflation, not only
is India’s inflation differential with its major
trading partners the highest among Asian economies, but has risen in the past
one year
Though India’s NEER has weakened ~24% since 2010,
higher inflation differential has offset the impact of
weaker nominal currency
10 We must admit it is difficult to measure inflation differential accurately because of the tradable and non-tradable argument. Our measure of inflation differential is also not perfect. Apart from tradable and non-tradable baskets, different weights for different items in different countries also represent another limitation.
June 2016 34
Thematic | Economy
Exhibit 44: Comparison of India’s inflation differential with other Asian peers (2010=100)
Inflation differential = Broad REER/ Broad NEER index
Exhibit 45: Rising inflation differential has offset the impact of weak nominal exchange rate
Source: BIS, RBI, MoSL
Box 3. A look at inflation targeting regimes in other major economies
The exhibit below compares the recent inflation in some inflation targeting and some non-inflation targeting economies. Ofthe nine economies considered (besides India), five are inflation targeting and the rest do not target inflation explicitly.
Five of these nine economies have inflation within the target range. Interestingly, two of the four non-compliant economies – Brazil and Russia are reeling under stagflation, while South Africa is flirting with recessionary pressures. Barring thesethree economies, India’s inflation is the highest at above 5%.
Comparison of recent inflation in inflation targeting developing economies Country Target measure Inflation targeting Desired inflation 2016* inflation Brazil Headline CPI Yes 4.5% +- 2 pp 9.9 China Headline CPI No 3.5% 2.2 India Headline CPI … 4.0% +- 2 pp 5.3 Indonesia Headline CPI Yes 4.5% +-1 pp 4.2 Malaysia Headline CPI No 2%-3% 3.1 Philippines Headline CPI Yes 4.0% +-1 pp 1.1 Russia Headline CPI No 5%-6% 8.1 Singapore Headline CPI No 3%-4% (0.7) South Africa Headline CPI Yes 3% - 6% 6.4 Thailand Core CPI Yes 0.5% -3.0% (0.4)
* Jan-April 2016Source: Report of the expert Committee to Revise and strengthen the monetary policy framework, various official sources, RBI, MoSL
80
100
120
140
Mar
-10
Mar
-11
Mar
-12
Mar
-13
Mar
-14
Mar
-15
Mar
-16
Inflation differential with trading partners
China India Indonesia Philippines
(2010=100)
High inflation differential = Low competitiveness
70
90
110
130
150
Mar
-10
Mar
-11
Mar
-12
Mar
-13
Mar
-14
Mar
-15
Mar
-16
NEER Inflation differential
(2010=100)
34%
24%
June 2016 35
Thematic | Economy
II.2.3. What does current account balance (CAB) tell us?Linked with the first two variables is the current account balance (CAB). Though CABhas improved substantially in the past few years, the question is if the adjustment iscomplete. We believe CAB has not yet improved to a level that is in line with theeconomic activity. The adjustment is incomplete.
Exhibit 46 shows the movement in India’s CAB during the three episodes – early 2000s (FY99-04), boom period (FY03-08) and recent period (FY12-FY17). Two key highlights from the exhibit are: 1. The recent period began with highly unfavorable circumstances.2. The current period is reminiscent of the boom period rather than the early
2000s period.
Towards the end of the slowdown in early 2000s, India’s current account had a surplus of 2.1% of GDP in FY04 against a deficit of 1% of GDP in FY99 (the beginning of the slowdown). As the economy entered into the boom period, current account balance worsened from +2.1% of GDP in FY04 to -1.3% of GDP in FY08. In the recent period, though the CAD (current account deficit) has narrowed substantially from an all-time peak of 4.8% of GDP in FY13 to an estimated 0.8% of GDP in FY16. The current CAD level is closer to what it was at the beginning of the early 2000s period or late boom period (Exhibit 47). This makes us uncomfortable.
Exhibit 46: Trends in current account balance (CAB)
Source: RBI, CSO, MoSL
Exhibit 47: India’s CAB in the past two decades
Source: RBI, CSO, CMIE, MoSL
As discussed earlier, the recent economic recovery is driven by consumption demand rather than investment demand. To cement our analysis further, we have re-classified India’s merchandise trade into three baskets – oil, consumption and investments, and accordingly, calculate trade balance on each of these baskets. We show the break-up of India’s merchandise trade balance using these classifications during two periods – early 2000s (Exhibit 48 on the next page) and the recent period (Exhibit 49) to help understand the contribution of each item to total trade deficit. Key highlights are:
1. The balance on consumption basket has fallen from a decent surplus of 1.5% ofGDP in FY14 to only 0.5% in FY16. Notably, the average surplus on consumptionbasket in the past two decades was 1% of GDP.
(9)
(6)
(3)
0
3
6
0 2 4 6 8 10 12 14 16 18 20 22
Number of quarters
Early 2000s Boom period Recent
(% of GDP)
(6)
(4)
(2)
0
2
4
FY97 FY99 FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15 FY17F
Current account balance(% of GDP)
Ealy 2000s
Boom period Recent period
The current CAD level is closer to what it was at the
beginning of the early 2000s period or late boom
period. This makes us uncomfortable.
The balance on consumption basket has
fallen from a decent surplus of 1.5% of GDP in FY14 to
only 0.5% in FY16
June 2016 36
Thematic | Economy
2. The deficit on investment basket, however, has been broadly unchanged in thepast three years at closer to 3% of GDP. In the early 2000s slowdown, the deficiton investment basket was closer to nil and increased towards 3% of GDP byFY07. The long-term average deficit has been 2.2% of GDP.
3. Finally, the non-oil trade deficit (excluding rest items) was 3.2% of GDP in FY16,close to what it was in FY06-FY07 and more than double of 1.5% of GDP in FY15.The average deficit on non-oil basket has been less than 2% of GDP.
Exhibit 48: Components11 of goods’ trade in early 2000s Exhibit 49: Components11 of goods’ trade in recent period
* Including non-consumption, non-investment (rest) items also Source: RBI, CSO, CMIE, MoSL
Alternatively, we further classify merchandise trade balance based on oil, valuables (gold, silver, pearls, precious stones, etc) and non-oil non-valuables. Traditionally, India’s trade deficit was primarily constituted by oil only. As the economy opened up, India’s attraction for valuables started impacting its external account, as valuables account moved from an average surplus of 0.4% of GDP till mid-1990s to an average deficit of 0.5% of GDP in mid-2000s (exhibit 50). Finally, from mid-2000s onwards, the economy moved into deficit mode on non-oil non-valuables as well. India’s trade deficit on non-oil non-valuables was 2.3% in FY16, only slightly lower than the average deficit of 2.7% of GDP in the past decade.
Exhibit 50: Components of CAB since 1990s (% of GDP)
Valuables includes gold, silver, pearls, precious stones etc Source: RBI, CMIE, MoSL
1.1 1.8 1.4 1.7
(0.9)
0.2
(0.4) (0.3)
(3.0)
(3.2) (2.6) (3.1)
FY 00 FY 01 FY 02 FY 03
Consumption Investment Oil* CAB
(% of GDP)
0.1 1.5 0.7 0.5
(4.3) (2.9) (3.2) (3.3)
(6.1) (5.8) (4.4) (2.9)
FY 13 FY 14 FY 15 FY 16
Consumption Investment Oil* CAB
(% of GDP)
(15)
(10)
(5)
0
5
FY 94 FY 96 FY 98 FY 00 FY 02 FY 04 FY 06 FY 08 FY 10 FY 12 FY 14 FY 16
Oil Valuables Non-oil non valuable Trade balance
The non-oil trade deficit was 3.2% of GDP in FY16,
close to what it was in FY06-FY07 and more than double
of 1.5% of GDP in FY15
From mid-2000s onwards, the economy moved into
deficit mode on non-oil non-valuables as well.
India’s trade deficit on non-oil non-valuables was 2.3% in FY16, slightly lower than the average deficit of 2.7% of GDP in the past decade
11 Consumption includes agriculture items, leather products, readymade garments, gems & jewelry and paper/wood items Investments include all other items excluding consumption basket, petroleum and ‘other commodities’.
June 2016 37
Thematic | Economy
Overall though the current account deficit (CAD) has improved substantially from an all-time peak of 4.8% of GDP in FY13 to less than 1% of GDP in FY16, it is closer to the CAD at the beginning of the previous slowdown (FY00) or towards the end of the previous boom period (FY08). Notwithstanding the crash in non-fuel commodity prices, almost two-third of the gains on oil and valuables trade in the past three years has been offset by higher deficit on non-oil non-valuables. Further, while the deficit on investment basket was largely unchanged in the past three years, about one-third of the gains on account of lower oil prices were offset by lower surplus on consumption deficit in the past two years, which reflects high consumption demand, as discussed above.
About one-third of the gains on account of lower oil
prices were offset by lower surplus on consumption
deficit in the past two years, which reflects high
consumption demand
June 2016 38
Thematic | Economy
II.3. Remember the “Theory of Everything”
In this section, we look at the factors that allowed the Indian economy to move from a low-growth period in the early 2000s to high-growth in the mid-2000s. We find that investments were the key driver of GDP growth during the mid-2000s,
which made the high-growth period sustainable. To repeat that performance, we believe India must re-build its collapsing household
savings, which is the key source of financing for domestic investments. Moreover, the revival in investments has to be led by the private corporate sector, as
higher public or household investments hurt capital efficiency.
Thus far, we have dissected India’s current macro-economic environment. We make two key conclusions. One, the current slowdown is not as severe as the topline corporate statistics suggest. Consumption growth has been resilient and this has helped limit the deceleration in economic activity. Two, the tag of ‘fastest growing economy in the world’ has led to a few noteworthy features in the economy – lower savings, higher-than-desired retail inflation and sub-optimal adjustment in current account deficit (CAD). After understanding the current situation, the obvious question is, what to expect next? Before we get on to our expectations and projections, it would be a good idea to understand the transition of the Indian economy from the low-growth early 2000s to the boom period of FY04-08.
The most notable feature of the boom period was sustainable high growth. By sustainable, we mean non-inflationary acceleration in real GDP growth. Although real GDP grew at an average of 8.8% between FY04 and FY08, more than double of that between FY01 and FY03, retail inflation averaged 4% between FY04 and FY06, similar to the inflation rate during the slowdown (FY00-03). The key reason of sustainable high growth during mid-2000s was that the key driver of economic activity was investment rather than consumption.
Exhibit 51 shows the major contributors to real GDP growth in the three episodes we have studied in our analysis. Although the contribution of consumption (private + government) to real GDP growth increased from 3.4 percentage points (pp) inearly 2000s to 5.1 pp during the boom period, the contribution of investmentsalmost quadrupled from 1.4 pp to 5.7 pp. In other words, the average growth ininvestments during the boom period was ~19% per annum, as against a meagergrowth of 6% in the early 2000s (Exhibit 52). As the economic boom was primarilydriven by corporate investments and better capital efficiency (measured byincremental capital-output ratio (ICOR)), the higher growth period was non-inflationary or sustainable.
The key reason of sustainable high growth
during mid-2000s was that the key driver of economic
activity was investment rather than consumption
The average growth in investments during the
boom period was ~19% per annum, as against a meager
growth of less than 6% in the early 2000s
R II.3. Remember the “Theory of Everything” growing
June 2016 39
Thematic | Economy
Exhibit 51: Contributors to real GDP growth (pp) Exhibit 52: Average growth in GDP components (% CAGR)
Source: RBI, CSO, MoSL
Not surprisingly then, the ratio of investment to GDP (also known as investment rate) increased dramatically from 24.8% of GDP in FY03 to 38.1% of GDP in FY08 (Exhibit 53). The ratio of final consumption, on the other hand, fell from 75.8% of GDP to 67.2% in FY08 (Exhibit 54).
Exhibit 53: Investment rate increased rapidly during the boom period…
Exhibit 54: …while consumption rate fell to an all-time low level of that period
Source: RBI, CSO, MoSL
Things, however, have reversed in the past few years. The investment rate has fallen from its all-time peak of 39.6% of GDP in FY12 to 32.5% in FY16 - the lowest since FY04, while the consumption rate has increased to above 70%, marking the highest level in 12 years. We firmly believe that if the Indian economy has to re-witness the boom period of 2004-08, investment is the only route. In other words, the share of investment has to pick up again at the cost of consumption.
This brings us to the question of “What is required for investment rate to rise in the coming years?” The answer lies in an identity, which we call “The Theory of Everything”.
Investment = Savings + Foreign borrowings
The identity, quoted above, tells us that domestic investments in an economy can either be financed by domestic savings or through foreign borrowings. The latter is only those foreign borrowings (or foreign capital inflows), which finance current account deficit (CAD). If foreign capital does not finance CAD, it will add up to
3.4 5.1 4.0 1.5
5.7
1.2
(5)
0
5
10
15
2000-03 2004-08 2013-16
Consumption Investments Net exports
Discrepancy GDP growth
6.1
15.4
6.6 4.5
18.7 17.8 20.1
7.2
3.2 2.8
(1.0)
6.0
Investments Exports Imports Consumtpion
2000-03 2004-08 2013-16
0
12
24
36
48
FY 5
1
FY 5
6
FY 6
1
FY 6
6
FY 7
1
FY 7
6
FY 8
1
FY 8
6
FY 9
1
FY 9
6
FY01
FY06
FY11
FY16
E
Total investmentUp from 24.8% in FY03
to 38.1% in FY08
(% of GDP)
50
65
80
95
110
FY 5
1
FY 5
6
FY 6
1
FY 6
6
FY 7
1
FY 7
6
FY 8
1
FY 8
6
FY 9
1
FY 9
6
FY01
FY06
FY11
FY16
E
Final consumption
All-time lowest level of 67.2% in FY08
(% of GDP)
The investment rate has fallen from its all-time peak of 39.6% of GDP in FY12 to 32.5% in FY16 - the lowest
since FY04, while the consumption rate has
increased to above 70%, marking the highest level in
12 years
June 2016 40
Thematic | Economy
foreign exchange reserves, which do not add anything to investments (or consumption) of an economy. Consequently, the identity could be re-written as:
Investment = Savings + Current account deficit
Therefore, to increase investments, either domestic savings have to go up, or CAD has to widen. Let’s look at what happened during the first decade of the 21st century.
India’s CAD moved from a deficit of 1% of GDP in FY2000 to a surplus of above 1% of GDP in FY03. Notably, however, domestic savings were largely intact at ~25% of GDP during the slowdown of early 2000s. As can be concluded from the above identity, the narrowing of CAD, along with stable domestic savings led to a contraction in investment rate from 26.5% of GDP in FY00 to 24.7% of GDP in FY03.
Nevertheless, things began to change dramatically since FY04. Although CAB continued to improve towards the post-independence highest level of +2.3% of GDP, total savings in the economy rose from 26% to 29% of GDP, helping to push the investment rate higher to 27% in FY04. Further, as the economy strengthened, current account moved from a surplus of 2.3% of GDP in FY04 to a deficit of 1.3% in FY08 and total savings increased from 29% of GDP in FY04 to ~37% of GDP in FY08. Domestic investments rose from 27% to 38% during the boom period (Exhibit 55).
Exhibit 55: Financing of domestic investments in India
E = estimates Source: RBI, CSO, MoSL
Exhibit 56 on the next page compares the identity at key turnaround points in the economy. As investments increased from ~27% of GDP in FY04 to ~38% of GDP in FY08, national savings contributed the lion’s share of ~70% (moved from~29% of GDP to ~37% of GDP). Foreign capital (or CAD) accounted for less than one-third of the total increase in domestic investments during the boom period. Nevertheless, between FY08 and FY13, incremental domestic investments were entirely driven by foreign borrowings, as the fall in domestic savings (of 3pp) was completely offset by widening CAD (3.5pp). This is what made the economic growth over FY09-13 highly unsustainable. As Exhibit 57 shows, with CAD returning to more normal levels, domestic investments have also fallen in the recent period. In FY16, we believe the
23.2 25.5 23.7 24.8 25.9 29.0 32.4 33.4 34.6 36.8 32.0 33.7 33.7 34.6 33.8 33.0 33.0 31.8
0.9 1.0 0.5
(0.7) (1.2) (2.3)
0.4 1.2 1.0
1.3 2.3
2.8 2.7 4.3 4.8 1.7 1.3 0.8
-15
0
15
30
45
FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E
National savings CAD Domestic investments(% of GDP)
Between FY08 and FY13, incremental domestic
investments were entirely driven by foreign
borrowings, as the fall in domestic savings was completely offset by
widening CAD
June 2016 41
Thematic | Economy
investment rate has fallen further (to sub-33%), as the savings rate is estimated to have fallen below 32% and CAD also narrowed further to sub-1% of GDP.
Exhibit 56: Contribution of savings and foreign borrowings to domestic investments at key turnaround points
Exhibit 57: Contribution of savings and foreign borrowings to domestic investments in the recent period
Source: RBI, CSO, MoSL
Extending the above identity, another key feature to note is the contribution of various institutions to economic growth. An economy has three different players – households, private corporate sector and consolidated public sector (including central and state governments and public enterprises). Each of these institutions saves and invests in the economy. If an institution saves more than its investment, it becomes a ‘net lender’ to the economy. On the contrary, higher investments than savings imply that the institution is a ‘net borrower’. In an ideal and normal period, households are ‘net lenders’ (save more), private corporate sector is the key ‘net borrower’ (key investor) and the public sector is the minor ‘net borrower’. The sum of the balances (savings - investments) of these three institutions defines the current account balance (CAB) or the balance with the rest of the world.
Exhibit 58 on the next page shows the break-up of savings and investments by each of the three institutions in the Indian economy in the past two decades. There are two key highlights pertaining to three key periods: 1. Key trends on sectoral savings: The first leg of higher savings in early 2000s
(FY01-04) was driven by households and the public sector. However, the secondleg of higher savings during the mid-2000s (FY04-08) was contributed by theprivate corporate sector and the public sector. During the most recent period(FY13-16E), the fall in national savings is entirely driven by households, which ispartially offset by higher corporate savings.
2. Key trends on sectoral investments: During the early 2000s, the share ofhouseholds in total investments increased, while the share of private corporatesector fell towards 20% of total investments in FY03. As the economy improved,the corporate sector led the investment recovery. The share of the corporatesector increased to 45% of total investments, while the share of households fellfrom 50% of total investments to 30%. In the recent period (FY12-16E), theshare of households has fallen once again from ~45% of total investments tosub-35%, made up by the private corporate (60%) and the public sectors (40%).
29.0 36.8 33.8 31.8
(2.3)
1.3 4.8 0.8
(20)
0
20
40
60
FY04 FY08 FY13 FY16E
National savings CAD Domestic investments
(% of GDP)
34.6 33.8 33.0 33.0 31.8
4.3 4.8 1.7 1.3 0.8
0
12
24
36
48
FY12 FY13 FY14 FY15 FY16E
National savings CAD Domestic investments
(% of GDP)
During the most recent period (FY13-16E), the fall
in national savings is entirely driven by
households, which is partially offset by higher
corporate savings
As the economy improved, the corporate sector led the
investment recovery
June 2016 42
Thematic | Economy
Exhibit 58: Details of sectoral savings and investments in India
% of GDP Savings Investment
E&O (3) CAD# Total (1) Households Corporate Public
sector Total (2) Households* Corporate Public sector
FY98 24.2 18.1 4.2 1.9 24.5 8.7 8.4 7.4 1.1 1.3 FY99 23.2 19.5 3.8 -0.2 23.5 9.5 6.7 7.3 0.7 0.9 FY00 25.5 21.7 4.3 -0.5 26.8 12.2 7.0 7.6 -0.2 1.0 FY01 23.7 21.3 3.7 -1.3 24.1 12.1 4.9 7.1 0.1 0.5 FY02 24.8 23.1 3.3 -1.6 25.6 13.2 5.1 7.2 -1.3 -0.7 FY03 25.9 22.2 3.9 -0.3 25.0 12.8 5.7 6.4 -0.2 -1.2 FY04 29.0 23.1 4.6 1.3 26.1 13.0 6.5 6.6 0.7 -2.3 FY05 32.4 23.6 6.6 2.3 32.5 14.7 10.3 7.4 0.4 0.4 FY06 33.4 23.5 7.5 2.4 34.3 12.8 13.6 7.9 0.4 1.2 FY07 34.6 23.2 7.9 3.6 35.9 13.0 14.5 8.3 -0.2 1.0 FY08 36.8 22.4 9.4 5.0 38.0 11.9 17.3 8.9 0.1 1.3 FY09 32.0 23.6 7.4 1.0 35.5 14.8 11.3 9.4 -1.2 2.3 FY10 33.7 25.2 8.4 0.2 36.3 15.0 12.1 9.2 0.2 2.8 FY11 33.7 23.1 8.0 2.6 36.5 15.3 12.8 8.4 0.0 2.7 FY12 34.6 23.6 9.5 1.5 39.6 18.8 13.2 7.5 -0.6 4.3 FY13 33.8 22.4 10.0 1.4 38.3 17.5 13.6 7.2 0.4 4.8 FY14 33.0 20.9 10.8 1.3 34.7 14.4 13.1 7.1 0.0 1.7 FY15 33.0 19.1 12.7 1.2 34.2 12.7 14.1 7.4 0.1 1.3 FY16E 31.8 17.8 12.8 1.2 32.5 11.2 13.7 7.6 0.1 0.8 E = estimates * Includes valuables# Current account balance = Total investments + errors & omissions (E&O) - total savings Data on 2004-05 base is up to FY11; FY12-FY15 is on 2011-12 base; FY16 figures are our estimates Source: CSO, RBI, MoSL
From savings and investments, we derive sectoral balances (savings – investments) of each institution and look at the contribution of each institution to the economy’s current account balance (CAB). Exhibit 59 on the next page shows the sectoral balances at key turnaround points in time, while the long-term series is shown in Exhibit 60. As the CAB improved from -1% of GDP in FY00 to +2.3% of GDP in FY04, the key drivers were the public sector and households. The deterioration of CAB to -1.3% of GDP in FY08 was entirely because of the corporate sector. Another key finding is that the deterioration in CAD between FY08 and FY13 was primarily because of the household sector, rather than the consolidated public sector, as is widely believed12. In the recent period, however, the improvement in CAB was majorly driven by the corporate sector, which continued to increase its savings (see Exhibit 58 above) and failed to match its investments with higher savings. The public sector also continued to borrow on net basis at a higher rate, eating up a significant portion of the low resources provided by households.
The deterioration in CAD between FY08 and FY13
was primarily because of the household sector,
rather than the consolidated public sector,
as is widely believed
12 “…Juxtaposing savings with investment, it becomes clear that it was the large saving-investment gap of the consolidated public sector, complemented by a less pronounced gap in the private corporate sector, which could not be fully defrayed by the savings of households, that constituted the aggregate saving-investment gap…” says the Economic Survey 2014-15 which was released on 27 February 2015.
June 2016 43
Thematic | Economy
Exhibit 59: Sectoral balance at key turnaround points
Source: RBI, CSO, MoSL
Exhibit 60: Long-term series of sectoral balances
Source: RBI, CSO, MoSL
Why does sectoral analysis matter?
As stated earlier, in an ideal and normal world, households should be the ‘net lender’ to the economy, the private corporate sector should be the key ‘net borrower’, while the public sector should be a minor ‘net borrower’. This is because the private corporate sector is the most efficient investor in the economy, which invests primarily in ‘equipment & software’, while household investments are primarily into real estate. The former helps to increase productivity in the economy.
Exhibit 61 shows that the corporate sector invests almost three-fourth of its total investments in machinery & equipment, while households invest almost entirely in construction (or dwellings). Exhibit 62 shows that while over half the total real estate investment in the country is by households, more than 70% of the investment in ‘machinery & equipment’ is by the private corporate sector. Notably, the public sector also invests more than three-fifth in the construction activities, which si also a low-efficiency activity.
Exhibit 61: Investments by institutions in different assets
* Includes investment in cultivated biological resources and intellectual property
Exhibit 62: Investments in different assets by institutions
Source: RBI, CSO, MoSL
9.4
(2.6)
(8.1)
10.2
(2.0) (5.3)
10.6
(7.9)
(3.9)
5.0
(3.6)
(5.8)
6.5
(0.9) (6.3)
Households Corporate Public
FY00 FY04 FY08 FY13 FY16E
(% of GDP)
-20
-10
0
10
20
FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14 FY16E
Households Corporate PublicE&O CAB
(% of GDP)
62.0
26.0
92.8
38.0
74.0
7.2
Public sector Private corporate Households
Construction Machinery & equipment*(% of total)
25.8 22.4
17.8
71.4 56.4
6.2
Construction Machinery & equipment*
Households Private corporate Public sector(% of total)
The corporate sector invests almost three-fourth
of its total investments in machinery & equipment, while households invest
almost entirely in construction
June 2016 44
Thematic | Economy
Exhibits 63 and 64 summarize the impact of sectoral investments on the real economy. The exhibits clearly show that real GDP growth is highly positively correlated with corporate investments, while higher household investments (or physical investments) coincide with a weak economy.
Exhibit 63: Real GDP growth is positively correlated with corporate investments…
3yma = 3-year moving average
Exhibit 64: …and negatively correlated with household investments
Source: RBI, CSO, MoSL
The analysis of the transition of the Indian economy from the low-growth period in the early 2000s to the high-growth period in the mid-2000s gives us three lessons: 1. High growth is sustainable (non-inflationary) if driven by investment boom.2. Recovery or turnaround in domestic investments must be financed by national
savings rather than by foreign borrowings (or CAD).3. The more the share of the private corporate sector in total investments, the
better it is for the economy. On the contrary, higher share of real estateinvestments (or household investments) coincides with a weak economy.
0
3
5
8
10
0
15
30
45
60
FY92 FY95 FY98 FY01 FY04 FY07 FY10 FY13 FY16E
Corporate investment Real GDP (RHS)
(% of total GFCF)
(YoY, 3yma)
0
3
5
8
10
0
15
30
45
60
FY92 FY95 FY98 FY01 FY04 FY07 FY10 FY13 FY16E
Household investment Real GDP (RHS)
(% of total GFCF)
(YoY, 3yma)
June 2016 45
Thematic | Economy
II.4. Expectations for next two years Key expectations are: A surplus monsoon could push agricultural output growth towards 6%, which may
help GDP to grow 7.8% in FY17. Non-farm GDP growth, however, could fall from 8.3%to 8% this year.
Although we expect retail inflation to average 4.7% in FY17, it is likely to reverse thetrajectory and average 5% in FY18, primarily because of continuation of consumption-driven recovery.
Accordingly, while we don’t expect RBI to cut policy rates substantially from thecurrent levels, bond yields could drop towards 7% by March 2017 due to RBI’s openmarket operations worth INR1,600b.
Finally, the Indian Rupee (INR) is likely to weaken further and average 68 against theUS Dollar (USD) in FY17. However, we expect the INR to remain strong in REER terms.
As per our understanding of the Indian economy, the basis of which we have detailed in the previous sections of Part II, this final section is devoted to the most likely future trajectory. We have divided this section into three segments. In the first segment, we look at the economic projections for the next two years – FY17 and FY18. The detailed economic projections are provided in Appendix IV. In the second segment, we give our views on the bond market and follow it up with our forecasts for INR in the final section of this part.
II.4.1 Where do we see Indian economy moving in the next twoyears?Real GDP growth of 8% achievable in the next two years: To begin with, we believethat real GVA (gross value added) growth could jump from 7.2% in FY16 to 7.7% inFY17. The biggest delta in economic growth would come from the agricultureeconomy, excluding which we expect real GVA to grow 8% in FY17, lower than 8.3%in FY16. Our expectation of better agriculture output is based on the IMD’s (IndianMeteorological Department13) monsoon projections. The higher growth hinges onhope to that extent. Whether the actual monsoon will be as good as the IMDexpects is for us to see; however, historical data suggests (Exhibits 65-66) thatagricultural output has been better than the long-term average in the years ofsurplus monsoon (irrespective of the extent of the surplus). Since the 1980s,agriculture output growth has averaged 8.4% in the years associated with a surplusSouth-West (SW) monsoon. We assume real agriculture output growth of 6% inFY17, as against a meager growth of 1.2% in FY16 and a decline of 0.2% in FY15.
Our expectation of better agriculture output is based
on the IMD’s (Indian Meteorological
Department) monsoon projections. The higher
growth hinges on hope to that extent
Since the 1980s, agriculture output growth has averaged 8.4% in the years associated
with a surplus South-West (SW) monsoon
E II.4. Expectations for next two years economy
13 http://www.imd.gov.in/pages/press_release.php
June 2016 46
Thematic | Economy
Exhibit 65: Agriculture output is positively impacted by good South-West (SW) monsoon
Source: RBI, CSO
Exhibit 66: Surplus SW monsoon has ALWAYS resulted in better agriculture output growth
Dotted years imply surplus monsoon
Deriving GDP (gross domestic product) numbers from GVA requires us to add in our assumption for net indirect taxes (NIT). We believe real GDP could grow 7.8% in FY17 and 8.1% in FY18, assuming real NIT grows 8.6% in FY17 and 9.6% in FY18. Like in the past few years, we believe consumption demand would remain the key driver of real GDP growth. Accordingly, we expect the share of (nominal) consumption to move up to 71% of (nominal) GDP in FY17 and further to ~72% in FY18 (Please see Exhibit 34 on page 23). Total investments, on the other hand, will remain a secondary contributor to higher real GDP growth (Exhibit 67).
Exhibit 67: Key contributors to real GDP growth
Source: RBI, CSO
Exhibit 68: Consumption to outpace investment growth
Source: RBI, CSO
The widening gap between consumption and investment growth, as shown in Exhibit 68 above, is likely to make it challenging to maintain high sustainable (or non-inflationary) growth. If consumption continues to drive real GDP growth, it would be primarily financed by savings, as growth in real disposable income is unlikely to accelerate substantially in the next couple of years. Household savings will continue to inch down from ~18% of GDP in FY16E to ~16% by FY18 (Exhibit 69). Within household savings, net financial savings are unlikely to rise meaningfully and are likely to remain broadly unchanged at 7.8% in FY18. If so, gross savings of the economy will continue to shrink. As discussed in Section III, lower savings will make pick-up in investments unlikely, as the widening CAD (as per our projections) will fail
(10)
(5)
0
5
10
(30)
(20)
(10)
0
10
FY2002 FY2005 FY2008 FY2011 FY2014 FY2017F
SW monsoon Agriculture output (RHS)
(% deviation from LPA)
(% YoY) (10)
(5)
0
5
10
15
20
FY1981 FY1987 FY1993 FY1999 FY2005 FY2011 FY2017F
Agriculture output(% YoY)
Long-term average growth of 3.4%
3.0 3.8 4.8 4.4 5.3 5.9 1.7
-0.4
2.2 1.4
2.3 2.5
(3)
0
3
6
9
FY13 FY14 FY15 FY16E FY17F FY18F
Consumption Investments Net exports Discrepancies
(pp)
90
105
120
135
150
165
Q4 FY12 Q4 FY13 Q4 FY14 Q4 FY15 Q4 FY16 Q4 FY17 Q4 FY18
Real consumption Real investments ex valuables
(FY12 = 100)
Forecast
We believe consumption demand would remain the
key driver of real GDP growth. Accordingly, we
expect the share of (nominal) consumption to
move up to 71.4% of (nominal) GDP in FY17 and
further to ~73% in FY18
Net financial savings are unlikely to rise meaningfully
and are likely to remain broadly unchanged at 7.8%
in FY18
June 2016 47
Thematic | Economy
to offset the fall in national savings (Exhibit 70). Accordingly, gross capital formation (or total investment) is likely to fall from 32.5% of GDP in FY16 to 30.7% in FY18.
Exhibit 69: National savings likely to fall further…
E = MoSL's estimate F = MoSL’s forcasts
Exhibit 70: …which implies a fall in investment rate
Source: RBI, CSO
However, inflation unlikely to fall to 4% by January 2018: With higher consumption and lagging investment, economic growth will soon become unsustainable. This combination will prevent retail inflation from falling towards 4%, as is targeted by the Reserve Bank of India (RBI) by January 2018. We believe retail inflation will ease further from 4.9% in FY16 to 4.7% this year (meeting its 5% target by January 2017); however, with our growth projections and drivers, we expect inflation to move higher and average 5% in FY18, with a reading of above 5% in January 2018. Accordingly, we expect the policy repo rate to fall to 6.25% by the end of 2016 and stay unchanged for the entire 2017. With an average retail inflation of 5%, it will imply a real policy rate of 1.25% in FY18.
23.6 22.4 20.9 19.1 17.8 16.9 16.1
9.5 10.0 10.8 12.7 12.8 11.8 11.3
FY12 FY13 FY14 FY15 FY16E FY17F FY18F
Households Private corporate Public sector(% of GDP)
34.6 33.8 33.0 33.0 31.8 29.9 28.6
4.3 4.8 1.7 1.3 0.7 1.4 2.0
0
12
24
36
48
FY12 FY13 FY14 FY15 FY16E FY17F FY18F
National Savings CAD Investments(% of GDP)
With our growth projections and drivers, we
expect inflation to move higher and average 5% in
FY18, with a reading of above 5% in January 2018
June 2016 48
Thematic | Economy
II.4.2 Bond market: Expect 10-year yield to fall towards 7% byMarch 2017Based on our real GDP growth and core WPI forecasts (Please see Appendix IV), webelieve high-powered money supply (M0) will have to increase 12.7% in FY17. Itmeans that the RBI will have to inject INR2,650b (USD39b) in the form of foreignexchange reserves (FXR) and open market operations (OMOs). Our base casebalance of payments (BoP) projection is a surplus of USD21.4b in FY17 (see Exhibit71 below), which implies that OMOs of USD17.6b (or INR1,200b) will be needed tomeet M0 requirements. Including additional OMOs of INR500b on account of RBI’sintent to provide durable liquidity in the system, the RBI may have to conduct totalOMOs worth INR1,700b (USD25b) in FY17, implying an average monthly OMO ofINR142b (or USD2.1b). Considering the demand for central government (CG) papersby various participants (banks’ demand will be impacted based on FCNRredemptions), there will be an excess demand of INR770b for CG securities, which,we believe, could pull down yields towards 7% by March 2017.
Base case: Excess demand of INR720b to pull yields towards 7%... Exhibit 71 shows the entire working of the excess CG-sec demand the markets could witness in FY17. We believe real GDP could grow 7.8% in FY17 and estimate core WPI inflation at 0.6% for FY17, which implies 12.7% growth in the reserve money (or high-powered money, M0). In absolute terms, this implies an injection of INR2,650b (USD39b) in M0 by the RBI. Broadly, M0 is injected via two ways – using foreign exchange reserves (FXR) and RBI’s open market operations (OMOs). If FXR are more than required, RBI conducts OMO sale, implying selling of government securities to such excess liquidity. On the contrary, if FXR are less than needed, RBI buys government securities and injects money via OMO purchases. As per our base case, which includes current account deficit (CAD) of 1.4% of GDP in FY17 and an outflow of USD12b on account of FCNRB redemption, we expect a surplus of $21.4b on the balance of payments. It implies that the RBI will have to buy government securities worth USD17.6b (or INR1,195b) in FY17 to meet M0 demand.
Exhibit 71: Calculation of potential OMOs in FY17
Unit Base case No FCNR redemption
Higher FCNR redemption
Reserve money requirement* (1) % YoY 12.7 INR b 2,650
FCNR(B) redemption USD b -12.0 0.0 -20.0
BOP surplus/Forex reserves (2) USD b 21.4 33.4 13.4 INR b 1,455 2,271 911
OMOs requirement (3) = (1)-(2) INR b 1,195 379 1,739 Durable liquidity (4) INR b 500 Total OMOs (5) = (3)+(4) INR b 1,695 879 2,239 Central G-sec supply INR b 4,252 CG-sec gap# (6) INR b 928 357 1,717 Excess CG-sec demand (7) = (5)-(6) INR b 767 522 522
Average USDINR rate of 68.0 assumed for FY17 * M0 growth = constant + α(real GDP growth) + β(non-food manufacturing WPI inflation) + ε,# Please see Exhibit 72 on the next pageSource: RBI, Union Budget documents, MoSL
Our base case balance of payments (BoP) projection is a surplus of USD21.4b in
FY17 (see Exhibit 71 below), which implies that OMOs of
USD17.6b (or INR1,200b) will be needed to meet M0
requirements
We believe real GDP could grow 7.8% in FY17 and
estimate core WPI inflation at 0.6% for FY17, which
implies 12.7% growth in the reserve money
The RBI will have to buy government securities
worth USD17.6b (or INR1,195b) in FY17 to meet
M0 demand
June 2016 49
Thematic | Economy
Additionally, to meet its intent of providing durable liquidity to the system, we assume additional OMOs worth INR500b, implying total OMOs worth INR1,695b in FY17. If so, we believe that there could be an excess demand for central government securities, which will pull down yields towards 7% by March 2017.
Impact of FCNRB redemption on banks, and thus, G-secs It is also important to note that FCNR(B) redemption would also have a direct impact on banks’ deposits – banks are the largest holders/buyers of government securities. The higher the redemption, the lower will be deposit growth, hurting banks’ ability to buy G-secs. Exhibit 72 below shows the potential buying of G-secs by commercial banks under various scenarios – based on FCNRB redemptions. Under our base case scenario of USD12b redemption, we assume that commercial banks (CBs) would offset 70% of the redemption (12*68*0.7 = 571) by subscribing less to G-secs. Accordingly, CBs will buy only INR1,147b (or 27%) of CG-secs supplied in FY17 as against an estimated 43% in FY16. If so, there will be a gap of INR928b, which will have to be bought by the RBI. Nevertheless, with OMOs worth INR1,695b, it implies an excess demand for G-secs, which, we believe, will pull down yields towards 7%.
Exhibit 72: Key buyers of central government papers Base case
No FCNR redemption
Higher FCNR redemption
Total supply (1) 4,252
Total demand (2) 3,324 3,895 2,535
Net commercial banks’ demand = (a) - (b) 1,147 1,718 358
Commercial banks’ demand (a) 1,718 1,718 1,718
Impact of FCNRB redemption# (b) 571 0 1,360
FIIs 451
Insurance companies 935
Others* excluding RBI 791
G-sec gap = (1) – (2) 928 357 1,717
Average USDINR rate of 68.0 assumed for FY17, Base case = $12b outflow; Higher FCNR(B) redemption = $20b,
# Assuming 70% of the reduction in deposits (USD12 bn) due to FCNR(B) redemption is financed by subscribing to lower G-secs in Base case, 100% (of USD20 bn) in Bear case,
* Include provident funds, mutual funds, corporate etc,Source: RBI, MoSL
Worst case may not really be worse for CG-secs What if FCNRB redemption is much higher? Further, what if banks offset the entire (100%) fall in deposits by CG-secs? Interestingly, it will not hurt bond markets significantly, as we expect lower BoP surplus to be entirely offset by higher RBI OMOs. A higher redemption (of say USD20b) on account of FCNRB this year, will bring down BoP surplus to USD13.4b. It will also reduce the ability of banks to buy CG-secs. However, lower FXR will require the RBI to conduct more OMOs, which, as per our estimate, could be closer to INR2,240b (or USD32.9b) (see last column in Exhibit 71 below). If so, even the higher G-sec gap of INR1,717b (Exhibit 72) will be easily covered by higher OMOs. Therefore, even higher FCNRB redemption – the so-called worst case scenario – may not really be worse for G-secs, which will continue to witness excess demand, and thus, lower yield. The fall in yield, however, could be closer to 7.1-7.2%, rather than 7%.
The higher the redemption, the lower will be deposit
growth, hurting banks’ ability to buy G-secs
Lower FXR will require the RBI to conduct more OMOs, which, as per our estimate,
could be closer to INR2,240b (or USD32.9b)
June 2016 50
Thematic | Economy
What if RBI grows reserve money (M0) by 10% instead of 12.7%? One could argue that the real risk for G-secs in FY17 (which we otherwise believe would be a good year for bond markets) is the possibility of RBI belief that lower growth is required in M0. Let’s assume that RBI feels comfortable to increase reserve money by 10% against our expectation of 12.7%. It means an increment of INR2,100b in reserve money in FY17. As per our base case then, RBI will have to conduct OMOs worth INR1,145b including OMOs for durable liquidity. Notably, although there will be an excess demand for G-secs, it will be much lower at INR217b, which may reduce the extent of fall in the benchmark sovereign yields.
Overall, we believe that FY17 will be a good year for bond markets, as the yields could fall toward 7% due to excess demand for central government papers.
Overall, we believe that FY17 will be a good year for bond markets, as the yields could fall toward 7% due to
excess demand for central government papers
June 2016 51
Thematic | Economy
II.4.3 Exchange rate: Expect average of INR68/USD in FY17
We use a 6-currency (or narrow) REER (real effective exchange rate) model to forecast INR/USD. Our INR/USD forecasts take into account movements in the currencies of India’s other major trading partners such as the Euro (EUR) and the Chinese Renminibi (CNY). We expect the INR to weaken 3.8% against the USD and average at INR68/USD in FY17. It is most likely to weaken another 2.7% and average at INR69.8/USD in FY18. (Please note that our forecasts are based on forecasts of inflation for trading partners and the movements in EUR/USD and USD/CNY, which we have taken from Bloomberg).
How much has INR weakened against USD in the past four years? INR is down from 47.9 against USD in FY12 to 65.5 in FY16. ~37% weaker? No, INR has weakened less than 7% since FY12. The difference between 37% and 7% is the inflation differential between the US and Indian economies. While the INR has weakened ~37% in nominal terms against the USD, a large part of the weakness has been offset by the rising inflation differential, leading to a minor ~7% weakness in real terms. The former (nominal exchange rate (NER)) is what we usually discuss in daily work-life; however, what actually matters for the economy and investors is the latter (real exchange rate (RER)). Exhibit 73 below shows the movement of the INR against the USD in nominal and real terms. Notably, INR/USD has been broadly unchanged in real terms since 2012, as the sharp weakness in nominal terms was largely offset by higher and rising inflation differential (Exhibit 74).
Exhibit 73: Differential between nominal and real USD/INR…
Source: RBI, Bloomberg
Exhibit 74: …explained by the inflation differential
Source: RBI, Bloomberg
What about EUR and CNY? The US is India’s third largest trading partner. Eurozone is the largest trading partner, followed by China. Therefore, it is important to understand the movements in the Euro (EUR) and the Renminbi (CNY) against the INR; these are actually derived from the movements of the EUR and CNY against the USD. Though the INR has strengthened ~10% against the EUR in nominal terms in the past four years, it has strengthened ~18% in real terms because of higher inflation differential (Exhibit 75). Moreover, like against the USD, while the INR has weakened ~37% against the CNY in nominal terms, it has weakened ~11% in real terms (Exhibit 76).
80
95
110
125
140
Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Nominal USD/INR Real USD/INR
(2013-14=100)
Strong INR
Weak INR
80
90
100
110
120
Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Price differential(2013-14=100)
Higher India's inflation vis-a-vis US'
While the INR has weakened ~37% in nominal
terms against the USD, a large part of the weakness
has been offset by the rising inflation differential,
leading to a minor ~7% weakness in real terms
Though the INR has strengthened ~10% against
the EUR in nominal terms in the past four years, it has
strengthened ~18% in real terms because of higher
inflation differential
June 2016 52
Thematic | Economy
Exhibit 75: Differential between nominal and real EUR/INR…
Source: RBI, Bloomberg
Exhibit 76: …and CNY/INR
Source: RBI, Bloomberg
Expect INR to weaken against USD but strengthen in REER terms Overall, apart from nominal exchange rate, domestic inflation also affects foreign trade. Just like the exchange rate, understood as domestic currency relative to foreign currency, the inflation differential between the domestic economy and the trading partner is also important.
It is not possible to forecast INR/USD without accounting for other important currencies such as the EUR and CNY. Therefore, we use a real effective exchange rate (REER) model14 to forecast INR/USD. We implicitly take into account the movements of other important currencies against the USD. Since the narrow REER consists of six currencies (including the USD), we use Bloomberg consensus estimates for the remaining five currencies (USDEUR, CNYUSD, JPYUSD, HKDUSD and GBPUSD). Further, we use Bloomberg estimates for inflation forecasts of trading partners and merge them with our forecasts for India’s inflation to project INR/USD. Given below (Exhibit 77) are our forecasts for bilateral exchange rates in nominal terms and India’s narrow REER for FY17 and FY18.
Exhibit 77: Currency forecasts for the next two years INR/USD INR/EUR INR/CNY REER*
FY14 60.5 81.2 9.9 99.9
FY15 61.1 77.5 9.9 106.0
FY16 65.5 72.3 10.3 109.4
FY17F 68.0 74.4 10.3 109.8
FY18F 69.8 74.0 10.6 111.2 F = Forecasts
* Narrow index (against six currencies). This index is our calculation, which is insignificantly differentfrom official REER index.Source: RBI, Bloomberg, MoSL
90
102
114
126
138
Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Nominal EUR/INR Real EUR/INR
(2013-14=100)
Strong INR
Weak INR
90
100
110
120
130
Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Nominal RMB/INR Real RMB/INR
(2013-14=100)
Strong INR
Weak INR
It is not possible to forecast INR/USD without
accounting for other important currencies such
as the EUR and CNY. Therefore, we use a real effective exchange rate
(REER) model to forecast INR/USD
14 We have used forecasts for other currencies from Bloomberg as of May 31, 2016. The key assumption of our model is that INR/USD will remain unchanged (at 100.0) in real terms in FY17 and FY18. We calculate the nominal INR/USD, using inflation forecasts for India (MoSL) and the US (from Bloomberg) to calculate bilateral real exchange rate.
June 2016 53
Thematic | Economy
How do changes in foreign currency impact INR/USD? Assuming the sanctity of Bloomberg forecasts, we do not expect the INR to weaken towards 70 against the USD in FY17. Nevertheless, higher-than-expected depreciation in any other trading partner currency vis-à-vis the USD will open the room for further weakness in INR against USD. Exhibit 78 below shows the impact of a 10% shock (unexpected) in the five major currencies. Other factors remaining unchanged, our analysis reveals that a 10% weakness in the EUR (average 0.99 against USD versus Bloomberg forecast of 1.10) in FY17 will allow the INR to weaken an additional 3.5% against the USD to keep the REER level same as in our base-case scenario. In other words, INR/USD could average 70.4 in FY17, as against 68.0, if the EUR falls to parity against the USD.
Similarly, if the CNY weakens 10% more than current expectations, the INR will have to weaken an additional 2.5% against the USD and average at 69.8 in FY17 to keep the REER index unchanged at 109.8.
Exhibit 78: Impact of non-USD currency shock (10%) on INR/USD
INR/ USD
INR/ EUR
INR/ CNY
INR/ JPY
INR/ HKD
INR/ GBP REER Adjusted
REER*
Adjusted INR/ USD#
Additional weakness in
INR/USD Base case 68.0 74.4 10.3 0.6 8.8 98.6 109.8 EUR -7.3% (67.0) 113.7 70.4 3.5% RMB -9.5%(9.3) 112.7 69.8 2.6% JPY -1.9%(0.5) 110.5 68.4 0.6% HKD -5.7%(8.0) 110.5 68.4 0.6% GBP -10.1%(88.7) 110.5 68.4 0.6%
Apart from nominal exchange rates, inflation will also tend to change REER. As a rule of thumb, the higher (lower) the inflation in trading partner (given India’s inflation), the lower (higher) the nominal depreciation needed to maintain REER. As a corollary, the lower (higher) the domestic inflation (given foreign inflation), the lower (higher) the nominal depreciation required to keep REER unchanged.
Higher-than-expected depreciation in any other
trading partner currency vis-à-vis the USD will open the
room for further weakness in INR against USD
The higher (lower) the inflation in trading partner
(given India’s inflation), the lower (higher) the nominal
depreciation needed to maintain REER
June 2016 54
Thematic | Economy
III. Will India be ready to grow at 10% by 2020?Current growth model unsustainable; 10% looks challenging
We take a step forward and investigate what the Indian economy could look like in 2020. In particular, we discuss if the economic growth could touch 10% by 2020. We argue that it will be challenging for India to graduate from the current growth rate
of 8% per year to 10% on sustainable basis by 2020, unless there is a shift fromconsumption-driven to investment-led growth.
This is primarily because we believe that the current level of retail inflation is high,which will rise further under the existing economic model. We believe inflation mustfall towards 2-3% for at least a few quarters.
The initial phase of lower consumption growth could be painful; however, as inflationundershoots the medium-term target of 4% and households start re-building theirsavings, it will create conducive environment for investments to drive economicrecovery.
Besides, higher savings and lower inflation, global economy, and capital efficiency willalso play a key role in helping India to touch 10% growth in the 2020s.
We believe that the current economic model, in which consumption continues to outpace investments and drive real GDP growth, could remain in place for at least the next two years (till FY18). This will help India touch 8% real GDP growth. However, consumption-driven growth will increasingly become more destabilizing, as inflation will face upward pressure. Hence, India must replace consumption with investments as the key growth driver (opposite of what is recommended for China). The issue does not seem alarming currently, especially due to the recent weakness in inflation; however, the longer the current model continues, the more unsustainable the economy will become. For sustainable growth, investments must be the key driver. How does India shift from consumption to investments?
There are two ways in which India could bring investments to the forefront: First, by increasing the investment rate (as % of GDP), and second, by increasing the efficiency of investments (or capital). The latter is measured as incremental capital output ratio (ICOR). Over 2004-08, the Indian economy witnessed a rise in investment rate along with higher capital efficiency (or lower ICOR). A look at the four Asian Tigers – Hong Kong, South Korea, Singapore and Taiwan – however, shows that the former (higher investment rate) is an easy, convenient and more widely established source of higher growth. The latter (higher capital efficiency) has its limits.
Consumption-driven growth will increasingly become
more destabilizing, as inflation will face upward
pressure. Hence, India must replace consumption with
investments as the key growth driver
There are two ways in which India could bring
investments to the forefront: First, by
increasing the investment rate (as % of GDP), and
second, by increasing the efficiency of investments
June 2016 55
Thematic | Economy
III.1. What does history tell us?Exhibit 79 below shows the key economic parameters for the four Asian Tigersbetween the 1960s and the 1980s, the high growth (8%+) period for theseeconomies. Two of the four economies – Hong Kong and Singapore – grew rapidlywithout impressive capital efficiency (low ICOR). On the other hand, Korea had anaverage growth of above 9% for three decades, with an investment rate of below30% and an average ICOR of only 2.2x. A comparison of Hong Kong and Taiwanshows that notwithstanding similar investment rate, the average growth rate in theformer was only 85% of that in latter, primarily because of better capital efficiencyin Taiwan. Exhibit 80 compares ICORs of the Asian Tigers, reflecting different capitalefficiency in these economies during the high-growth period.
Exhibit 79: Summary of key parameters during 1960s-80s
Investment rate
1960s-80s GDP growth ICOR* Average Min-Max
Hong Kong 8.2 7.4 27.3 21.1-37.4
Korea 9.2 2.2 20.0 8.1-30.0
Singapore 8.7 5.7 44.0 30.7-53.1
Taiwan 9.7 3.5 28.7 15.4-39.0
*Calculated as average investment rate in ‘t’ and ‘t-1’ period divided by GDP growth in ‘t’ period
Exhibit 80: Capital efficiency in Asian Tigers
3-year moving averageSource: World Bank, Official sources, MoSL
The history, thus, shows some economies witnessed higher growth due to better capital efficiency and some due to higher investment rate. Excessive reliance on either method – higher investment rate or better ICOR – may make an economy unsustainable. The former may limit private consumption or lead to wider CAD, while the latter may lead to underutilization of savings. A combination of the two methods is the best way to approach sustainably higher growth. During 2004-08, high growth in the Indian economy was driven by a rise in investment rate and improved capital efficiency (ICOR). India must attain a similar model this time.
0
5
10
15
20
25
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
Korea Hong KongSingapore Taiwan
(x)
A comparison of Hong Kong and Taiwan shows that
notwithstanding similar investment rate, the
average growth rate in the former was ~85% of that in latter, primarily because of better capital efficiency in
Taiwan
Excessive reliance on either method – higher
investment rate or better ICOR – may make an
economy unsustainable
June 2016 56
Thematic | Economy
III.2. What is needed to increase investment rate in India?For higher investments, national savings must rise. To start with, it is important tolook at the composition of total national savings. Barring the recent drop inhousehold savings, the sector contributed almost 70% to the national savings.Therefore, it is imperative to understand the behavior of households. As shown inExhibit 81 below, household savings in India are divided into three parts – grossfinancial savings (GFS), financial liabilities and physical savings (investments). Since alarge portion of financial liabilities is used to build physical savings, the former arededucted from GFS to arrive at net financial savings (NFS). NFS, along with physicalsavings, comprise total household savings.
Exhibit 81: Major contributors to India’s national savings Household
% of GDP Total (1)=(4)+(5)
Gross financial savings (2)
Financial liability (3)
Net financial savings
(4)=(3)-(2)
Physical savings (5)
Private corporate sector (6)
Public sector (7)
Total national savings
(8)=(1)+(6)+(7)
FY97 15.8 11.2 1.2 10.0 5.8 4.4 2.2 22.4 FY98 18.1 10.9 1.6 9.3 8.7 4.2 1.9 24.2 FY99 19.5 11.5 1.5 10.0 9.5 3.8 -0.2 23.2 FY00 21.7 11.7 1.8 10.2 11.5 4.3 -0.5 25.5 FY01 21.3 11.4 1.5 9.9 11.4 3.7 -1.3 23.7 FY02 23.1 12.1 2.2 10.5 12.6 3.3 -1.6 24.8 FY03 22.2 12.7 2.4 10.0 12.3 3.9 -0.3 25.9 FY04 23.1 13.7 2.5 11.0 12.1 4.6 1.3 29.0 FY05 23.6 13.8 3.7 10.1 13.4 6.6 2.3 32.4 FY06 23.5 15.8 5.0 11.9 11.7 7.5 2.4 33.4 FY07 23.2 17.8 6.6 11.3 11.9 7.9 3.6 34.6 FY08 22.4 15.5 3.8 11.6 10.8 9.4 5.0 36.8 FY09 23.6 12.9 2.9 10.1 13.5 7.4 1.0 32.0 FY10 25.2 15.3 3.1 12.0 13.2 8.4 0.2 33.7 FY11 23.1 13.9 3.6 9.9 13.2 8.0 2.6 33.7 FY12 23.6 10.7 3.3 7.4 15.9 9.5 1.5 34.6 FY13 22.4 10.7 3.3 7.4 14.7 10.0 1.4 33.8 FY14 20.9 10.4 2.7 7.7 13.0 10.8 1.3 33.0 FY15 19.1 10.0 2.3 7.7 11.0 12.7 1.2 33.0 FY16E 17.8 9.7 2.0 7.7 9.9 12.8 1.2 31.8 Data based on 2004-05 until FY11; 2011-12 base from FY12 onwards Source: RBI, CSO, MoSL
As per the recent available data, household savings declined to ~19% of GDP in FY15 (and below ~18% as per our estimate in FY16) from an all-time high of 25% in FY10. While NFS has been unchanged at ~7.5% of GDP in the past five years, it has fallen substantially from an average of ~11% in the first decade of the 21st century. The latter matters because NFS is the key source of financing for non-household domestic investments. Since NFS, however, is derived by deducting financial liabilities from GFS, we delve deeper into household GFS and its constituents.
A look at the composition of household GFS (Exhibit 82) shows that deposits (bank and non-bank) account for more than half of total financial savings, another one-third goes into long-term safe assets (insurance, pension and government paper), currency accounts for another 10%, while risky assets (shares and debentures) account for less than 5%. Overall, Indian households prefer short-term safe assets such as bank deposits and resist risky assets. Bank deposits play a vital role in household financial savings, and thus, India’s national savings.
Barring the recent drop in household savings, the
sector contributed almost 70% to the national savings
Overall, Indian households prefer short-term safe
assets such as bank deposits and resist risky
assets
June 2016 57
Thematic | Economy
Exhibit 82: Households’ gross financial savings (GFS) and components
% of GFS Currency Deposits Life insurance PF & pensions Shares & debentures
Claims on government Others*
FY97 11.7 43.1 9.1 17.8 6.6 8.5 3.2 FY98 11.2 43.7 9.4 17.9 6.0 9.1 2.8 FY99 11.1 43.5 9.6 18.5 5.5 9.7 2.1 FY00 10.8 42.5 10.0 19.1 5.7 10.1 1.8 FY01 10.2 42.1 10.5 19.3 5.6 10.8 1.5 FY02 10.2 41.8 11.0 18.8 5.3 11.7 1.3 FY03 10.0 41.8 11.6 18.2 4.9 12.4 1.0 FY04 10.1 41.6 11.8 17.5 4.6 13.8 0.6 FY05 9.9 41.3 12.3 16.8 4.2 15.1 0.4 FY06 9.7 41.9 12.6 15.9 4.4 15.1 0.3 FY07 9.6 44.3 13.0 14.9 4.8 13.0 0.4 FY08 9.7 45.2 14.2 14.1 5.5 10.7 0.6 FY09 10.1 46.9 15.0 13.6 4.8 9.0 0.6 FY10 10.0 46.2 16.6 13.6 4.8 8.4 0.5 FY11 10.4 46.9 16.9 13.5 4.2 7.6 0.5 FY12 10.5 47.9 17.3 13.2 3.9 6.6 0.5 FY13 10.5 48.8 17.3 13.0 4.0 5.9 0.5 FY14 10.2 50.3 17.2 12.8 3.8 5.3 0.5 FY15 10.2 50.2 17.4 13.1 3.9 4.8 * Units of UTI and trade debt (net) Source: RBI, MoSL
Since deposits are the key saving instrument for households, it is important to understand the role of deposits rates – nominal or real – in influencing household deposits. To calculate interest rate on deposits, we have extracted data on maturity-wise household term deposits from RBI’s annual publication, Basic Statistical Return (BSR). Using the maturity-wise deposit interest rates provided by RBI, we calculate weighted nominal deposit rate (WNDR) for households. We deflate WNDR by consumer price index for industrial workers (CPI-IW) to calculate weighted real deposit rate (WRDR). Exhibit 83-84 shows the correlation between (nominal and real) deposit rates and household deposit growth. Given below are our key findings:
1. Based on the data for the past 23 years (since mid-1990s), we find householdterm deposits are significantly and positively correlated with nominal depositrate (WNDR), not real deposit rate (WRDR).
2. From mid-1990s until 2008-09, nominal deposit rates were more importantbecause of two reasons: (1) Limited avenues to park savings initially (1990s), and(2) Average inflation of 4.5% between 1999 and 2007. As inflation trendedupwards and real rates turned negative in 2008, the relationship betweenWRDR and household deposit growth strengthened.
3. In the past couple of years, however, as inflation has subsided and WRDRmoved into positive territory, WNDR seems more important again.
4. Accordingly, we believe that inflation plays an important role in determiningwhether nominal or real deposit rate matters for households. As inflation movesabove a threshold level, WRDR becomes more important for depositors. Withrelatively subdued inflation, WNDR is more relevant.
5. The inflation threshold is dynamic and determined by the level of real interestrates (WRDR). If inflation is high enough to turn real rates negative, WRDR turnsmore relevant. If inflation is low enough to keep WRDR positive, nominal ratesare more important for depositors.
We find household term deposits are significantly and positively correlated
with nominal deposit rate (WNDR), not real deposit
rate (WRDR)
Inflation plays an important role in determining whether nominal or real deposit rate
matters for households
With relatively subdued inflation, WNDR is more
relevant
June 2016 58
Thematic | Economy
Exhibit 83: Nominal deposit rate and household deposits
# Calculated using maturity wise deposits and deposit rate 3-year moving average (3yma)
Exhibit 84: Real deposit rate and household deposits
*Weighted real deposit rate is nominal rate deflated by CPISource: RBI, CSO, MoSL
We also find, analytically, that nominal deposit rate and household deposits are highly correlated (Exhibit 85 below). However, correlation does not imply causation, and thus, we also look at partial correlation of household deposits with deposit rates. Interestingly, we do not find deposit rates impacting household deposit growth. In fact, more surprisingly, real deposit rates have a negative correlation with household deposits, which is significant at 10% level. However, real interest rates with a lag of one-year have shown a strong positive impact on deposit growth in the recent years. If so, then household deposits are set to fall further in FY17, as WRDR peaked in FY15 (exhibit 84 above).
Exhibit 85: Statistical inferences between deposit rates and household deposits Pair-wise correlation Partial correlation
WNDR WRDR WNDR WRDR FY1993-FY2016
Contemporaneous 0.6364* (0.2686) 0.2240 (0.3318) One-year lag 0.5768* (0.2509) 0.0813 0.0964
FY1993-FY2008 Contemporaneous 0.7965* (0.2730) 0.4585 0.1807 One-year lag 0.9269* (0.1610) 0.2564 0.1139
FY2008-FY2016 Contemporaneous 0.3350 0.2382 0.7084 (0.7357)** One-year lag 0.4337 0.4992 0.3829 0.9126*
*Significant at 1% level, ** significant at 10% level Source: RBI, MoSL
If real interest rates do impact household deposits, what is the level of real deposit rate needed to encourage higher deposits? Courtesy RBI, a range of 1.25%-1.5% for real interest rates has been broadly established in the markets. However, a look at the real deposit rates during early 2000s (previous slowdown episode) show that WRDR was as high as 6% in 2000 and averaged 2.9% in the decade ending FY08 (Exhibit 86). In comparison, WRDR was 2.6% and positive for the second consecutive year in FY16 (after five years of negative WRDR since FY09).
4
7
9
12
14
0
8
16
24
32
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
FY12
FY14
FY16
E
HH term deposits WNDR# (RHS)
(% YoY, 3yma)
(%, 3yma)
(6)
(3)
0
3
6
0
8
16
24
32
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
FY12
FY14
FY16
E
HH term deposits WRDR* (RHS)
(% YoY, 3yma)
(%, 3yma)
Real deposit rates have a negative correlation with
household deposits, which is significant at 10% level
A look at the real deposit rates during early 2000s
(previous slowdown episode) show that WRDR was as high as 6% in 2000 and averaged 2.9% in the
decade ending FY08
June 2016 59
Thematic | Economy
Exhibit 86: Historical trend in nominal and real deposit rates Exhibit 87: Repo rate and deposit rate share strong relation
3-year moving average = 3yma , Source: RBI, CSO, MoSL
Whether India needs a real deposit rate of 2% or 5% is probably not as important for domestic savers today, as it was a few years ago because inflation has eased. Since we don’t expect inflation to rise substantially in the foreseeable future to make real rates negative, we believe that nominal deposit rate will matter for household deposits in the future. If so, this strong correlation between WNDR and household deposit growth presents a structural constraint to reduction in policy interest rates. Exhibit 87 above shows the close movements of policy repo rate and nominal deposit rate (WNDR). Substantial cut in policy rates would tend to reduce deposit rates too. This may discourage households from increasing their deposits, and thus, financial savings.
To revive growth in household deposits, we need higher nominal deposit rate, implying higher policy repo rate. Since we don’t see any reversal of the current regime of accommodative monetary policy by the RBI, we don’t expect a pick-up in household savings in the foreseeable future. Consequently, GDP growth will remain consumption driven, as lower domestic savings and limited improvement in capital efficiency will keep investment rate low in FY17 and FY18, as discussed in Section IV of Part II.
To revive household financial savings, households must be incentivized to make more bank deposits. While this may not appeal to policymakers (or bankers) today because of the weak bank credit growth, we believe it is better to be prepared for a pick-up in credit. As and when credit picks up, if sufficient funds or deposits are not in place, the markets would witness shortage of liquidity, and thus, higher rates. This is why we believe it is important to keep an eye on the crashing savings rate in the economy. Without adequate savings, the economy will not be able to grow sustainably.
(5)
(3)
0
3
5
8
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
FY12
FY14
FY16
E
WRDR(%, 3yma)
4
6
7
9
10
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
E
Repo rate WNDR(%)
Substantial cut in policy rates would tend to reduce deposit rates too. This may
discourage households from increasing their deposits,
and thus, financial savings
GDP growth will remain consumption driven, as
lower domestic savings and limited improvement in
capital efficiency will keep investment rate low
As and when credit picks up, if sufficient funds or
deposits are not in place, the markets would witness
shortage of liquidity, and thus, higher rates
June 2016 60
Thematic | Economy
Box 4. Do expected interest rates matter?
One might argue that the current deposit rate may not be as useful for depositors as the expected rate of return. Hence, one must incorporate the impact of expected real deposit rate (ERDR) to examine the impact of interest rates on household deposits.
How does one calculate ERDR? We use household expectations of 3-month (or 12-month) inflation to deflate the nominal deposit rate to arrive at ERDR. The RBI started conducting the inflation expectation survey of households (IESH) in September 2005, and the quarterly data is available since September 2006. Thus, we have annual data available since FY08. The exhibit below graphs India’s ERDR (based on 3-month expectations) and one-year lagged ERDR (ERDR(-1)) with household deposit growth.
We find that one-year lagged ERDR has a very strong correlation with household term deposits. We reached a similar conclusion from WRDR in Exhibit 85 above.
Overall, our analysis reveals that real deposit rates (expected or current) matter for depositors if inflation is higher than a threshold, which has been the case since FY08. Nevertheless, if inflation is expected to remain subdued, as was the case between 2000 and 2007, nominal deposit rates matter. Thus, we expect nominal rates to become crucial than real rates in the future, which as explained above, acts as a constraint to significant monetary easing.
Household term deposits (% YoY) and expected real deposit rate (ERDR, %)
Source: RBI, MoSL ERDR(-1) = One-year lagged ERDR
-4
-2
0
2
4
0
10
20
30
40
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E
HH term deposits ERDR (RHS) ERDR(-1) (RHS)
June 2016 61
Thematic | Economy
III.3. Expect limited gains from better capital efficiencyApart from higher investment rate, economies could make their capital (orinvestments) more efficient and improve their growth rates accordingly. A keyadvantage of lower ICOR (or better capital efficiency) is that it directly leads to anincrease in the potential output, or the maximum output that can be achieved witha given amount of resources. However, capital efficiency is a structural issue. Notsurprisingly then, most economies have seen higher investment rate leading tohigher growth at least in the initial period. Let’s look at India’s ICOR.
During the FY04-08 period, India’s ICOR fell towards 3.5x, the lowest level since mid-1980s. Real GDP growth averaged ~9% per annum during the period. With an investment rate of above 30%, an ICOR of 3.5x implies a real GDP growth of ~9.5%.
Exhibit 88 below compares India’s ICOR with that of China’s. Since the 1980s, India’s ICOR has averaged above 5x as against 4.3x in China (India’s ICOR averaged 4.7x in the post-liberalization period). In other words, given the same set of resources (and same labor productivity), India’s real GDP growth will be ~20% lower that of China’s due to inefficient capital. The Indian economy must work towards better capital efficiency, not only to improve its potential output, which, according to RBI’s working paper, has fallen in the recent period, but also to improve its actual growth rate.
Exhibit 88: India v/s China’s capital efficiency Exhibit 89: India’s capital efficiency since mid-1970s
3-year moving average = 3yma ,Source: CSO, World Bank, MoSL
Nevertheless, with capital efficiency currently closer to 4x, as against the best level of 3.5x since 1980s, there is limited gains from this avenue (Exhibit 89). Further, in the absence of high corporate investments, higher public or household investments may limit the gains in capital efficiency.
0
3
6
9
12
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
India China
China - 4.3x
India - 5.1x
Long-term average
(x, 3yma)
0
3
6
9
12
FY 8
4
FY 8
7
FY 9
0
FY 9
3
FY 9
6
FY 9
9
FY 0
2
FY 0
5
FY 0
8
FY 1
1
FY 1
4
FY17
F
(x, 3yma)
Best of 3.5x in mid-2000s
A key advantage of lower ICOR (or better capital
efficiency) is that it is directly leads to an increase
in the potential output, or the maximum output that
can be achieved with a given amount of resources
Given the same set of resources (and same labor
productivity), India’s real GDP growth will be 10-20%
lower that of China’s due to inefficient capital
With capital efficiency currently closer to 4x, as
against the best-ever level of 3.5x, there is limited gains from this avenue
June 2016 62
Thematic | Economy
III.4. How important is the global environment?Apart from domestic savings and capital efficiency, we will be closely looking at theglobal economic growth, which has an important role to play in shaping the Indianeconomy. Exhibit 90 below compares India’s real GDP growth with that of the worldeconomy’s. India’s economic growth is highly correlated with other major worldeconomies. This is further reinforced in exhibit 91. It shows that, as per partialcorrelations, India’s economic growth is highly and significantly correlated withChinese economy. With almost all major world economies witnessing slowergrowth, India’s revival in GDP growth is impressive. In fact, even if India is able tosustain its current growth amid falling growth in most other economies, India’sdominance will continue to increase in the world economy.
Exhibit 90: Comparison of India’s economic growth with world economic growth
Exhibit 91: How does India’s economic growth relate with growth in other major economies?
Partial correlation Pair-wise correlation
1996-2015 2008-15 1996-2015 2008-15
China 0.4690* 0.4329** 0.5429* 0.4867*
Euro zone 0.0330 0.2465 0.3487** 0.6236*
Japan 0.2401** 0.0965 0.4608* 0.5873*
UK (0.1763) (0.0414) 0.2503** 0.4732*
USA 0.2406** 0.0832 0.3016* 0.4779*
* Significant at 1% level, ** significant at 5% level, *** significant at10% level , Source: RBI, CSO, MoSL
One of the key factors supporting the high growth period of the mid-2000s was the sharp turnaround in the global economy during that period. Better global environment does not only help in increasing India’s exports, but also in creating a conducive environment for investors to increase investments, which, then leads to higher income growth, and thus, sustainable economic growth.
0
3
6
9
12
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
EWorld India(% YoY,
2yma)
India’s economic growth is highly correlated with other
major world economies
Better global environment does not only help in
increasing India’s exports, but also in creating a
conducive environment for investors to increase
investments
June 2016 63
Thematic | Economy
III.5. Seven key things to decide Indian economic outlook in 2020
1. Savings behavior: The first economic parameter on our watch will behouseholds’ financial savings. It is highly improbable for a developing economyto improve its growth rate without investments. The latter must be financedthrough domestic savings, rather than foreign capital, which tends to be highlydestabilizing.
2. Capital efficiency: Along with higher savings, it is also imperative for the Indianeconomy to reduce its ICOR or improve capital efficiency. This could be achievedby increasing competition in some key industries, creating market-determinedenvironment and reducing tax-based considerations for the corporate sector.
3. Inflation: By increasing competition and reducing market inefficiencies, asubstantial drop in inflation can be achieved. We believe retail inflation must fallbelow the medium-term target of 4% to reduce the high ‘price gap’ theeconomy has witnessed in the past decade.
4. Global environment: It is highly unlikely for an economy to perform in isolationin this globalized world. The global environment is as important as the domesticfundamentals. Without a stronger world economy, the domestic potential willremain capped.
5. Monetary policy: In contrast to many market participants, we don’t see a needto cut policy interest rates substantially from the current levels. To encouragehouseholds to increase their financial savings, deposits – which account for halfof gross financial savings – must be incentivized by keeping interest rates(nominal and real) high. This, we argue, poses a structural constraint tosignificant cuts in policy rates.
6. Higher tax-to-GDP ratio: From the fiscal policy side, the Indian economy cannotremain at the bottom of the tax collection list. With gross tax receipts (central +state) at less than 15% of GDP, the (general) government sector will always findit difficult to support the economy (by consumption or investments) withoutcreating imbalances (in terms of higher fiscal deficit). Since household savingshave already fallen, the economy must make sure to apportion as low aspossible to the relatively inefficient public investments. Although the legislativenod to goods & service tax (GST) is seen as the panacea to weak tax structure inthe country, implementation will hold the key.
7. Indian Rupee: Finally, although we believe that the INR is likely to weakenagainst the USD in the next two years, higher inflation differential will keep theINR stronger in real terms, which will continue to affect India’s competitiveness.India must bring down inflation differential to improve its competitiveness,which will also help the INR to strengthen against the USD. A stronger currencywill also encourage savers.
Overall, we believe that achieving 10% real growth by 2020 is not going to be an easy task. Further, unless the transition from consumption to investments is complete, policy makers should not attempt to increase growth rates, as this may destabilize the economy.
June 2016 64
Thematic | Economy
Conclusion
The objective of commissioning this research note was to share the lenses with which we analyze the Indian economy. The report was divided into three parts. In the first part, we compared the performance of the Indian economy with the performance of other emerging market economies. The second part detailed our understanding of India’s domestic fundamentals, based on which we made our forecasts for FY17 and FY18. This part was further divided into four sections, where we used the KURE theme. The third part looked at the key factors that will help determine the India 2020 outlook.
In Part I, we established the comparative outperformance of the Indian economy using four key economic parameters: 1. India’s standing in the world economy has strengthened in the past decade – it
has moved up from the world’s 12th largest economy in 2008 to the 7th largest in2016.
2. At a time when most of the major economies (including China) are facing thethreat of a declining working population (aged 15-64 years), the Indian economycontinues to enjoy favorable demographics.
3. An index of macroeconomic vulnerability shows India’s dramatic improvementin the past four years; this has helped to keep it at the top of investors’ minds.Further, the rational investors’ rating index (RIRI) shows India’s outperformancesince 2012.
4. Finally, total debt in India is not anywhere close to alarming levels. In fact, thedebt intensity of GDP growth in India is one of the lowest among majordeveloping and emerging economies.
In Part II, we begin by discussing how the unincorporated and unregistered corporate sector may be eating away the share of India Inc. By incorporating the mid-level and bottom level of the corporate pyramid with the top level, we not only established the sanctity of the new GDP series, but also concluded that the current slowdown is not as severe as the previous slowdown in the 2000s, primarily because of the resilient consumption demand.
In Section II of this Part, we discussed the three unique features – low savings, higher inflation and incomplete adjustment in CAD, which have helped India to become the fastest growing economy in the world. We argued that consumption is being supported by lower household savings, rather than higher disposable income. Consequently, retail inflation has been running higher than the optimal level. A measure of ‘price gap’ shows that CPI is currently ~55%, implying that the actual CPI index is 55% higher than the optimal index. Moreover, we strongly believe that notwithstanding recent narrowing in India’s CAD, higher consumption-led deficit has restricted the desired adjustment in CAD.
Based on these three unique features, we made an attempt to explain a large part of the economy by revisiting an economic identity, which says that domestic
In Part II, we begin by discussing how the
unincorporated and unregistered corporate
sector may be eating away the share of India Inc.
We argued that consumption is being
supported by lower household savings, rather
than higher disposable income.
In Part I, we established the comparative
outperformance of the Indian economy using
four key economic parameters
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investments are equal to national savings and CAD. In Section III, we analyzed the behavior of three key economic participants – households, private corporate sector, and public sector, and compare them with their own history and their counterparts in other economies. We concluded that Indian households, unlike their history and their counterparts in other economies, have reduced their savings in the past few years, which is one of the key reasons for resilient consumption demand, and thus, GDP growth.
Finally, we detailed our projections for the next two years in Section IV of Part II. We believe that the current economic model will continue for at least the next two years, which will help real GDP growth touch 8% by FY18. Nevertheless, the continued fall in national savings will put upward pressure on inflation, which, we believe will average 5% in FY18 as against 4.7% in FY17. We do not expect RBI to cut policy rates significantly from the current levels.
Notwithstanding the limited cuts in policy interest rates, we expect the benchmark bond yield to move towards 7% by March 2017, primarily driven by high expected OMOs by the RBI – to the tune of INR1,600b. Further, while we expect the INR to weaken further and average at 68 against the USD in FY17, it is likely to strengthen marginally in REER terms.
In Part III, we looked at the key seven factors which, we believe, would play a major role in determining the outlook for the Indian economy in 2020. Of these seven factors, we discussed the three most important factors – savings, capital efficiency and global environment in greater detail. We concluded that the longer the current economic model of consumption-driven GDP growth remains in place, the more likely it is to destabilize the economy. India must try to shift towards investments, for which higher savings are a pre-requisite. In the absence of significantly higher growth in disposable income, consumption may have to be curtailed to push savings higher. We believe that while 8% growth could be reached by FY18, the task of reaching 10% growth by 2020 will be challenging.
Indian households, unlike their history and their counterparts in other
economies, have reduced their savings in the past few
years, which is one of the key reasons for resilient
consumption demand, and thus, GDP growth.
We concluded that the longer the current
economic model of consumption-driven GDP growth remains in place,
the more likely it is to destabilize the economy.
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Appendix I: Data details
The long time series of GDP is taken form Organisation for economic co-operation and development (OECD), which provides quarterly data on India’s GDP and components from FY97 onwards. Wherever OECD data is not available (such as income, savings etc) we have using splicing to create a single series. Data prior to 2011-12 is on 2004-05 base, while the new series (2011-12 base) is used from 2011-12 onwards.
Due to the availability of long time series, retail inflation refers to consumer price index to industrial workers (IW), unless otherwise specified.
The three episodes used in this study are early 2000s, boom period and the recent period. Each episode comprises of a five year period. ‘Early 2000s’ refers to the period between FY99 and FY04, ‘boom period’ refers to the period between FY03 and FY08, and the current period is FY12 to FY17 (MoSL estimate). FY99, FY03 and FY12 are the base years for the respective episodes.
As far as corporate data statistics is concerned, there is a significant change. Prior to the new GDP series, RBI quarterly survey of ~2,700 large companies was considered as the data source for corporate sector data. However, Ministry of corporate affairs (MCA) started collecting data on about 500,000 companies from 2011-12 companies, which is used in the new GDP series. As against the broadly held belief of the large companies representing the true condition of India’s corporate sector, the inclusion of mid-tier companies from MCA database changes the picture substantially. We have compared RBI sample with MCA database in this study.
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Appendix II: Understanding current account balance
According to an identity in national accounts, current account balance could also be defined as the difference between a nation’s savings and investments. In other words, total domestic investments could be financed either through domestic savings or foreign borrowings. The latter is roughly equivalent to the financial account balance of a nation, which according to the Balance of Payments (BoP) identity is considered to be a correspondent of the nation’s current account deficit with a reverse sign. This is because current account deficit (surplus) is expected to be financed (used) through capital account inflows (outflows) to keep the BoP in equilibrium.
Thus, if a nation increases its investments, either domestic savings have to rise or the nation will have to borrow from outsiders, which will lead to an increase in the current account deficit. The identity can be written as:
Domestic investments = Total savings + foreign borrowings
As foreign borrowings are equivalent to current account deficit (not balance), the equation can be re-written as:
Domestic investments = Total savings + current account deficit
Re-arranging the equation, we get
Current account deficit = Domestic investments – total savings
Thus, if a nation is investing more than its domestic savings, it will run a current account deficit. On the contrary, if savings are higher than investments, current account will be in surplus.
Further, any economy can be segregated into three sectors – households (HH), business (non-public financial and non-financial corporations) and general government (GG, including all government entities). Just like an economy, a sector would run either a deficit – implying higher investments than savings – or a surplus, implying higher savings (if savings are exactly equal to investments, it implies a neutral sector).
Therefore, a nation’s current account balance can be disaggregated into the balances of these three domestic sectors. To understand the movements in current account in a better (and different) way, we have looked at the balances of each sector in an economy.
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Appendix III: Rational Investor Ratings Index (RIRI) In its Economic Survey 2014-15, the government of India (GoI) introduced macro vulnerability index (MVI) and rational investors’ ratings index (RIRI). We have used a slightly modified form of these indices in our study. The MVI assesses a country’s risk profile by combining three key macro parameters – fiscal deficit, current account deficit and inflation. We add these three data series to arrive at MVI index. We replace fiscal deficit with the primary deficit (fiscal deficit excluding interest payments) of the government and use the same structure to re-calculate MVI for several economies. The lower the MVI index is, the safer the economy is. A reduction (increase) in MVI over time reflects improvement (deterioration). We have used all data from International Monetary Fund (IMF) April 2016 World Economic Outlook and define emerging & developing Asia as per IMF. Further, we have created a group of economies, which are rated the same as India (BBB-) by Standard & Poor’s (S&P). The RIRI, as explained by the Economic Survey, is computed by averaging a country’s GDP growth rate and its macroeconomic indicators; the latter measured as the average of the fiscal deficit, current account deficit, and inflation (all with negative signs). Thus, equal weight is given to growth and macroeconomic stability (slightly modified version of MVI). The greater the number, the better should be its investor rating.
http://indiabudget.nic.in/budget2015-2016/vol1_survey.asp
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Appendix IV: Detailed Economic Projections
Exhibit 92: Detailed projections for the real sector Macro indicators Unit FY12 FY13 FY14 FY15 FY16E FY17F FY18F
Nominal variables
Gross domestic product at market prices (GDPMP) US$ b 1,820 1,826 1,863 2,040 2,073 2,215 2,413
GDPMP % YoY n/a 13.9 13.3 10.8 8.7 11.1 11.9
Private consumption expenditure (PCE) % of GDP 56.2 57.0 57.7 57.6 59.5 59.7 60.3
Government consumption expenditure (GCE) % of GDP 11.1 10.7 10.2 10.9 10.6 11.4 11.9
Gross capital formation (GCF) % of GDP 39.6 38.3 34.7 34.1 32.4 31.5 30.8
Exports of goods & services % of GDP 24.5 24.5 25.3 22.9 19.9 19.1 18.6
Less: Imports of goods & services % of GDP 31.1 31.2 28.3 25.9 22.5 21.6 21.2
Gross Value Added at basic prices (GVABP) % YoY n/a 13.6 12.7 10.5 7.0 10.9 11.8
Agriculture & allied activities % of GVA 18.5 18.2 18.3 17.4 17.0 17.4 17.3
Industry1 % of GVA 32.5 31.7 30.8 30.0 29.7 28.9 28.3
Services % of GVA 49.0 50.0 50.9 52.6 53.2 53.7 54.4
Real variables
Real GDPMP % YoY n/a 5.6 6.6 7.2 7.6 7.8 8.1
PCE % YoY n/a 5.3 6.8 6.2 7.4 7.8 8.3
GCE % YoY n/a 0.5 0.4 12.8 2.2 9.3 12.7
GCF % YoY n/a 4.2 (1.1) 6.0 3.8 6.8 7.3
Gross fixed capital formation (GFCF) % YoY n/a 4.9 3.4 4.9 5.3 6.6 7.1
Exports of goods & services % YoY n/a 6.7 7.8 1.7 (5.2) 1.9 5.8
Less: Imports of goods & services % YoY n/a 6.0 (8.2) 0.8 (2.8) 2.5 6.5
Real GVABP % YoY n/a 5.4 6.3 7.1 7.2 7.7 7.9
Agriculture & allied activities % YoY n/a 1.5 4.2 (0.2) 1.2 5.8 3.8
Industry1 % YoY n/a 3.6 5.0 5.9 7.4 6.2 6.9
Manufacturing % YoY n/a 6.0 5.6 5.5 9.3 7.0 8.2
Services % YoY n/a 8.1 7.8 10.3 8.9 9.0 9.7
Community services etc % YoY n/a 4.1 4.5 10.7 6.6 8.7 10.8
Non-agriculture GVABP % YoY n/a 6.3 6.7 8.6 8.3 8.0 8.7
Non- agriculture non-community GVABP % YoY n/a 6.7 7.2 8.3 8.7 7.9 8.3
Other real sector
Index of industrial production (IIP) % YoY 2.9 1.1 (0.1) 2.8 2.4 5.2 5.8
Nominal personal disposable income (PDI)2 % YoY n/a 13.6 12.8 7.0 8.7 11.1 11.9
Real PDI2,3 % YoY n/a 3.6 4.9 2.9 4.1 6.3 7.0
Incremental capital-output ratio (ICOR)4 unit n/a 7.0 5.7 5.0 4.6 4.4 4.2 1 Industry includes mining & quarrying Manufacturing, electricity and construction
2 MoSL estimates, FY16 data not yet out, MOSL estimate 3 Nominal PDI deflated by PCE deflator
4 The ratio of last two years’ investments (as a percentage of GDP) and GDP growth - it is calculated using real-term data Source: RBI, CSO, CMIE, MoSL
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Exhibit 93: Detailed projections of Prices, rates and Money & banking Macro indicators Unit FY12 FY13 FY14 FY15 FY16 FY17F FY18F
Price measures
GVABP deflator % YoY n/a 7.8 6.0 3.2 (0.1) 3.0 3.6
GDPMP deflator % YoY n/a 7.9 6.2 3.3 1.0 3.1 3.6
PCE deflator % YoY n/a 9.7 7.5 4.0 4.5 4.5 4.6
Consumer price index (CPI) % YoY n/a 9.9 9.4 5.9 4.9 4.7 5.0
Food & beverages % YoY n/a 11.2 11.9 6.5 5.1 4.4 4.8
Fuel & light % YoY n/a 9.7 7.7 4.2 5.3 5.0 4.5
Core CPI1 % YoY n/a 8.7 7.2 5.6 4.6 5.1 5.3
Wholesale price index (WPI) % YoY 8.9 7.4 6.0 2.0 (2.5) 1.9 2.9
Primary articles % YoY 9.8 9.8 9.8 3.0 0.2 4.2 4.7
Fuel & power % YoY 14.0 10.3 10.2 (0.9) (11.7) 0.3 2.5
Manufactured products % YoY 7.3 5.4 3.0 2.4 (1.1) 1.2 2.0
Non-food manufactured products % YoY 7.3 4.9 2.9 2.4 (1.5) 0.6 1.2
Food items (raw + processed) % YoY 7.1 9.3 9.4 4.9 2.5 5.4 5.9
Crude oil price US$/bbl 111.9 108.0 105.5 84.0 46.2 45.0 50.0
Gold price US$/ounce 1,649 1,654 1,326 1,248 1,151 1,200 1,200
Money & Banking
Reserve money (M0)2 % YoY 8.7 5.8 9.8 13.1 12.8 15.1 13.1
Broad money supply (M3)3 % YoY 13.5 13.6 13.4 10.8 10.4 11.3 12.3
Bank deposit % YoY 13.5 14.2 14.1 12.6 8.1 8.8 11.7
Bank credit % YoY 17.0 14.1 13.9 10.4 9.9 11.1 12.0
Credit-deposit ratio % 78.0 77.9 77.8 76.3 77.6 79.2 79.4
Incremental credit-deposit ratio % 95.5 77.1 76.8 64.3 94.0 97.4 81.0
Key rates
Policy repo rate (year-end) % pa 8.50 7.50 8.00 7.50 6.75 6.25 6.25
10-yr treasury yield (year-end) % pa 8.54 7.96 8.80 7.74 7.47 ~7.00 …
INRUSD (average) unit 48.0 54.5 60.5 61.2 65.5 68.1 70.0 1 CPI excluding ‘Food & beverages’ and ‘Fuel & light’
2 M0 growth = constant + α(real GDP growth) + β(non-food manufacturing WPI inflation) + ε 3 Broad money supply (M3) calculated using money multiplier
Source: RBI, CSO, CMIE, MoSL
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Exhibit 94: Detailed projections for the external sector Macro indicators Unit FY12 FY13 FY14 FY15 FY16E FY17F FY18F
Current account balance US$ b (78.2) (87.8) (32.4) (26.7) (17.3) (30.6) (47.5)
Merchandise US$ b (189.7) (195.7) (147.6) (144.9) (127.9) (139.5) (160.7)
Invisibles US$ b 111.5 107.8 115.3 118.2 110.6 108.9 113.2
Total credit US$ b 527.0 530.0 551.4 557.8 501.2 510.3 537.6
Merchandise US$ b 309.8 306.6 318.6 316.5 266.6 275.9 293.8
Petroleum products US$ b 55.9 60.6 63.1 56.9 29.2 29.3 34.0
Valuables1 US$ b 46.4 43.0 41.1 40.6 39.0 43.0 46.3
Invisibles US$ b 217.2 223.6 232.8 241.2 234.6 234.5 243.7
Services US$ b 140.9 145.7 151.5 157.7 154.0 157.7 164.4
Total debit US$ b 605.2 618.1 583.7 584.5 518.5 540.9 585.1
Merchandise US$ b 499.6 502.2 466.2 461.5 394.5 415.3 454.6
Petroleum products US$ b 155.0 164.0 164.8 138.3 82.7 88.6 109.2
Valuables1 US$ b 90.8 83.6 58.2 62.0 53.0 57.8 61.1
Invisibles US$ b 105.7 115.8 117.5 123.0 124.0 125.6 130.5
Services US$ b 76.9 80.8 78.5 81.1 82.7 85.2 89.0
Capital and Financial account US$ b 67.8 89.0 48.7 89.4 50.2 52.0 72.0
Foreign direct investment (FDI) US$ b 22.0 19.8 21.6 31.6 36.0 35.0 38.0
Foreign portfolio investment (FPI) US$ b 16.6 26.7 4.8 40.9 (2.7) 15.0 20.0
Non-resident Indians (NRI) deposits US$ b 11.9 14.8 38.9 14.1 16.0 2.0 13.0
Errors & omissions US$ b (2.4) 2.7 (0.9) (1.1) 0.0 0.0 0.0 Change in forex reserves (+(withdrawal)/-(accretion)) US$ b 12.8 (3.8) (15.5) (61.4) (32.9) (21.4) (24.5)
Current account balance (CAB) % of GDP (4.3) (4.8) (1.7) (1.3) (0.8) (1.4) (2.0)
Non-oil % of GDP 1.1 0.9 3.7 2.7 1.7 1.3 0.3
Non-oil non-Gold % of GDP 4.3 3.8 5.3 4.5 3.3 2.9 1.8
Forex reserves (+(withdrawal)/-(accretion)) % of GDP 0.7 (0.2) (0.8) (3.1) (1.5) (1.0) (1.0)
Savings-Investments
National savings % of GDP 34.6 33.8 33.0 33.0 31.8 29.9 28.6
Households % of GDP 23.6 22.4 20.6 19.1 17.8 16.9 16.1
Corporate sector % of GDP 9.5 10.0 10.8 12.7 12.8 11.8 11.3
Public sector % of GDP 1.5 1.4 1.3 1.2 1.2 1.2 1.2
Domestic investments % of GDP 39.0 38.6 34.7 34.2 32.5 31.3 30.7
Households % of GDP 15.9 14.7 13.0 11.0 9.7 8.9 8.1
Corporate sector % of GDP 13.2 13.6 13.1 14.1 13.7 13.9 14.3
Public sector % of GDP 7.5 7.2 7.1 7.4 7.6 7.0 6.6 E = FY16 is MoSL estimate
1 Valuables include items related to gold, or any other precious metal Source: RBI, CSO, CMIE, MoSL
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Exhibit 95: Detailed projections for the central government finances Macro indicators Unit FY12 FY13 FY14 FY15 FY16RE FY17BE FY18F
Total receipts INR b 7,884 9,202 10,566 11,529 12,503 14,442 16,475
% YoY (4.3) 16.7 14.8 9.1 8.4 15.5 14.1
Net tax collection INR b 6,298 7,419 8,159 9,036 9,475 10,541 12,150
Direct tax receipts INR b 4,974 5,624 6,424 6,989 7,560 8,512 9,789
% YoY 10.9 13.1 14.2 8.8 8.2 12.6 15.0
Indirect tax receipts INR b 3,917 4,738 4,963 5,459 7,036 7,797 8,967
% YoY 13.7 20.9 4.8 10.0 28.9 10.8 15.0
Non-tax collection INR b 1,586 1,783 2,407 2,493 3,028 3,901 4,325
Non-tax receipts INR b 1,217 1,374 1,989 1,979 2,586 3,229 3,875
Non-debt capital receipts INR b 369 409 419 515 442 671 450
Disinvestment INR b 181 259 294 377 253 565 300
Total expenditure INR b 13,044 14,104 15,594 16,637 17,854 19,781 22,240
% YoY 8.9 8.1 10.6 6.7 7.3 10.8 12.4
Revenue spending INR b 11,458 12,435 13,718 14,670 15,477 17,310 19,523
% YoY 10.1 8.5 10.3 6.9 5.5 11.8 12.8
Interest payments INR b 2,731 3,132 3,743 4,024 4,426 4,927 5,314
Subsidies INR b 2,181 2,571 2,546 2,583 2,578 2,504 2,500
Pensions INR b 612 695 749 936 957 1,234 1,358
Capital spending INR b 1,586 1,669 1,877 1,967 2,377 2,470 2,717
% YoY 1.3 5.2 12.5 4.8 20.9 3.9 10.0
Fiscal balance INR b (5,160) (4,902) (5,029) (5,107) (5,351) (5,339) (5,765)
% of GDP (5.9) (4.9) (4.5) (4.1) (3.9) (3.5) (3.4)
Revenue balance INR b (3,943) (3,642) (3,570) (3,655) (3,416) (3,540) (3,498)
% of GDP (4.5) (3.7) (3.2) (2.9) (2.5) (2.3) (2.1)
Primary balance INR b (2,428) (1,770) (1,286) (1,083) (925) (412) (451)
% of GDP (2.8) (1.8) (1.1) (0.9) (0.7) (0.3) (0.3)
Net debt1 INR b 40,880 46,276 52,302 58,065 63,537 69,901 75,666
% of GDP 46.8 46.5 46.4 46.5 46.6 46.5 45.1 FY16 is revised estimate (RE), FY17 is budget estimate (BE) and FY18 is our forecasts (F)
1 Net debt for FY16 is MoSL estimate
SECTOR UPDATES
SECTOR UPDATES
SECTOR UPDATES
THEMATIC GALLERY
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Pending Regulatory inspections against Motilal Oswal Securities Limited: SEBI pursuant to a complaint from client Shri C.R. Mohanraj alleging unauthorized trading, issued a letter dated 29th April 2014 to MOSL notifying appointment of an Adjudicating Officer as per SEBI regulations to hold inquiry and adjudge violation of SEBI Regulations; MOSL replied to the Show Cause Notice whereby SEBI granted us an opportunity of Inspection of Documents. Since all the documents requested by us were not covered we have requested to SEBI vide our letter dated June 23, 2015 to provide pending list of documents for inspection.
List of associate companies of Motilal Oswal Securities Limited -Click here to access detailed report Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issues, and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by research analyst(s) in this report. The research analysts, strategists, or research associates principally responsible for preparation of MOSt research receive compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors and firm revenues Disclosure of Interest Statement Companies where there is interest Analyst ownership of the stock No Served as an officer, director or employee No A graph of daily closing prices of securities is available at www.nseindia.com and http://economictimes.indiatimes.com/markets/stocks/stock-quotes
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For Hong Kong: This report is distributed in Hong Kong by Motilal Oswal capital Markets (Hong Kong) Private Limited, a licensed corporation (CE AYY-301) licensed and regulated by the Hong Kong Securities and Futures Commission (SFC) pursuant to the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) “SFO”. As per SEBI (Research Analyst Regulations) 2014 Motilal Oswal Securities (SEBI Reg No. INH000000412) has an agreement with Motilal Oswal capital Markets (Hong Kong) Private Limited for distribution of research report in Kong Kong. This report is intended for distribution only to “Professional Investors” as defined in Part I of Schedule 1 to SFO. Any investment or investment activity to which this document relates is only available to professional investor and will be engaged only with professional investors.” Nothing here is an offer or solicitation of these securities, products and services in any jurisdiction where their offer or sale is not qualified or exempt from registration. The Indian Analyst(s) who compile this report is/are not located in Hong Kong & are not conducting Research Analysis in Hong Kong.
For U.S Motilal Oswal Securities Limited (MOSL) is not a registered broker - dealer under the U.S. Securities Exchange Act of 1934, as amended (the"1934 act") and under applicable state laws in the United States. In addition MOSL is not a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act" and together with the 1934 Act, the "Acts), and under applicable state laws in the United States. Accordingly, in the absence of specific exemption under the Acts, any brokerage and investment services provided by MOSL, including the products and services described herein are not available to or intended for U.S. persons.
This report is intended for distribution only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the Exchange Act and interpretations thereof by SEC (henceforth referred to as "major institutional investors"). This document must not be acted on or relied on by persons who are not major institutional investors. Any investment or investment activity to which this document relates is only available to major institutional investors and will be engaged in only with major institutional investors. In reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the "Exchange Act") and interpretations thereof by the U.S. Securities and Exchange Commission ("SEC") in order to conduct business with Institutional Investors based in the U.S., MOSL has entered into a chaperoning agreement with a U.S. registered broker-dealer, Motilal Oswal Securities International Private Limited. ("MOSIPL"). Any business interaction pursuant to this report will have to be executed within the provisions of this chaperoning agreement.
The Research Analysts contributing to the report may not be registered /qualified as research analyst with FINRA. Such research analyst may not be associated persons of the U.S. registered broker-dealer, MOSIPL, and therefore, may not be subject to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading securities held by a research analyst account.
For Singapore Motilal Oswal Capital Markets Singapore Pte Limited is acting as an exempt financial advisor under section 23(1)(f) of the Financial Advisers Act(FAA) read with regulation 17(1)(d) of the Financial Advisors Regulations and is a subsidiary of Motilal Oswal Securities Limited in India. This research is distributed in Singapore by Motilal Oswal Capital Markets Singapore Pte Limited and it is only directed in Singapore to accredited investors, as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time.
In respect of any matter arising from or in connection with the research you could contact the following representatives of Motilal Oswal Capital Markets Singapore Pte Limited: Varun Kumar Kadambari Balachandran [email protected] [email protected] Contact : (+65) 68189232 (+65) 68189233 / 65249115 Office Address:21 (Suite 31),16 Collyer Quay,Singapore 04931
Motilal Oswal Securities Ltd
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