what we are reading - volume 2 · 13 december 2018 [email protected] 5 our strategist and...

18th January 2019

What We Are Reading - Volume 2.018

The enclosed 2.018 version focuses on global themes for 2019, India economic view, capex green-shoots, US-China trade dispute, India strategy and predictions for 2019. It also includes reports on transportation in India and insights for better decision making.

• Global Themes 2019 CLSA

• India Economic View Citi

• The Capex Green Shoots Antique

• US-China Trade Dispute China Report

• India Strategy CLSA

• Transportation Kotak

• Year Ahead Predictions: 2019 AT Kearney

• Four Keys to Better Decision Making Daniel Kahneman

Global Themes 2019Best ideas in Asian equities

13 December 2018

Portfolio stocks since last rebalancing Portfolio performance

Source: CLSA, Factset Source: CLSA, Factset

Find CLSA research on Bloomberg, Thomson Reuters, Factset and CapitalIQ - and profit from our evalu@tor proprietary database at clsa.com For important disclosures please refer to page 65.

(30)

(20)

(10)

0

10

CCCC

Aya

la C

orp

MSC

I Wor

ld

AIA

MSC

I Asia

SBI H

oldi

ngs

Alp

habe

t

Sam

sung

Ele

c

Sam

soni

te

Chin

a M

oly

Alib

aba

Fanu

c

Price change since rebalancing(%)

(20)

(10)

0

10

20

30

Inception Rebalanced

Port World Asia(%)

www.clsa.com

What to watch for with Shaun Cochran

Looking into 2019, our macro mavens see global growth peaking mid-year as the US tax relief and China stimulus come to a close. That said, they are not convinced a recession is assured or that the trade war will scuttle expansion, but China’s first full-year deficit will put downward pressure on the renminbi. Long-duration US Treasuries seem to be the only recommendation resilient to all likely scenarios we anticipate (clearly the return of inflation is not one of those). Therefore, we’re not surprised that the recommended style bias for equities remains bond-proxies and quality (high-through-the-cycle ROICs), nor that our chartist remains cautious for 2019, but sees emerging market outperformance as the next phase after impending lows.

GLOBAL STRATEGY: Trade deals and treasuries. GREED & fear has long argued an interim deal on Sino-US trade is achievable. The G20 summit gave the first evidence that bias should be retained in 2019. Of course, binary trade outcomes make investment decisions more difficult. What is refreshingly clear is GREED & fear’s steadfast structurally deflationist views. Long-duration US Treasuries are seemingly policy-proof.

GLOBAL ECONOMICS: Mid-year global growth peak. Chief economist Eric Fishwick expects the growth rate of the world’s two largest economies to peak by mid-year as policy support does the same. However, he is not concerned about a trade war as he notes that it is zero-sum globally and should not hurt the USA as the government can recycle tariffs into spending. He also does not see trade as the primary driver of the Chinese economy, but argues that China will print its first full-year current account deficit in 2019, putting downward pressure on the semi-pegged renminbi.

GLOBAL MICROSTRATEGY: Bond-proxies and quality. Head of Microstrategy, Desh Peramunetilleke suggests Asia will continue to suffer a bear market as rising rates and persistent earnings downgrades suppress rallies in the historically strong first quarter. Assuming no US recession, the cycle should bottom out in 2H19. Until we reach this all-clear point, the team recommends bond-proxies and quality stocks.

GLOBAL TECHNICALS: Market lows ahead. Chief chartist Laurence Balanco sees rising volatility, widening credit spreads, emerging-market and Asian weakness, and widespread developed-market topping patterns as signs of a synchronised, rolling global bear market (defined as 20% plus falls). However, it’s not all bad news, as such experiences typically precede leadership changes with emerging markets beginning to outperform developed ones once markets bottom. Sector-wise, energy, materials and/or financials are potential future leaders.

Stocks to watch. We select from a cross-section of country and sector favourites to list 10 ideas that offer investors the best exposure to our 2019 themes. We remove Samsonite from the existing portfolio given our unsuccessful attempt for a tactical trade after its collapse in 1H18 upon accusations of accounting irregularities. We replace it with Singaporean healthcare stock Venture as its own retracement on 2018 earnings disappointment has created more reasonable expectations.

Key themes stocks, 2019 US Alphabet GOOGL US

China Alibaba BABA US

CCCC 1800 HK

China Moly 3993 HK

Hong Kong AIA 1299 HK

Japan Fanuc 6954 JP

SBI Holdings 8473 JP

Korea Samsung Elec 005930 KS

Philippines Ayala Corp AC PM

Singapore Venture Corp VMS SP

Economic volatility

Also inside Global: Commodities; Oil, gas and petrochemicals; Technicals; Strategy; Banks; Autos; Battery; Automation; Thematics

Asia: Tech; Consumer; Gaming; Healthcare

China: CRR strategy; Infrastructure; Oil, gas and petrochemicals; Power; Thru Trains; Property; Autos; Internet; Consumer discretionary; Education

Hong Kong: Conglomerates

Japan: Benthos

Korea: Strategy

Taiwan: Semiconductors; Strategy

India: Strategy

Singapore: Strategy Malaysia: Strategy Thailand: Strategy Indonesia: Strategy Philippines: Strategy Australia: Mining & Metals; Strategy Global: Themes 2018

http://www.clsa.com/



https://www.clsa.com/member/report/607794368

user

Highlight

user

Highlight

user

Highlight

user

Highlight

Investment thesis Global Themes 2019

13 December 2018 [email protected] 3

Global themes CLSA’s 10th annual Global Themes report arrives almost a decade after this global expansion began. The world’s political and economic leadership, and the associated geopolitical and monetary conditions, have significantly changed since 2009 with the one constant being rising debt-to-income levels. As investors contemplate how to profit from these opportunities and protect themselves from the related risks, our analysts have laid down their tarot decks to glean how to best proceed in 2019. In classic CLSA style, they don’t always agree.

Chief economist Eric Fishwick notes that world trade growth is currently narrow: the USA has pulled away from Europe, driving developed world demand while China is the emerging markets’ engine. He is confident that the world’s two largest economies will grow into 1H19, but this will be short-lived. Trump’s fiscal package begins unwinding in 2H19 and China will have passed through its own stimulus. This ‘buy now and sell in May’ bias is in stark contrast to recent market sentiment as are Eric’s trade views noting that it is zero-sum for the world. China’s pain won’t extend globally and stimulus efforts will resist damage to its growth. He believes tariffs are unlikely to do much harm to the US economy as it runs a deteriorating deficit and the government recycles tariffs into spending.

On Sino-US trade, Christopher Wood long argued that an interim deal is achievable. The G20 summit gave the first evidence of that bias, which he retains into 2019. Both sides understand that retaliatory dynamics ultimately serve no one. There is a deal to be made and The Donald’s instincts are clearly to strike one and declare a ‘victory’. 1Q19 will determine if there is one China can tolerate.

Trump’s willingness to deal aligns with Theorality’s view that 2020 will meaningfully constrain the administration on the back of the mid-term election results, the Mueller investigation and the looming fiscal cliff. A recommendation to indict at least one senior administration member is a clear and present danger.

World trade growth is good; trade volume growth at 3mma % YoY Effects of Trump’s tariffs on Chinese goods

Source: CLSA, cpb.ni Source: CLSA, Office of the United States Trade Representative

As to trade dynamics, Eric predicts that China will print its first full-year current account deficit in 2019 as it remains a pro-consumption economy and domestic growth continues to outpace global. This will show absolute mercantilist claims against China to be outdated (albeit the relative US trade surplus remains stark). The other critical ramification is for the pegged Rmb - the longer the deficit persists the more difficult the PBoC will find managing the crawling peg.

(5)(4)(3)(2)(1)0123456789

10

12 13 14 15 16 17 18

Developed economiesEmerging economiesTotal

(3mma %YoY)

34 50 50

250 250200

267

0

100

200

300

400

500

600

6 Jul 18 23 Aug 18 24 Sep 18 1 Jan 19 (?) ???

(US$bn) 25% 10% 10% or 25%

The 10th in our annual series

Our macro mavens see slowing growth but no

train wreck despite the trade tussles

Ironically, China will report its first annual

deficit next year

GREED & fear goes as far as a compromise deal

being the base case

Trump administration faces material

indictment risk



4 [email protected] 13 December 2018

Zooming in on China, CRR strategist Haixu Qiu see less risk to the economy from Trump’s tariffs than from the souring private sector. Echoing economics, CRR is assuming Beijing is cognisant of declining sentiment and seeks to reverse it. They expect favourable credit policies for SMEs and corporate tax cuts. On the liquidity front, head of China industrial research and capital access Alexious Lee agrees. Besides the already announced Rmb1.35tn special fund, he expects further Belt and Road Initiatives via fresh PPP orders, of which state engineering, procurement, construction (EPC) contractors are the core beneficiaries. He favours CCCC and CRRC.

This is welcome relief for head of resources research Andrew Driscoll as trade tensions and tepid Chinese demand have dragged down base-metal prices. He believes the emerging demand support factors will gel with metal prices trading well into industry cost curves and supply has already started to respond. All of which should lift his top picks OZ Minerals, Alumina and Vedanta.

On the flip side is China’s impact on global gas markets. Here it is domestic demand outstripping supply that is tipping the equation. Beijing’s strong commitment to control pollution under the ‘Beautiful China’ banner is already driving seismic shifts in its energy consumption and fuel mix. The emphasis on coal-to-gas switching reforms will enact a move away from regulated pricing to allow a greater role for market forces. We should expect stricter monitoring of adherence to environment policies to persist. This will benefit large SOEs such as our top picks CNOOC, PetroChina and Sinopec.

‘Beautiful China’ is more than coal-to-gas, enjoying Xi Jinping’s personal support. Head of power and ESG research Charles Yonts directs us towards wind (Longyuan/Huaneng Renewables) on its strong 2018 operating performance and we expect policy improvements to continue in 2019. Environmental utilities have passed the worst of the order flow and funding risks, and Charles argues that a post-placement China Everbright offers asymmetric optionality.

Looking at policy-driven opportunities, the International Maritime Organisation (IMO) fuel directives become effective in 2020: a cap of 0.5% on sulphur content on bunker fuel versus the current 3.5%. While many uncertainties remain on how ship owners and operators will comply, compliance would undermine high sulphur fuel oil (HSFO) demand and margins favouring complex over simple refiners.

Sino-BRI collaboration; overseas contract revenue & new orders Global refinery product output (2016); structural change to follow

Source: CLSA, MOC, CITICS Securities Source: CLSA, IMO

0

50

100

150

200

250

300

350

2013 2014 2015 2016 2017 18CL 19CL

(US$bn) Overseas contracting revenue New orders

Gasoline23%

Jet/Kerosene7%Middle

Distilate31%

Heavy Fuel Oil

12%

Others18%

LPG3%

Naphtha6%

China - a wavering domestic economy that

absolutely needs stimulus

Base metal prices to experience relief

The commodity with the strongest Chinese

demand support is gas

Of the other ‘Beautiful China’ plays, Charles

favours the wind sector

Complex refiners will benefit from tighter

sulphur rules for bunker fuel


user

Highlight

user

Highlight

user

Highlight

user

Highlight



Our strategist and sector heads see the potential for fundamental growth to capitulate, but not quite yet. Meanwhile, our chief chartist Laurence Balanco believes rising volatility, widening credit spreads, emerging-markets and Asian weakness, and widespread developed-market topping patterns all suggests that, globally, equities are lined up for a synchronised bear market (defined as 20% plus falls). The encouraging element of all this downside is that it provides a classic set-up for leadership changes where Laurence sees emerging markets taking over leadership from developed markets, and energy and materials and/or financials as potential sector leaders in the future.

MSCI EM and MSCI World weekly chart MSCI Asia ex-Japan - rolling 3M earnings revision (18F)

Source: CLSA, Wind Note: bottom-up calculated with free float adjustment based on current MSCI universe. Source: CLSA, Facset

Interestingly, on the potential emerging-to-developing-market transition, head of China capital access Alexious Lee sees the possible renewal in the Chinese public credit cycle, the peaking of share-pledge risk in 3Q18 and potentially rising index inclusion factors in 2019 as catalysts to renew A-share interest. The subsequent question is whether the constituents, especially SOEs, see this as an opportunity to raise alternative financing. On balance, he sees it all as positive.

With so many mixed fundamental and choppy market signals, Chris is refreshingly clear in his steadfast structurally deflationist views. He recommends buying long-duration US Treasuries. While tensions rose in October 2018 as investors fretted over a 10-year Treasury bond breakout, he reminds readers that yields did not surpass the 37-year log-scale trend line. Although the false alarm of reaching an intraday high of 3.26% on 10-year yields threatened to question this base case that US cyclical momentum has peaked, he expects to see the deflationary trends reassert themselves as US earnings and GDP slow in 2019.

This all gels well with Desh Peramunetilleke and his Microstrategy team. They expect ongoing rate hikes, combined with the flattening of the yield curve, to continue to fuel debate about the potential for a US recession. In that context, Asia will continue to suffer a bear market as rising rates and persisting earnings downgrades suppress any rallies in the historically strong first quarter. As to the appropriate strategy, on their base case the USA won’t experience a recession, investors should expect the cycle to bottom out somewhere in 2H19 at which point valuations will be pushed upwards. Until we reach this all-clear point, they recommend focusing attention on bond-proxies and quality (high ROIC/ROEs through the cycle) that have corrected sharply this year and are now trading below-average PB.

0.5 0.

90.

2 0.3 0.

80.

5 0.6

1.2

2.1

2.6

3.2 3.

5

3.3

2.7

2.2

2.9 2.

9

3.5

2.9

2.3

1.2

0.9

0.4 0.

50.

420.

0(0

.6)

(1.2

)

(1.4

)(2

.1)

(3)

(2)

(1)

0

1

2

3

4

Jun

16

Aug

16

Oct

16

Dec

16

Feb

17

Apr

17

Jun

17

Aug

17

Oct

17

Dec

17

Feb

18

Apr

18

Jun

18

Aug

18

Oct

18

L3M earnings revision (18F, %)

Strained market conditions to continue

and then emerging markets outperformance

A potential increase in Chinese inclusion factors could help

One area of unwavering conviction is GREED &

Fear’s love of long-duration US Treasuries

Microstrategy supports the cautious tone and

prefers quality and bond-proxies until

markets settle


user

Highlight

user

Highlight



While the global auto sector is an obvious whipping boy for Trump’s trade war, the more interesting risk Japan autos analyst Christopher Richter highlights is the likely decline in 2019 sales versus the downgraded 2018 figures, which will primarily be driven by China. The positives within a challenged environment are electrification, autonomous vehicles and the implications of 5G for connectivity.

Alexious sees similar themes playing out in China in a characteristically policy-accelerated manner. While all this is Beautiful China positive, Chinese automakers will not benefit. Startups developing intelligent-connected vehicles (ICV), self-drive technology and NEVs are increasing competition, are compressing margins and forcing sector consolidation, which initially benefits consumers over investors.

Of auto’s three positive themes, enabling electrification is closest to a profitable inflection point. Electric vehicle (EV) sales remain robust, buoyed by falling battery prices, improving customer acceptance, infrastructure availability as well as stricter (ex-US) regulations on internal-combustion engines (ICE). A shift from carrots (incentives) to sticks (regulations) means momentum will be sustained. These stricter policy thresholds drive the need for improved driving ranges and energy densities, which favours technology leaders, especially given stricter quality and safety standards. Oil, gas and petro analyst Ken Shin sees a transfer of value from upstream materials and components in the battery supply chain to cell manufacturers, with CATL and LG Chem benefitting the most.

Global auto sales volume SAAR; approaching a stall Chinese ICE and NEV shipment volume forecast; slowing volume

Source: CLSA Source: CLSA, CAAM, CITIC Securities

However, Australia materials analyst Dylan Kelly believes the market has overlooked ex-China rare earths for alternative exposure to lithium, cobalt and nickel sulphate. China’s dominance in rare earths, at over approximately 90% of supply, will undergo a structural shift resulting from ‘Beautiful China’ and supply-side reforms, which may squeeze supply (especially if trade-war tensions escalate). As the largest ex-China producer, Lynas Corp is strategically positioned to benefit as the primary alternative for what should be increased global demand for rare earths.

Potential trade war escalation aside, a major auto sector replatforming clearly offers opportunities as does partial trade clarity on a new Nafta agreement. Global head of automation Morten Paulsen is confident that next year will offer the best buying opportunity in three years as new technologies boost the efficiency of automated solutions in new markets. While trade resolutions may not be around the corner, what is more certain is Asia’s ambitions to modernise factories.

0

5

10

15

20

25

30

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

(m units)

(5)

0

5

10

15

20

0

5,000

10,000

15,000

20,000

25,000

30,000

2013 2014 2015 2016 2017 18CL 19CL 20CL

(%)

ICE NEV YoY (RHS)

(000' units)

In global auto we actually expect an aggregate demand

contraction in 2019 . . .

. . . although electrification will ramp,

especially in China

We like the battery companies as

bargaining power tips in their favour

Dylan is unperturbed by Lynas’ volatility,

suggesting investors buy on weakness . . .

. . . while Morten sees 2019 as the best buying opportunities for Fanuc

and Keyence in three years


user

Highlight

user

Highlight



Head of technology Nicolas Baratte argued last year that Asian tech had rallied too much and was ready to take a breather. That proved a good call and, in his view, is still ongoing. He suggests revisiting tech stocks in late 1Q19 or early 2Q. As such, beware of sexy value traps. What made a stock cheap in the old rising consumer unit volumes world does not necessarily hold water today. He prefers less well understood or owned smallcap Chinese names like ChinaSoft and Dahua.

Turning to the tech sector, Sebastian Hou see the cyclical downturn that he has been calling for as incomplete. He sees pervasive demand deceleration, excessive inventory across the supply chain and unfavourable leading macro indicators. The similarities he sees in this cycle versus the dot-com bust could make this correction the biggest since the GFC. He recommends selectively hiding in relatively defensive large-cap names, with lower beta and solid FCF, such as TSMC.

His Korean counterpart Sanjeev Rana expects the DRAM weakness to continue until at least 1H19. For NAND, he expects ASP declines to continue through the entire year. That said the margin lows in 2H19 will exceed all previous cycle suggesting valuations are relatively attractive but need an earnings floor.

Internet analyst Elinor Leung believes voice assistants have reached an inflection point, with China’s global share of the market rising by over 10% to 29%. With cloud services also branching out across industries as China migrates to the era of the internet of things, industry incumbents Alibaba, Tencent and Baidu maintain their leading positions.

Global smart speaker adoption; China outpaces the world Do we need tougher rules for breaches of data privacy?

Source: CLSA Source: CLSA, HarrisX

Globally, it is important to note that last year Sir Tim Berners-Lee, co-creator of the web, announced Inrupt, a startup to fund The Solid Project. Solid is a decentralised platform that gives individuals ownership of their data by allowing storage in Personal Online Data Stores (PODS). Its goal is essential in turning current practices, and therefore business models, on their head. In this context Theorality wonders if 2019 will be the year the internet pivots towards a privacy-oriented approach. Shaun Cochran prefers old-media content (Disney) over new media ‘time-on-platform’ companies (Facebook).

Switching the focus back to Asia, head of consumer researcher Oliver Matthew expects M&As between foreign brands seeking access to the Chinese market and domestic companies facing distribution barriers to continue flowing. Beginning faintly in 2018, the focus is now on millennials seeking premium items. Thus fashion, health goods and cosmetics are particularly promising.

46 42

20 29

0

10

20

30

40

50

60

70

80

90

100

1Q18 3Q18

(%) Others

UK

China

US

Yes83%

No17%

Sebastian is steadfast that semiconductors are

yet to bottom

Sanjeev likes DRAM valuations but wants to

see trough margins to go full bull

Elinor is excited about the transition to more mature voice systems

Theorality sees the global risk for the

incumbents as a shift towards a privacy

oriented model

Oliver suggests M&A will pick up in the

consumer space for access to China . . .

Nicolas’ believes 2018’s tech market trend is

still ongoing


user

Highlight

user

Highlight

user

Highlight



Narrowing into China, analyst Dylan Chu advises focusing on defensive positions until at least 3Q19. He sees weak discretionary consumption after property prices peaked, and deteriorating wage and employment data. The generally calm retail market means that OEMs may offer refuge from additional macro-uncertainties. He favours Shenzhou International.

Consumer goods retail sales YoY growth; continued slowing China’s internet education platform market; explosive growth

Source: CLSA, NBS Source: CLSA

In contrast, one sector where Chinese spending is not letting off, regardless of the macro conditions, is education. Mariana Kou believes three emerging catalysts will continue to drive growth: personalisation, decentralisation and globalisation. Growth is particularly strong in online education and this is beneficial for citizens in lower-tier cities, who are showing greater interest to pay for such. Our top pick is Tal Education on the back of its building investments in AI and data.

Things aren’t quite as clear cut for the Asian gaming sector as macro-economic and trade uncertainties have created significant overhangs for the share prices. Still, as VIP growth has decelerated, the fundamentals around mass growth remain firm and we expect 9% growth in 2019. With the weakness in VIP largely priced in, the defensive nature of mass should support cashflow growth for the sector. For regional head of gaming and conglomerates, Jonathan Galligan, the conglos side presents a similar divergence between share-price performance and bottom-up fundamentals. While the conglos outperformed the market unceremoniously in 2018 despite little growth in earnings or NAV, 2019 is shaping up to see more healthy NAV and earnings growth. For the highly defensive sector, we forecast NAV growth of 12% in 2019 with the wildcard of structural changes to capital allocation looming large. Although some conglomerates covered ought to divest, acquisitions remain a possibility.

Regional head of healthcare, David Stanton, notes that drug affordability and accessibility continue to apply downward pressure on the market with payers, including those in the USA and China. This is driven by payer scrutiny as they seek to take advantage of genericisation of existing treatments and rising competition from biosimilar products. Importantly, this is in many respects an opportunity for Asian producers who seek to develop innovator and copycat drugs (biologics and biosimilars) in emerging markets where entry barriers are low and then enter higher-priced, established markets. His preferred BUY-rated Asian innovators are CSL, Takeda, Beigene and Hua Medicine.

6

7

8

9

10

11

12

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

2Q18

3Q18

Oct

18

(%)

79.7

98.8

124.

5

158.

6

197.

6

244.

9

302.

0

370.

4 453.

6 555.

2

0.2 0.30.3

0.61.7

4.1

7.6

12.2

17.9

24.0

0

100

200

300

400

500

600

700

2013

2014

2015

2016

2017

2018

E

2019

E

2020

E

2021

E

2022

E

(Rmbbn) B2C Internet-education platforms

79.999.1

124.8159.2

199.3

249.0

309.6

382.6

471.5

579.2

13-17 Cagr: +25.7%

17-22 Cagr: +23.8%

. . . while Dylan says stock strategies on the

ground should favour defensive business

models

Mariana is still excited about secular education

opportunities despite the policy risks

Jonathan sees a mixed bag on Asia gaming and conglomerates needing

trade clarity

David sees a more compelling story in Asia

healthcare innovators like CSL and Takeda


user

Highlight

user

Highlight

user

Highlight



Distilling into our country views, Japan strategist Nicholas Smith sees an opportunity to mitigate the effects of the trade war as well as a potentially easy win for Abe. With just 38% food self-sufficiency, Japan can’t feed itself. And with 67% of farmers over the age of 65, Nicholas suggests that undersupply is about to get incomparably worse. By cutting tariffs on food imports, Abe can offer a ‘victory’ to Trump and so mollify his aggression with a ‘deal’. He also notes this strategy offers Abe plausible deniability for dismantling a politically sensitive tariff moat.

Less obvious policy decisions are found in Korea. Local head of research, Paul Choi, expects economic difficulty with falling exports likely to be exacerbated by a weakening property market in 1H19 after a series of policy own-goals in 2018. The Korean won therefore becomes the saving grace, as its expected depreciation will lend a hand to Korean exporters. Interestingly, the besieged DRAM makers - Samsung Electronics and SK Hynix - and shipbuilders such as Hyundai Heavy are well geared to this relief.

15-year ₩/US$ rate Nifty earnings growth projections

Source: CLSA, QuantiWise Source: CLSA

Another market troubled by tech weakness is Taiwan. Potential tariff-induced supply-chain adjustments and a domestic political standoff further compound this decelerating tech cycle. With such an entrenched industry structure keeping the island tethered to global tech trends (EV, 5G, datacentre, etc) it is difficult to expect momentum, especially in 1H19. The upside is that Taiwan as a market continues to run a net-cash aggregate balance sheet and so companies are in excellent shape to weather the slowdown.

In contrast, India strategist Mahesh Nandurkar argues that the persistent optimism embedded in consensus Nifty estimates will prove less acute next year. Economic activity should pick up from levels seen in FY11-15 as irregular initiatives come to an end (such as demonetisation, the NPL clean-up and GST implementations) and, assuming that downside risks don’t materialise from generous margin assumptions, Nifty earnings growth could be 18-20%. Corporate banks present the best opportunities, with ICICI being our favourite.

Over to Asean, languishing global markets will take their toll on Singapore’s economy given its dependence on international trade. Although the ride may be tough, Singapore will perform better than others in the region given its robust currency and yields. Our top pick here is DBS, but more broadly we recommend a defensive strategy favouring dividends.

900

1,000

1,100

1,200

1,300

1,400

1,500

1,600

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

6

22

11

7 10

1

(4)

8 9 10

18-2

0

25

(10)

(5)

0

5

10

15

20

25

30FY

10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

CL

FY20

CL

(% YoY)

Downside riskto earnings

In Japan, Abe has an easy win by cutting farming tariffs and

blaming Trump

Korea faces external softness and domestic

policy own-goals, which means the won

will weaken

Caught in the middle, Taiwan is too tech-

focused to offer more than dividend

support . . .

. . . however, India is hoping to deliver on

earnings with stronger domestic potential

Singapore remains, at the market level, a

slave to global trade . . .




Another market caught in macro crosswinds is Indonesia. A volatile currency, rising oil prices (for the bulk of the year) and rate hikes have all constrained economic recovery since 2017. Head of research Sarina Lesmina sees elections heralding a return to momentum. Assuming the recent oil-price weakness does not violently retrace, and that the global liquidity tightening begins to ease into 2019, lower borrowing costs and infrastructure spend can trigger a consumption and economic recovery. In this light, JCI is still a laggard with sensible valuations.

Turning to Malaysia, there are some lofty goals with a German-like Industry 4.0 blueprint that aims to make Malaysia a prime destination for high-tech industries, including a development of an aerospace-industry hub. Coupled with a Sino-US trade war and clear evidence of rising FDI in 2018 - the question becomes, is Malaysia a viable production alternative? She hopes so, recommending healthcare, banks and select tech exposure.

Thai head of research Suchart Techaposai faces far less political clarity, although the military-led government appears committed to delivering elections in 2019. With the National Strategy and Reform Plan set in place for the future government to implement, Suchart sees a rerating of Thai banks, contractors and properties as likely. The valuations are also undemanding so domestic demand stocks are the best alternative for now.

Disappointing Thai investment Singapore dividend portfolio performance

Source: CLSA, NESDB Source: CLSA, Bloomberg

In the Philippines, after a torrid 2018 that has seen the PCOMP down 10.26% YTD, head of research Alfred Dy believes a number of things could go right in 2019. Potential catalysts include: falling inflation, improving earnings growth, pre-election spending, and progress on tax reform and infrastructure initiatives. While peak valuations are less conducive to ‘what if’ thinking, he notes that value has re-emerged with consensus PEs of 15x going into 2019 (under the 1sd below mark). As such, Alfred says the market is poised for a comeback, suggesting investors should be more inclined to add exposure than to take profit from here.

Finally, in Australia, the housing market should draw most attention with head of research Richard Johnson forecasting falling property prices and other indicators, which should make observers wary of the broader economic outlook - and is consistent with the aggressive market underweight Global strategist Christopher Wood has run for years.

(20)(10)

01020304050607080

1Q12

3Q12

1Q13

3Q13

1Q14

3Q14

1Q15

3Q15

1Q16

3Q16

1Q17

3Q17

1Q18

3Q18

(% YoY) Public construction investmentPublic investment

(5)

0

5

10

15

20

25

70

80

90

100

110

120

130

140

May

15

Aug

15

Nov

15

Feb

16

May

16

Aug

16

Nov

16

Feb

17

May

17

Aug

17

Nov

17

Feb

18

May

18

Aug

18

Nov

18

(%)Outperformance to MSCI SGCLSA dividend cocktail (LHS)MSCI SG (LHS)

(13 May 15 = 100)

. . . whereas our Indonesia strategist

sees genuine potential for a rebound . . .

. . . and our Malaysia strategist sees FDI opportunity where

China sees a trade war

Thailand is in desperate need of

political clarity which should present itself throughout the year

Alfred Dy believes Philippines valuations

now offer and asymmetric risk

reward . . .

. . . while Australia needs to push through

a housing downturn


user

Highlight

See Appendix A-1 for Analyst Certification, Important Disclosures and non-US research analyst disclosures.Citi Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Certain products (not inconsistent with the author's published research) are available only on Citi's portals.

02 Jan 2019 09:13:37 ET │ 28 pages Emerging Markets Asia

India Economics View2019 Outlook – Macro Worries to Ease, Politics Takes Over

Nascent investment recovery to counter headwinds to consumption — Weexpect FY20 GDP growth at 7.4%, as the nascent investment recovery couldneutralize the near-term consumption slowdown. Lower oil prices, improvingbanking system health/credit flow and the possibility of rural stimulus will beimportant tailwinds to watch. However, slowdown in NBFC lending, election-relateduncertainty and the structural concerns of less-than-adequate formal employmentgrowth and deteriorating terms of trade for farmers limit our growth expectations.

Benign food and fuel inflation, uncomfortable core — Expect a modest bouncein CPI to 4% avg. in FY20 on a low base. Persistent surplus causing a structuraldecline in food CPI but wary of some mean reversion in 2019. Headline CPI to staybelow the 4% mark until 1HFY20 before picking up to 4-4.5% in 2HFY20. Core CPIis likely to converge to headline driven by relatively softer growth and strong base.

Fiscal commitment strong but revenues disappoint — More concerns aboutslippage from the 3.3% of GDP deficit target for FY19 as indirect tax collectionsplummet. Innovative accounting through using NSSF and other means likely to bedeployed. Populist promises likely but fiscal implications could be back-ended.

Monetary easing could be shallow if fiscal slips — On the back of persistentundershooting of headline CPI, lower oil and stable currency, we assign a 60%probability to a stance change and a 15% probability of a rate cut in Feb itself. Acombination of relatively strong growth, high core inflation and uncertainty overfiscal stimulus appear to be the hurdles in front of substantial easing. OMOpurchases support a bond rally; expect more in FY20 but at a reduced pace.

BoP to swing into surplus but basic balance still weak — With CADapproaching ~2% of GDP in FY20, we expect a BoP surplus of US$20bn but thebasic balance to remain in deficit, exposing INR to the volatility of FPI flows. RBI tobe vigilant for external risks and likely to rebuild reserves, USDINR to trade in 68.5-70.5 range.

Politics in focus — BJP-led alliance is likely to form the government in the Apr-May general elections in our base case though recent state election results indicatethat surprises cannot be ruled out.

Strategy – INR and India rates outlook: External headwinds for INR havereceded. But INR’s outperformance will likely be cushioned by potential USD buyingby RBI. As a result, we prefer to take INR exposure on an opportunistic and tacticalbasis. Also, we seek opportunities to buy the election event volatility. India rates arelikely to push lower across tenors as expectations of rate cuts take a firmer hold.Potential for positioning squeeze persists, but that should present an opportunity toget back into receivers. We discuss potential risks to a bullish fixed income view.

Citi Research

Economics

Samiran Chakraborty AC

[email protected]

Anurag Jha AC

[email protected]

Gaurav Garg AC

[email protected]

user

Highlight

user

Highlight

user

Highlight

India Economics View2 January 2019 Citi Research

3

GDP growth trends have been quite volatile in 2018 as the relatively strong momentum of the earlier part of the year has waned. We believe 2019 could be another year of robust but choppy growth as there are multiple uncertainties.

Question marks on rural demand, stimulus dependence: Persistent deflation in food prices with rising input costs has worsened the outlook for agriculture and our rural demand index has moderated from its highs (though still quite strong). Relatively late winter sowing could also add to stress in agriculture. Affordable housing-driven construction growth has supported the non-agri component of rural demand but we anticipate that the construction growth could be decelerating in 2019 and there are no signs of any pick-up in rural wage growth as the labor surplus sustains. Much will depend on whether the government opts for any pre-election stimulus for agriculture in the form of farm loan waivers, cash transfer to compensate for lack of MSP realization or some form of universal basic income. We maintain that the excess supply problem in agriculture doesn’t have a quick fix and expect that food prices will increase only gradually in 2019.

Urban consumer sentiment remains weak, some tailwinds emerging: A combination of less than adequate jobs/income growth, high oil prices and anemic asset price increase has kept urban consumer sentiment in a “pessimistic” zone for two years. However, lowering of household savings and a steady flow of retail credit have ensured that the urban consumption demand doesn’t plummet. In the near term, the credit flow could be impacted from relatively slower growth in the shadow banking system (~10-15bps impact on GDP growth) but sharply lower oil prices could neutralize the effect (10% drop in oil prices increase GDP growth by 15bps).

Government and net exports to be supportive: The possibility of pre-election stimulus/impetus to finish projects remains the wildcard for consumption although, in the recent past, only once did the government breach the fiscal deficit target in a pre-election year – in 2009, more as a response to the global financial crisis. Also, evidence of consumption boost from election-related activity is weak in the GDP data. Nevertheless, we assume a small boost to growth in the early part of the year from election-related activity. While fiscal discipline has been maintained by the government, we are not factoring in any further reduction in fiscal impulse in our projections for FY20. In fact, there could be small upside because of headwinds from net exports abating in 2019 as the current account deficit improves.

A nascent capex recovery in place: Double-digit investment growth in three consecutive quarters makes us hopeful about a nascent pick-up in investment cycle aided by sectors where demand growth has been strong and capacity utilization levels are improving. Our investment indicator is also showing a sustained broad-based pick-up. Improved corporate profitability, expectations of softer interest rate, reduced leverage in the corporate sector and gradual strengthening of the financial sector balance sheet (NPA ratios likely to decline in 2019) with progress in IBC and public sector bank recapitalization are supportive conditions for higher capex. We are witnessing early signs of credit flow to industry which should ensure bank credit growth stays robust. However, we acknowledge that the high capex requirement sectors, like power and metals and mining, might take time to join this process and there could be funding challenges in the SME space for further capex. Elections will be another risk to this recovery as political uncertainty could temporarily suppress business sentiment.

We revise down our FY19 GDP growth to 7.3% (7.5% earlier) as the 2Q FY19 printed a surprisingly low 7.1%. Adverse base effects are anyway likely to pull down 2H FY19 prints. FY20 GDP growth could get materially altered by electoral outcomes but we expect it to clock 7.4% if political stability is retained.

Growth

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight


4

Figure 1. Economic Activity Heat-map

Qtr GDP IIP Car Sales

CV Sales

2-W sales

Tractor Sales

Air Traffic

Rail Freight

Cargo Traffic

Credit Indirect Tax

PMI Mfg

PMI Svc

Rural Wages

New Projs

corp earning

Diesel Sales

Petrol Sales

Sep-12 7.5% 0.4% -7.6% 1.7% -3.8% -11.8% -7.1% 1.4% -0.8% 16.9% 17.9% 52.8 55.0 18.8% -44.8% 64.8% 10.3 6.1Dec-12 5.4% 2.1% -2.0% -4.8% 6.0% 3.9% -5.0% -0.3% -2.7% 16.2% 20.1% 53.7 53.9 18.2% -43.0% 4.8% 4.2 6.7Mar-13 4.3% 2.2% -20.5% -8.7% -0.6% -1.7% 2.2% -1.1% -1.0% 15.7% 31.1% 53.1 54.3 17.8% -34.7% 5.5% 2.7 5.8Jun-13 6.4% 1.1% -10.4% -8.1% -0.8% 26.2% 3.5% 1.8% -1.0% 14.0% 0.2% 50.5 52.0 17.0% -13.5% 96.8% 0.8 12.9Sep-13 7.3% 4.8% 2.2% -21.8% 8.2% 21.2% 13.1% 3.7% 5.8% 16.2% 6.1% 49.4 46.7 15.7% 11.4% -9.4% (2.2) 6.8Dec-13 6.5% 3.0% -5.5% -24.5% 9.0% 20.6% 6.4% 0.1% 1.1% 15.0% 5.8% 50.5 47.0 16.1% 33.0% 1.5% (1.1) 9.5Mar-14 5.3% 4.2% -3.2% -25.2% 13.1% 12.0% 2.0% 1.2% 1.4% 14.3% 5.9% 51.7 48.2 12.4% -12.4% -3.4% (1.6) 6.0Jun-14 8.0% 5.6% 2.2% -16.2% 13.2% -1.4% 7.3% 3.3% 4.3% 13.2% -0.4% 51.4 51.1 10.0% -22.1% 27.2% 0.3 10.5Sep-14 8.7% 4.4% 6.0% -3.8% 19.0% 0.3% 12.9% 6.3% 3.6% 10.9% 9.7% 52.1 51.5 5.6% 139.4% 4.0% 2.5 11.6Dec-14 5.9% 3.8% 7.0% 4.6% 1.2% -21.8% 13.2% 7.9% 6.9% 10.6% 7.5% 53.1 51.3 4.4% 158.1% -3.5% 1.1 8.8Mar-15 7.1% 2.4% 4.3% 4.9% -0.2% -29.9% 16.9% 3.5% 4.0% 9.8% 16.5% 52.1 53.1 5.3% 117.6% -13.2% 2.5 16.3Jun-15 7.7% 1.2% 8.7% 4.7% 0.6% -16.2% 16.4% 0.9% 4.7% 9.5% 37.6% 51.8 49.9 5.1% 35.9% 0.9% 3.7 12.5Sep-15 8.2% 2.4% 10.6% 9.5% -1.3% -24.8% 17.1% -2.9% 3.8% 9.0% 31.5% 52.1 51.3 6.0% -4.5% -5.7% 8.5 16.2Dec-15 7.3% 4.2% 15.1% 11.0% 4.4% -1.6% 17.5% -6.9% 1.3% 9.7% 36.3% 50.0 52.3 5.09% -34.8% -10.0% 7.8 14.5Mar-16 9.3% 5.4% -1.7% 20.0% 8.6% 7.9% 19.7% -8.4% 7.4% 11.0% 21.5% 51.5 53.3 5.31% 16.7% -14.7% 11.3 15.3Jun-16 8.1% 7.1% -1.4% 13.0% 14.3% 14.8% 17.3% -8.6% 6.2% 9.2% 34.5% 51.0 51.7 5.77% 14.6% 3.2% 4.7 10.0Sep-16 7.6% 4.5% 11.5% -0.2% 20.6% 27.7% 21.1% -8.0% 4.6% 9.4% 19.4% 52.2 52.9 4.61% -33.8% 9.7% 1.1 12.1Dec-16 6.8% 3.8% -2.3% -1.1% -4.6% 17.7% 19.4% -4.7% 12.4% 6.7% 24.2% 52.1 49.3 5.56% -31.9% 23.6% 5.7 12.0Mar-17 6.1% 3.1% 8.1% 5.7% -2.3% 13.1% 15.9% -0.2% 4.7% 4.3% 14.6% 51.2 50.2 5.99% -10.5% 20.5% (3.8) 1.8Jun-17 5.6% 1.9% 4.0% -9.1% 7.8% 8.4% 15.5% 3.4% 5.3% 5.2% 13.4% 51.7 51.8 5.88% -33.3% -16.1% 5.9 10.9Sep-17 6.3% 3.3% 9.0% 21.1% 12.3% 36.7% 13.5% 5.0% 1.2% 6.1% 30.3% 50.1 48.0 5.92% -61.4% 6.3% 7.2 9.8Dec-17 7.0% 5.9% -0.5% 33.7% 15.7% 7.8% 16.5% 8.6% 4.3% 8.6% 8.1% 52.5 50.0 4.53% -20.8% 18.0% 4.7 7.3Mar-18 7.7% 6.5% 0.9% 30.9% 24.8% 44.0% 20.2% 7.4% 8.1% 10.8% -16.8% 51.8 49.9 3.66% -25.7% -4.2% 9.6 13.5Jun-18 8.2% 5.1% 18.0% 51.5% 15.9% 25.7% 17.1% 8.2% 3.9% 12.5% 36.3% 52.0 51.2 3.61% -7.2% 21.1% 3.6 8.7Sep-18 7.1% 5.2% -2.4% 27.5% 4.9% 0.0% 16.1% 6.9% 6.4% 12.9% -16.8% 52.1 52.2 3.44% 11.6% 8.3% 2.7 6.6Dec-18 5.7% -2.2% 18.5% 9.3% 9.8% 13.7% 7.0% 4.3% 14.4% -12.9% 53.1 52.3 0.4 5.9

Source: CEIC, Bloomberg, Citi Research

Figure 2. Rural and Urban demand moderate in 2H-2018 Figure 3. Consumer sentiment has not revived after demonetization

0.200.250.300.350.400.450.500.550.600.650.70

Jan-

14

May-1

4

Sep-

14

Jan-

15

May-1

5

Sep-

15

Jan-

16

May-1

6

Sep-

16

Jan-

17

May-1

7

Sep-

17

Jan-

18

May-1

8

Sep-

18

Urban demand macro factors Rural demand macro factors

859095

100105110115120125130

Jun-11Mar-12Dec-12Sep-13Jun-14Mar-15Dec-15Sep-16Jun-17Mar-18Dec-18Current Situations Future Expectations

NDA comes to power

Demonetization

Pessimism

Optimism

Source: CEIC, Company reports, Citi Research Source: CEIC, Citi Research


5

Figure 4. Rural wage growth continues to languish Figure 5. Similar story for Urban wage growth too

(5)

-

5

10

15

20

25

Nov-05 Nov-07 Nov-09 Nov-11 Nov-13 Nov-15 Nov-17

%YoY

Nominal Rural Wage Real Rural Wage

-8%

-3%

2%

7%

12%

17%

Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18

% YoY

Nominal wage Real wage

Source: CEIC, Citi Research Source: CEIC, Citi Research, Urban wage growth measured through different services

Figure 6. Signs of weakness in passenger car sales Figure 7. ….and 2W sales too

-50%

0%

50%

100%

150%

200%

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

3m/3m saar

PV Sales 6 per. Mov. Avg. (PV Sales)

-100%

-50%

0%

50%

100%

150%

200%

250%


3m/3m saar

2W Sales 6 per. Mov. Avg. (2W Sales)

Source: CEIC, Citi Research Source: CEIC, Citi Research

Figure 8. Investment starts to contribute to GDP growth Figure 9. The investment recovery is visible in our indicator too

(2.0)

-

2.0

4.0

6.0

8.0

10.0

FY13 FY14 FY15 FY16 FY17 FY18 FY19E FY20E

%YoY

Consumption GCF Net Exports GDP

0%

5%

10%

15%

20%

25%

0.20

0.30

0.40

0.50

0.60

0.70

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

1QFY

182Q

FY18

3QFY

184Q

FY18

1QFY

192Q

FY19

3QFY

19

MII Index (LHS) GFCF Growth (RHS)

QuarterlyAnnual

Source: Citi Research Source: CEIC, Citi Research, MII = Monthly Investment Indicator


6

Figure 10. What is improving/worsening on the investment side Figure 11. Nominal interest rates likely to be on a gradual decline

Q3FY19 Q2FY19 Q1FY19 Q4FY18 Q3FY18What improved in Q3Air Cargo 23.9% 10.3% 11.9% 5.0% 7.8%Capital Goods prod 16.8% 6.0% 8.6% 8.6% 7.4%Cement 18.4% 12.6% 16.4% 18.7% 11.1%Freight Traffic 7.4% 4.3% 6.5% 4.8% 4.2%Electricity 8.5% 7.0% 5.1% 7.3% 6.3%Non Food Credit 13.7% 13.0% 12.2% 11.4% 7.8%What worsened in Q3Infra industries 4.7% 5.4% 5.5% 5.4% 5.2%Diesel 1.0% 2.7% 3.6% 9.6% 4.7%Port Traffic 4.0% 6.4% 4.0% 8.3% 4.3%Steel Production 2.2% 4.7% 2.4% 3.8% 7.8%Capital goods imports 9.3% 18.3% 18.5% 14.9% 10.2%Bitumen 13.7% 24.2% 16.1% 9.6% 3.9%CV Sales 12.8% 27.4% 52.5% 29.9% 32.0%

5.0

7.0

9.0

11.0

13.0

Feb-12 Jan-13 Dec-13 Nov-14 Oct-15 Sep-16 Aug-17 Jul-18

%

Repo rate WALR Outstanding Loans WALR Fresh Loans

Source: CEIC, Citi Research Source: CEIC, Citi Research WALR = Weighted Average Lending Rate

Figure 12. Capacity utilization improves, but more room to go Figure 13. Banking Sector NPA falls after eight long years

7071727374757677787980

Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Jun-18Deseasonalized Capacity Utilization Last 5 yr avg

10.4

8.8

7.2

5.2

3.5

2.5

2.3

2.3

2.4 2.5 3.1 3.6 4.1 4.3

7.6

9.6

11.5

10.8

--

--

-- 1.2

2.8 4.5 3.5

5 5.8 5.9 6.43.9

2.40.9

0.5

-

2

4

6

8

10

12

14

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

1HFY

19

%

Gross NPLs Restructured Assets

Source: CEIC, Citi Research Source: CEIC, Citi Research, % of total assets

Figure 14. Deposit growth lags the sharp improvement in credit Figure 15. …which is also quite broad-based

05

101520253035404550

Dec-97 Dec-00 Dec-03 Dec-06 Dec-09 Dec-12 Dec-15 Dec-18

%YoY

deposit YoY credit YoY

-245 -295 -225

434

-114 -195 -93 -73 -28 -30

31

3,272

662 640 878295 67 143 123

-131 -164 -381-1,000-500

0500

1,0001,5002,0002,5003,0003,500

Tota

l cre

dit

NBFC

Infra

loan

s

Hous

ing

Agri

Chem

icals

Infra

Pow

er

Infra

road

s

Text

iles

Cons

umer

dur

able

s

Iron

and

stee

l

INR bn

7MFY18 7MFY19



7

A sustained downdrift in headline CPI from mid-2018 onwards with a strong divergence between headline and core inflation has surprised the markets. We expect a modest bounce in 2019 on a low base but still forecast a benign outlook.

Food price deflation – some tentative explanations: We note that food inflation has been declining (on a seasonally-adjusted MoM basis) consistently from FY13 onwards. This has led to food inflation staying below the headline for almost three years now. There appears to be a structural element in this decline which has got accentuated in the last three quarters where seasonally-adjusted MoM food inflation has been negative. One of the factors driving this could be steady increase in supply of foodgrain and horticulture crops despite weather disturbances which has possibly overshadowed demand growth. The overall supply has probably also benefited from better supply-chain management reducing wastage and price volatility. Introduction of GST has likely aided this by removing the state borders. Even a sharp drop in net agri products exports (down ~US$9.5bn between FY14 and FY17) could have exacerbated the excess supply situation. On the other hand, the increase in cost of production has been materially lower in the last four years, contributing to lower food inflation. Although the pass-through for India is not perfect, lower global food prices (in deflation for almost four years now) surely helped in the structural decline.

The illusive MSP pass-through: The current bout of deflation is particularly surprising considering the fact that the government increased the MSP of 13 summer (Kharif) crops by an avg ~ 20% in production weighted terms. In our daily wholesale price tracker of these crops, the weighted avg price increase has been only 4% from the day of MSP announcement and for retail prices, the cereals CPI inflation fell to three-year low of 1.25%YoY in Nov. It appears that without the reinforcements from rural wage growth and global food price inflation, MSP on its own is not having the desired impact on food prices. Delayed winter sowing and any populist reaction by government considering the political fallout of protracted food deflation appear to be the upside risks to food prices.

Core inflation diverges from food: The momentum in core inflation has started inching up from mid-2017 onwards as the economy was coming out of the twin shocks of demonetization and GST and it was aided by idiosyncratic events like HRA increase for public sector employees. Inflation in items like health and education has been consistently high, partly reflecting the change in spending pattern. Output gap appears to be closing as the GDP growth nears the 7.5% mark. However, our preferred measure of non-volatile CPI index (excluding pulses, veggies, housing, transportation, wt=73%) fell to 3.7%YoY in November, an all-time low for the current 2011-12 data series.

Low fuel prices could also be supportive: With expectations of Brent crude averaging US$60/bbl in 2019 vs US$72 in 2018, we expect the pressure on the fuel index to be low. In our estimate, a 10% drop in oil prices leads to ~20bps fall in headline CPI.

Outlook for 2019: Going forward we expect headline CPI to stay below 4% mark until 1HFY20 before picking up towards 4-4.5% in 2HFY20 under the broad assumption of crude prices staying close to US$60/bbl and monsoon conditions stable. This would imply FY19 CPI to avg at 3.7% and FY20 at 4%.The divergence between core and food inflation is likely to narrow as the relatively softer growth and strong base drag down core inflation. Food inflation has shown some characteristics of structural decline but delayed winter crop sowing and a weak base should be supportive of deflationary trends in food inflation reversing in 2019. Large MSP hikes in 2018 have not impacted food prices as yet and remain a wild card if finally

Inflation

user

Highlight

user

Highlight


8

prices drift towards MSP in 2019. Headline CPI is likely to stay below 4% in 1H 2019 but could be approaching 4.5% by Dec 2019 on adverse base effect.

Figure 16. Softening of food inflation momentum, core inflation remains more stable

1.0%

0.7%

0.5%

0.4%

0.2% 0.3

%

-0.3%

-0.1%

0.2%

0.1%

0.4%

0.57%

0.64%

0.33%

0.38%

0.40%

0.44%

0.44%

0.41%

0.49%

0.43%

0.35%

-0.50%

-0.30%

-0.10%

0.10%

0.30%

0.50%

0.70%

0.90%

1.10%

FY13

FY14

FY15

FY16

FY17

FY18

1QFY19

2QFY19

3QFY19

FY19E

FY20E

% MoM

Food CPI Core CPI

Source: CEIC, Citi Research

Figure 17. Broad-based decline in inflation for even protein items Figure 18. Vegetable price volatility reducing

0%2%4%6%8%

10%12%14%16%18%

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

% YoY

Meat&Fish Cereals Milk

60

80

100

120

140

160

180

200

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19Vegetables Index Poly. (Vegetables Index)



9

Figure 19. MSP pass-through far lower than expected Figure 20. Cost of agri input materials increasing

-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%

7/5 7/20 8/4 8/19 9/3 9/18 10/3 10/18 11/2 11/17 12/2 12/17 1/1Paddy based Index Rice Based Index

-20%-15%-10%-5%0%5%

10%15%20%25%30%


%YoY

input cost labor cost input materials

Source: Bloomberg, Citi Research, % change in a CPI-weighted MSP items price index from the date of MSP announcement


Figure 21. Service sector inflation starts inching up to the mid-point of their respective medium-term ranges

5.5%6.5%

0.9%

11.3%

4.9%6.5%

8.8%

5.5% 4.8%

8.6%

6.0%7.8%

3.5%5.2% 5.7%

-2%0%2%4%6%8%

10%12%14%16%

House

Rent

School

Fee

Teleph

one ch

arge

Bus/Tra

m fare

Cable

tv

Doc c

onsult

fee

Servan

t/cook

Private

tutitio

n

Taxi/au

to fare

Barber

/Beaut

ician

Medic

al test

s

Hospi

tal cha

rges

Tailor

fee

Grindi

ng cha

rge

Core C

PI Serv

ices

%YoY

Max Min current


Figure 22. Different measures of core inflation (%YoY) Figure 23. Fuel inflation could correct following sharp oil price drop

3%

4%

5%

6%

7%

8%

9%

10%

Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Nov-18

%YoY

Core CPI ex trans ex housingCore CPI YoYCore CPI ex-transCPI ex pulses, veggies ex housing ex trans

-4%

-2%

0%

2%

4%

6%

8%

10%

-80%-60%-40%-20%

0%20%40%60%80%

100%

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

CPI trans YoYBrent YoY

Brent INR YoY LHS CPI transportation YoY RHS



10

Figure 24. Inflation expectations stay elevated Figure 25. Projecting convergence of headline and core CPI in FY20

02468

1012141618

Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Nov-18

%YoY

Infl. Exp 3m ahead Infl. Exp 12m ahead

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%


%YoY

Headline CPI Core CPI %YoY



11

The government has reiterated its commitment to stick to the FY19 fiscal deficit target of 3.3% of GDP despite the Apr-Nov deficit being 115% of the target. Although the February budget is likely to be a vote-on-account budget without major announcements, the mantle of continuing fiscal prudence will lie with the post-election budget to be presented in June.

Revenue shortfall acute but expenditure discipline maintained: While direct tax collection growth at 13.6% in the Apr-Nov period has been comfortable (BE 14.4%), indirect tax collection growth of only 2% is falling far short of the 19% target. There could be ~INR1.3trn shortfall in indirect taxes even if the growth rate improves to 20% for the rest of the year, which itself appears to be a tall ask. Tardy GST collections primarily to be blamed – monthly average at INR968bn against a target of INR1.06trn. Even the divestment revenue at INR 338bn is way short of the budget estimate of INR 800bn. Expenditure growth at 9.1% is close to the target (10.1%) but further pruning could be required. Heavy-spending infra ministries like Roads and Railways have seen robust spending growth but social sector ministries like HRD and Women and Child development have been slow in spending.

Innovative ways to meet the FY19 fiscal deficit target might not be enough: Although it appears that meeting the 3.3% target is going to be challenging, the government still has some levers. One, the National Small Savings Fund (NSSF) collections at INR1.3trn has been much better than the budget estimate of INR 750bn. Even towards the end of FY18, ~INR400bn was loaned out from this account to reduce the expenditure on food subsidy and keep the fiscal deficit at 3.5%. Two, there could be some surplus in the compensation cess fund of GST which can now be shared equally between the states and the center after recent legislative changes. Three, RBI could be asked to provide an additional interim dividend. Four, some expenditure could be pushed back to 1QFY20, taking advantage of the cash accounting system. Despite these accounting levers, meeting the 3.3% of GDP fiscal deficit target appears to be increasingly difficult.

Populism, but how? Markets always worry about fiscal populism in a pre-election phase but, in the last few instances, the governments have been relatively prudent even in that period, except 2008-09 (though it was also to counter the global financial crisis). The spate of farm loan waivers announced from 2017 onwards could cost the state exchequer ~INR 2trillion (~1.2% of GDP), though the actual impact could be staggered over several years. Even if a national farm loan waiver is announced, we do not expect it to be rolled out before elections and hence it is more of a FY20 fiscal risk. Other kinds of income support for farmers (Telangana model) could be less distortionary but more difficult to implement given lack of proper land records, and it could be regressive too. PM Modi has promised to bring 99% of the items under 18% or less GST rates (at present ~97% of the 1,200 items fall in this category). This is prompting some tweaks in GST rates despite stiff revenue challenges.

State fiscal health still a concern: States had budgeted for a 2.6% of GDP fiscal deficit in FY19 after breaching the 3% mark for three years running. There is not much consolidation noticed in our 12-month rolling state fiscal deficit data despite a sharp cutback in capital expenditure growth. Tax revenue growth for the states has also been tardy, indicating that their fiscal marksmanship could be continuing even in FY19 with chances of the 2.6% target being breached. Large farm loan waivers could only worsen this situation

Fiscal

user

Highlight

user

Highlight

user

Highlight


12

Figure 26. FYTD deficit reaches a historic high in November Figure 27. Revenue shortfall causing the deficit to rise

43% 45% 48

%

70%

49%

63%

61% 65

%

35%

59%

43%

59%

75%

101% 103%

91%

85.7%

102.9

% 114.8

%

10%

30%

50%

70%

90%

110%

130%

FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15 FY17 FY19

%

fiscal deficit as % of budgeted

47%

48%

47% 54

%

47% 50

%

50% 52

%

46% 52

%

52%

52% 55

%

65%

65%

64%

63.9%

66.7%

66.1%

50%

49%

47% 48%

46%

45% 46% 49

% 53%

48%

55%

47%

45% 48

%

48% 52

.0% 56.0%

53.4%

49.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%


%

expenditure as % of budgeted revenues % budget

Source: CEIC, Citi Research, *for the Apr-Nov period Source: CEIC, Citi Research, *for the Apr-Nov period

Figure 28. Table of Central Govt Expenditure 7MFY19 vs budget Figure 29. Direct tax compliance increase

Ministry Budget: FY19 (INR bn)

Expenditure: Apr-Oct 2018

(INR bn)

Expenditure: Apr-Oct

2018, % BE

%YoY

Defence 4044 2654 65.6 9.2Consumer Affairs, Food and Public Distribution

1759 1377 78.3 3.4

Rural Development 1149 769 66.9 12.1Home Affairs 1076 731 68.0 18.0Human Resource Development

850 461 54.3 -0.8

Road Transport and Highways

710 534 75.2 29.0

Chemicals and Fertilisers

706 508 72.0 15.2

Agriculture 576 394 68.5 20.2Railways 551 309 56.1 34.9Health and Family Welfare

546 349 64.0 21.1

68.4

54.3

37.9

54.2

31.7

9.9 8.6

0

10

20

30

40

50

60

70

80

FY18 FY17 FY14 Apr- Aug2018

Apr-Aug2017

New filersin FY18

New filersin FY17

mn

Up 26%

Up 71%

Up 15%

Source: Budget Documents, CEIC, Citi Research Source: PIB, Citi Research

Figure 30. Central government’s total indirect tax collections very flat in FY19

- - - 0

939

536 576 496 495 508317

496 607 523 492

261 490 526

416 514

(600) (400) (200)

- 200 400 600 800

1,000 1,200

Apr-1

7

May-1

7

Jun-17

Jul-17

Aug-1

7

Sep-1

7

Oct-17

Nov-1

7

Dec-1

7

Jan-18

Feb-18

Mar-1

8

Apr-1

8

May-1

8

Jun-18

Jul-18

Aug-1

8

Sep-1

8

Oct-18

Nov-1

8

Rs Bn

Customs+Excise+Service CGST Cess IGST GST (CGST+IGST+Cess)



13

Figure 31. Oil dependence of exchequer was on the rise Figure 32. GST collections fall short of the INR 1.06trn pm target

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%

-

1,000

2,000

3,000

4,000

5,000

6,000

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 1H19

%GDPINR bn

Contribution to central govt Contribution to state govtsTotal contribution as% GDP

Month IGST CGST SGST Comp Cess

Total

Nov-17 395 157 229 79 861Dec-17 431 136 194 77 839Jan-18 453 148 208 82 891Feb-18 450 146 205 81 882Mar-18 448 157 215 73 894FY18 avg. 431 132 191 69 823Apr-18 505 187 257 86 1035May-18 491 159 217 73 940Jun-18 495 160 220 81 956Jul-18 499 159 223 84 965Aug-18 499 153 212 76 940Sep-18 501 153 211 80 944Oct-18 534 165 228 80 1007Nov-18 497 168 231 80 976Dec-18 479 164 225 79 947FY19 avg. 500 163 225 80 968


Figure 33. State finances leave little room for farm loan waiver Figure 34. Expected improvement in general government deficit difficult

INR bn Quantum of

proposed Loan

waiver

Total agri loan

outstanding end FY18

Total crop loans

disbursed in

FY17

Fiscal def as % of GSDP

Debt as % of GSDP

MP 360 671 429 3.4% 25%Rajasthan 180 737 579 3.5% 33%Chhattisgarh 61 110 94 3.0% 16%Karnataka 420 901 417 2.8% 18%Maharashtra 345 3293 413 1.8% 17%Uttar Pradesh 360 666 37 3.1% 25%Punjab 100 720 580 4.5% 42%Assam 6 103 15 12.7% 18%Total 1832 7201 2564

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0


% of GDP

Center fiscal deficit State fiscal deficit


Figure 35. No major improvement in states fiscal deficit Figure 36. …despite sharp pullback in capital expenditure growth

-6,000

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18

INR bn

Thou

sand

s

Revenue Surplus or Deficit Fiscal Surplus or Deficit

-5%

0%

5%

10%

15%

20%

25%

30%

Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18

%YoY 12 month rolling

Expenditure Expenditure: Revenue Expenditure: Capital

Source: CEIC, Citi Research, 12-month rolling deficit Source: CEIC, Citi Research


14

India’s external sector outlook remains inextricably linked with global crude prices, unlike several other EM economies that may be impacted by the evolving contours of a Sino US trade war. The recent plunge in Brent crude price by over 30% in past three months creates a favorable backdrop for India’s balance of payments and Indian rupee, but only as long as the prices stay benign.

Current account deficit set to narrow by US$15bn in FY20: After rising to a five-year high of 2.9% of GDP in 2QFY19, the current account deficit is set to narrow in FY20 to a relatively more comfortable ~2% of GDP on account of lower oil forecast (US$60/bbl in FY20 vs US$72/bbl in FY19). In US$bn terms, we expect FY20 current account deficit at US$59bn from US$74bn in FY19. Note that everyUS$1/bbl decline in crude reduces annual trade deficit by around US$1.3bn. We expect gold imports to stay largely unchanged at US$36bn with gold prices likely to flat line at US$1275/oz. We continue to expect exports and non-oil non-gold imports to stay resilient at 10% and 11% respectively in FY20. The relative constancy of the high non-oil trade deficit remains a structural concern as neither import substitution nor export promotion have achieved their desired pace.

Capital account surplus to rise by US$34bn in FY20: It was not just the current account that worsened in FY19, but the capital flows also fell from US$91bn in FY18 to an estimated US$49bn in FY19 with FPI flows turning from US$22bn inflow to US$8bn outflows. For FY20, we expect portfolio flows to normalize to US$16bn as lower crude prices and stable outcome post general elections (our base case) could enhance attractiveness for Indian assets. We expect FDI flows to also pick up to US$36bn in FY20 after having dipped in last two years, although recent notification regarding FDI in ecommerce market place companies could act as a dampener.

BoP to swing into surplus, Basic Balance still in deficit: As a result of improved current and capital account dynamics, we expect the balance of payments for FY20 to swing to a surplus US$24bn as compared to a deficit US$25bn in the previous year. That said, the basic balance (FDI+CAD) could stay in deficit even in FY20 (-US$23bn vs -US$43bn last year), which will keep the Central Bank vigilant for external risks and possibly predisposed towards rebuilding reserves and resilience.

INR Outlook: rebuilding reserves, REER overvaluation to cap gains: Since end FY18, the RBI’s foreign exchange reserves have declined by ~US$30bn (US$424bn to US$394bn) and its forward book has swung from long US$21bn to short US$3bn, resulting into a total drag of over US$50bn. As for the exchange rate, while the INR fell by a meaningful ~10% against the dollar, its drop was only 4% in real effective exchange rate terms. In fact, the rupee was still overvalued by ~10% as per 36 country REER (2004-05 base). So while the swing in balance of payment to a surplus in FY20 remains a major tailwind for INR, we expect the gains to be capped for the following reasons: 1) RBI will look to opportunistically rebuild its depleted reserves; 2) RBI will remain watchful of further REER overvaluation; 3) basic balance remains negative thus exposing INR to FPI flow volatility. As a result, we expect the rupee to trade at 68.5 in 0-3m and 70.5 over 6-12m horizon in 2019. The crude price and general election results will be crucial determinants of current account and capital account flows respectively, and any disappointment would introduce a downside risk to the rupee.

External Sector

user

Highlight


15

Figure 37. Balance of Payment to turn to surplus in FY20 Figure 38. .. Led by narrowing in current account deficit

-20

13 13

-13

416

61

18 22

44

-25

24

-6-20

-36

-56-68

-11

414 20

-18

-43-23

-80.0

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

FY09 FY11 FY13 FY15 FY17 FY19E

US$bn

Overall BoP Basic Balance

-4 -1 -3 -6 -5 -5 -4 -5 -3

3 614

-2-10-10

-16-28

-38-48

-78-88

-32-27-22

-15

-49

-74

-59

-6-5-4-3-2-10123

-100

-80

-60

-40

-20

0

20

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

EFY

20E

Current Account Balance(LHS) % to GDP(RHS)

US$bn % GDP


Figure 39. Lower oil prices to help narrow current account deficit Figure 40. Capital flows to improve in FY20 on better FPI flows

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

FY20

E

% GDP

CAD % GDP Net Oil Imports % GDP

0

2

4

6

8

10

0

20

40

60

80

100

120FY

93FY

94FY

95FY

96FY

97FY

98FY

99FY

00FY

01FY

02FY

03FY

04FY

05FY

06FY

07FY

08FY

09FY

10FY

11FY

12FY

13FY

14FY

15FY

16FY

17FY

18FY

19E

FY20

E

Capital account % to GDP

US$Bn %


Figure 41. FDI inflows have moderated from their recent highs Figure 42. FPI flows turn negative in FY19 in both equity and debt

10

20

30

40

50

8/2012 8/2013 8/2014 8/2015 8/2016 8/2017 8/2018

USD bn

Net FDI 12 month trailing sum Gross FDI 12m trailing sum

0 2 2 2 19 10 11

613

-10

23 24

9

26

1318

-28 4

-70

00 0 0

1 0

-2

1

3

0

7 8

10

5

-5

27

-1 -1

19

-7

-20

-10

0

10

20

30

40

50

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

YTD

Debt Equity

US$bn



16

Figure 43. Forward adjusted reserves down over US$50bn in FY19 Figure 44. RBI likely to intervene in FY20 to recoup reserves

200

250

300

350

400

450

500

Oct-1

2

Apr-1

3

Oct-1

3

Apr-1

4

Oct-1

4

Apr-1

5

Oct-1

5

Apr-1

6

Oct-1

6

Apr-1

7

Oct-1

7

Apr-1

8

Oct-1

8

US$bn

Thou

sand

s

Fx Reserves Forward adj reserves

65.0

75.0

85.0

95.0

105.0

115.0

125.0

-25.0-20.0-15.0-10.0-5.00.05.0

10.015.020.0

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Jan-

13Ju

l-13

Jan-

14Ju

l-14

Jan-

15Ju

l-15

Jan-

16Ju

l-16

Jan-

17Ju

l-17

Jan-

18Ju

l-18

REERUS$bn

RBI Net Intervention 36-country REER


Figure 45. Balance of Payment Projection for FY20E ( US$bn)

FY13 FY14 FY15 FY16 FY17 FY18 FY19E FY20Ea.Trade Balance -195.7 -147.6 -144.9 -130.1 -112.4 -160.0 -190.0 -176.8 Exports 306.6 318.6 316.5 266.4 280.1 309.0 347.0 381.7 Imports 502.2 466.2 461.5 396.4 392.6 469.0 537.0 558.5 ow : Gold 53.8 28.9 34.4 27.5 27.5 33.6 35.6 36.3 : Oil 164.0 164.8 138.3 82.9 87.0 109.1 137.9 119.3 : Non-oil Non-gold 272.9 256.6 275.3 270.5 269.9 317.0 355.0 394.1b. Invisibles 107.5 115.2 118.1 107.9 97.1 111.3 116.3 117.7Services 64.9 73.0 76.6 69.7 67.5 77.6 82.0 86.4 ow:Software Services 63.5 67.0 70.4 71.5 70.1 72.2 78.0 81.9Transfers 64.0 65.3 65.7 62.6 56.0 62.4 65.0 64.0 ow:Private Transfers 64.3 65.5 66.3 63.1 56.6 62.9 65.5 64.5Investment Income -21.5 -23.0 -24.1 -24.4 -26.3 -28.7 -30.7 -32.71. Current Account (a+b) -88.2 -32.4 -26.8 -22.2 -15.3 -48.7 -73.8 -59.1% GDP -4.8 -1.7 -1.3 -1.0 -0.7 -1.9 -2.7 -2.0c.Loans 31.1 7.8 3.2 -4.6 2.4 16.7 15.0 14.0d.Foreign Investment 46.7 26.4 73.5 31.9 43.2 52.4 23.0 52.0

ow: Portfolio Investments 26.9 4.8 42.2 -4.1 7.6 22.1 -8.0 16.0 : FDI 19.8 21.6 31.3 36.0 35.6 30.3 31.0 36.0e.Banking Capital Net 16.6 25.4 11.6 10.6 -16.6 16.2 14.0 16.0

Ow: NRI deposits 14.8 38.9 14.1 16.1 -12.4 9.7 11.0 14.0f. Other capital -5.0 -10.8 1.1 3.3 7.6 6.2 -3.0 1.0g.Rupee debt service -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1Capital Account (c:g) 89.3 48.8 89.3 41.1 36.5 91.4 49.0 83.0Overall Balance of Payment 3.8 15.5 61.4 17.9 21.6 43.6 -24.8 23.8Source: Citi Research


17

Change in monetary policy stance expected soon: In hindsight, the change in monetary policy stance to “calibrated tightening” by the RBI in Oct 2018 appears to have been premature. The persistent undershooting of headline CPI, lower oil and stable currency opens up the possibility of change in policy stance and/or a rate cut in the Feb policy itself. We assign a 60% probability to a stance change and a 15% probability of a rate cut in Feb. The influence of the new RBI Governor, Mr. Shaktikanta Das, on the nuances of the MPC thought process would be critical for the markets. While the RBI has targeted to keep the ex-ante real policy rates in the 125-175bps range, the ex-post real policy rates have turned out to be significantlyhigher because of forecast misses on inflation. Any signs of change in theforecasting approach, more emphasis on near-term inflation trajectory and anyindication of supporting growth through lower real rates could increase rate-cutexpectations. We will update our stance change/rate-cut probabilities based onincoming data and any change in MPC narrative.

Hurdles to substantial easing: The Feb decision will also depend on the fiscal stance expressed in the budget. If the government plans any fiscal easing in FY20 or slips sharply on the FY19 target, then the scope of monetary easing will be limited as core inflation concerns will be lingering on the backdrop of rather robust growth. This combination of relatively strong growth, high core inflation and uncertainty over fiscal stimulus appears to be the hurdle in front of substantial monetary easing though rate cycle might have peaked out. Adding to it, some might argue that the structural issue of lower household financial savings might warrant slightly elevated real rates for longer. Otherwise, despite softening of market rates, deposit rates could inch up to incentivize household financial savings and shift of that into bank deposits – in FY18 only 26% of household gross financial savings was in bank deposits versus an average 55% in the five years before that. This is leading to marginally higher lending rates despite soft inflation prints.

Liquidity assurance a defining moment: Banking system liquidity got squeezed in FY19 with a remarkable INR 2trn increase in currency in circulation and US$25bn FX intervention in the spot market. To counter this liquidity drainage, the RBI has infused INR1.9trn through OMO purchases and, in a market-friendly development, has given an explicit assurance to increase the total FY19 OMO purchase to at least INR 3.38trn. The RBI’s proactive assurance has mitigated the liquidity woes during the NBFC stress and is likely to provide comfort during the seasonally tight 4QFY19 (could be accentuated by election spend) when RBI will make at least INR 1.5trn of OMO purchases. We expect OMO purchase to continue in FY20 too but the extent may be lower as the BoP is likely to switch from deficit to surplus.

Bond markets – OMO, rate cuts, fiscal: With ~90% of the net supply of government bonds being bought by the RBI in FY19, bond markets have witnessed a sharp rally as the demand supply balance has become skewed towards excess demand. Even a fiscal slippage, though a non-negligible risk, might not be able to alter this skew any time soon. There could be some more room for this rally if the MPC indicates its comfort for rate easing in 2019. However, if fiscal risks become large enough to cause rating concerns, then the bond rally could halt.

Time to uphold Central Bank independence: Markets have taken the change of guard in RBI in their stride. The new Governor has promised to uphold the autonomy of the central bank and, over the course of the year, markets are likely to assess Central Bank independence from his policy actions. We expect continuity in the interest rate and FX policies with no significant government influence. On other issues, like transfer of excess capital of RBI, governance structure in RBI, MSME credit, change in norms for PCA banks and NPA recognition, we expect a more consultative approach with stakeholders.

Rates and Liquidity

user

Highlight

user

Highlight


18

Figure 46. Real policy rate remains high Figure 47. …as the output gap closes

(10.0)

(8.0)

(6.0)

(4.0)

(2.0)

-

2.0

4.0

6.0

0

1

2

3

4

5

6

7

8

9

10

Dec-0

2

Dec-0

3

Dec-0

4

Dec-0

5

Dec-0

6

Dec-0

7

Dec-0

8

Dec-0

9

Dec-1

0

Dec-1

1

Dec-1

2

Dec-1

3

Dec-1

4

Dec-1

5

Dec-1

6

Dec-1

7

Dec-1

8Real rate RHS Repo Rate

Real Policy Rate

-8-6-4-20246

Q1 F

Y06

Q4 F

Y06

Q3 F

Y07

Q2 F

Y08

Q1 F

Y09

Q4 F

Y09

Q3 F

Y10

Q2 F

Y11

Q1 F

Y12

Q4 F

Y12

Q3 F

Y13

Q2 F

Y14

Q1 F

Y15

Q4 F

Y15

Q3 F

Y16

Q2 F

Y17

Q1 F

Y18

Q4FY

18

%


Figure 48. Liquidity in deficit mode for most of 2018 Figure 49. Citi Financial Condition Index for India (FCI)

(5,000) (4,000) (3,000) (2,000) (1,000)

- 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

Sep-

13De

c-13

Mar-1

4Ju

n-14

Sep-

14De

c-14

Mar-1

5Ju

n-15

Sep-

15De

c-15

Mar-1

6Ju

n-16

Sep-

16De

c-16

Mar-1

7Ju

n-17

Sep-

17De

c-17

Mar-1

8Ju

n-18

Sep-

18De

c-18

Hund

reds

sys liquidity core liquidity 14 per. Mov. Avg. (sys liquidity) 14 per. Mov. Avg. (core liquidity)

Rs bn

Core Liquidity

System Liquidity -6-5-4-3-2-1012

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

Jan-

13

Jan-

14

Jan-

15

Jan-

16

Jan-

17

Jan-

18

Jan-

19

Loose

Tight

Source: CEIC, Citi Research Source: Bloomberg, Citi Research

Figure 50. OMO reach all-time high in FY19 to neutralize FX intervention Figure 51. Annual OMO purchase/sale vs annual Gsec issuance net

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

Rs trn

Net Fx Intervention Net OMO Purchases total

40%24% 21%

31% 33%

12%

-14%

13%

32%

-22%

92%

-40%

-20%

0%

20%

40%

60%

80%

100%

-1500-1000-500

0500

1000150020002500300035004000

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

RBI Net OMO purchase(INR bn, LHS) % of Annual Borrowing



19

Politics will be pivotal for macros and markets in 2019 as India approaches the general elections in Apr-May. Policy reforms are likely to be absent in the run-up to the elections, with chances of an indulgent dose of populism. The post-election period could usher in discussions about reforms through legislative changes if there is a stable government as the political capital to undertake contentious reforms is high in the early part of the government’s term.

State election results point towards a close contest: In the Dec state elections, Congress toppled the BJP government in three important Hindi-heartland states of Rajasthan, Madhya Pradesh and Chhattisgarh. BJP held 62 out of 65 Lower House seats from these three states in the 2014 election and hence a substantial loss in seats for BJP in the 2019 elections in these three states could be feared. While anti-incumbency could have been behind BJP’s loss of vote share in all the three states, the opposition parties would be energized by the invincibility of BJP in Northern India being arrested. This could help opposition unity in the run-up to the general elections, particularly in states like Uttar Pradesh. If this unity persists then the “math” clearly suggests difficult times ahead for BJP but a seamless transfer of votes would require the “chemistry” of opposition parties to work too. If the chemistry works, the dynamics of opposition unity can become a major risk to the formation of a BJP-led government at the center in 2019.

Different voting pattern in state vs general elections implies base case of BJP-led government with reduced majority: As Fig 26 shows, the voting pattern differed substantially between state and national elections in 2013-14. While it is debatable whether the same person votes differently between state and national elections, it is quite clear that the share of votes of the smaller parties (“Others” in the table) drops substantially in the national elections and BJP has benefitted disproportionately from this shift in the past. With the vote share gap being very small between BJP and Congress in the state elections, our base case for macro forecasts remains of a BJP-led government with a much reduced majority. Opinion polls closer to the election date would be a barometer to test this forecast.

Risks of populism increase: While the BJP-led government has shown exemplary fiscal responsibility in the first four years, the markets might be wary about risks of populism. It is difficult to pump-prime the economy in a short span of time before the code of conduct for the national elections kicks in, but the government might be tempted to change the narrative through some new announcements. Some schemes to guarantee MSP in the hands of the farmer through cash subsidies or an area-based cash subsidy, promise of a universal basic income and even a national farm loan waiver could come under consideration (though the FM has denied any such plan) if the electoral decline of BJP has to be tackled from the economic side. Also, relaxations in GST rates, and small relief for direct tax payers could be considered. The noise level on non-economic issues could also rise substantially.

Elections outcome and economic policy: Different political parties are likely to announce their election manifestos in late Mar/early Apr. These are likely to give pointers towards the future course of economic policy. However, we do not expect a sudden U-turn in the policy direction regardless of the political outcome. If a BJP-led coalition comes to power then, for the first time, it has a chance of having a majority in both houses of the Parliament, though the recent setback in the three state elections will be a deterrent towards achieving that. It could be easier to push through reforms which require legislative approval if it can achieve a majority in both houses. For a Congress-led alliance the lack of Upper House majority could affect the pace of decision making. The number of coalition partners could also have a bearing on the speed of policymaking. Major political risk will arise only if none of the parties are in a position to offer a stable government.

Politics

user

Highlight

user

Highlight


20

Figure 52. Voting Pattern Shifts between State Assembly and National Elections

% of votes polled Assembly 2013 National 2014 Assembly 2018Madhya PradeshBJP 45.7 54.8 41.1Congress 37.1 35.4 41Others 17.2 9.8 17.9

ChhattisgarhBJP 42.3 49.7 32.8Congress 41.6 39.1 43.2Others 16.1 11.2 24

RajasthanBJP 46 55.6 38.8Congress 33.7 30.7 39.3Others 20.3 13.7 21.9Source: Election Commission, Citi Research, *Assembly 2018 results are not yet final

Figure 53 State election results have altered BJP’s national dominance Figure 54. BJP unlikely to achieve RS majority soon

25%41% 43%

67% 69%51%

0

5

10

15

20

25

0%10%20%30%40%50%60%70%80%

May 2014 July 2015 July 2016 July 2017 Dec-17 Dec-18

Number of states

% of Popn

Population under BJP States under BJP

9270

8294

6882

0102030405060708090

100

BJP+ INC+ Others

Rajya Sabha Seats

End 2018 End 2019

Source: Election Commission, Citi Research Source: Election Commission, Citi Research

Figure 55. Rural houses construction slows in FY19 Figure 56. Similar deterioration in rural roads too

0.2 0.41.1 1.1 1.4

2.1

3.3

4.6

2.8

00.5

11.5

22.5

33.5

44.5

5

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 (tillDec)

mn units

Total including states IAY PMAY-G State schemes

CAGR 42%

8566 69

100 100

130 134

72

0

20

40

60

80

100

120

140

160

0

10

20

30

40

50

60

FY12 FY13 FY14 FY15 FY16 FY17 FY18 FYTD19

Kms/dayThousand kms

Length constructed,LHS ( thousand km)

Rate of construction per day, RHS (km)

Source: PMAY-G website, Citi Research Source: PMGSY website, Citi Research


21

External headwinds for INR have receded…The pressure on INR from its struggle to win more capital inflows to finance a yawning current account deficit has certainly eased. Fed hike expectations have been priced out considerably and global yields have receded. The USD is likely to weaken in 2019, as the Fed signals the end of its hiking cycle. This shapes a less hostile external backdrop for capital inflows into India.

…in fact, the lower oil price is proving to be a tailwind. Not only has the outlook improved for portfolio inflows into EM in general, and India in particular, the financing requirement of current account has also shrunk considerably. A sharp drop in oil prices (~40% from the highs in 2018) has eased the current account deficit expectations to below 2% of GDP. This has squeezed bearish INR positions and is reflected in normalization of USDINR NDF points.

But INR’s outperformance will likely be cushioned by potential USD buying by RBI…RBI’s intervention is likely to get more asymmetric in 2019 as it seeks to replenish USD reserves amid a potential pick-up in portfolio inflows. Sharp decline in FX reserves in 2018 (Figure 59) and arguably a still strong currency on REER basis are likely to shape RBI’s intervention bias. This shall curb any excessive outperformance of INR even as flow seasonality is favourable for INR at start of the year. As a result, we prefer to take INR exposure on an opportunistic and tactical basis.

…and risk of a market un-friendly election outcome. Although our base case is for BJP-led government with a reduced majority, the risk of a market un-friendly outcome like a hung parliament has risen especially since the outcome of five State Elections in late 2018. This risk does reflect in elevated levels of USDINR implied volatility covering the election dates in Apr-May’19. We seek opportunities to buy the election event volatility.

India rates are likely to push lower across tenors…Continued downside CPI inflation surprises (with even the core inflation coming off), disappointing growth data and change in RBI’s governorship have flipped market expectations of monetary policy from hikes to cuts. This bias for next move from RBI MPC to be a dovish move is likely to persist, in our view. Together with policy makers’ preference to ease liquidity pressures – thus far, mainly through OMO bond buybacks – this should continue to keep yields on a downward trend.

…as expectations of rate cuts take a firmer hold. ND-OIS curve is already reflecting 2x25bp rate cuts over next 12 months. There seems room for the market to price in more rate cuts further out, potential flattening 1s2s. Potential for positioning squeeze persists, but that should present an opportunity to get back into receivers. 1y1y ND-OIS can potentially ease towards 5.70% (from about 6.23%) once the rate cut cycle gets under-way. Bond yields are also likely to drift lower and 10y bond yield could ease down towards 7.10%, under the base-case election outcome.

Risks to the bullish fixed income view and potential reasons for a steeper yield curve: 1) fiscal slippage: if the central government slips down the populist path and/or revenue shortfall persist; 2) timing of rate cuts: delayed rate cuts may flatten the curve; 3) evolution of data: upside CPI inflation risks pricing of rate cuts; 4) potential squeeze higher in oil prices; and 5) election risk: hung parliament or apopulist leaning coalition government.

Strategy Outlook: INR and India Rates


22

Figure 57. USDINR implied volatility reflects the election event risk Figure 58. Seasonality for INR tends to be favourable at start of the year especially in Mar

5

5.5

6

6.5

7

7.5

8

8.5

9

100

120

140

160

180

200

220

240

Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19

6m USDINR NDF points

6m implied volatility (RS)

(0.50)

-

0.50

1.00

1.50

2.00

2.50

3.00

J F M A M J J A S O N D

Source: Bloomberg, Citi Research Source: Bloomberg, BIS, Citi Research; Note: average cumulative performance of INR’s NEER 2014-17

Figure 59. RBI’s intervention is likely to get more asymmetric as it seeks to replenish USD reserves

Figure 60. Short tenor ND-OIS yields are likely to drift lower once the rate cut cycle gets under way

200

250

300

350

400

450

500

Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18

Headline FX reserves

Net FX reserves

USD bn

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Jan-14 Oct-14 Jul-15 Apr-16 Jan-17 Oct-17 Jul-18

1y1y ND-OIS1y ND-OISPolicy rate

Source: CEIC, Citi Research Source: Bloomberg, Citi Research

Figure 61. Received positioning in offshore seems stretched: Potential positioning squeeze could be an opportunity to receive

Figure 62. Low CPI inflation trajectory may continue to shape bias for rate cuts down the road

6.0

6.2

6.4

6.6

6.8

7.0

7.2

7.4

7.6

7.8

8.0

-40-35-30-25-20-15-10

-505

1015

Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18 Jan-19

Spread b/w 5y ND-OIS and OIS (bp)5y ND-OIS (RS)5y OIS (RS)

0

2

4

6

8

10

12

Apr-11 Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Oct-15 Jul-16 Apr-17 Jan-18 Oct-18RBI median projection Latest CPI

RBI's CPI fan chart (as of Dec)

Source: Bloomberg, Citi Research Source: RBI, Citi Research


23

Figure 63. India Macroeconomic Summary FY07 – 20E

Fiscal Year to 31 March FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19E FY20ENational Income IndicatorsNominal GDP(Rs bn) 42,947 49,871 56,301 64,778 77,841 87,363 99,440 112,335 124,680 137,640 152,537 167,731 188,036 210,867Nominal GDP (US$ bn) 950 1,241 1,224 1,367 1,708 1,816 1,841 1,860 2,027 2,111 2,273 2,600 2,706 3,004Per Capita GDP (US$) 847 1,090 1,061 1,168 1,440 1,489 1,491 1,468 1,600 1,642 1,742 1,969 2,024 2,221Real GDP growth – mkt prices (%) 9.3 9.8 3.9 8.5 10.3 6.6 5.5 6.4 7.4 8.2 7.1 6.7 7.3 7.4By Demand (%YoY)Consumption 7.7 9.4 7.7 8.4 8.2 8.9 4.7 6.2 6.6 7.3 8.0 7.2 8.0 7.9 Pvt Consumption 8.5 9.4 7.2 7.4 8.7 9.3 5.5 7.3 6.4 7.4 7.3 6.6 7.8 7.9 Public Consumption 3.8 9.6 10.4 13.9 5.8 6.9 0.6 0.6 7.6 6.8 12.2 10.9 9.0 7.8Gross Fixed Capital Formation 13.8 16.2 3.5 7.7 11.0 12.3 4.9 1.6 2.6 5.2 10.1 7.6 9.5 8.2Cons; Invst, Savings * (%GDP)Consumption 68.0 67.2 68.6 69.1 67.5 67.3 67.1 67.9 68.6 69.2 69.9 70.5 71.0 71.3Gross Capital Formation 35.7 38.1 34.3 36.3 36.5 39.0 38.7 33.8 34.3 31.8 30.3 30.6 31.2 31.3Gross Domestic Savings 34.6 36.8 32.0 33.7 33.7 34.6 33.9 32.1 32.2 30.7 30.7 28.8 28.5 29.4By Activity (%YoY)GVA (%YoY) 9.6 9.3 6.7 8.6 8.9 6.7 5.4 6.1 7.2 8.1 7.1 6.5 7.1 7.3 Agriculture growth (%) 4.2 5.8 0.1 0.8 8.6 5.0 1.5 5.6 -0.2 0.6 6.3 3.4 4.2 3.0 Industry growth (%) 12.2 9.7 4.4 9.2 7.6 7.8 3.3 3.8 7.0 9.8 6.8 5.5 7.8 7.3 Services growth (%) 10.1 10.3 10.0 10.5 9.7 6.6 8.3 7.7 9.8 9.6 7.5 7.9 7.4 8.4Monetary Indicators (% YoY)Money supply 21.7 21.4 19.3 16.9 16.1 13.5 13.6 13.4 10.9 10.1 10.1 9.2 10.0 12.5Inflation – WPI (Avg) 6.5 4.8 8.0 3.6 9.6 8.8 7.5 4.6 0.4 -3.1 1.9 3.0 4.5 3.8CPI (Avg) 6.8 6.2 9.1 12.3 10.5 8.4 9.9 9.4 5.9 4.9 4.5 3.6 3.7 4.0Bank credit growth 28.1 22.3 17.5 16.9 21.5 17.0 14.1 13.9 10.4 9.5 8.2 10.0 11.0 12.0Deposit growth 23.8 22.4 19.9 17.2 15.9 13.5 14.2 14.1 12.6 7.5 15.3 6.2 9.5 11.0Fiscal Indicators (% GDP)Centre's fiscal deficit) -3.3 -2.5 -6.0 -6.5 -4.8 -5.9 -4.9 -4.5 -4.1 -3.9 -3.5 -3.5 -3.3 -3.0State fiscal deficit -2.1 -1.4 -2.3 -2.9 -2.1 -1.9 -2.0 -2.2 -2.6 -3.6 -3.4 -3.0 -2.6 -2.6Combined deficit (Centre+State) -5.4 -4.0 -8.3 -9.3 -6.9 -7.8 -6.9 -6.7 -6.7 -7.5 -6.9 -6.5 -5.9 -5.6Combined liabilities ( dom+ext) 79.9 76.1 76.8 75.5 70.2 71.9 71.1 71.6 71.0 72.6 71.7 72.9 72.1 69.5External Sector (% YoY)Exports (US$bn) 128.9 166.2 189.0 182.4 256.2 309.8 306.6 318.6 316.5 266.4 280.1 309.0 347.0 381.7 % YoY 22.6 28.9 13.7 -3.5 40.4 20.9 -1.0 3.9 -0.6 -15.9 5.2 10.3 12.3 10.0Imports (US$bn) 190.7 257.6 308.5 300.6 383.5 499.5 502.2 466.2 461.5 396.4 392.6 469.0 537.0 558.5 %YoY 21.4 35.1 19.8 -2.6 27.6 30.3 0.5 -7.2 -1.0 -14.1 -1.0 19.5 14.5 4.0Trade deficit (US$bn) -61.8 -91.5 -119.5 -118.2 -127.3 -189.8 -195.7 -147.6 -144.9 -130.1 -112.4 -160.0 -190.0 -176.8Invisibles (US$bn) 52.2 75.7 91.6 80.0 79.3 111.6 107.5 115.2 118.1 107.9 97.1 111.3 116.3 117.7Current Account Deficit (US$bn) -9.6 -15.7 -27.9 -38.2 -48.1 -78.2 -88.2 -32.4 -26.8 -22.2 -15.3 -48.7 -73.8 -59.1 % to GDP -1.0 -1.3 -2.3 -2.8 -2.8 -4.3 -4.8 -1.7 -1.3 -1.0 -0.7 -1.9 -2.7 -2.0Capital Account (US$bn) 45.2 106.6 7.4 51.6 63.7 67.8 89.3 48.8 89.3 41.1 36.5 91.4 49.0 83.0% GDP 4.8 8.6 0.6 3.8 3.7 3.7 4.8 2.6 4.4 1.9 1.6 3.5 1.8 2.8Forex Assets (incl gold) (US$bn) 199.2 309.2 252.3 277.0 303.5 294.4 292.6 303.7 341.4 355.6 370.0 424.4 399.6 423.4Months of imports 12.5 14.4 9.8 11.1 9.5 7.1 7.0 7.8 8.9 10.8 11.3 10.9 8.9 9.1External Debt (US$bn) 172.4 224.4 224.5 260.9 317.9 360.8 409.4 446.2 474.7 485.0 471.3 529.3 514.4 529.4 Short Term Debt (US$bn) 28.1 45.7 43.3 52.3 65.0 78.2 96.7 91.7 85.5 83.4 88.1 102.2 98.7 103.7Exchange RateUS$/INR - annual avg 45.2 40.2 46.0 47.4 45.6 48.1 54.0 60.4 61.5 65.2 67.1 64.5 69.5 70.2% depreciation 2.0 -11.1 14.4 3.0 -3.8 5.5 12.3 11.9 1.8 6.0 2.9 -3.9 7.8 1.0

* At current prices. FY13-15 GDP data based on New GDP seriesSource: CSO, RBI, Ministry of Finance, Citi Research estimates

Statistical Snapshot

ANTIQUE STOCK BROKING L IMITED 02 January 2019 ||||| 1FROM THE RESEARCH DESK

INDIA STRATEGY

The Capex green-shoots!The economy gains its mojo back!The year gone by was not without its share of surprises. The INR tumbledweighed down by rising imbalances in external sector, as did stocks led by FIIselling - the highest in a decade. Outlook for 2019 will be shaped by theearnings trajectory which though not particularly weak remains susceptibleto downgrades in the banking sector. In 2019, markets are likely to be volatilewith multiple global and local events, the most important being the generalelections in May and further noise around the global trade war. However, webelieve that policy formulation, irrespective of the formation in power, hasbecome more predictable and thrust towards infra, housing and roads isunlikely to see a cut-back. As for sectors, consumption will remain a relevanttheme for the markets but we also believe that capex cycle recovery will emergeas a preferred bet as utilizations rise and earnings pick-up from cyclical lows.Our Nifty year-end target for 2019 is 12,250 based on FY21e EPS of INR 720.

2019: Expect some volatility but macro fears knownThe good bit is that the worst macro out-turns - oil, BoP shock, interest rates and liquiditycrunch- have coalesced in 2018 itself. It is unlikely that there will be a co-ordinated deteriorationin each of these variables for 2019 as well. Global volatility will be a drag on marketperformance especially in 1HCY19 and that will co-incide with the noise around generalelections. But we neither foresee a jump in CPI nor will a liquidity crunch even at a base caseof crude at USD 70/bbl. Macro volatility will be more contained although the stock volatilitywill peak out in 1HCY19.

2019: A year for the investment revivalIndia's capex cycle has disappointed over the last 4-5 years with GFCF/GDP ratio at sub-30% levels since 2013. However, we believe that investment rate has bottomed out andwhile there is unlikely to be a full-fledged capex uptick in 2019, an incipient recovery is afoot-buoyed by a cyclical uptick in corporate capex across sectors like energy, metals and powerwhile momentum will be sustained in public sector through thrust on infra and roads, againirrespective of the formation post 2019 general elections. Exports are adding a tailwind withincreased focus from both domestic as well MNC engineering companies. From a bottom-upperspective, this observation is corroborated by our analysis on the sectoral capex pipe-lineas well as the order inflows which are up by 32% YoY.

2019: Top picks and model portfolioThe capex related sectors (capital goods and corporate focused banks) have underperformedin the last cycle and valuations are at a steep discount as compared to consumption sector.Going ahead, we expect earnings growth to accelerate for these two sectors. We areoverweight the capital goods sector and also as a proxy for the investment cycle, we prefercorporate focused banks as credit costs are likely to decline sharply and the sector emergesstronger by FY20. Funding constraints in NBFCs are beginning to ease out and we like playersin niche segments such as gold financing and CV financing. We remain cautious on exportplays like pharma as we see room for further earnings cuts while in IT we are neutral as theoutlook for deal momentum is balanced by risks such as escalation in trade wars and reversalin USDINR. Consumption will continue to remain a relevant theme due to structural tailwinds('AAA' phenomenon*) but the valuations already build in a lot of these positives.

Overall, earnings trajectory seems to have stabilized and although minor downgrades arepossible we are unlikely to see large cuts such as in FY14-17 cycle. Financials will be in focusgiven its outsized contribution as credit costs are expected to decline. Our Nifty EPS for FY21estands at INR 720 and based on current 1 yr forward P/E of 17x, our index target for thenext year stands at 12,250.

Dhirendra Tiwari+91 22 4031 [email protected]

Dipojjal Saha+91 22 4031 [email protected]

Top picks:Large Caps: TCS, HDFCB, SBIN,ICICIBC, LT, HNDL, MRCO, DRRD,UPLL, SIEM

Mid Caps: MUTH, HWA, VOLT,BYRCS, KVB, NITEC, NJCC, TMKN,CCLP, DN

* AAA phenomenon is Awareness, Aspiration and Availability as highlighted in our flagship ‘Hello India’ report

user

Highlight

user

Highlight

user

Highlight

user

Highlight


Key chartsNifty EPS Nifty sectoral PAT growth (%)

Source: Bloomberg, Antique Source: Bloomberg, Antique

Nifty EPS contribution (FY16-21e)

Source: Bloomberg, Antique

On a trailing basis, valuations are still above long term averages


Sector (% YoY) FY18 FY19e FY20e FY21eAuto ex TTMT 5.4 2.9 19.2 2.8TTMT 53.9 -34.2 26.6 8.1Cement -41.8 17.3 11.5 13.8Consumption 18.2 14.1 16.7 14.2Energy 4.5 9.6 19.3 8.3Pvt corp banks -47.8 6.4 Loss to profit 31.2PSU banks Profit to loss Loss to profit NA 40.3Other banks/fin 49.0 10.0 16.4 37.6Health Care -45.9 9.5 25.7 26.7Industrials 22.4 29.2 14.4 3.0IT Services 2.0 16.0 13.2 9.1Materials 33.3 100.9 -3.4 13.9Telecom -23.8 Profit to loss Loss Loss to profitUtilities -3.6 30.7 10.7 14.1Nifty 7.5 15.0 22.0 16.6

9512

8 175 20

7 239 28

3

247 28

4 330

351 38

5 427

391

402

427

447 50

061

0 717

0

100

200

300

400

500

600

700

FY

03F

Y04

FY

05F

Y06

FY

07F

Y08

FY

09F

Y10

FY

11F

Y12

FY

13

FY

14F

Y15

FY

16F

Y17

FY

18F

Y19

e

FY

20e

FY

21e

-15%

-5%

5%

15%

25%

35%

Nifty EPS YoY, RHS

5

10

15

20

25

30

Dec

-06

Jun-

07

Dec

-07

Jun-

08

Dec

-08

Jun-

09

Dec

-09

Jun-

10

Dec

-10

Jun-

11

Dec

-11

Jun-

12

Dec

-12

Jun-

13

Dec

-13

Jun-

14

Dec

-14

Jun-

15

Dec

-15

Jun-

16

Dec

-16

Jun-

17

Dec

-17

Jun-

18

Dec

-18

(Nift

y tr

ailin

g P

/E)

Trailing P/E Average +1 Std. Dev -1 Std Dev

11.9 9.2 5.4

7.9 6.5 5.6 3.7

0

402.0

48.6

28.1 16.2

4.3 -3.5 -4.3 -9.8 -9.9498.2

111.8

41.617.9

11.0

9.7

1.7

1.2

716.9

350

400

450

500

550

600

650

700

750

FY

16

Mat

eria

ls

Ene

rgy

Fin

anci

als

IT S

ervi

ces

Indu

stria

ls

Con

sum

ptio

n

Util

ities

Hea

lth C

are

Cem

ent

Tel

ecom

Aut

o

FY

19

Fin

anci

als

Ene

rgy

IT S

ervi

ces

Util

ities

Aut

o

Con

sum

ptio

n

Mat

eria

ls

Hea

lth C

are

Indu

stria

ls

Tel

ecom

Cem

ent

FY

20e

(Con

trib

utio

n to

Nift

y E

PS

)


Why will 2019 be the year of investment pick-up?Over the last few years, a big concern has been the dwindling investment rate. GFCF to GDPat FY17 stood at 28.5%, a far below from its FY12 peak of 34.3% and also below thedecadal average of 29.3%. However, since the last 2 quarters, this investment rate is graduallyinching up and now stands at 29.2% as of Sep-2018, a good 120bps off its Sep-2017 lows.

GFCF to GDP off its lows

Source: CMIE, Antique

The slowdown between F12-17 and where we stand now?The sub-categorisation of GFCF has changed between the extant and older series but broadlythe GFCF can be split into two broad segments- machinery and construction. As of FY17, bothconstruction and machinery contributes almost equally to GFCF. Further, as per classificationby institution, the GFCF can be split into public sector, private sector and households.

What does the GFCF comprise of?


Through the above illustration, a 2x3 matrix for GFCF can be constructed and important,larger sub-segments identified. For the public sector, the main driver is public administrationand defence followed by utilities while for the private sector it is predominantly machineryand for households it is real estate.

29.2

15.0

17.0

19.0

21.0

23.0

25.0

27.0

29.0

31.0

33.0

35.0

FY

83

FY

85

FY

87

FY

89

FY

91

FY

93

FY

95

FY

97

FY

99

FY

01

FY

03

FY

05

FY

07

FY

09

FY

11

FY

13

FY

15

FY

17

FY

19td

GF

CF

to G

DP

, %

user

Highlight


The GFCF cycle over the last decade can be broken down into four phases- the sharp uptickbetween FY05-08, followed by a slump in FY09, a transient recovery in FY10-12 and postthat an entrenched slowdown between FY13-16. The contributors to the different phases areas highlighted below:

Phases of capex cycle in IndiaPhase Main capex drivers

FY06-08 'True' capex cycle led by private sector machinery segment but saw participation frompublic sector construction and a late cycle thrust from household sector as well

FY09 Dragged down by private sector machinery capex

FY10-12 Largely led by household sector capex (real-estate) and moderating private sector machin-ery capex

FY13-16 Slowdown in real estate, uptick in public sector construction

FY16-17 Of interest is the uptick seen in FY17-18. Although disaggregated data for FY18 is notavailable, data for FY17 suggests a mild revival for private sector machinery capex alongwith a steady uptick in public sector construction segment.


The drivers of GFCF: by assets… ...by institutions

Source: CMIE, Antique Source: CMIE, Antique

In the backdrop of a prolonged slowdown in GFCF between FY13-FY17, the recentimprovement in the investment rate from 27.5% to 29.2% of GDP has generated a fair bit ofinterest. Two questions are being raised (1) is this growth uptick for real, and (2) if so, howsustainable is this?

To understand both the aspects we looked at a cross-section of both macro as well as microlevel data. The broad findings are that:

Top down macro-data suggesting an uptick1) Strong thrust on capital expenditure from the public sector: Public sector

thrust remains healthy, with contribution from states, centre as well as CPSEs. In fact, thecapex by states as well as CPSEs contribute almost 75% of total public sector spend. Thelast few years has seen a significant jump in off-budgetary spending by CPSEs andstates too have ramped up their capital expenditure. It is unlikely that we see this trendsoftening especially from the states given the strong thrust on specific segments like roadsand irrigation. The only doubt remains on the sustainability of central government's capexgiven the emerging fiscal constraints and also the uncertainties around the 2019 generalelection outcome. The three broad categories of central government's expenditure isdefence, railways and roads. Whichever formation heads the new government, we areunlikely to see a pull-back in roads and railways. On defence though, the growth ratehas been 7% CAGR since 2015 and there could be some scale-back if a new formationcomes into place.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

FY

84

FY

87

FY

90

FY

93

FY

96

FY

99

FY

02

FY

05

FY

08

FY

11

FY

14

FY

17

As

% o

f GF

CF

, 3 y

r av

g

Construction Machinery

0.0

10.0

20.0

30.0

40.050.0

60.0

70.0

80.0

90.0

100.0

FY

84

FY

87

FY

90

FY

93

FY

96

FY

99

FY

02

FY

05

FY

08

FY

11

FY

14

FY

17

As

% o

f GF

CF

, 3 y

r av

g

Public sector Private corporate sector Household sector

user

Highlight


Public sector capex: thrust likely to continueComponent, nominal terms (% share) FY12-FY19, CAGR %

CPSE 36.3 11.7

State Govt 40.8 17.8

Union govt 22.8 9.6Source: CMIE, Antique

Extra budgetary funding key for roads and railways Developmental capex from state governments will remain high


2) Utilisation levels are inching up: System wide capacity utilization levels are northof 75% as per RBI's OBICUS survey. PMIs also remain strong and the RBI’s various industrialsurveys also point to recovery gaining ground. The only lacunae still remains the sub-partraction in new projects announcement which is still languishing at 6% of GDP, althoughit must be mentioned that stalled projects to GDP is also falling. This data possibly validatesour observation that even though capex cycle is recovering from a low base, we are stilla couple of years away from a full-fledged uptick in investment cycle.

Utilisation levels across industries inching up PMI also remains healthy


22%

20%

9%8%

7%

4%

30%

Irrigation

Roads and Bridges

Pow er

Rural Development

Water Supply andSanitation

Urban development

Others

0

100

200

300

400

500

600

2013 2014 2015 2016 2017 2018

Ext

erna

l bor

row

ing,

INR

bn

Indian Railw ays NHAI

60

65

70

75

80

85

Dec

-08

Jun-

09D

ec-0

9Ju

n-10

Dec

-10

Jun-

11D

ec-1

1Ju

n-12

Dec

-12

Jun-

13D

ec-1

3Ju

n-14

Dec

-14

Jun-

15D

ec-1

5Ju

n-16

Dec

-16

Jun-

17D

ec-1

7Ju

n-18

Cap

acity

util

isat

ion,

%

40.0

45.0

50.0

55.0

60.0

65.0

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

May

-12

Nov

-12

May

-13

Nov

-13

May

-14

Nov

-14

May

-15

Nov

-15

May

-16

Nov

-16

May

-17

Nov

-17

May

-18

Nov

-18

Indi

a P

MI

user

Highlight


The nascent uptick in the investment cycle is being led by higher utilization levels as consumptiondemand picks up pace. Steel demand, for instance has risen by 8% YoY in 2018, buoyed bythe infra push across sectors like roads and housing. Auto demand, despite the recent hiccups,is likely to maintain a healthy trend of ~8-10% over the next few years as will the demand forcore FMCG products which has already seen a decent uptick post the demonetisation inducedmoderation. Also as we had highlighted in our flagship 'Hello India' report there is a significantlatent demand for consumer durables and discretionary goods like ACs and home appliances.As we had highlighted that the 'premiumization theme is not entirely new to India but webelieve that the story is now at a critical inflexion point, ready for a lift-off. The enablers areincreased access to electricity and better roads while per-capita incomes are coalescingtowards a threshold level which will lead to even more demand for deep discretionary items.'

Even from a sector positioning perspective although multiples in consumption sector aredemanding, we are unlikely to see many negative surprises as far growth is concerned. Thesector is riding the wave of 'AAA' phenomenon - Awareness, Aspiration and Availability andthus growth is likely to be secular. Relative positioning for a switch between consumption toinvestment theme is only a tactical call as the sector's underlying dynamics remains robust.Thus even as there may be short term disruptions (such as the recent liquidity crisis), consumptionwill continue to be a relevant theme for the markets.

Steel demand expected to be healthy Car sales expected to pick-up post recent moderation


FMCG voloume traction to remain healthy Construction sector well-supported by govt schemes


0

2

4

6

8

10

12

14

16

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

Ste

el d

eman

d, %

, YoY

-10

-5

0

5

10

15

20

25

30

35

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

Pas

seng

er c

ar s

ales

, % Y

oY

0

2

4

6

8

10

12

14

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

Con

stru

ctio

n se

ctor

GD

P, %

Yo Y

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

HU

VR

vol

ume

grow

th, %

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight


New projects bottoming out Stalled projects beginning to come off


Also what cannot be ignored is the traction seen in the IIP. Industrial production growth at5.8% FY19 td is the highest in last five years. Capital goods segment is showing particulartraction, buoyed by CV cycle but the growth in other segments too is catching up. There is ameaningful uptick in construction segment, albeit on a low base. The sum total of all frequentlytracked indicators suggest that investment activity is bottoming out, if not an outright increase.

On annual basis, tracking highest IIP growth in last one year With particular emphasis on capital goods sub-index


3) Do not write-off the strong CV cycle: The last two years have witnessed a verystrong upsurge in CV cycle with sales growth at 15% CAGR. The strength in the CV cyclehas often been a precursor to the uptick in the overall GFCF cycle. The recent slowdownnotwithstanding, we expect the CV cycle to post a strong momentum as (1) sales areconcentrated in the higher tonnage segments indicating traction in construction activity(2) contrary to perception, excess in the system is far lower than those created in 2010-13 cycle (3) we are behind the worst phase of the credit squeeze and liquidity is likely toreturn to normal levels from here-on.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0S

ep-0

2

Sep

-03

Sep

-04

Sep

-05

Sep

-06

Sep

-07

Sep

-08

Sep

-09

Sep

-10

Sep

-11

Sep

-12

Sep

-13

Sep

-14

Sep

-15

Sep

-16

Sep

-17

Sep

-18

New

pro

ject

s an

noun

ced

% G

DP

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Sep

-02

Sep

-03

Sep

-04

Sep

-05

Sep

-06

Sep

-07

Sep

-08

Sep

-09

Sep

-10

Sep

-11

Sep

-12

Sep

-13

Sep

-14

Sep

-15

Sep

-16

Sep

-17

Sep

-18

Sta

lled

proj

ects

% G

DP

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

FY

83F

Y85

FY

87F

Y89

FY

91

FY

93F

Y95

FY

97F

Y99

FY

01F

Y03

FY

05

FY

07F

Y09

FY

11F

Y13

FY

15

FY

17F

Y19

td

IIP, %

, YoY

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0S

ep-0

5

Sep

-06

Sep

-07

Sep

-08

Sep

-09

Sep

-10

Sep

-11

Sep

-12

Sep

-13

Sep

-14

Sep

-15

Sep

-16

Sep

-17

Sep

-18

IIP c

apita

l goo

ds, %

YoY


CV cycle has been the harbinger of GFCF


MHCV growth - lead & lag with GDP Excess capacities much lower than in the previous cycle


4) Lower rates, more supportive liquidity: Based on the recent soft readings in theCPI and the continuous downside surprises, we believe that RBI policy stance will remainneutral if not accommodative for major part of FY20. CPI for December is likely to be sub2% and in such a scenario a rate tightening cycle is unlikely. Also the RBI has stepped upon its OMOs and has expanded its December OMO purchase by INR 100bn to INR500bn. The RBI also announced that in Jan 2019 it plans to conduct OMOs for anotherINR 500bn and will consider similar quantum of OMO purchases

No further rate hikes by RBI Even as liquidity is likely to remain supportive


-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

FY

85

FY

87

FY

89

FY

91

FY

93

FY

95

FY

97

FY

99

FY

01

FY

03

FY

05

FY

07

FY

09

FY

11

FY

13

FY

15

FY

17

(% Y

oY)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

(% Y

oY)

CV GFCF- RHS

0

2

4

6

8

10

12

14

16

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19E

% capacity growth % GDP growth

% FY10-12 FY16-19e

GDP growth (CAGR) 7.8% 7.0%

Capacity Addition growth ( CAGR) 13.4% 8.3%

Multiple to GDP (x) 1.7x 1.2x

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

May

-12

Nov

-12

May

-13

Nov

-13

May

-14

Nov

-14

May

-15

Nov

-15

May

-16

Nov

-16

May

-17

Nov

-17

May

-18

Nov

-18

May

-19

Nov

-19

Indi

a re

po r

ate,

%

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

FY

19td

RB

I OM

O (

INR

bn


Bottom-up sector level data too indicating a pick-upCorporate capex turning aroundIn our view, corporate GFCF in India has followed a seven year upcycle-downcycle. The firstreal corporate capex cycle was in 1995-97 which was a result of the capacity addition inthe machinery segment. In fact the lifting of various quotas and industrial licensing, led to aspurt in addition of new machinery in the mid-90s implying a higher productivity growth aswell. However, growth was not sustainable as there was there was little contribution fromthe public sector while private sector push fizzled out in the face of Asian financial crisis.

Emerging from the recession of the early 2000s, the sharp increase in capacity additionbetween FY04-08 was the highest ever. Like the mid-90s capex cycle, this was too drivenby higher investment in the machinery and equipment segment. In fact, the machineryand equipment segment contributed to 53% of the incremental GFCF. This was also amore broad-based capex cycle with jump in corporate capex not restricted to a sectoralone as multiple tailwinds (domestic and global) converged in augmenting capacitygrowth across various sectors including metals and cement.

From 2011-12 onwards, the corporate capex cycle has shown signs of stagnation andthe overall GFCF cycle was driven by higher growth in the public sector capex. However,within the private sector, power was the outperformer with significant additions in generation(especially thermal) and distribution.

Thus with a near seven year stagnation and as capacity utilization picks up, we believethat there is a case for private corporate capex cycle to pick up speed. We highlightbelow in charts the main sectors and rationale behind the revival of capex.

After seven year hiatus, private corporate capex to witness a recovery


Relative valuations in favour of Capital Goods sector


0

500

1,000

1,500

2,000

2,500

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Cap

ex (I

NR

bn)

Crude Oil Power Telecom Automobile & Ancillaries Iron & Steel

Indicates phases of corporate capex

0.00

0.20

0.40

0.60

0.80

1.00

1.20

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

Jan-

17

Jul-1

7

Jan-

18

Jul-1

8

Jan-

19

Ca

p g

oo

ds

vs F

MC

G s

ect

or

ex

ITC

1 yr fw d P/E Average

user

Highlight

user

Highlight


Steel- Higher domestic demand will be the key driver of capex

Steel consumption in India has grown at a CAGR of 5.6% over the last three years and iswitnessing robust growth this fiscal with YTD consumption up 8% YoY at 56MT. Domesticdemand is expected to remain healthy on the back of increased spending by the governmenton infrastructure and outlay on affordable housing with preference for domestic steelunder the national steel policy. Although there is short term liquidity concerns which couldhamper steel demand in the near term we expect the impact to be short lived. World SteelAssociation forecasts domestic steel consumption to grow by 7.6%/7.2% for CY18/19erespectively.

Capacity utilization for the industry has risen to ~82% in FY18 and with robust growthprojected for the next two years ,we are seeing major steel players announcing newcapacity expansion plans as well as actively bidding for stressed steel assets to capitalizeon the growth in demand. Major announcements include Tata Steel commencing Phase IIat its Kalinganagar facility which would increase capacity by 5MTPA as well as JSWannouncing expansion at Vijaynagar facility by 5MTPA and Dolvi facility by 5MTPA

Capacity utilization off its lows… …to result in higher capex

Source: Company, Antique Source: Company, Antique

Cement - Un-relented Capacity additions in Cement space continueIndia is the world's second largest cement market, currently boasting of ~470-475MT ofannual effective capacity. Despite the oversupply scenario, cement players in India haveconstantly been adding capacity over the past six-to-eight years in the race to gain largerscale dominance and access to better performing regional markets. The industry witnessedcapacity addition of ~100MTPA during FY14-18, which put pressure on capacity utilizationas volume growth was subdued at a CAGR ~4-5% during this period. While we estimateIndustry utilisations at sub-70% for FY18, with lot of manufacturers not disclosing theproduction details, there is no clarity on the exact utilisation number for the industry, moreso for Clinker utilisation.

Despite the suboptimal utilisation levels, the cement industry seems to be gearing up forthe up-cycle in demand, as reflected by the massive capacity addition in the pipeline.Industry did witness double digit volume growth in the past 4 quarters. Over the pastyear, Cement sector has seen a splurge of capacity addition announcements. The upcomingexpansions are mix of Greenfield and brownfield projects. There are a number of players(Old, Relatively new and Newly born) who want to become big in the sector and arelooking to add capacities in expectation of the healthy (to possibly very healthy) volumegrowth over near to medium term - which shows the intent of some of these companies tobecome a more relevant player in the sector and their region of operation.

Almost every meaningful player is looking to add capacity over next 2-3 year period. Weestimate that cement industry could commission ~70MTPA of new capacities betweenFY19e and FY21e, as unrelenting fight for capacity market share continues.

-

20

40

60

80

100

120

140

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17FY18P

74767880828486889092

Steel sector capacities (mn tn)

Total Crude steel production (mn tn)

Capacity Utilization (%)

-

20

40

60

80

100

120

140

160

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

FY

19e

FY

20e

FY

21e

Cap

ex (

INR

bn)

Tata Steel JSW SAIL JSPL

user

Highlight

user

Highlight

user

Highlight


FY19-20 to see un-relented capacity additions in cementCapex (INR mn) FY16 FY17 FY18 FY19 FY20e FY21e

ACC 11,236 5,222 5,349 4,000 4,000 4,000

Ambuja 6,214 3,911 5,623 8,000 10,000 10,000

Dalmia Bharat 6,384 5,658 1,994 12,680 23,110 15,680

JK Lakshmi Cem 1,470 1,270 1,380 2,000 1,000 1,000

Orient Cement 3,697 1,070 1,481 700 700 700

Shree Cements 7,356 12,809 25,251 18,000 14,000 12,000

UltraTech Cem 20,770 12,609 19,380 18,000 12,000 12,000

Birla Corp 1,694 2,065 2,792 3,000 8,000 10,000

Deccan Cement 71 277 89 200 200 200

Heidelberg 1,249 474 232 600 600 600

India Cement 1,632 788 1,977 2,000 5,000 5,000

JK Cement 3,163 2,949 1,775 8,000 14,500 3,000

Mangalam Cement 660 909 193 1,200 200 200

NCL Indutries 185 1,606 2,228 700 400 400

Ramco Cement 2,780 3,067 4,958 8,000 6,500 2,000

Sagar Cement 1,251 1,452 1,965 3,000 3,200 2,500

Sanghi Industries 464 752 2,891 6,000 7,000 500

Star Cement 817 890 324 1,800 2,700 700

Total 71,093 57,777 79,882 97,880 113,110 80,480Based on reported data and management commentaries Source: Company, Antique

Power sector capex - The light is at the end of the tunnel!

Doubtless for power generation as a sector as such, the last few years were bad. In India,the slower industrial growth and poor health of the state Distribution companies (Discoms)resulted in precipitous drop in power consumption. During FY16-18, the power consumptiongrowth just ticked around 4-4.5%-- a far cry from a desirable level of 6-7%. Worse, duringthe same period, demand growth from remunerative industry sector, which accounts for40% of the aggregate demand, collapsed to a meager 1%. This exerted further pressureon state-owned-Discom's financials. Even worse, coupled with sharp capacity addition inpast 4-5 years, the spot power prices fell. These events led to a negative feedback loop.A spate of bankruptcies, undue strain on the banking system, and a chronic drought fornew project announcements: these were just a part of apocalyptic canvas.

From FY11, the power demand has grown by 5% CAGR, with growth moderating in thelast few years

Source: CEA, Antique

10,3

71

18,7

79

19,9

27

16,7

25

20,6

43

22,4

42

6,99

0

5,00

8

2,72

0

75%73%

70%

66%64%

62%60% 61% 61%

0

5,000

10,000

15,000

20,000

25,000

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19E

50%

55%

60%

65%

70%

75%

80%

Thermal capacity added (MW) Thermal PLF (RHS)


However, the dire situation is a thing of past; a turnaround is around thecorner

The economic activity is on the upswing. The early signs of private capital expenditure arevisible. This is expected to revive demand in next few years (FY19 running at 5%+). Alongside,intervention of UDAY scheme is making the financial health of key states better, which in turnis leading to increased demand. We believe this trend is expected to continue.

Power shortage situation looming large; the ask PLF is high, drawing parallelto FY07.

As on date, 52GW of thermal power capacity is under construction. We assume 36GW ofnet coal based capacity addition (after deduction of 2GW annual capacity retirement) tillFY24. Further, during the same phase, we assume a high target of ~150GW of renewablecapacity. Yet we think India may hit power shortage of 4% in FY24. This is all based on apremise that the average demand over FY19-24 will grows by 6.2% (Antique Estimates).Further, we plug in high 68% PLF for all thermal plants in the country (as contrast to 61%now). This is possible only if central sector power plants run at all-time high PLF of 76-77%-- asituation seen in FY06-07, when power shortage rose to 7-8%.

In this backdrop of looming energy crisis, a re-ignition of power sector investments, weanticipate, is clear on cards

Source: CEA, Antique

In the last few months, spot prices moved up due to shortage of coal and growing demand(Indexed price of electricity to 100)


94

96

98

100

102

104

106

108

110

112

114

1-N

ov-1

3

1-M

ar-1

4

1-Ju

l-14

1-N

ov-1

4

1-M

ar-1

5

1-Ju

l-15

1-N

ov-1

5

1-M

ar-1

6

1-Ju

l-16

1-N

ov-1

6

1-M

ar-1

7

1-Ju

l-17

1-N

ov-1

7

1-M

ar-1

8

1-Ju

l-18

1-N

ov-1

8

10,3

71

18,7

79

19,9

27

16,7

25

20,6

43

22,4

42

6,99

0

5,00

8

2,72

0

13,2

20

15,2

85

400

400

3,98

0

2.8%2.2%

0.4% 0.8%1.7% 1.5%

2.1%

0.2% 0.6%

-1.0%

3.9%

-4.2%-4.1%-3.7%

0

5,000

10,000

15,000

20,000

25,000

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

FY

19E

FY

20E

FY

21E

FY

22E

FY

23E

FY

24E

-5%-4%

-3%-2%-1%0%

1%2%3%

4%5%

Thermal capacity added (MW) Pow er Deficit (RHS)

user

Highlight


Order books and exports also pointing to significant tractionExports - Industrial players have seen a boost

Engineering is by far the largest segment in the Indian industry, employing over 4mn skilledand semi-skilled workers. The sector has witnessed tremendous growth, led by significantinvestments in power projects and infrastructure development. India's merchandise exportsregistered a growth of 12.5% YoY during 1HFY19.

Break up of Engineering

Source: Industry, Antique

Thus, engineering companies have reported traction in exports. Several domestic industrialcompanies have resorted to increased thrust on exports in order to diversify or beat thedomestic slow down. In case of foreign engineering companies, the growth in exports isadditionally driven by the group's thrust on exports given lower cost from developing countriesand making certain countries its global hub for certain products. The obvious beneficiariesare countries like India which has further accentuated by rising wages in China.

Besides targeting the developed economies of Europe and US which makes up about 40% ofexports, Indian companies are incrementally diversifying in the developing markets of Africa,South America, Middle East and South East Asia. For this, we have seen companiescollaborating with technology institutes for developing skilled manpower and R&D

Rise in overall engineering exports Break up of engineering exports


Ferrous23%

Automobiles21%

Industrial Machinery

17%

Non-Ferrous13%

Other Engg Products

10%Electrical

Machinery9%

Shipping4%

Aviation3%

-

15

30

45

60

75

90

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

Exports (USD bn)

user

Highlight

user

Highlight


Public sector thrust to continuePublic sector capex across important segments such as power generation, roads, railways,metros, renewables, defence and housing can unlock significant capex opportunities. Weestimate that incrementally new investments in these areas can result in at least INR 5-6tn/year capex. Below we highlight two segments- roads and railways in little more detail.

Potential spending over the next five years

Source: Antique

Roads

Government revises the NH construction target to 10,000kms for FY19; weexpect 14600 for FY20For FY19, this translates into construction rate of 27kms a day, deviating from earlier revised downnumber of 30kms a day, forecasted by industry experts and companies. As against this target,India has achieved construction of 5759 km i.e. 57.59% as on 30th November, 2018. Most of thechallenges are encountered in timely acquisition of land, shifting of utilities (like electrical lines,Water supply lines etc.) coming in the right of way, time taken in obtaining statutory clearances(such as forest, tree-felling, wildlife clearances etc.) problems encountered in availability of soil/aggregate etc. Most of these challenges relate to the states, which are sorted out through regularmonitoring and reviews with the state authorities, central government opines.

Land acquisition in GujaratThe Gujarat High Court quashed and set-aside the 'poor compensation' awarded to severallandowners whose plots were acquired by the NHAI for the construction, expansion, andwidening of NH 8-E (51) between Bhavnagar and Veraval, and the Vadodara-MumbaiExpressway. The court has also remanded the matter back to the competent authorities whoare supposed to re-determine the compensation afresh in accordance with law.

NHAI to borrow INR2trn to fund Bharatmala, other projectsThe funds would be raised to partly finance a slew of infrastructure projects, includingBharatmala. The centre plans to invest a INR6.9trn during FY18-23, of which INR3.8trn is forthe Bharatmala Pariyojana and about INR3trn for other projects including the conventionalhighways that it normally finances.

Power generation: With 6-7% growth in powerdemand and a virtual collapse in commissioning ofnew projects, India is likely to face a power shortagein the next few years which will trigger a new powercapex cycle with a potential investment of INR 1.5tn/annum. As on date, 52GW of thermal power capacityis under construction. We assume 36GW of net coalbased capacity addition (after deduction of 2GWannual capacity retirement) till FY24.

Metros: The approved opportunity size is INR2trn.In Mumbai, INR1.3trn metro projects are underway.In Delhi, INR450bn phase-IV is approved. ExcludingMumbai lines and Delhi phase-IV, there are many morerail projects on cards. For instance, Government hasapproved INR680bn projects.

Defence: Defence capex likely at INR 1tn for FY19eand is expected to grow at 5-8% p.a. Thrust onlocalisation and offset can result in a significantopportunity for Indian manufacturers as well.

Railways: We estimate the railways capitalexpenditure cINR1.62trn. This is a part of approvedINR8.6trn five year plans of the past. The year beforehad INR1.45trn budgeted. Further we foresee INR2trnadditional opportunity-both from HSR and RRTSprojects.

Roads: The central budgeted expenditure on roadsis cINR750bn. However, with INR1.3trn HAM projects,done by private players, and states engaging inindividual projects, the market size is estimated atINR1.5trn.

Renewables: Enhancing India's renewable powercapacity to 175GW by 2024, at an estimatedinvestment of INR 6tn.

Housing: Under Pradhan Mantri Awas Yojana(PMAY) - urban and rural housing with stronggovernment intent, presents a huge opportunity inIndia. It is being implemented across all the states witha target to deliver 20mn houses by FY22.

user

Highlight

user

Highlight


Total projects awarded are on a rising trend


Pace of construction is moving up


Daily completion of projects is dependent on land acquisition/financial closures


6491

1116 1438 3069 4368 43377396

10000 10000

3303

48834821

5730

119349659

10000 10000

800

0

4,000

8,000

12,000

16,000

20,000

FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19E FY20E

NHAI MORTH

5013 57324250 4410

6061

82319829

10950

14600

0

2000

4000

6000

8000

10000

12000

14000

16000

FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Kms constructed by NHAI

1416

12 12

17

23

2730

40

-

5

10

15

20

25

30

35

40

FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Kms/day constructed by NHAI


Plus, there are opportunities from Bharatmala too


Adding to the above, there are others in fray as well.


Funding of NHAI is intactINRmn 2017 2016 2015

Receipts of Cess 23,270 154,200 68,860

Toll Plough Back 75,000 65,000 54,480

Additional budgetary support 56,490 3,700 6,000

Capital Gain Tax exemption bonds 55,730 42,810 33,430

Other Bonds 275,450 190,000 -

Decrease in cash - - 61,970

Other Inflows 19,000 11,870 13,150

Total 504,940 467,580 237,900

Land Acquisition 178,230 219,340 90,980

Project Expenditure 208,430 125,730 78,850

Repayment of Loans 70,100 51,300 42,920

Increase in Cash 16,360 40,680 -

Other outflows 31,810 30,530 25,140

Total 504,940 467,580 237,900Source: Industry, Antique

2620015500

0 5300 0 1600 0 10000

5860090006000

24800 10000

34800

5000 2000 80020000

20,000

40,000

60,000

80,000

100,000

Eco

nom

icC

orrid

or

Inte

r-co

rrid

or&

feed

erR

oute

s

Nat

iona

lC

orrid

ors

Effi

cien

cy

Bor

der

&In

tern

atio

nal

conn

ectiv

ity

Coa

stal

& P

ort

conn

ectiv

ityro

ads

Exp

ress

way

s

Tot

al u

nder

Bha

ratm

ala

Par

iyoj

ana

NH

rem

aini

ngun

der

NH

DP

Tot

al to

be

built

or

upgr

aded

Total Length (In Kms) Phase-I (In kms)

624111

2,8953,359

2,605

9,594

-1,0002,0003,0004,0005,0006,0007,0008,0009,000

10,000

PortConnectivity

SARDP-NE Others BRT NH(O) Total Others

In Kms


Railways:

Reportedly, the railways is seeking highest-ever capital expenditure of INR1.65-1.7trn for theupcoming Budget. Meanwhile, to cough up the finances, the ministry has sought help fromrailway ministry to increase gross budgetary support by 28% from the budgeted INR530bn inFY19 to around INR680bn in 2019-20.

Particulars (All figures in INRbn) FY17 FY18 FY19B FY20E

New lines - network expansion 144 212 285 328

Doubling - network decongestion 91 180 174 200

Gauge conversion - network expansion 38 37 39 45

Track renewals - safety spending 51 83 104 119

Road safety works - Road over / under bridges 32 62 63 72

Traffic facilities - yard remodelling & others 9 31 29 33

Signalling - telecom works 10 23 20 23

Electrification projects 29 35 63 72

Other electrical works 1 9 2 3

Rolling stocks 196 252 319 367

Leased assets - payment of capital component 70 80 92 106

Workshops including production units 15 33 26 30

Metropolitan transport projects 14 14 16 19

- Govt commercial undertaking 5 7 18 21

- Non-Govt JV / SPVs 71 168 95 109

Others 324 85 71 82

Total Expenditure 1,099 1,310 1,415 1,627Source: Antique

Another plausible theme is high-speed/semi-high speed rail corridor. Be it bullet trains (high-speed) or regional rail transport (semi-high speed), the progress made can translate into anaddressable opportunity of ~INR2trn in the near term (NCR-phase 1 RRTS and Ahmedabad-Mumbai bullet train).

As a part of integrated plan for 2032, Regional Rapid Transit System (RRTS) is a dedicated,high-speed, high-capacity commuter service connecting regional nodes in National CapitalRegion (NCR). Also, RRTS is different from conventional railway. It aims to provide reliable,high-frequency, point-to-point regional travel at a dedicated path way. Further, RRTS is differentfrom metro.

A huge opportunity in high-speed rail corridorRoute Length (Kms)

1 Pune-Mumbai-Ahmedabad 680

2 Delhi-Chandigarh-Amritsar 480

3 Delhi-Agra-Lucknow-Varanasi-Patna 1,000

4 Howrah-Haldia 140

5 Hyderabad-Dornakal-Vijayawada-Chennai 780

6 Chennai-Bengaluru-Ernakulam-Thiruvananthapuram 1,020

7 Delhi-Jaipur-Jodhpur 530

Total HSR kms 4,630Source: Antique

user

Highlight

user

Highlight


Metros: INR2trn opportunity approved; to fill up the order book soon.

In Mumbai, INR1.3trn metro projects are underway. In Delhi, INR450bn phase-IV is approved. Excluding Mumbai lines and Delhi phase-IV, there are manymore rail projects on cards. For instance, Government has approvedINR680bn projects.

Since May-2014 to this date, for instance, 13 new metro projects with a total length of about248 Kms at a total cost of INR680bn have been approved. This includes Nagpur, Ahmedabad,Gurugram, Lucknow, Chennai Extension, Pune, Delhi Metro Extensions, Noida - GreaterNoida, Bhopal and Indore.

Operational status: At present, about 536 kms of Metro Rail lines are operational in 10cities. This includes Delhi & NCR, Bangalore, Hyderabad, Kolkata, Chennai, Jaipur, Kochi,Lucknow, Mumbai and Gurugram.

Around 650 kms of metro rail projects are at various stages of implementation in Delhi &NCR, Kolkata, Bangalore, Chennai, Kochi, Jaipur, Mumbai (including state initiatives byMMRDA), Hyderabad, Nagpur, Ahmedabad, Lucknow, Pune, Noida, Bhopal and Indore.About 750 kms of metro rail systems and 373 km of Rapid Rail Transit Systems (RRTS) areunder planning in various cities.

user

Highlight


Elections are important but not the most critical macro factorWith the advent of the 2019 general elections, there is a fair bit of concern over the outcomes.This is especially true given the recent electoral reversals which the ruling BJP has faced in theassembly (state) elections in December 2018. We are of the view that a positive or negativeelection outcome can affect markets only sentimentally but are unlikely to dent the macro-outturns. Our premise is based on the following:

1) Flagship schemes unlikely to witness any changes: Irrespective of the newregime in place, we believe that structural reforms are likely to continue, whicheverregime is in place. We highlight two schemes- the Pradhan Mantri Gram Sadak Yojana(or PMGSY, rural roads and infra) and Mahatma Gandhi National Rural EmploymentGurantee Act (or MGNREGA, rural employment). The PMGSY was launched in 2000under the previous NDA dispensation. This was one of the flagship schemes of thegovernment and ushered in new development in rural infra. However when the UPA-1came to power, it neither reduced the allocation for the scheme, nor diluted it. In factrural infra continued to be a priority for the UPA-1 government as well. Similar was thecase with MGNREGA which was the flagship scheme of the UPA government.Allocations increased significantly post the 2008 financial crisis as the governmentlooked to pump-prime the economy and is viewed as a program to enhance its ruraldevelopment schemes. In fact, many of the rural development schemes which thecurrent government is pursuing be it rural housing or electrification are expandedmodifications of the UPA schemes.

Allocation and thrust on flagship schemes have remained steady across electoral formations

Source: Budget documents, Antique

In a similar vein we believe that the current government's social sector projects- be it PMUjjwala Scheme (LPG cylinder for every household) or Saubhagya (electrification) isunlikely to be changed. If anything there could be tweaks to enhance the programfurther.

2) Institutionalization of reforms: Most reforms over the last decade or so havebeen institutionalized. For example, as we had highlighted in our flagship Hello Indiareport, the schemes are administered through Aadhaar based DBT (Direct BenefitTransfer) to plug the leakages. The cumulative total direct benefit transfer since FY15 isINR 5.6tn with INR 1.9tn transferred in FY19 so far and the annual savings have beenin the range of INR 330-350bn for the central schemes alone. Therefore, given thehuge savings any new dispensation is unlikely to roll-back the institutional reformswhich have taken place. A point to note is that whatever maybe the political overtones,our understanding based on our discussions in Hello India is that the states are adoptingAadhaar based DBT for most local schemes as well.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

FY02 FY03 FY04 FY05 FY06 FY07 FY08

Ru

ral r

oad

s ex

ecu

tio

n, k

ms

NDA UPA

0

100

200

300

400

500

600

700


MG

NR

EG

A a

lloca

tio

ns, I

NR

bn

UPAUPA

user

Highlight


State Number of schemes under DBT

Punjab 119

Karnataka 164

Kerala 59

Tamil Nadu 102

Telangana 43

Source: DBT website, Antique

3) Empirical evidence also points to electoral formations being growthneutral: Simple empirical evidence also suggests that political formation at the centrehas been immune to growth. Prior to BJP gaining a majority in the 2014 elections, thelast time a party won such a large mandate was the Congress in 1984. And one canargue that the most of the reforms in the intervening period were carried out by coalitiongovernments. Reforms trajectory can be sustained irrespective of the formation at thecentre and governance has matured not to disrupt long term structural changes.

Structural upswing in growth unlikely to be affected by elections

Source: Antique

Markets have invariably bounced back post elections

Source: Antique

0

2

4

6

8

10

12

FY

95

FY

96

FY

97

FY

98

FY

99

FY

00

FY

01

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

FY

19e

GD

P, %

Yo

Y

NDA

UPA

BJP

40

60

80

100

120

140

160

180

M-1

0

M-9

M-8

M-7

M-6

M-5

M-4

M-3

M-2

M-1 M

M+1

M+2

M+3

M+4

M+5

M+6

M+7

M+8

M+9

M+1

0

Sen

sex

per

form

ance

aro

un

d e

lect

ion

s (i

nd

exed

to

100

)

2004 2009 2014

Elections

States, irrespective of thepolitical affiliation areadopting DBT for theirrespective schemes

22CHINAREPORT I January 2019

COVER STORY

Trade tensions between the US and China, the world’s two largest economies, have been and continue to be a major concern for investors all over the world, injecting a great

level of uncertainty into the global economy. It is therefore imperative to examine the economic fundamentals of the Sino-US trade imbal-ance. To do that, we must look at both countries’ economic policies to trace the roots of the issue.

he US has been in constant trade deicit since 1976. Since 1999, its deicit has never dipped below two percent of GDP, peaking in 2006 at 5.5 percent. Since then, it has maintained an average level of

about three percent of the country’s GDP.One major reason behind the US’s trade deicit lies in its low sav-

ings rate and high rate of consumption. In the past decade, the aver-age personal savings rate of Americans hovered around six percent, reaching a historical low of 2.4 percent in 2017. he US Federal gov-ernment also has no savings, having run on deicit for 17 years since 2002. By the end of September 2018, US gross national debt reached a record high of US$21.52 trillion, accounting for 105.4 percent of its current-dollar GDP.

he Trump administration’s tax cut plans are expected to further

US-China Trade Dispute

us should look inward to solve Trade DeficitThe trade imbalance between the US and China stems from internal problems in the US, which can only be addressed by an inward-looking approach. Trade friction can only lead to lose-lose results

By Zhu Min and Miao YanliangP

ho

to

by

Sh

en

g J

iap

en

g

user

Highlight

user

Highlight

user

Highlight


raise the debt level in the coming years. A high debt level, combined with a low savings rate, means the US consumes more than it produc-es, so the additional spending has to go to foreign goods and services. With minimal savings to put into investment, the US has to either borrow from foreign investors, or to extract foreign funds to the US. his is the driving force behind the US trade deicit, which exists not just with China, but with almost all industrial powers.

Another major reason is the dollar’s status as the global reserve cur-rency, which allows the US to enjoy what economists call an “exorbi-tant privilege.” Unlike any other country which needs to produce an equivalent value of products to obtain US$100, the US can simply print a 100 dollar bill to purchase imports from other countries. he US is also immune from concerns over a current account payment crisis, which can be caused by a persistent current account deicit in any other country.

his means that when the US government does not have enough revenue, it can always resort to issuing treasury bonds. By the end of 2017, the total amount of treasury bonds amounted to US$12.3 tril-lion, more than 50 percent of which had been purchased by foreign investors.

his is why the Trump administration is able to launch a tax cut plan and expand the government deicit at the same time, even though it will further push up government debt. It is estimated that the iscal deicit of the US Federal Government will increase from 3.5 percent of annual GDP in 2017 to 4.6 percent in 2019.

To put it simply, the US’s global trade deicit, including that with China, is a result of structural problems inherent in the US economy, including a low savings rate, high consumption rate and an expan-sionary iscal policy, something enabled and encouraged by the i-nancial privilege of the dollar’s global reserve currency status. hat is precisely why the US trade deicit has grown by a further seven percent in the three-month period between May and July, despite ad-ditional import tarifs imposed on major trading partners, including China. In fact, Washington’s trade protectionism will very likely harm its own long-term economic development.

Not Seeking Surplus China appears to be just the opposite of the US in many aspects.

Compared to the US, China has long maintained a very high savings rate. Since joining the World Trade Organisation (WTO) in 2001, China’s total exports have rapidly increased, maintaining an annual growth rate of over 20 percent between 2001 and 2007. In the same period, China’s personal savings rate increased from 36 percent in 2000 to 51 percent in 2007.

While the rapid increase in exports has made a great contribution to China’s economic growth, it has also led to an unbalanced economy, especially when a high savings rate resulted in a low consumption rate,

Share of US exports to GDP

Share of US imports to GDP

US balance of trade to GDP

US trade deficit (right axis)

Foreign holders of US treasury securities (left axis)

Source: US Bureau of Economic Analysis

Source: US Treasury Department, US Bureau of Economic Analysis

Share of US imports, exports and trade balance to GDP

US trade deicit and foreign holders of US treasury securities (Unit: US$ billion)

user

Highlight

user

Highlight

user

Highlight


COVER STORY

a problem exacerbated by the global inancial crisis in 2008. Since then, China has conducted sweeping structural reforms to promote domestic consumption. Between 2007 and 2017, the contribution of domestic consumption to national economic growth increased from 50.1 percent to 58.8 percent, while the service sector accounted for 51.6 percent of the economy in 2017, up from 42.9 percent in 2007.

In the meantime, China’s trade surplus with the rest of the world as a percentage of GDP has steadily decreased since 2007. In 2017, China’s current account surplus dropped from 9.9 percent of annual GDP in 2007 to 1.3 percent in 2017, about the same level as prior to China’s entry into the WTO. During the irst half of 2018, China reported a current account deicit of US$28.3 billion, the irst in 20 years. his shows that China has not intentionally adopted unilateral commercialism as a way to maximise its trade surplus as some have accused it of. Instead of focusing on promoting exports, China’s eco-nomic policy centres on domestic-oriented structural reform.

Moreover, much of the trade deicit with China is created by US companies. For example, Apple iPhone products alone contribute about US$17 billion to the trade deicit of the US on paper. But in reality, most of its value went to various foreign suppliers of Apple, such as South Korea’s Samsung and Japan’s Toshiba. It is estimated that only ive percent of the manufacturing cost of iPhone products goes to Chinese suppliers. It is both unfair and unrealistic to expect China to sacriice its own interests and economic health to solve a problem that results from an internal imbalance in the US economy.

Given the diferent structures of the two economies, the trade relationship between China and the US is still complementary. First, unlike the trade disputes between the US and Japan in the 1980s

– between two developed economies as Japan’s per capita GDP hadalready reached the same level as the US’s – the trade relationshipbetween the US and China is still one between a developed economyand an emerging economy, as China’s GDP per capita is only one-seventh the size of the US’s.

Second, unlike Japan, whose GDP was only 32 percent of that of the US in 1985, the Chinese economy is now 62 percent of the US’s, which means China has the potential to provide a much greater mar-ket for American products, making the trade relationship between the two countries more reciprocal.

hird, bilateral trade between the US and China is more of a sup-ply-chain trade, which is associated with international production networks, rather than inter-industry or intra-industry trade. In short, it means rather than directly competing with each other within an industry, the US and China occupy diferent positions in an inter-national supply chain. By 2016, labour intensive products, including light industrial products and low-end electronic products, accounted for 80 percent of China’s exports to the US. In the meantime, the US has a solid position in the supply chain of high-end industries, with exports of intellectual property worth US$128 billion, 26 times that of China.

Supply Chain Declinehe problem with the supply chain trade between the two coun-

tries is structural. For example, while American multinationals have garnered huge proits from their trade with China, the supply chain of low-end industries in the US may witness a decline, such as those in the rust belt states. Given the overall reciprocity of the bilateral

US household savings rate (left axis)

US federal budget deficit to GDP (left axis)

US household account balance to GDP (right axis)


Household savings rate, federal budget deicit and trade deicit in the US

user

Highlight

user

Highlight

user

Highlight


relationship, the US should address this problem through domes-tic structural measures to better distribute resources between the winners and losers of globalisation, rather than using its entire trade with China as a scapegoat.

Curbing the DeicitIn the past years, the Chinese economy has been transforming into

one driven by consumption, which will not only help China sus-tain its economic growth, but will provide massive opportunities for advanced economies, including the US.

In the past years, China has experienced major demographic chang-es, which has led to a decline in its labour force. hese changes will inevitably drive down China’s savings rate and promote consump-tion. In the process, China’s consumption will increasingly shift from low-end consumer products to high-end products, which will ofer advanced economies, including the US, greater market potential.

As a matter of fact, this scenario is already happening. In 2017, Chinese purchased 32 percent of the world’s luxury products, mostly made by foreign companies. China’s overseas students and outbound tourists also made major contributions to the economic growth of various countries, including the US. During the earlier trade negotia-tions, China ofered to increase imports of American products and services, which serves the interests of both countries.

By contrast, escalating the trade dispute with China will not only fail to fundamentally address the trade imbalance of the US, but will also limit the access of American products to the Chinese market, hurting US consumers and the country’s economic development in the long run.

he US must be aware that the robust economic growth experi-enced by the US in 2018 came as a result of its recent tax cuts and is-cal stimulus. By the time the policy efects start to diminish in 2020, its side-efects, such as inlation, will start to kick in. Trade tensions with China will further drive up inlation, causing consumers to rein in their spending and US companies to possibly reduce investment due to concerns over uncertainties. All these will increase the possibil-ity of an economic recession in the coming years.

To efectively solve its trade imbalance, the US should look inward to address its structural problems within its economy. In the past de-cades, the US has taken advantage of its inancial dominance to pa-per over its domestic problems at a very low cost. Whenever the US encountered a inancial problem, it has resorted to printing money, directly or indirectly.

But as the US continues to abuse its inancial dominance, it has eroded many countries’ trust and conidence over the global mon-etary order that centres on the greenback. If the US continues to re-fuse to relect on ways to address its domestic economic problems and instead entrenches itself further into its debt-centric approach, it will further dampen conidence in the US dollar and expose the US economy to serious inancial crisis.

Zhu Min is chairman of the National Institute of Financial Research, Tsinghua University and former vice president of the IMF. Miao Yanliang is a chief economist with the State Administration of Foreign Exchange Investment Centre.

China - current account

balance to GDP

US - current account

balance to GDP


Source: International Monetary Fund

US products ranked by level of trade deicit with China in 2017 (Unit: US$ billion)

Current account balance ratio to GDP – China and US (including IMF predictions for 2018-2023)

Com

mun

icatio

n eq

uipm

ent

Com

pute

r equ

ipm

ent

Misc

ellan

eous

com

mod

ities

Clot

hing

Kitch

en fu

rnitu

re

Sem

icond

ucto

rs

Foot

war

e

Hous

ehol

d ap

plian

ces

Audi

o/Vi

sual

equi

pmen

t

Plas

tics

user

Highlight

user

Highlight

user

Highlight

India strategyMarket outlook

Find CLSA research on Bloomberg, Thomson Reuters, Factset and CapitalIQ - and profit from our evalu@tor proprietary database at clsa.comFor important disclosures please refer to page 7.

Mahesh [email protected]+91 22 6650 5079

Abhinav Sinha+91 22 6650 5069

Alok Srivastava+91 22 6650 5037

15 January 2019

IndiaMarket Strategy

www.clsa.com

Budget 2019 – What to expectFarmer support scheme may be on its way, impacting capex spendThe pressure to further expand the farmer welfare programme ahead of the 2019 national elections is high for PM Modi. A possible announcement of a nationwide direct farmer support scheme is quite likely in the budget on 1 Feb, or possibly even earlier. A Telangana-style scheme could cost ~Rs1.2trn, further complicating fiscal maths, as it could be a recurring liability. The RBI’s possible large dividend might help just one time. The GST-led tax revenue shortfall of 75-80bps of GDP is not reflected in the reduced Govt expenditure for FY19 due to off-balance-sheet funding, which is not a sustainable solution and will create its own problems later and distort the reported fiscal deficit for FY19. We expect the ‘real’ govt expenditure growth to slow down. The impact on capex will be even greater if the farmer support scheme is implemented. ITC should see some relief rally, as the budget is unlikely to tinker with tobacco taxation.Direct support to farmers could cost the Centre Rs700bn/annumq Proliferation of farm loan waivers and BJP’s recent defeat in state elections have led to

expectations of major policy intervention by the Central govt for farmer support.q Modi has largely ruled out a national farm loan waiver, but a scheme implemented by

the Telangana govt is seen as promising. The ‘Rythu Bandhu’ (Farmer InvestmentSupport Scheme) provides Rs4,000/acre/season to farmers as direct cash support.

q Telangana’s ruling party TRS scored an emphatic win in the recent state elections.Other states, viz, Odisha (BJD ruled) and Jharkhand (BJP ruled), have since announcedsimilar schemes in their states.

q The Telangana scheme costs Rs120bn. It covers all farmers irrespective of landholding. A nationwide scheme may follow the Odisha model which limits the scheme tosmall and marginal farmers, ie, whose land holdings are less than 5 acres.

q Such a scheme will cover 47-48% or ~230-240m acres of total crop area (includingmulti-cropping). It would cover 86% of all farmers, making it fairly broad-based.

q At Rs5,000/acre, the cost of such a scheme would be Rs1.15-1.20trn. However, theCentre could split the costs with the participating states, say, in a 60-40 ratio. Thiswould then imply a cost of ~Rs700bn/35bps of GDP to the Centre in FY20.

Bridging GST shortfall to be crucial for FY20 budget spending spurt q We estimate (link) a total FY19 GST shortfall at Rs1.5trn or 80bps of GDP. While this is

largely to the Central Govt’s account, since the Central Govt shares 42% of its ownrevenues with states, the shortfall will effectively reflect for both state & central govt.

q The large GST shortfall keeps total indirect tax growth at just 6% vs 23% budgeted.This will mean that the good growth in direct taxes (17%, near target) notwithstanding,Centre’s net (of state share) tax collections would be 8ppt/Rs1.0trn short of target.

q Potential compliance improvement should drive a GST growth of 20% during FY20.

Off-balance-sheet borrowings, disinvestment pressures unlikely to subsideq The ~50bps of revenue shortfall in FY19 will mostly (~40bps) be bridged by an increase

in off-balance-sheet expenditures. These could include pushing the food subsidyexpenditure onto the books of FCI among other things.

q Large disinvestment programmes (Rs1.8trn over FY18-19) and repeated off-balance-sheet spending (c.Rs1.2trn over FY18-19) have created a high base effect of on-budgetspending. As such, mean reversion to better-quality fiscal will take time and FY20could still see another Rs0.8-1.0trn disinvestment being targeted.

Limited scope for fiscal consolidation in FY20q Starting any large social spending scheme, as above, without a commensurate measure

to increase revenues would mean that the government may not be able to budget for amore than 10-20bps of fiscal consolidation in FY20.

q Also, the government would clearly be hard-pressed to fund capex directly via its ownbudget. Any such increases then would need off-balance-sheet spending to risefurther. Interestingly, the government’s auditor CGA has pointed out this issue, whichcould force the government to disclose the impact of such borrowing on its budget.

user

Highlight

user

Highlight

user

Highlight

Budget 2019 – What to expect India strategy

15 January 2019 [email protected] 2

86% of farmers own <5 acres of landFigure 1 Figure 2

Distribution of farm holdings by no. of units : Total 146m Distribution of farm holdings by operated area (Acres) : 390m

Source: CLSA, Ministry of Agriculture Source: CLSA, Ministry of Agriculture

Supporting small farmers to cost Rs700bn/annumFigure 3

Estimation of cost for a potential national farmer support schemeTotal cropped area (m acres) 500 Takes into account multiple-crops;

About 40% of land is cultivated twice per year

Land owned by marginal and small farmers (%) 47% Land holding of <4.9 acresArea eligible for farmer support scheme (m acres)

235 This still covers 86% of farmers

Assume support per acre of land cultivated (Rs) 5,000 If land cultivated twice, farmer gets Rs10k

Per annum cost of farmer support (Rs bn) 1,175 This is the total costAssume centre's share of the cost (%) 60% Rest to be borne by statesCentre's annual expenditure on the scheme (Rs bn)

705 ~35bps of FY20 GDP

Source: CLSA, Ministry of Agriculture

States are leading the way in direct farmer support alreadyFigure 4

Direct farmer support schemes announced by states so farState Scheme details Budgetary

costs/annum (Rs bn)

Year start

Beneficiaries

(m)Telangana Input Assistance scheme Rythu Bandhu to provide

direct cash assistance of Rs4,000/acre/season for purchasing agri input; No land size restriction

120 1HFY19

6

Odisha Broad rural support scheme KALIA to provide Rs5,000/acre/season to farmers with small (<5 acres) land holdings; Also gives ~Rs2k-2.5k/annum to landless farming agri labour; Pays for insurance and provides interest-free crop loans for farmers

33 2HFY19

3

Jharkhand Similar to Rythu bandhu scheme - provides Rs5,000/acre/season to small farmers (<5 acres land)

22 1HFY20

2

Total 175 11Source: CLSA

Marginal (<1.2 acres)68%

Small (1.2-4.9 acres)18%

Semi-Medium (4.9-9.9 acres)

9%

Medium (9.9-24.7 acres)

4%

Large (>24.7 acres)

1% Marginal (<1.2 acres)24%

Small (1.2-4.9 acres)23%

Semi-Medium (4.9-9.9 acres)

24%

Medium (9.9-24.7 acres)

20%

Large (>24.7 acres)

9%

We would like to thank Evalueserve for its help in preparing our research reports. Bhavik Mehta (IT); Kamal Verma (Banking & Financial Services); Kushal Shah (Midcaps), Jinesh Pagaria (Capital Goods, Utilities, Power); and Suraj Yadav (Cement, Oil & Gas) provide research support services to CLSA.

The Rythu Bandhu scheme of Telangana has led the

way for similar such schemes to be announced

elsewhere

Accurate mapping of land records is important for the success of this scheme and

lack of such reliable anddigitised records in some

states could mean that the scheme is implemented

phase-wise

user

Highlight



Limited scope for fiscal consolidation in FY20Figure 5

Fiscal accounts and estimations for FY19 and FY20Rs bn FY17 FY18 FY19BE FY19CL FY20CL % YoY

FY19BE% YoY

FY19CL% YoY

FY20CLCorporation 4,849 5,712 6,210 6,683 7,686 8.7 17.0 15.0Income 3,648 4,082 5,290 4,776 5,492 29.6 17.0 15.0Total direct 8,497 9,794 11,500 11,459 13,178 17.4 17.0 15.0Excise 3,821 2,586 2,596 2,457 2,580 0.4 (5.0) 5.0Service 2,254 812 52 65 65 (93.5) (92.0) 0.0Customs 2,586 1,369 1,125 1,301 1,457 (17.8) (5.0) 12.0CGST - 2,048 6,039 4,611 5,533 194.8 125.1 20.0IGST - 1,688 500 300 360 (70.4) (82.2) 20.0GST Cess collections 626 900 946 1,088 43.8 51.1 15.0Total indirect taxes 8,661 9,130 11,212 9,680 11,083 22.8 6.0 14.5Others & adjustments (65) 232 (25) - -Total taxes 17,094 19,157 22,687 21,139 24,261 18.4 10.3 14.8Less state share 6,080 6,730 7,881 7,343 8,427 17.1 9.1 14.8Net tax revenues (1) 11,014 12,427 14,806 13,796 15,833 19.2 11.0 14.8Non-tax revenues (2) 2,728 1,925 2,451 2,500 2,750 27.3 29.9 10.0Non-debt capital receipts (3) 654 1,158 922 900 990 (20.4) (22.3) 10.0Total revenues (1+2+3 = 4) 14,396 15,510 18,179 17,196 19,573 17.2 10.9 13.8

Revenue expenditure (5) 16,906 18,790 21,418 20,784 23,581 14.0 10.6 13.5Food subsidy 1,102 1,003 1,693 1,193 1,693 68.8 18.9 41.9

Other subsidies 939 908 950 950 998 4.6 4.6 5.0Interest 4,807 5,292 5,758 5,758 6,276 8.8 8.8 9.0

Other revenue expenditures 10,058 11,586 13,016 12,883 14,614 12.3 11.2 13.4Capital expenditure (6) 2,846 2,637 2,999 2,999 3,149 13.7 13.7 5.0Total expenditure (on budget)(5+6 = 7)

19,752 21,427 24,422 23,784 26,730 14.0 11.0 12.4

Off-balance sheet spending (8)* 250 400 - 800 300Actual expenditure (7+8 = 9) 20,002 21,827 24,422 24,584 27,030 11.9 12.6 10.0

Fiscal deficit (7-6 = 10) 5,356 5,917 6,243 6,588 7,157 5.5 11.3 8.6GDP (11) 152,537 167,731 187,223 188,407 211,016 11.6 12.3 12.0FD as % GDP (10/11 = 12) 3.51 3.53 3.33 3.50 3.39 -20bps -3bps -11bpsSource: CLSA, Ministry of finance. BE is budget estimate. *CLSA Estimates

Weak Centre GST collections…Figure 6

Monthly GST collections for the Central government

Source: CLSA, CGA, PIB

0

100

200

300

400

500

600

700

800

900

1,000

Aug17

Sep17

Oct17

Nov17

Dec17

Jan18

Feb18

Mar18

Apr18

May18

Jun18

Jul18

Aug18

Sep18

Oct18

Nov18

Dec18

Centes's GST collection as per govt accountsFY18 AverageFY19 Average

(Rs bn)

FY18 average : Rs465bn/mth FY19YTD average :

Rs400bn/mth

-14% YoY

Centre’s GST collections are actually running down YoY on a monthly run-rate basis



…have led to a substantial shortfall in total tax revenuesFigure 7

Direct and indirect tax collections

Source: CLSA, CGA. Indirect taxes include GST. P is provisional or close to Actual. BE is budget estimate.

Substantially slowing the fiscal consolidation trendFigure 8

Fiscal deficit as % GDP

Source: CLSA, Ministry of finance

Incrementally higher amount of deficit being ‘hidden’Figure 9

Total debt on Food Corporation of India (FCI) balance sheet

Source: CLSA, FCI, Ministry of finance.

15

5

12

17

23

18 16

2

7

0

5

10

15

20

25

Direct taxes Indirect taxes (*) Total taxes

FY18P FY19 BE FY19YTD% YoY

6.3

4.9

5.9

4.94.5

4.1 3.93.5 3.5 3.5 3.4

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19CL FY20CL

Fiscal deficit as % GDP% GDP

0.8 0.9 0.9

1.3

1.7

2.2

0.0

0.5

1.0

1.5

2.0

2.5

Mar'14 Mar'15 Mar'16 Mar'17 Mar'18E Mar'19CL

Debt on FCI balance sheetRs Trn

Direct tax collections have done well but too large a

shortfall in GST

Since GST rollout in FY18, fiscal consolidation has

slowed substantially

Under-provisioning of expenses, such as food

subsidy, is leading to more debt being taken on off-

balance-sheet of the government and on the

programme implementing agencies such as FCI and

NHAI



Disinvestment target is still some way offFigure 10

List of disinvestments done / likely in FY19Issue Amount raised (Rs

bn)Comment

Bharat 22 ETF 83 22 stocks including 19 PSUs like SBI, Power Grid etc. and 3 private cos (Axis, ITC, L&T) with govt.

stakesRITES Ltd. 5 IPOIRCON international 5 IPOGarden Reach Shipbuilders 3 IPOKIOCL 2 Buy-backCoal India 53 OFSHSCC India 3 Sale to another PSU (NBCC)NLC India 10 BuybackNALCO 3 BuybackCPSE ETF - 3 170 11 listed PSUs like NTPC, GAIL etc; sold at a

discount to market price which pressures stockBHEL 10 BuybackCochin Shipyard & Others 5 Buyback etcTotal YTD FY19 351Proposed issuesIOCL 25 Buyback announced alreadySJVN 70 Sale to another PSU (NTPC)REC 140 Sale to another PSU (PFC)NHPC 200 Sale to another PSU (NTPC)Other IPOs 15 Railway companiesCPSE ETF / Bharat 22 / SUUTI

50-150 Another tranche can be used as balancing item

Issues in Pipeline for FY19 500-600Total FY19E ~800bn targetSource: CLSA, DIPAM

States are doing well on GST: Cess in large surplusFigure 11

GST compensation cess collection, draw down and surplus till Nov’18

Source: CLSA, CGA, PIB

144 152

296

0

100

200

300

400

500

600

700(Rsbn)

FY18 FY19YTD Surplus

Collection Draw down Surplus

Cumulative surplus in GST compensation cess, meant

to compensate states for GST shortfall is Rs296bn

The large disinvestment target has seen government

adopt multiple measures such as creation of cross holdings in PSUs, selling

stakes in several PSUs via ETFs, etc



RBI balance sheetFigure 12

Summary balance sheet of RBIAs on 30 June (Rsbn) 2014 2015 2016 2017 2018Liabilities

Issue department 13,445 14,732 17,077 15,063 19,120Notes issued 13,445 14,732 17,077 15,063 19,120

Banking department 12,798 14,159 15,353 17,978 17,056Net worth 65 65 65 65 65

Capital 0.05 0.05 0.05 0.05 0.05Reserves 65 65 65 65 65

Deposits 3,893 5,327 5,223 9,136 6,701Banks 3,677 3,947 4,294 5,042 5,071Others 215 1,380 929 4,094 1,630

Contingency & other reserves 8,227 8,058 9,343 8,410 9,631Contingency 2,424 2,434 2,429 2,510 2,549Revaluation reserve 5,803 5,624 6,914 5,900 7,082

Surplus transferable to Govt. 527 659 659 307 500Other liabilities 87 50 63 60 159

Total liabilities 26,244 28,892 32,430 33,041 36,176Assets

Issue department 13,445 14,732 17,077 15,063 19,120Gold 650 637 729 690 743Foreign securities 12,783 14,083 16,336 14,367 18,367G-Secs and others 12 12 12 6 9

Banking department 12,798 14,159 15,353 17,978 17,056Investments 11,494 12,464 13,774 16,911 14,315

G-Secs 6,685 5,175 7,023 7,558 6,297Foreign securities 4,793 7,276 6,728 9,221 7,879Others 16 13 23 132 138

Loans 371 802 520 173 1,639Government 7 26 20 50 569Banks 364 777 501 123 1,069Others 0 0 0 0 0

Gold 590 579 662 627 697Fixed assets 5 4 3 4 4Other assets 338 310 393 263 402

Total assets 26,244 28,892 32,430 33,041 36,176Source: RBI, CLSA

Government has argued that the adequacy of the

contingency reserves of RBI needs to be assessed and if

in excess then a part of it could be given out as

dividend to help the fiscal

For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.

Airlines used pricing lever to accelerate share gains from IR since FY2015

Airlines matched Indian railways in terms of comparable volumes (long-distance AC travel) in

FY2017 and have extended their lead in the last two years. The last four years have been great

for airlines as they garnered a dominant ~80% share in growth volumes for long-distance AC

travel. Airlines would end FY2019 with a four-year volume CAGR of 20% versus a ~5% CAGR

for IR’s comparable volumes. Over this period, airlines have reduced their pricing by almost 20%

against broadly static base pricing of Indian Railways. Airlines have also benefitted in volume

terms from the flexi-pricing scheme of IR - volume activity for 2nd

AC rail travel declined yoy for

a nine-month period after the introduction of flexi-fares on premium trains. The outperformance

for airlines has come at the cost of profitability - airlines have grown pricing at a sub-2% CAGR

over the past nine years versus a 5% CAGR in key input costs.

Recent moderation in air travel reflective of limited scope of further gaining from railways

Growth in domestic air volumes has moderated to 11% yoy in Nov 2018 (13% yoy in Oct-

2018) after growing ~20% over 1HFY19. Our assessment of route-wise traffic suggests that the

moderation is driven by the top 50 routes (40% of volumes), with other routes (60% of volumes)

growing in excess of 20% on a yoy basis. The thirteen nodes forming the top-50 routes (tier 1

and 2 cities) are where airlines would have benefitted from share gains from Indian railways.

While noting limited scope of growth support to air volumes from IR, we note scope of some

reversal as IR intends to utilize the capacities freed on existing north-west/north-east corridor

(70% freight will move to DFC) for running more premium passenger trains.

A steady price hike may be the best way forward for airlines from hereon

With the shift of growth in volumes to airlines having happened to a large extent, airlines may

consider taking price hikes from hereon. Airlines may take comfort in limited inelasticity in

demand seen in FY2013, when a ~20% hike in prices led to a modest 4% yoy decline in

volumes. We note the high sensitivity of a small increase in yields (e.g. for Indigo, an increase of

Rs100 in yield or 2.5% higher quantum yields ~20% higher FY2021E EPS).What may moderate

down the pace of price increase for airlines is recent relaxations by IR to its flexi-fare scheme.

Indian Railways largely continues with flexi-fare scheme with some changes

Indian Railways has benefited from the flexi-fare scheme with a recent response to a Lok Sabha

question quantifying Rs10 bn of additional revenues in FY2018 (amount to 7% growth over AC

rail revenues in FY2017). With no meaningful loss seen in occupancy in the key

Rajdhani/Shatabdi/Duronto trains, Indian Railways has made changes to its flexi-pricing scheme

largely to address the issue of low-occupancy in other trains. The changes include (1) discontinuation

of such scheme in 15 trains and for another 32 trains during the lean period, (2) reducing cap

on surge pricing now at 1.4X of base rate versus 1.5X earlier and (3) graded discount on trains

with low occupancy four days prior to chart preparation. These changes would impact travel

after 15th March 2019.

Transportation India

Stage set for steady price increases by airlines. With the theme of share gains from

IR having largely played out, airlines may consider taking modest price increases to aid

moderating volume growth prospects. Airlines have used the pricing lever to accelerate

share gains from railways and in the process have been able to pass on a modest 30%

of the cost increase over the past nine years to its customers. Increase in yields at stable

pricing can meaningfully aid profitability and fair value for airlines businesses.

ATTRACTIVE

DECEMBER 26, 2018

THEME

BSE-30: 35,470

Aditya Mongia

Ajinkya Bhat

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight


KOTAK INSTITUTIONAL EQUITIES RESEARCH 3

Exhibit 1: Air travel has significantly outperformed long-distance AC rail travel over the next four years Comparison of passenger volumes across air and rail modes of transport, March fiscal year-ends, 2010-2019E ( bn kms)

Source: Indian Railways, DGCA, Kotak Institutional Equities estimates

Exhibit 2: Air travel is accounting for majority share of growth volumes for long-distance AC travel Share of air travel in growth volumes of long distance AC travel, March fiscal year-ends, 2011-8MFY19E (%)

Notes: (a) We assume long-distance AC rail travel to outperform the growth of passenger revenues by 3% forFY2018/8MFY19.


0

20

40

60

80

100

120

140

160

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

Long-distance AC rail

13% CAGR

5% CAGR

0

20

40

60

80

100

120

140

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

Domestic air travel

9% CAGR

19% CAGR

60

40

(35)

28

41

79 81 81 79

(60)

(30)

-

30

60

90

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

8M

FY1

9E

Share of air travel in growth volumes

Share Average (2011-15) Average (2015-18)

India Transportation

4 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Exhibit 3: Airlines have meaningfully reduced tariff since FY2015 versus static base tariff of Indian

Railways for AC rail travel Comparison of domestic air and long-distance AC rail volumes, March fiscal year-ends, 2010-18E (Rs per pax-km)

Notes (a) Data on air is based on disclosed actuals and estimates for Indigo.(b) FY2018 figures for rail is based on revised estimates of Indian Railways.


Exhibit 4: Airlines have also benefitted in volume terms from introduction of flexi-fare schemes Percentage variation on passenger count across key classes of trains impacted by flexi-fares scheme of Indian Railways (%)

Source: Lok Sabha questions, Kotak Institutional Equities

1.1 1.2 1.2 1.3 1.4 1.5 1.5 1.5 1.5

3.1 3.23.4

4.14.3 4.4

3.9

3.5 3.6

0

1

2

3

4

5

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

2nd AC rail Air travel

(9.5)

0.7

(2.5)

4.6

(12)

(10)

(8)

(6)

(4)

(2)

0

2

4

6

2nd AC 3rd AC Chair car Sleeper

Change over Sep 2016 - June 2017 on a yoy basis


KOTAK INSTITUTIONAL EQUITIES RESEARCH 5

Exhibit 5: Airlines have grown tariff at much below the cost inflation CAGR of per unit revenue and cost for Indigo, March fiscal year-ends, 2010-19E (%)

Source: Company, Kotak Institutional Equities estimates

Exhibit 6: Growth in the passenger traffic for the top-5% routes has moderated meaningfully over

the past six months Yoy growth in the top-50 routes for domestic air passenger traffic (%)

Source: DGCA, Kotak Institutional Equities

1.2

4.8

5.35.0

4.6

0

1

2

3

4

5

6

Tariff Fuel cost Staff cost Rental Others

CAGR (%) over 2010-19E

14

11 10 10

17

2018

7 8

11 1110

3

21

12

-

10

20

30

40

Oct

-17

Nov-

17

Dec-

17

Jan

-18

Feb-1

8

Mar-

18

Apr-

18

May-

18

Jun-1

8

Jul-1

8

Aug

-18

Sep

-18

Oct

-18

Top 50 routes Remaining routes Total

India Transportation

6 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Exhibit 7: Modest 4% yoy decline in volumes against 20% growth in pricing in FY2013 reflects

inelasticity of demand for air travel against price increase Yoy change in volumes for air travel and in tariff, March fiscal year-ends, 2011-19E (%)

Notes: (a) We assume tariff of Indigo as that for air travel.

Source: DGCA, Kotak Institutional Equities estimates

Exhibit 8: Air travel is likely to grow volumes in healthy double-digit over the next four years Comparison of passenger volumes across air and rail modes of transport, March fiscal year-ends, 2010-2023E ( bn kms)


2

5

21

5

2

(10) (11)

3

(3)

20

12

(4)

4

13

21 22

19 18

(15)

(10)

(5)

0

5

10

15

20

25

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

E

Yoy growth in air travel activity

Tariff Volumes

Notes:

(a) The above analysis assumes air volumes would become 1.6X AC rail volumes over the next four years

-

100

200

300

400

500

600

700

800

900

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

Domestic air+ AC rail+ sleeper

8% CAGR

8% CAGR

-

50

100

150

200

250

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

Domestic air

9% CAGR

12% CAGR

19% CAGR

-

20

40

60

80

100

120

140

160

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E


13% CAGR

6% CAGR

5% CAGR

-

20

40

60

80

100

120

140

160

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

Sleeper rail

8% CAGR

5% CAGR4% CAGR

-

100

200

300

400

500

600

700

800

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

Domestic air+ AC rail+ sleeper

9% CAGR

7% CAGR

7% CAGR

-

50

100

150

200

250

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

Domestic air

9% CAGR

12% CAGR

19% CAGR

-

20

40

60

80

100

120

140

160

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E


13% CAGR

6% CAGR

5% CAGR

-

20

40

60

80

100

120

140

160

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

E

20

19

E

20

20

E

20

21

E

20

22

E

20

23

E

Sleeper rail

8% CAGR

5% CAGR4% CAGR

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

https://blogs.cfainstitute.org/investor/2018/06/08/daniel-kahneman-four-keys-to-better-decision-making/ 1/7

Daniel Kahneman: Four Keys to BetterDecision MakingBy Paul McCaffrey (https://blogs.cfainstitute.org/investor/author/paulmccaffrey/)

Nobel laureate Daniel Kahneman has transformed the fields of economics and investing. At their most basic, his revelations demonstrate that human beings and the decisions they make are much more complicated — and much more fascinating — than previously thought.

He delivered a captivating mini seminar on some of the key ideas that have driven his scholarship, exploring intuition, expertise, bias, noise, how optimism and overconfidence influence the capitalist system, and how we can improve our decision making, at the 71st CFA Institute Annual Conference (https://annual.cfainstitute.org/) in Hong Kong.

“Optimism is the engine of capitalism,” Kahneman said. “Overconfidence is a curse. It’s a curse and a blessing. The people who make great things, if you look back, they were overconfident and optimistic — overconfident optimists. They take big risks because they underestimate how big the risks are.”

But by studying only the success stories, people are learning the wrong lesson.

“If you look at everyone,” he said, “there is lots of failure.”

The Perils of Intuition

(https://www.cfainstitute.org)

https://blogs.cfainstitute.org/investor/about-us/

https://blogs.cfainstitute.org/investor/authors/

https://blogs.cfainstitute.org/investor/follow-the-enterprising-investor/

https://blogs.cfainstitute.org/investor/author/paulmccaffrey/

https://blogs.cfainstitute.org/investor/category/behavioral-finance/

https://blogs.cfainstitute.org/investor/category/leadership-management-communication-skills/

https://blogs.cfainstitute.org/investor/category/portfolio-management/

https://annual.cfainstitute.org/

https://www.cfainstitute.org/

user

Highlight

user

Highlight

2/7

“We trust our intuitions even when they’re wrong,” he said.

But we can trust our intuitions — provided they’re based on real expertise. And while wedevelop expertise through experience, experience alone isn’t enough.

In fact, research demonstrates that experience increases the confidence with whichpeople hold their ideas, but not necessarily the accuracy of those ideas. Expertiserequires a particular kind of experience, one that exists in a context that gives regularfeedback, that is effectively testable.

“Is the world in which the intuition comes up regular enough so that we have anopportunity to learn its rules?” Kahneman asked.

When it comes to the finance sector, the answer is probably no.

“It’s very difficult to imagine from the psychological analysis of what expertise is thatyou can develop true expertise in, say, predicting the stock market,” he said. “Youcannot because the world isn’t sufficiently regular for people to learn rules.”

That doesn’t stop people from confidently predicting financial outcomes based on theirexperience.

“This is psychologically a puzzle,” Kahneman said. “How could one learn when there’snothing to learn?”

That sort of intuition is really superstition. Which means we shouldn’t assume we haveexpertise in all the domains where we have intuitions. And we shouldn’t assume othersdo either.

“When somebody tells you that they have a strong hunch about a financial event,” hesaid, “the safe thing to do is not to believe them.”

Noise Alert

Even in testable domains where causal relationships are readily discernible, noise can distort the results.

Kahneman described a study of underwriters at a well-run insurance company. While not an exact science, underwriting is a domain with learnable rules where expertise can be developed. The underwriters all read the same file and determined a premium. That there would be divergence in the premium set by each was understood. The question was how large a divergence.

“What percentage would you expect?” Kahneman asked. “The number that comes toAccept

https://hbr.org/2016/10/noise

user

Highlight

user

Highlight

user

Highlight

user

Highlight

user

Highlight

Better Decision Making | CFA Institute Enterprising Investor

3/7

“Which really means that those underwriters are wasting their time,” he said. “How canit be that people have that amount of noise in judgment and not be aware of it?”

Unfortunately, the noise problem isn’t limited to underwriting. And it doesn’t requiremultiple people. One is often enough. Indeed, even in more binary disciplines, using thesame data and the same analyst, results can differ.

“Whenever there is judgment there is noise and probably a lot more than you think,”Kahneman said.

For example, radiologists were given a series of X-rays and asked to diagnose them.Sometimes they were shown the same X-ray.

“In a shockingly high number of cases, the diagnosis is different,” he said.

The same held true for DNA and fingerprint analysts. So even in cases where thereshould be one foolproof answer, noise can render certainty impossible.

“We use the word bias too often.”

While Kahneman has spent much of his career studying bias, he is now focused onnoise. Bias, he believes, may be overdiagnosed, and he recommends assuming noise isthe culprit in most decision-making errors.

“We should think about noise as a possible explanation because noise and bias lead youto different remedies,” he said.

Hindsight, Optimism, and Loss Aversion

Of course, when we make mistakes, they tend to skew in two opposing directions.

“People are very loss averse and very optimistic. They work against each other,” he said.“People, because they are optimistic, they don’t realize how bad the odds are.”

As Kahneman’s research on loss aversion has shown, we feel losses more acutely thangains.

“Our estimate in many situations is 2 to 1,” he said.

Yet we tend to overestimate our chances of success, especially during the planningphase. And then whatever the outcome, hindsight is 20/20: Why things did or didn’twork out is always obvious after the fact.

“When something happens, you immediately understand how it happens. Youimmediately have a story and an explanation,” he said. “You have that sense that youlearned something and that you won’t make that mistake again.”

These conclusions are usually wrong. The takeaway should not be a clear causalrelationship.

“What you should learn is that you were surprised again,” Kahneman said. “You shouldlearn that the world is more uncertain than you think.”

So in the world of finance and investing, where there is so much noise and bias and solittle trustworthy intuition and expertise, what can professionals do to improve theirdecision making?

Kahneman proposed four simple strategies for better decision making that can beapplied to both finance and life.

1. Don’t Trust People, Trust Algorithms

Whether it’s predicting parole violators and bail jumpers or who will succeed as aresearch analyst, algorithms tend to be preferable to independent human judgment.

user

Highlight

user

Highlight

“The single best advice we hae in framing is broad framing,” he said. “See the decision as a member of a class of decisions that you’ll probably have to take.”

3. Test for Regret

“Regret is probably the greatest enemy of good decision making in personal finance,” Kahneman said.

So assess how prone clients are to it. The more potential for regret, the more likely they are to churn their account, sell at the wrong time, and buy when prices are high. High-net-worth individuals are especially risk averse, he said, so try to gauge just how risk averse.

“Clients who have regrets will often fire their advisers,” he said.

4. Seek Out Good Advice

Part of getting a wide-ranging perspective is to cultivate curiosity and to seek out guidance.

So who is the ideal adviser? “A person who likes you and doesn’t care about your feelings,” Kahneman said.

For him, that person is fellow Nobel laureate Richard H. Thaler.

“He likes me,” Kahneman said. “And couldn’t care less about my feelings.”

This article originally appeared on the 71st CFA Institute Annual Conference blog (https://annual.cfainstitute.org/).

. “There are very few examples of people outperformingalgorithms in making predictive judgments. So when there’s the possibility of using an algorithm, people should use it. We have the idea that it is very complicated to design an algorithm. An algorithm is a rule. You can just construct rules.”

And when we can’t use an algorithm, we should train people to simulate one.

“Train people in a way of thinking and in a way of approaching problems that will impose uniformity,” he said.

2. Take the Broad View

Don’t view each problem in isolation.

https://annual.cfainstitute.org/

http://cfainstitute.gallery.video/annual18

http://blogs.cfainstitute.org/investor/follow-the-enterprising-investor/

https://blogs.cfainstitute.org/investor/tag/behavioral-biases/

https://blogs.cfainstitute.org/investor/tag/behavioral-economics/

https://blogs.cfainstitute.org/investor/tag/cfa-institute-annual-conference/

https://blogs.cfainstitute.org/investor/tag/daniel-kahneman/

https://blogs.cfainstitute.org/investor/tag/economics/

user

Highlight

user

Highlight

user

Highlight

He exposes two key shortcomings tht humans possess. Our knowledge on any subject is more limited than we realize and our inability to predict the future because noise will always get in the way.

There is no such thing as a Nobel prize in economic sciences. Beginning in 1901, Nobel Prizes have been awarded in the following five categories: literature, peace, physics, chemistry, and “physiology or medicine.” In 1969, in an effort to improve the image of economists, enthusiasts managed to establish the confusingly named “Bank of Sweden Price in Economic Sciences in Memory of Alfred Nobel.”

The Wall Street Journal and The New York Times carefully refer to this award as the Nobel Memorial Prize in Economic Science. Recipients are not Nobel Laureates.

Amartya Sen, after receiving the prize in 1998, said in an interview: “I’ve always been skeptical of the prize, but it’s difficult to express that until you get it because people think it’s sour grapes.”

Reply (https://blogs.cfainstitute.org/investor/2018/06/08/daniel-kahneman-four-keys-to-better-decision-making/?replytocom=559927#respond)

4. — John LaVine (http://www.johnlavinemedia.com) says:

8 August 2018 at 11:47(https://blogs.cfainstitute.org/investor/2018/06/08/daniel-kahneman-four-keys-to-better-decision-making/#comment-564537)

I found this piece humorously informative, referring to the mental patterns thataffect our risk taking and assessment. I do believe that my best successes in themarket have come from some long shots, albeit with a reason for the gamble taken.

Despite some losses, often at the suggestion of investment by learnedprofessionals, rather than my own gut, I have to feel optimistic and think that sincethe market is so often driven by knee-jerk emotion, that we’re all better off by toomuch optimism than cautious pessimism, unless we’re set for life. I, of course, am,as long as I don’t live to see 2019.


5. — Martin Colwell says:

15 August 2018 at 09:13(https://blogs.cfainstitute.org/investor/2018/06/08/daniel-kahneman-four-keys-to-better-decision-making/#comment-565503)

I would suggest readers read Thinking Fast And Slow by Messrs Kahnemahn andTwersky to fully understand how to control bias and ‘gut feeling’ so that it isrelative but not your main driver for decisions.


https://blogs.cfainstitute.org/investor/2018/06/08/daniel-kahneman-four-keys-to-better-decision-making/?replytocom=558691#respond


http://www.johnlavinemedia.com/

