India 2020: Consumption driven to investment led-Why and How?

Thematic | Economy

Economy

India 2020: Consumption

driven to investment led -

Why & How?

Economy

Executive summary

This report aims to explain the framework with which we analyze the Indian economy. The

intent is to share the lenses we use to look at an(y) economy. We have not seen other

reports using this framework to explain the Indian economy.

Why should one read this report?

Is this a report written by an Economist? “We know India’s real GDP growth and

have heard the market forecasts…”, “India’s current account deficit is in control and

inflation is likely to remain stable…”. Why should we read this report? If one

believes that Economics is all about GDP growth, inflation, etc, one must read this

report, because we show that (a) Economics is much more, and (b) Economics could

be way more fun than it usually appears to be. Three things that differentiate this

report are:

Covering an economy in one identity:

“What if a large part of an economy could

be explained by a single identity?”

This is exactly what we have done here.

Notwithstanding its vastness, we believe an economy could be explained by one

single identity. We call this

“The Theory of Everything”.

This single identity

covers a large part of the economy by taking care of five facets – fiscal deficit,

current account deficit, consumption, savings and investments. This identity also

helps to understand the behavior of three participants in an economy –

households, private corporate sector, and (consolidated) public sector.

Purely data-driven analysis, no airy talk:

“In God we trust, all other must bring

data.”

- W Edwards Deming. We are not God, and that’s why you will see only

data-driven analysis here. If a finding cannot be backed by data, it comes with a

fair degree of uncertainty (especially in macroeconomics), which is why we have

resisted such analysis. Every conclusion in this report is supported by data from

reliable sources. There is a reason why we have more than 90 exhibits in a 70-

page report. This, we believe, is our strength. We don’t make conclusions out of

thin air.

Independent analysis helps us challenge, if needed, market consensus:

“If

everyone is thinking alike, then somebody isn't thinking.”

– George S Pattron Jr.

Since

our analysis is entirely data-driven, we are able to stick out our neck and

make conclusions, as you will see below, which may be in contrast to common

beliefs.

Overall, while GDP growth and inflation are important, it is equally important to

understand them in an appropriate manner. This is exactly what we intended to do.

This report is divided into three parts. Part I analyzes the comparative performance

of the Indian economy, which is what matters for investors. Part II covers the

domestic fundamentals of the economy. We propound the KURE framework and

explain the economy in a single equation. In Part III, we discuss the possible

scenarios for India by 2020. We believe that the economy must address few

challenges, if it wants to graduate to a sustainable high growth path.

June 2016

Mr Nikhil Gupta

Please click here for Video Link

ECONOMY

Thematic | Economy

Key conclusions

Not only do we establish

the sanctity of the new GDP

series, but also conclude

that the current slowdown

is not as severe as the

previous slowdown in the

2000s

Consumption demand is not really weak…:

Irrespective of the tag of

“the

fastest growing economy in the world”,

one keeps hearing about weak

consumption demand, as is reflected by the subdued topline of India Inc. By

incorporating the mid-level of the corporate pyramid with the (highly covered)

top level, not only do we establish the sanctity of the new GDP series, but also

conclude that the current slowdown is not as severe as the previous slowdown

in the 2000s, primarily because of resilient consumption demand. In other

words, we firmly establish that the current economy is driven by consumption,

rather than investments.

…as reflected by falling savings, high inflation and wide external deficit:

Notably, India’s consumption has been relatively resilient amid weak disposable

income growth. As a consequence, household savings in India have fallen to the

lowest level in two decades. In fact, a comparison of the current slowdown with

that of the early 2000s shows that the combination of high consumption and

weak investment has inevitably led to higher inflation in India. By creating a

measure of price gap (actual inflation – desired inflation), we find that India’s

inflation is ~55% higher today. This makes us conclude that like the wholesale

price index (WPI), retail inflation (based on consumer price index (CPI)) must

undershoot the medium-term target for at least a few quarters. Moreover, we

find that although current account deficit (CAD) has narrowed recently, it has

not improved to a desired level.

Lower savings act as a structural constraint to higher investment rate…:

As a

result of falling savings and narrower CAD, investment rate has also fallen. Using

“The Theory of Everything”,

we show that an increase in national savings is a

necessary condition for investment rate to pick up again. This is primarily

because the contribution of foreign capital to domestic investments, going

forward, will be limited due to incomplete adjustments in CAD. Further, we

argue that the revival in investment rate has to be led by the private corporate

sector, as higher household (or public) investments imply lower efficiency of

capital, which must be avoided.

…which may make higher sustainable growth challenging:

Overall, we believe

that the current economic model could remain in place for the next few years,

which will help India touch 8% real GDP growth. However, consumption-driven

growth will increasingly become destabilizing (as inflation will continue to rise).

India must replace consumption with investments as the key driver of growth

(exactly opposite of what is recommended for China). The transformation, we

believe, would involve some sacrifice in terms of GDP growth, which implies

India could take a little longer (probably after 2020) to graduate to the next level

of economic growth (9-10%). We would not be surprised to see the Indian

economy growing at 7-8% for a few years, as investments take over

consumption as the key driver of GDP growth. After the transformation,

however, India could grow at 10% on sustainable basis.

India’s consumption

has been relatively

resilient amid weak

disposable income

growth

An increase in national

savings is a necessary

condition for investment

rate to pick up again

Consumption-driven

growth will

increasingly become

destabilizing (as

inflation will continue

to rise)

June 2016

Thematic | Economy

Info graphic:

perspective

Indian

economy

from

investors’

June 2016

Thematic | Economy

Info graphic:

perspective

Indian

economy

from

Economist’s

June 2016

Thematic | Economy

How long can consumption drive economic growth?

Notwithstanding the recent

debate on actual GDP growth

(whether 6% or 7%), there is no

argument over the fact that

consumption is the key driver of

economic growth in India,

while investments lag

In the words of the Reserve Bank of India (RBI), the Indian economy is a beacon of

stability. Indeed, it is. Irrespective of one’s (dis)comfort with the new GDP series, the

Indian economy has turned corners in the past few years. Although the world

economic growth has eased further from 3.5% in 2012 to 3.1% in 2015, India’s GDP

growth has improved.

Growth being driven by consumption…:

The tag of

“fastest growing economy in the

world”,

however, needs some introspection. Notwithstanding the recent debate on

actual GDP growth (whether 6% or 7%), there is no argument over the fact that

consumption is the key driver of economic growth, while investments lag

(Exhibit 1).

Exhibit 1: Average growth in key real GDP components (% pa)

13.3

2001-04

2013-16

8.4

5.6

3.2

2.8

6.0

4.1

Investments

Exports

(1.0)

Imports

Consumtpion

* Consumption includes both private and government consumption

Source: Central Statistics office (CSO), MoSL

In fact, growth in consumption has been resilient enough to make the recent

economic performance look better than the economic performance in the previous

slowdown in the early 2000s

(Exhibit 2).

The average growth in the past four years

has been 6%, closer to 7.2% growth during the boom period in mid-2000s and much

better than 4.5% growth in the previous slowdown in early 2000s. What kind of

introspection, then, are we talking about? (Please see Appendix I at the end of

report for details on data used in this report.)

Exhibit 2: India’s real GDP growth has not slowed as much due to consumption (Index)

7.2%

4.5%

Recent period

since FY13

Boom period

in mid-2000s

Slowdown in

early 2000s

Source: Organisation for Economic co-operation and development (OECD), MoSL

June 2016

Thematic | Economy

Our analysis of India’s growth

drivers makes us skeptical of the

sustainability of the current

economic model, in which

consumption is doing all the

heavy lifting, while investments

are resting on their laurels

…financed by household savings:

Notwithstanding high economic growth, policy

makers must not lose sight of the drivers of economic growth. Our analysis of India’s

growth drivers makes us skeptical of the sustainability of the current economic

model, in which consumption is doing all the heavy lifting, while investments are

resting on their laurels. There are three key reasons, which make us believe so:

1. Consumption is financed by savings, rather than higher disposable income. It

implies consumption is replacing potential investments

(Exhibit 3).

2. Notwithstanding the recent sharp deceleration in CPI-based retail inflation, the

current inflation is still higher than the medium-term target of 4%. In fact,

India’s inflation differential with major trading partners has risen further in the

past one year, hurting India’s competitiveness

(Exhibit 4).

3. Related with the first reason, the share of consumption in India’s current

account deficit (CAD) has widened, while investment-led deficit has narrowed

substantially. Ideally, India’s current account should have been in surplus.

without Exhibit 4: Despite recent fall in India’s inflation, widening

differential v/s trading partners has hurt competitiveness

140

120

100

(2010=100)

Inflation differential with trading partners

High inflation

differential =

Low competitiveness

Exhibit 3: Consumption growth has happened

proportionate growth in disposable income

Early 2000s

160

140

120

100

Number of years

Boom period

Real personal disposable income

Recent

China

India

Indonesia

Philippines

Real disposable income is nominal income deflated by PCE deflator

Data from FY15 onwards are our estimates/projections

Calculated using nominal and real effective exchange rate data

Source: CSO, Bank for International Settlements (BIS), MoSL

Resilient consumption may continue driving growth for the next two years…:

Regardless of our skepticism, we would not be surprised if the current economic

model continues for the next few years. Accordingly, savings will fall further, CAD

will widen and inflation will start reversing its current south-ward trajectory.

Not only might the

economy then find it

difficult to grow at 10% by

2020, but it might also find

it challenging to maintain

8% growth

…unlikely to lead to sustainable growth:

With these forces tightening their grip on

the economy, policy makers will have to shift their focus back on containing these

beasts. Not only might the economy then find it difficult to grow at 10% by 2020,

but it might also find it challenging to maintain 8% growth. The four key changes

necessary for the economy to move to a sustainable growth path, and then

graduate to higher growth are:

1. Inflation must fall towards 2% at least for a few quarters

2. National savings, driven by households, must witness an increase

3. Domestic investments, driven by private corporate sector, must replace

consumption-driven growth

4. Global environment has to be supportive

June 2016

Thematic | Economy

Today’s Indian

economy must be

compared with the

previous slowdown in

the early 2000s rather

than the boom period

of 2005-08

What leads us to these conclusions:

At a time when 4% inflation looks difficult, a

recommendation of bringing inflation down to 2% may appear misplaced to our

readers. The key difference between our research and the market participants could

be the benchmark with which we compare the current economic environment. We

believe that today’s Indian economy must be compared with the previous slowdown

in the early 2000s rather than the boom period of 2005-08. This comparison not

only tells us that the current environment is more buoyant than in the early 2000s,

but also that (1) retail inflation is much higher, (2) national savings must rise for

revival of the investment cycle, and (3) higher investments must be driven by the

corporate sector rather than households.

A prolonged rural slowdown may be required…:

To bring down inflation, rural

wages may be a catalyst

(Exhibit 5).

We would not be surprised if the current

episode of weak rural wages is prolonged. There are two key reasons for this: (a) the

rural sector has high marginal propensity to consume, and (b) productivity of the

rural sector is low, not justifying higher wage growth. Hence, the rural economy is

unlikely to be as buoyant as it was between FY09 and FY13.

Exhibit 6: …strongly correlated with inflation

Avg growth was +8.5%

between FY11 and FY13

(5)

*Data for January-February 2016

Nominal rural wage growth (%, YoY)

y = 0.4891x + 2.2216

R² = 0.7949

We would not be

surprised if the current

episode of weak rural

wages is prolonged

Exhibit 5: Rural wages have collapsed recently (% YoY)…

(7)

(14)

Real rural wages

Avg growth was +0.1%

between FY00 and FY10

CPI index for rural laborers (RL)

Source: Labour Bureau, Reserve Bank of India (RBI), MoSL

…leading to lower consumption unless savings are rebuilt:

If so, a fall in

consumption growth, we believe, may be inevitable to bring down inflation. Further,

consumption growth will have to moderate to a level where savings start to re-build.

This may be unavoidable because we do not expect incomes to grow fast enough to

support higher consumption and higher savings (like in FY04-FY08 period). As

savings re-build, it will allow the investment rate to increase. Given limited gains due

to capital efficiency, an increase in investment rate is necessary for India to increase

its economic growth from 7-8% towards 10%.

Consumption must be replaced by investments:

In short, lower consumption is

necessary to help bring down inflation, re-build saving and keep CAD contained. The

longer the current economic model continues, the more destabilizing it will become.

The shift from consumption to investments, thus, will become inevitable for the

economy. There could be some disturbances during the transition; however, this is

an unavoidable to create a sustainable model of development.

The shift from

consumption to

investments, thus, will

become inevitable for

the economy

June 2016

Thematic | Economy

Is political agenda supporting our thesis?

The government sector plays a critical role in determining the buoyancy of the rural

economy, and thus, India’s inflation. Therefore, one must keep an eye on the

government’s preferences.

Firstly, we must note that the current government, in its first stint, has shown its

ability and experience in allowing the economy to adjust during the early 2000s. We

believe that the domestic adjustments during that period – namely, lower inflation,

current account surplus, high deposit rates, etc – created strong potential for the

economy to grow sustainably at a faster rate. To grow at 10% in the 2020s, we

believe the economy must create the same potential. This is unlikely without the

government’s support.

Therefore, it is important to note how the central government has done in the past

couple of years. To bring inflation down further, a key requirement is continued

slowdown in rural wages, unless their productivity increases. The government’s core

revenue expenditure (excluding interest) plays an important role in determining

rural buoyancy. Core revenue expenditure growth was 4% in FY16, marking the

lowest growth in 34 years. This, we believe, helped to keep rural wage growth

contained

(Exhibit 7).

Since the correlation works with a lag of 18-24 months, we

expect rural wages to remain subdued in the foreseeable future

(Exhibit 8).

Core revenue expenditure

growth was less than 4% in FY16,

marking the lowest growth in 34

years. This, we believe, helped to

keep rural wage growth

contained

Exhibit 7: Core revenue expenditure* (RE) growth lowest in Exhibit 8: …which is highly correlated (with lag) with real

more than three decades in FY16…

rural wages

(10)

(% YoY)

Revenue spending ex interest

RE ex interest (-24m)

(% YoY,

12mma

Real rural wages (RHS)

(% YoY)

(2)

*Excluding interest payments

RE growth is with a lag of 24 months

Source: Union Budget documents, CMIE, Labour Bureau, MoSL

Unlike the CG’s high

influence in driving

consumption growth, we

believe its influence in total

investments is limited

While the government has curtailed its consumption spending, it has pushed ahead

its capital expenditure. In FY16, the central government’s capex grew more than

25%, marking its highest growth in six years. Nevertheless, unlike the CG’s high

influence in driving consumption growth, we believe its influence in total

investments is limited because (a) the share of the government (central + states) in

the economy’s total investments is ~13%, and (b) like household investments, public

investments are not as efficient as corporate investments. Notably, the share of the

government has risen from 9.5% in FY12 to ~13% in FY15; however, higher public

investments limit the gains in capital efficiency.

June 2016

Thematic | Economy

Exhibit 9: Key investors in the economy

FY12

11.1

9.5

43.4

Households

Private corporate

Government*

Other public sector

36.1

43.3

* General government (Central + States)

Source: Central Statistics Office (CSO), CMIE, MoSL

12.8

9.9

33.9

Households

Private corporate

Government*

Other public sector

FY15

June 2016

Thematic | Economy

Key economic projections for FY17-18

Exhibit 10: Economic forecasts of key macro-economic parameters

Economic variable

Real sector

Real GDP

Consumption*

Fixed investments

Real GVA

Industry#

Services

Nominal GDP

IIP

Real PDI

Total savings

Total investments

Prices & rates

CPI

WPI

GDP deflator

10-yr yield (year-end)

INR/USD (average)

Bank credit

Bank deposits

Balance of payments

CAD

Capital & financial account

Foreign exchange reserves

(+(withdrawal)/-(accretion))

Central government finances

Total receipts

Total spending

Revenue spending

Capital spending

Fiscal balance

% YoY

% of GDP

16.7

8.1

8.5

5.2

(4.9)

14.8

10.6

10.3

12.5

(4.5)

9.1

6.7

6.9

4.8

(4.1)

8.4

7.3

5.5

20.9

(3.9)

15.5

10.8

11.8

3.9

(3.5)

14.1

12.4

12.8

10.0

(3.4)

% of GDP

USD bn

(4.8)

5.0

(3.8)

(1.7)

2.5

(15.5)

(1.3)

4.4

(61.4)

(0.8)

2.3

(32.1)

(1.4)

2.4

(21.4)

(2.0)

3.0

(24.5)

% YoY

Unit

% YoY

10.1

7.4

7.9

7.96

54.5

13.6

14.1

14.2

9.3

6.0

6.2

8.80

60.5

13.4

13.9

14.1

5.9

2.0

3.3

7.74

61.2

10.8

10.4

12.6

4.9

(2.5)

1.0

7.47

65.5

10.4

9.9

8.1

4.7

1.9

3.1

~7.00

68.0

11.3

11.1

8.8

5.0

2.9

3.6

…

69.8

12.3

12.0

11.7

% YoY

% of GDP

5.6

4.5

4.9

5.4

3.6

8.1

13.9

1.1

3.6

33.8

38.6

6.6

5.8

3.4

6.3

5.0

7.8

13.3

(0.1)

4.9

33.0

34.7

7.2

4.9

7.1

5.9

10.3

10.8

2.8

2.9

33.0

34.2

7.6

6.6

5.3

7.2

7.4

8.9

8.7

2.4

4.1

31.8

32.5

7.8

8.1

6.6

7.7

6.2

9.0

11.1

5.2

6.3

29.9

31.3

8.1

9.0

7.1

7.9

6.9

9.7

11.9

5.8

7.0

28.6

30.7

Units

FY13

FY14

FY15

FY16

FY17F

FY18F

* Private + Government consumption

# Includes construction

Please see Appendix IV for detailed projections

Source: CSO, RBI, CMIE, MoSL

June 2016

Thematic | Economy

Info graphic: Indian economy from investors’

perspective

June 2016

Thematic | Economy

I. Indian economy from investors’ perspective

Unlike Economists, for whom absolute performance may be as important, comparative

performance holds the key for investors. The key parameters that confirm India’s

outperformance are:



Economic resilience has helped India to rise from the world’s 12 largest economy in

2008 to 7 this year, increasing India’s dominance in the world economy.



At a time when most major economies in the world are witnessing declining working

population, threatening to push them into stagnation, India’s demographic structure is

an enviable asset.



In the past four years, India’s vulnerability matrix has improved markedly and reward

matrix has also recovered. Hence, risk-reward matrix makes India the most attractive

investment destination.



Most importantly, the Indian economy has improved without increasing its leverage.

The debt-to-GDP ratio has been stagnant since 2012 and the debt intensity of India’s

GDP growth is one of the lowest among major emerging economies.

While most emerging

economies have lost share

in the past few years, the

dominance of China and

India (Indonesia too to a

lesser extent) has

increased in the world

economy

The Indian economy has come a long way from its weak fundamentals in 2012.

While some of the long-term structural factors remain benign, the extent of

improvement in other fundamentals vis-à-vis other major emerging market

economies has been excellent in the past 3-4 years. We believe this is what matters

most for global investors, who look at relative performance rather than absolute

performance. In this part, we look at the comparative performance of the Indian

economy vis-à-vis its counterparts in the developing world and some developed

economies too.

I.1. Economic resilience has increased India’s dominance in world economy:

Notwithstanding the Great Financial Crisis (GFC), which has rattled the developed

world for 7-8 years, growth of the Indian economy has been impressive.

Exhibit 11

shows the share of major developed economies (and India) in the world economy.

Barring the US, major developed economies have lost share in the world economy.

Exhibit 12

compares the share of major emerging and developing economies in the

past five years. While most emerging economies have lost share in the past few

years, the dominance of China and India (Indonesia too to a lesser extent) has

increased in the world economy.

Exhibit 11: Share of major advanced economies and India in Exhibit 12: Share of major developing economies in the world

the world economy (%)

economy (%)

Germany

India

Italy

USA (RHS)

2011

2012

2013

2014

2015

2016E

Gross domestic product (GDP) at current prices in US Dollar terms

2011

2012

2013

2014

2015

2016E

Brazil

India

Russia

China (RHS)

Source: International Monetary fund (IMF), MoSL

E=IMF’s estimates

June 2016

Thematic | Economy

Owing to the relative resilience of the Indian economy in the past few years, its

ranking in the world economy has improved dramatically. As

Exhibits 13-14

show,

India has moved up from the 12

largest economy in the world in 2008 to the 7

largest this year (as per IMF’s forecasts).

Exhibit 13: India’s ranking has improved from 12 in 2008…

2016E

China,

15.4

Japan,

Germany,

6.0

4.7

UK, 3.7

USA,

25.1

France, 3.3

India, 3.1

Italy, 2.5

Brazil, 2.1

Canada, 2.0

Spain, 1.7

Russia, 1.5

2016 data is IMF’s forecasts

Exhibit 14: …to 7 in 2016 in the world economy (%)

Others,

29.0

2008

2016E

Source: IMF, MoSL

India’s working population

continues to grow at 1.7%

per annum against the

global average of 1.1%.

I.2. India’s demographic structure an enviable asset:

At a time when the developed

world is feared to be suffering from secular stagnation

, partly because of declining

(or decelerating growth in) working population (aged 15-64 years), a vast youth

population (aged below 14 years) is an enviable asset for any economy.

Exhibit 15

shows that the growth in working population is decelerating at the global level;

however, India’s working population continues to grow at 1.7% per annum against

the global average of 1.1%. Notably, Eurozone (EZ), like Japan, is already witnessing

a shrinking working population, while China is facing stagnant working population.

Exhibit 16

shows the share of youth population in major economies, reflecting the

potential growth in working population after a decade or so. The lower the share of

youth population, the higher is the risk of contraction in working population over

the next decade. The share of youth population is the highest in India at 29.2% of

total population and the lowest in Japan at less than 13% in 2014.

Exhibit 15: Working population (aged 15-64 years,% YoY)

2.5

2.0

1.5

1.0

0.5

0.0

2010

2011

2012

2013

2014

China

India

USA

World

Exhibit 16: Share of youth population (aged 0-14 years)

29.2

19.1

12.9

26.2

17.7

17.2

15.2

China

India

USA

Japan

World

Source: World Bank, MoSL

Data for 2014

The concept was introduced by Lawrence H. Summers in late 2013, who is the Charles W. Eliot University Professor and President Emeritus

at Harvard University. Read an ebook on secular stagnation

here

June 2016

Thematic | Economy

India’s working population

continues to grow at 1.7%

per annum against the

global average of 1.1%.

Exhibit 17

below, which shows the median age of the population, reinforces India’s

favorable demographic structure vis-à-vis other large economies. The median age of

population in India is 27 years, lower than the world median of 30 years. Notably,

the median age in Japan is 47 years, which makes it the world’s oldest nation.

Further, the old-age (aged 65+ years) dependency ratio in India is 9% against the

world’s (and Asia’s) average of 13% (11%) in 2015

(Exhibit 18).

India’s demographic

structure gives it an enviable advantage, which, if utilized carefully, has the potential

to take India to the next level in economic development.

Exhibit 18: Old-age dependency ratio in 2015

46 46 47

(%)

31 32

28 28

Exhibit 17: Median age of population in 2015

(Years)

30 30 31

41 43

38 39 40 41

11 11 13 13

22 24

Source: United Nations Population Division (UNPD), MoSL

Old age dependency ratio is defined as the share of old-age (65+

years) as working population (15-64 years)

I.3. India’s vulnerability matrix has improved markedly…:

Whether capital flows are

driven by

investment model

(arguing change in macro environment precedes and

causes investment flows) or

liquidity model

(capital flows precede and cause

growth) is an ongoing debate

and beyond the scope of this report. There are

enough experiences to validate both theories; however, as investors usually carry

out fundamental research before making investment decisions, the

investment

model

dominates, at least conceptually. If macroeconomic risks increase in an

economy, capital inflows would reduce (or capital outflows would increase). It is,

thus, important to keep the domestic house in order (which is determined by the

state of other economies as well).

The government of India (GoI) introduced a macroeconomic vulnerability index

(MVI) in its 2014-15 Economic Survey, comprising of inflation, fiscal deficit and

current account deficit. We replace fiscal deficit with the primary balance (fiscal

deficit excluding interest payments) of the government and use the same structure

to re-calculate MVI for several economies. The lower the MVI index is, the safer the

economy is. A reduction (increase) in MVI over time reflects improvement

(deterioration).

Exhibit 19

on the next page compares the change in MVI for several

emerging economies, for the entire group of emerging & developing Asia and all

economies rated “BBB-” (India’s rating) by Standard & Poor’s. India is the second

most improved economy in the past four years – between 2012 and 2016. On the

other hand, the MVI index has increased since 2012 in its closest competitors –

China and Indonesia (the deterioration in Brazil and Russia is obvious because of

recession in these economies).

India is the second

most improved

economy in the past

four years – between

2012 and 2016

Pettis Michael,

“The Volatility Machine: Emerging economies and the threat of Financial collapse”,

Oxford University Press (2001)

The concept is borrowed from The Government of India (GoI) introduced in Economic Survey 2014-15. See Appendix III for details.

June 2016

Thematic | Economy

Exhibit 19: Change in MVI for various economies (2012-2016)

3.9

1.1

(0.9)

(8.6)

(11.4)

(0.8)

(0.7)

(0.6)

(0.3)

1.3

5.6

6.0

6.7

* Emerging & developing Asia, as defined by IMF

Average of all economies rated “BBB-“ by Standard & Poor’s

Source: Economic Survey 2014-15, IMF, MoSL

While India’s RIRI has

improved in the past five

years, China, Philippines

and Thailand have higher

RIRI

...and reward matrix has also recovered:

Gauging risk, however, is only one side of

the balance sheet assessment for investors. The rewards are equally important,

which could be measured by real economic growth. Consequently, we re-calculate

another index, known as Rational Investors Ratings Index

(RIRI), introduced in the

same Economic Survey of 2014-15. Higher RIRI implies higher reward and lower

vulnerability, which suggests better rating by investors.

Exhibit 20

below compares

the actual value of RIRI for the same set of economies in the past five years. While

India’s RIRI has improved in the past five years, China, Philippines and Thailand have

higher RIRI. Nevertheless, as financial markets react to incremental flow of

information, what may matter more for investors is change in RIRI rather than the

actual value of RIRI.

Exhibit 20: RIRI values for various economies

Brazil

Russia

-3

-5

2012

2013

2014

2015

2016E

* Emerging & developing Asia, as defined by IMF

Average of all economies rated “BBB-“ by Standard & Poor’s

Source: Economic Survey 2014-15, IMF, MoSL

China

Thailand

India

Turkey

Indonesia

E&D Asia*

Philippines

BBB-

While several economies

have improved on

vulnerability index since

2012, India and Turkey are

the only two economies

that have performed well

on the entire risk-reward

matrix

Risk-reward matrix makes India the most attractive investment destination:

Exhibit 21

on the next page shows the change in RIRI for the same set of economies

considered in this study. While several economies have improved on vulnerability

index since 2012

(Exhibit 19),

India and Turkey are the only two economies that

have performed well on the entire risk-reward matrix, measured by RIRI. This, we

believe, makes India a definite investment destination for global investors.

The concept is borrowed from The Government of India (GoI) introduced in Economic Survey 2014-15. See Appendix III for details.

June 2016

Thematic | Economy

Exhibit 21: RIRI values for various economies

2.3

1.1

(1.2)

(4.3)

(3.9)

(1.1)

(0.9)

(0.8)

(0.4)

(0.2)

* Emerging & developing Asia, as defined by IMF

Average of all economies rated “BBB-“ by Standard & Poor’s

Source: Economic Survey 2014-15, IMF, MoSL

I.4. Is Indian economy highly leveraged?

The Indian economy is usually associated

with high government debt, which is seen as a key concern. There is no doubt that

government debt in India is one of the highest among emerging markets; however,

the recent global financial crisis has taught us that what matters is total debt of the

non-financial sector (private + government), rather than just sovereign debt.

Therefore, we look at total debt of the economy (excluding financial sector).

In the emerging world,

government debt as a

percentage of GDP is one of

the highest in India.

Private debt in India is

among the lowest in the

sample considered for this

study

Exhibit 22

compares the total government debt of various emerging economies. In

the emerging world, government debt as a percentage of GDP is one of the highest

in India. However, as

exhibit 23

shows, private debt in India is among the lowest in

the sample considered for this study. Government debt is monitored closely by

investors, but this does not make it more important than private debt. Several

economies have witnessed slowdown (recession also) because of high private debt

(Spain and Ireland are classic examples). Private debt is just as important as

government debt; to get a holistic view of an economy, one should look at the total

non-financial debt of the economy.

Exhibit 23: Comparison of private non-financial debt in 2015*

(% of GDP)

193

120

133

Exhibit 22: Comparison of government debt in 2015*

(% of GDP)

*For the first three quarters of 2015

Source: BIS, IMF, MoSL

June 2016

Thematic | Economy

India’s total debt-to-GDP

ratio has been largely

unchanged in the past three

years, while it has increased

substantially in almost all

other major emerging

markets

Exhibit 24

shows the total non-financial debt of the sample. India lies in the middle,

implying neither too high nor too low debt. Again, investors are more interested in

the trend (or flow) of total debt rather than the outstanding stock.

“How is the debt-

to-GDP moving?”

is more pertinent for investors. The answer lies in

exhibit 25,

which shows that India’s total debt-to-GDP ratio has been largely unchanged in the

past three years, while it has increased substantially in almost all other major

emerging markets. This is what gives more confidence in the Indian economy.

Exhibit 25: Trend in debt-GDP ratio since 2012

234

139 150

187

(percent

points, pps)

Exhibit 24: Total non-financial debt in 2015*

(% of GDP)

119 119

104

* For the first three quarters of 2015

Source: BIS, IMF, MoSL

India features among

the economies with low

debt intensity – it needs

1.3 units of investment

to produce one unit of

GDP

Finally, an important metric related to an economy’s debt is “debt intensity

of GDP

growth”. This measures

“how many units of debt are needed to produce an

additional unit of GDP in the economy?”.

The lower it is, the better.

Exhibit 26

shows

the debt intensity for each of the 12 economies studied in this analysis. The exhibit

shows the average of the three-year period ending 2015 to smoothen any one-time

shocks. India features among the economies with low debt intensity – it needs 1.3

units of investment to produce one unit of GDP. This is in comparison to almost 4

units of debt needed by China, and an average of 2 units needed by the sample of

12 economies.

Exhibit 26: Debt intensity of economic growth (Unit)

3.9

2.3

2.4

2.9

4.3

0.6

0.9

1.2

1.3

1.5

1.7

Recent data as of 2015

Source: BIS, IMF, MoSL

Debt intensity of GDP growth = average change in debt in ‘t-1’ and ‘t’ period/change in GDP in ‘t’ period

June 2016

Thematic | Economy

II. Indian economy from economist’s perspective

To make projections, it is important to understand what happened in the recent

past and how the economy is doing currently. We have explained our

understanding of the Indian economy in this part of the report. We have analysed

this part using the KURE theme. We define KURE as:



Know Your Economy

The first challenge presented to us is the divergence between new GDP data

and India Inc topline.

GDP data or India Inc topline – what to believe? Is consumption demand low

or high in India? How painful/serious has been India’s current slowdown?

These are the questions we have answered in Section I.



UNIQUE TRENDS THAT MAKE INDIA WORLD’S FASTEST GROWING ECONOMY

We further discuss what has helped India become the

“fastest growing

economy in the world”.

The tag, we believe, has led to few changes in the economy, which, if not

addressed carefully and in time, have the potential to make the economy

unsustainable.

REMEMBER THE ‘THEORY OF EVERYTHING’



We follow Section II with an identity, which, according to us, covers a large

part of the economy.

We call it the

“Theory of Everything”

because the equation covers

consumption, savings, investments, fiscal deficit and current account

balance.

In other words, the identity has the potential to explain a large part of an

economy.

EXPECTATIONS FOR NEXT TWO YEARS



Finally, we conclude Part II by giving our detailed expectations on the Indian

economy for the next two years - FY17 and FY18.

We argue that India could touch 8% real GDP growth by FY18. We also give

our forecasts of the Indian Rupee (INR) against the US Dollar (USD) based on

real effective exchange rate (REER) model and our outlook for the bonds

market in FY17.

June 2016

Thematic | Economy

KURE Theme

Source: MOSL

June 2016

Thematic | Economy

Info graphic:

perspective

Indian

economy

from

Economist’s

June 2016

Thematic | Economy

II.1. K

now your economy

II.1. K

now your economy



We try to bridge the gap between resilient GDP growth and weak India Inc

topline by incorporating the medium and bottom levels of the corporate

pyramid.

We reckon that the listed corporate space may be losing market share to the

non-listed space, which continues to witness high sales growth and great

profit margins.

In the recent past, resilient consumption demand has helped to mitigate the

adverse pressure on real GDP growth, which is better than it was in the

previous slowdown in early 2000s.

There is a growing debate

between the Central

Statistics Office (CSO),

which releases India’s

national accounts data

including GDP, and India Inc

about the state of India’s

consumption

II.1.1 What to believe? GDP data or India Inc topline

There is a growing debate between the Central Statistics Office (CSO), which

releases India’s national accounts data including GDP, and India Inc about the state

of India’s consumption. Net sales of India Inc have plunged from a healthy growth of

9.5% in FY13 to a contraction of 3.5% in the first three quarters of FY16

(Exhibit 27).

Such abysmal topline numbers have led India Inc to believe that consumption

demand has declined dramatically in the country.

According to CSO, India’s nominal consumption (both private and government)

growth has eased only gradually from 14.5 % in FY13 to 11.2% in FY16. Further, real

consumption growth, as per CSO data, is estimated to grow 6.6% in FY16, much

better than 4.5% in FY13 and 5.8% in FY14.

Exhibit 27: Growing divergence between GDP data and India Inc sales

-10

(% YoY)

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

FY13 FY13 FY13 FY13 FY14 FY14 FY14 FY14 FY15 FY15 FY15 FY15 FY16 FY16 FY16 FY16

Consumption includes private and government

Source: RBI, CSO, MoSL

India Inc sales

GDP: Nom consumption

GDP: Real consumption

This is what makes the task of policymakers difficult. What to believe? This question

has troubled us for almost a year from the time CSO published new GDP estimates.

The question is of paramount importance to understand whether the economy

needs policy support to boost consumption or not.

We believe both sides of

the argument are correct.

National consumption has

been resilient; however,

India Inc is not enjoying it

We believe both sides of the argument are correct. National consumption has been

resilient; however, India Inc is not enjoying it. The unlisted or unincorporated

corporate sector is flourishing and gaining market share

Please refer to Appendix I for details on corporate data used in this analysis

June 2016

Thematic | Economy

Exhibit 28

shows that the share of RBI sample (2,700-odd companies) in national

consumption (from CSO data) has fallen from 44% in FY13 to 36.6% in FY15.

The share of companies

covered by MCA, but not by

RBI in its quarterly data, has

risen from ~11% in FY13 to

over 14% in FY15

Another interesting thing to note is that the share of companies covered by Ministry

of Corporate Affairs (MCA) (~250,000 companies), but not by RBI in its quarterly

data, has risen from ~11% in FY13 to over 14% in FY15. It implies that the share of

the uncovered corporate sector, which could be called the unorganized (or informal

or unregistered) sector, has also risen from ~45% in FY13 to 49% in FY15. (Please

note the change in GDP base did not change this analysis.)

Exhibit 28: Share of different sample of companies in national Exhibit 29: Sales growth of different sample of companies in

consumption

the past two years

(%)

RBI sample

Ex-RBI MCA sample

Others*

(% YoY)

RBI sample

42.5

45.2

10.8

44.0

FY13

47.0

13.5

39.5

FY14

49.0

14.4

36.6

FY15

2.0

FY14

18.4

3.6

FY15

18.7

16.5

Ex-RBI MCA sample

Others*

RBI sample corresponds to companies covered by RBI quarterly data for 2,700 odd companies

Ex-RBI MCA sample corresponds to expanded data covering 2,50,000 companies, which excludes RBI sample

* Others are companies not covered by MCA also (estimated as residual)

Source: RBI, CSO, MoSL

Exhibit 29

shows that while the sales of RBI sample companies grew at low single

digits (for changing set of companies) in FY14 and FY15, growth for the rest of the

corporate sector was in high teens. Deceleration in case of ‘others’, companies not

covered by MCA and which account for 49% of total consumption, was marginal –

from 18.4% YoY in FY14 to 16.5% in FY15.

Expanded coverage of the corporate sector explains higher GDP growth:

One of

the key revisions in the GDP data released by CSO last year was the use of new data

source – MCA database – for estimating the corporate sector’s contribution to the

economy. Earlier, the corporate sector’s contribution was estimated using the RBI

study on company finances, which was based on some 2,700-odd listed companies

and Index of Industrial Production (IIP). The MCA database covers almost 500,000

companies. Not surprisingly, data for the manufacturing sector has witnessed a

marked upward movement post revision.

The most-tracked listed

companies in the country,

captured by the RBI sample,

may not be the real

representative of the

economy

This may represent a classic sample problem. The most-tracked listed companies in

the country, captured by the RBI sample, may not be the real representative of the

economy. To understand the stark difference, we have prepared

Exhibit 30

for

different sample of companies released by RBI. Since RBI releases data only for the

past three years in a single press release, and MCA data was included in the recent

data released by RBI for 2014-15, we have MCA data only for three years – FY13,

FY14 and FY15. This data covers ~17,000 public limited companies against 2,700

companies covered in the RBI’s quarterly release. The exhibit is an eye-opener.

June 2016

Thematic | Economy

On the expanded coverage,

the PAT margin was more

than double at 10.8% in

FY13 and broadly

unchanged in FY15

If we just look at the ~2,700 companies’ data available on quarterly basis and

include large companies, profit margin seems to have stabilized at low levels.

However, with the CSO coverage quadrupling on inclusion of MCA database, the

condition of the corporate sector shows dramatic improvement. The PAT margin of

the limited coverage was ~6% in FY13 (~2,700 companies), which eased to ~5.5% in

FY14 and 5.8% in FY15. On the expanded coverage, the PAT margin was more than

double at 13.9% in FY13 and unchanged in FY15.

Exhibit 31

shows the PAT margin for the limited coverage, which gets most of the

attention, and compares it with that for the expanded coverage. The difference is

stark. The PAT margin for the companies not included in the limited coverage was as

high as 24% in FY15, more than 4x the PAT margin for the limited coverage.

Exhibit 31: Comparison

corporate samples (%)

30.2

24.3

24.0

The PAT margin for the

companies not included in

the limited coverage was as

high as 24% in FY15

Exhibit 30: Net profit margin of different corporate samples

released by RBI (%)

RBI quarterly data

Net profit margin

Expanded coverage

PAT

margin

for

different

RBI sample

Ex-RBI MCA sample

6.0

5.5

5.8

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

FY13

FY14

FY15

RBI sample corresponds to 2,700-odd companies (and include only public companies)

Expanded coverage is MCA sample implying coverage of ~17,000 public companies

Source: RBI, MoSL

Though the large

corporates, which are not

doing as well, receive most

of the investor attention,

policymaking decisions

should be constructed on

holistic analysis

Overall, the expanded coverage, which is now incorporated in CSO’s GDP data,

shows that consumption has not slowed as much as is reflected by the weak

position of the large corporates. Though the large corporates, which are not doing

as well, receive most of the investor attention, policymaking decisions should be

constructed on holistic analysis, which confirms resilient consumption in the

economy, holding up real GDP growth at high levels.

June 2016

Thematic | Economy

II.1.2. How painful/serious has India’s current slowdown been?

In order to understand that, let us compare the economic performance in the recent

period (FY12-17E) with that in the previous slowdown. Though liberalization began

in 1991, the economy actually opened up in 1995. An analysis of the Indian economy

in the past two decades shows that the only episode of significant slowdown was in

early 2000, which coincided with the Dot-com bubble in the US. Accordingly, we

have compared India’s recent performance with that in the early 2000s (FY99-04)

and the boom period (FY03-08).

The current

slowdown is not

as severe as the

previous one

Exhibit 32

compares India’s real GDP growth in the past five years with that of the

early 2000s and the boom episode. India’s real GDP growth has averaged 6.8% per

annum since FY12 as against 4.2% in the previous slowdown (early 2000s) and 8.8%

during the boom period. The current slowdown is not as severe as the previous one.

(Even if one believes that real GDP growth was 5.5% in FY15 and 6.0% in FY16, the

average growth would be ~5.5%, better than in early 2000s.)

Exhibit 33

shows the key reason for the better-than-early-2000s real GDP growth.

India’s consumption has grown ~6.5% in five years to FY17 (our projection for FY17),

close to the 7% growth witnessed in the boom period of FY04-08. Consumption

growth, however, averaged 4.5% in the early 2000s. The exhibit is in line with our

conclusion from the first part of the current section, where we argued that

consumption demand has not slowed dramatically in the current slowdown.

Exhibit 33: ….primarily because of strong consumption in

the recent slowdown

160

140

120

100

Number of quarters

Consumption includes both private and government consumption

Source: OECD, RBI, MoSL

(Index)

Early 2000s

Boom period

Recent

India’s consumption has

grown ~6.5% in five years to

FY17, close to the 7%

growth witnessed in the

boom period of FY04-08

Exhibit 32: India’s real GDP growth has not slowed

dramatically…

180

160

140

120

100

Number of quarters

Data from 4QFY16 onwards are our projections

(Index)

Early 2000s

Boom period

Recent

The share of consumption

in GDP is at the highest

level in the past 12 years.

Reinforcing our conclusion in

Exhibit 33,

we also find that consumption demand

(including private and government consumption) in India crossed 70% of GDP in

FY16, up from 67% in FY12, marking the highest level since FY05

(Exhibit 34

on the

next page). In other words, the share of consumption in GDP is at the highest level

in the past 12 years. In fact, we believe it will increase further towards 72% in FY17,

due to the continuation of consumption-driven growth in the economy.

Exhibit 35

on the next page compares the share of consumption across various Asian

economies in 2014 (the recent period for which data is available). It is apparent that

India has one of the highest shares of consumption, as against the lowest of 48% in

Singapore and the average of 65% in the sample taken.

It is apparent that India has

one of the highest shares of

consumption

June 2016

Thematic | Economy

Exhibit 34: India’s consumption is at the highest level in

more than a decade

FY00

FY03

FY06

FY09

FY12

FY15

FY18F

Consumption includes both private and government consumption

Data from FY16 onwards are our projections

70.1

67.2

70.1

Exhibit 35: Share of consumption in India vis-à-vis other

Asian peers

(%)

Consumption includes both private and government consumption

Source: World Bank

Box 1. What does potential output tell us about the recent slowdown?



In a recent working paper , Reserve Bank of India (RBI) attempted to estimate India’s potential GDP and output gap.

Although the focus of the RBI’s paper was different and not related to our study, a look at the historical trend of the output

gap (actual output – potential output) presented in the RBI’s paper gives an interesting and relevant finding. The exhibit is

shown below.



It is important to note that the negative output gap in the current slowdown is one of the lowest witnessed by the Indian

economy in several slowdowns since 1980s. The negative output gap did not even touch 2%; in all the past three

slowdowns since 1980, the negative output gas was close to 4%.



This implies that the fall in actual output below potential output is less severe than in the previous slowdown. This is exactly

what we have concluded in our analysis.

Composite output gap estimate

Source: RBI

Bhoi, Barendra Kumar and Behera, Harendra Kumar,

“India’s Potential Output Revisited”,

April 2016, RBI Working paper series 05/2016

June 2016

Thematic | Economy

II.2.

Unique trends that make India the fastest

II.2.

Unique trends that make India the fastest growing economy

Three key facts making India the fastest growing economy in the world:



Consumption has replaced investments as the key driver of growth. The former is

financed by savings, not disposable income.



Notwithstanding the fall in domestic inflation, the “price gap” remains as high as 54%.

Further, India’s inflation differential vis-à-vis major trading partners has increased

recently, hurting India’s competitiveness. We argue that inflation must be allowed to

undershoot the 4% target for at least a few quarters.



In comparison to the previous slowdown in the early 2000s, the recent adjustments in

India’s current account deficit are highly incomplete. The economy probably needs a

surplus on its external account to create the potential for high & sustainable growth.

Real personal disposable

income (PDI) growth in

the recent period has

lagged the growth

witnessed in early 2000s,

let alone the boom period

of FY04-08

Since 2008, real output growth has become rare. The developed world as a whole

has grown only 1%, while the developing and emerging economies have grown at an

average of 5.2%. India is the fastest growing economy in the world, estimated to

have grown 7.6% in the recently concluded year and expected to grow ~8% this

year. Our analysis shows that three unique but related factors have allowed the

Indian economy to become the fastest growing major economy in the world. As

discussed in the previous section, high consumption growth has helped India to

maintain its GDP growth. However, high consumption, at a time when investments

have slowed drastically, has come at the cost of higher inflation, lower savings and

higher current account deficit (CAD). We have discussed these three factors in this

section.

II.2.1. Higher consumption financed by savings, not higher

income

As discussed in the previous section, India’s consumption growth has been resilient

enough to make it the world’s fastest growing economy. Our first impression was

that resilient household income (households account for 85% of total consumption

in the economy) has led to the resilience in consumption demand. However, as

shown in

Exhibit 36

on the next page, real personal disposable income (PDI) growth

in the recent period has lagged the growth witnessed in early 2000s, let alone the

boom period of FY04-08. Real PDI grew at a cumulative rate of 29% in the five years

to FY04, 43% in the five years to FY08, and is expected to grow 23% in the five years

to FY17.

June 2016

Thematic | Economy

Exhibit 36: Real personal disposable income growth has been Exhibit 37: …implying consumption growth financed by

lackluster…

household savings

Early 2000s

160

140

120

100

Boom period

Recent

240

200

160

120

Early 2000s

Household savings

Boom period

Recent

Real personal disposable income

Number of years

Real disposable income is nominal income deflated by PCE deflator

Data from FY15 onwards are our projections

Number of years

Household savings in absolute terms (INR) converted into index

Source: CSO, RBI, MoSL

Indian household savings

have grown only 25% (in

absolute INR terms) against

~87% growth in the early

2000s and ~98% growth in

the mid-2000 period

If income growth is weaker than it was in the early 2000s, how have the households

maintained their consumption growth closer to the levels in FY04-08? The answer

lies in household savings

(Exhibit 37).

Since FY12, Indian household savings have

grown only 25% (in absolute INR terms) against ~87% growth in the early 2000s and

~98% growth in the mid-2000 period. As a percentage of GDP, household savings

have collapsed from 23.6% in FY12 to 19% in FY15 and are projected to dip further

towards 17% in FY17. This, as shown in

Exhibit 38,

is the lowest in the past two

decades.

Exhibit 38: Household savings have collapsed in the past few years

FY1996

(% of GDP)

Household savings

16.9%

FY1999

FY2002

FY2005

FY2008

FY2011

FY2014

FY2017F

FY16 is our estimate and FY17 is our forecast

Source: RBI, CSO, MoSL

Households have financed

their consumption out of

savings rather than higher

incomes. This strategy is

unsustainable in the longer

period

Households, thus, have financed their consumption out of savings rather than

higher incomes. This strategy is unsustainable in the longer period. Falling

household savings, which accounted for more than two-thirds of total savings in the

economy, act as a serious constraint on the ability of the non-financial corporate

sector to increase investments towards pre-crisis level. This is because savings are

the key source of investments. Without domestic savings, an economy has to

depend on foreign borrowings or current account deficit (CAD) for investments. As

we discuss later, there is not sufficient room for CAD to help investment rate

increase significantly.

June 2016

Thematic | Economy

While Indian households

reduced their savings and

increased their

investments, their US

counterparts did the

reverse by building savings

and cutting investments

It is also important to understand the behavior of Indian households vis-à-vis their

counterparts in other economies. We take the US as a representative of the

recession-hit economies.

Exhibits 39

and 40 compare household savings and

investments in India and in the US. Over FY09-13, while Indian households reduced

their savings and increased their investments, their US counterparts did the reverse

by building savings and cutting investments. The latter was a typical behavior of

households in all economies hit by recession/slowdown. Indian households

exhibited the opposite trend.

Exhibit 39: Household savings have collapsed in India…

FY06

FY08

FY10

FY12

FY14

FY16E

(% of GDP)

India

Household savings

(% of GDP)

We have calculated FY numbers for the US using quarterly data

FY16 data for the US is for Apr-Dec 2015

Exhibit 40: ….while investments were strong till recently

(% of GDP)

India

FY06

FY08

FY10

FY12

FY14

FY16E

USA (RHS)

Data for FY16 for India is MoSL’s estimate

Source: US Bureau of Economic Analysis (BEA), RBI, MoSL

Households' investments

(% of GDP)

USA (RHS)

The diverse behavior of

Indian households implies

two things – either they

believe that the slowdown

in disposable income is

fleeting, or that the fall in

savings is more structural in

nature

The diverse behavior of Indian households implies two things – either they believe

that the slowdown in disposable income is fleeting or that the fall in savings is more

structural in nature. Given India’s culture, demographic structure and the absence

of social security net, the latter seems unlikely. If the former is true, then

households’ perception of temporary slowdown could be challenged anytime, as

real disposable income growth has remained subdued for five consecutive years.

Indian household savings = net financial savings + physical savings

June 2016

Thematic | Economy

II.2.2. Has inflation eased sufficiently?

India’s retail inflation has fallen from double-digit levels in six consecutive years

between FY09 (starting April 2008) and FY14 (ending March 2014) to ~5% in FY16.

We expect retail inflation to average 4.7% in the current year (FY17) and undershoot

the 5% target for January 2017. Considering this, one could assume that inflation

has fallen sufficiently. In this section, we look at inflation from various perspectives

and conclude that retail inflation at 5% is higher than it should have been. We

believe inflation must be allowed to undershoot the medium-term target of 4% for

at least a few quarters

“Price gap” is as high as 54%:

Inflation is the rate of change in prices. Hence, the

base matters. If inflation has averaged 10% in the past few years, 5% in the next

year would imply much higher price level than in a scenario where inflation had

averaged 5% in the past few years as well. To help grasp the difference between the

rate of change in prices (inflation) and the price level (index), we introduce the

concept of “price gap”. Just like “output gap” is the difference between actual

output and potential output, we define “price gap” as the difference between actual

price (or index) level and the optimal (or target) level. The logic is simple. If the

authorities try to target zero output gap, the “price gap” should also be minimal -

the actual price level should be closer to the optimal price index. If the actual index

is higher than the optimal index, the economy will have a

positive price gap.

This

happens when

consumption

demand is very high and producers have bargaining

power. A

negative price gap

occurs when actual prices are lower than optimal,

which happens when

consumption

demand is low and producers/sellers lose their

bargaining power.

If the authorities try to

target zero output gap, the

“price gap” should also be

minimal

Price gap = Actual price index - Optimal price (or target) index

From late 1990s to 2006,

the actual index closely

tracked the optimal index.

In 2007, the “price gap”

turned positive and has

been rising consistently

since then

We derive the optimal price index through the desired (or targeted) inflation, which

we take as 4%.

Exhibit 41

compares the optimal index with the actual index level.

From late 1990s to 2006, the actual index closely tracked the optimal index. In 2007,

the “price gap” turned positive and has been rising consistently since then

(Exhibit

42).

The “price gap” scaled a peak of ~59% in April 2015. As per the recent reading in

April 2016, it was 54%.

Exhibit 42: “Price gap” estimate for Indian economy

54%

(25)

(%)

Price gap

18M MA

Exhibit 41: Comparison of optimal and actual price level

370

290

210

130

Optimal price level

(FY99=100)

Actual price level

CPI for industrial workers (IW) is used to measure retail prices

Optimal index is calculated assuming 4% inflation over the period

(Actual index - optimal price level)/Optimal level

Source: CSO, MoSL

Please note the entire analysis on inflation is conducted using Consumer Price Index for Industrial Workers (CPI-IW) for which a long

historical time series is available

June 2016

Thematic | Economy

Box 2. How has WPI-based price gap behaved?



After reading the section on retail price gap, we realized that the readers could be interested in looking at the wholesale

price gap, especially after the recent decline in wholesale price index (WPI).

We derive the WPI optimal price index through the desired (or targeted) inflation of 4%. WPI based price gap rose to its

highest level of 34% in late 2013, when CPI based price gap was 45%

(Exhibit 42

above).

As WPI-based inflation started easing from 2014 onwards and moved into negative territory in late 2014, the WPI price gap

has fallen substantially to 20% by April 2016. In fact, as per our projection of WPI for the next two years, we believe the gap

will narrow further toward 15% by the beginning of 2018.



Accordingly, as we have prescribed above, CPI also needs to undershoot the medium term target of 4% for at least few

quarters in order to bring the CPI index closer to the optimal price index.

Comparison of optimal WPI and actual WPI (FY99=100)

300

250

200

150

100

Optimal WPI

Actual WPI

WPI “Price gap” estimate for Indiasince late 1990s

(12)

(%)

WPI-based price gap

18M MA

Optimal WPI index is calculated with 4% inflation over the period

(Actual index - optimal price level)/Optimal level

Source: Office of Economic advisor (OEA), MoSL

Comparison of inflation in the previous slowdown:

Another way to analyze if retail

inflation has eased towards the desired level is to compare the current trajectory

with those in the previous slowdowns. Taking forward our analysis from the first

section of Part II, we have looked at the trajectories in three periods of five years

each – early 2000s (FY99=100), boom period (FY03=100) and recent period

(FY12=100).

Exhibit 43

on the next page compares the inflation trajectories during

these three episodes.

Compared to the previous

slowdown in the early

2000s, retail inflation is 20%

higher

The average retail inflation (based on CPI-IW) during FY00-04 was 3.9%, while it

averaged 5% during FY04-08. In comparison, retail inflation (based on CPI-IW)

averaged 8% over FY13-16. Compared to the previous slowdown in the early 2000s,

retail inflation is 20% higher (~17% higher than in the boom period).

For comparison purpose, we have also added the CPI-India series with our

projections for FY17. Notably CPI-India tracks CPI-IW very closely with the new

series only 2.5% lower than the old series of CPI-IW.

June 2016

Thematic | Economy

Exhibit 43: CPI trajectory during various episodes

150

135

120

105

Number of months

Early 2000s

Boom period

Recent

CPI-India

20%

FY17 numbers for CPI-India are our projections

Source: RBI, CSO, MoSL

All other things equal,

higher inflation reduces the

competitiveness of an

economy

Has India’s ‘inflation differential’ fallen?:

A key reason to track an economy’s

inflation trajectory is the impact of inflation on the economy’s competitiveness. All

other things equal, higher inflation reduces the competitiveness of an economy (one

could argue the role of tradable and non-tradable in this discussion; however, it is

beyond the scope of this study). Similarly, if the fall in inflation in ‘Economy A’ is

lower than the fall in inflation in its trading partners, even lower inflation will not

increase the competitiveness of Economy A, as the inflation differential (of Economy

A vis-à-vis its trading partners) remains high(er). Therefore, one must look at the

inflation differential of an economy vis-à-vis its trading partners.

Using the effective exchange rate data from Bank for International Settlements

(BIS), we calculate inflation differential

by dividing nominal effective exchange rate

(NEER) and real effective exchange rate (REER).

Exhibit 44

on the next page

compares India’s inflation differential with other Asian peers. Notwithstanding

easing domestic inflation, not only is India’s inflation differential with its major

trading partners the highest among Asian economies, but has risen in the past one

year. In other words, though India’s inflation has eased domestically, inflation in

India’s trading partners has fallen more. Due to high and rising inflation differential,

India, despite falling inflation, has not gained on competitiveness.

Exhibit 45

compares India’s inflation differential with the movement in nominal

effective exchange rate (NEER). Though India’s NEER has weakened ~24% since

2010, higher inflation differential has offset the impact of weaker nominal currency.

The INR has, thus, strengthened in real terms and this is hurting India’s

competitiveness.

Notwithstanding easing

domestic inflation, not only

is India’s inflation

differential with its major

trading partners the highest

among Asian economies,

but has risen in the past

one year

Though India’s NEER has

weakened ~24% since 2010,

higher inflation differential

has offset the impact of

weaker nominal currency

We must admit it is difficult to measure inflation differential accurately because of the tradable and non-tradable argument. Our measure

of inflation differential is also not perfect. Apart from tradable and non-tradable baskets, different weights for different items in different

countries also represent another limitation.

June 2016

Thematic | Economy

Exhibit 44: Comparison of India’s inflation differential with Exhibit 45: Rising inflation differential has offset the impact

other Asian peers (2010=100)

of weak nominal exchange rate

140

120

100

(2010=100)

Inflation differential with trading partners

High inflation

differential =

Low competitiveness

150

130

110

China

India

Indonesia

Philippines

Source: BIS, RBI, MoSL

(2010=100)

24%

NEER

Inflation differential

34%

Inflation differential = Broad REER/ Broad NEER index

Box 3. A look at inflation targeting regimes in other major economies



The exhibit below compares the recent inflation in some inflation targeting and some non-inflation targeting economies. Of

the nine economies considered (besides India), five are inflation targeting and the rest do not target inflation explicitly.

Five of these nine economies have inflation within the target range. Interestingly, two of the four non-compliant economies

– Brazil and Russia are reeling under stagflation, while South Africa is flirting with recessionary pressures. Barring these

three economies, India’s inflation is the highest at above 5%.



Comparison of recent inflation in inflation targeting developing economies

Country

Target measure

Inflation targeting

Brazil

Headline CPI

Yes

China

Headline CPI

India

Headline CPI

…

Indonesia

Headline CPI

Yes

Malaysia

Headline CPI

Philippines

Headline CPI

Yes

Russia

Headline CPI

Singapore

Headline CPI

South Africa

Headline CPI

Yes

Thailand

Core CPI

Yes

2016* inflation

9.9

2.2

5.3

4.2

3.1

1.1

8.1

(0.7)

6.4

(0.4)

* Jan-April 2016

Source: Report of the expert Committee to Revise and strengthen the monetary policy framework, various official sources, RBI, MoSL

Desired inflation

4.5% +- 2 pp

3.5%

4.0% +- 2 pp

4.5% +-1 pp

2%-3%

4.0% +-1 pp

5%-6%

3%-4%

3% - 6%

0.5% -3.0%

June 2016

Thematic | Economy

II.2.3. What does current account balance (CAB) tell us?

Linked with the first two variables is the current account balance (CAB). Though CAB

has improved substantially in the past few years, the question is if the adjustment is

complete. We believe CAB has not yet improved to a level that is in line with the

economic activity. The adjustment is incomplete.

Exhibit 46

shows the movement in India’s CAB during the three episodes – early

2000s (FY99-04), boom period (FY03-08) and recent period (FY12-FY17). Two key

highlights from the exhibit are:

1. The recent period began with highly unfavorable circumstances.

2. The current period is reminiscent of the boom period rather than the early

2000s period.

Towards the end of the slowdown in early 2000s, India’s current account had a

surplus of 2.1% of GDP in FY04 against a deficit of 1% of GDP in FY99 (the beginning

of the slowdown). As the economy entered into the boom period, current account

balance worsened from +2.1% of GDP in FY04 to -1.3% of GDP in FY08. In the recent

period, though the CAD (current account deficit) has narrowed substantially from an

all-time peak of 4.8% of GDP in FY13 to an estimated 0.8% of GDP in FY16. The

current CAD level is closer to what it was at the beginning of the early 2000s period

or late boom period

(Exhibit 47).

This makes us uncomfortable.

Exhibit 47: India’s CAB in the past two decades

Recent

(2)

(% of GDP)

(4)

(6)

Ealy 2000s

(% of GDP)

Current account balance

Boom period

Recent period

The current CAD level is

closer to what it was at the

beginning of the early

2000s period or late boom

period. This makes us

uncomfortable.

Exhibit 46: Trends in current account balance (CAB)

(3)

(6)

(9)

Early 2000s

Boom period

Number of quarters

Source: RBI, CSO, MoSL

FY97 FY99 FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15 FY17F

Source: RBI, CSO, CMIE, MoSL

The balance on

consumption basket has

fallen from a decent surplus

1. The balance on consumption basket has fallen from a decent surplus of 1.5% of

GDP in FY14 to only 0.5% in FY16. Notably, the average surplus on consumption

of 1.5% of GDP in FY14 to

only 0.5% in FY16

basket in the past two decades was 1% of GDP.

June 2016

As discussed earlier, the recent economic recovery is driven by consumption

demand rather than investment demand. To cement our analysis further, we have

re-classified India’s merchandise trade into three baskets – oil, consumption and

investments, and accordingly, calculate trade balance on each of these baskets. We

show the break-up of India’s merchandise trade balance using these classifications

during two periods – early 2000s

(Exhibit 48

on the next page) and the recent period

(Exhibit 49)

to help understand the contribution of each item to total trade deficit.

Key highlights are:

Thematic | Economy

The non-oil trade deficit

was 3.2% of GDP in FY16,

close to what it was in FY06-

FY07 and more than double

of 1.5% of GDP in FY15

2. The deficit on investment basket, however, has been broadly unchanged in the

past three years at closer to 3% of GDP. In the early 2000s slowdown, the deficit

on investment basket was closer to nil and increased towards 3% of GDP by

FY07. The long-term average deficit has been 2.2% of GDP.

3. Finally, the non-oil trade deficit (excluding rest items) was 3.2% of GDP in FY16,

close to what it was in FY06-FY07 and more than double of 1.5% of GDP in FY15.

The average deficit on non-oil basket has been less than 2% of GDP.

Exhibit 49: Components of goods’ trade in recent period

Consumption

(% of GDP)

1.4

(0.4)

1.7

(0.3)

(3.1)

0.1

(4.3)

1.5

(2.9)

(5.8)

(6.1)

Investment

0.7

(3.2)

(4.4)

Oil*

CAB

0.5

(3.3)

(2.9)

Exhibit 48: Components of goods’ trade in early 2000s

Consumption

(% of GDP)

1.1

(0.9)

(3.2)

(3.0)

0.2

1.8

Investment

Oil*

CAB

(2.6)

FY 00

FY 01

FY 02

FY 03

FY 13

FY 14

FY 15

FY 16

* Including non-consumption, non-investment (rest) items also

Source: RBI, CSO, CMIE, MoSL

From mid-2000s onwards,

the economy moved into

deficit mode on non-oil

non-valuables as well.

India’s trade deficit on non-

oil non-valuables was 2.3%

in FY16, slightly lower than

the average deficit of 2.7%

of GDP in the past decade

Alternatively, we further classify merchandise trade balance based on oil, valuables

(gold, silver, pearls, precious stones, etc) and non-oil non-valuables. Traditionally,

India’s trade deficit was primarily constituted by oil only. As the economy opened

up, India’s attraction for valuables started impacting its external account, as

valuables account moved from an average surplus of 0.4% of GDP till mid-1990s to

an average deficit of 0.5% of GDP in mid-2000s

(exhibit 50).

Finally, from mid-2000s

onwards, the economy moved into deficit mode on non-oil non-valuables as well.

India’s trade deficit on non-oil non-valuables was 2.3% in FY16, only slightly lower

than the average deficit of 2.7% of GDP in the past decade.

Exhibit 50: Components of CAB since 1990s (% of GDP)

(5)

(10)

(15)

FY 94

FY 96

FY 98

FY 00

FY 02

FY 04

FY 06

FY 08

FY 10

FY 12

FY 14

FY 16

Valuables includes gold, silver, pearls, precious stones etc

Source: RBI, CMIE, MoSL

Oil

Valuables

Non-oil non valuable

Trade balance

Consumption includes agriculture items, leather products, readymade garments, gems & jewelry and paper/wood items

Investments include all other items excluding consumption basket, petroleum and ‘other commodities’.

June 2016

Thematic | Economy

About one-third of the gains

on account of lower oil

prices were offset by lower

surplus on consumption

deficit in the past two years,

which reflects high

consumption demand

Overall though the current account deficit (CAD) has improved substantially from an

all-time peak of 4.8% of GDP in FY13 to less than 1% of GDP in FY16, it is closer to

the CAD at the beginning of the previous slowdown (FY00) or towards the end of the

previous boom period (FY08). Notwithstanding the crash in non-fuel commodity

prices, almost two-third of the gains on oil and valuables trade in the past three

years has been offset by higher deficit on non-oil non-valuables. Further, while the

deficit on investment basket was largely unchanged in the past three years, about

one-third of the gains on account of lower oil prices were offset by lower surplus on

consumption deficit in the past two years, which reflects high consumption demand,

as discussed above.

June 2016

Thematic | Economy

R II.3. Remember the “Theory of

of Everything”

II.3. R

emember the “Theory

Everything” growing

In this section, we look at the factors that allowed the Indian economy to move from a

low-growth period in the early 2000s to high-growth in the mid-2000s.



We find that investments were the key driver of GDP growth during the mid-2000s,

which made the high-growth period sustainable.



To repeat that performance, we believe India must re-build its collapsing household

savings, which is the key source of financing for domestic investments.



Moreover, the revival in investments has to be led by the private corporate sector, as

higher public or household investments hurt capital efficiency.

Thus far, we have dissected India’s current macro-economic environment. We make

two key conclusions. One, the current slowdown is not as severe as the topline

corporate statistics suggest. Consumption growth has been resilient and this has

helped limit the deceleration in economic activity. Two, the tag of ‘fastest growing

economy in the world’ has led to a few noteworthy features in the economy – lower

savings, higher-than-desired retail inflation and sub-optimal adjustment in current

account deficit (CAD). After understanding the current situation, the obvious

question is, what to expect next? Before we get on to our expectations and

projections, it would be a good idea to understand the transition of the Indian

economy from the low-growth early 2000s to the boom period of FY04-08.

The key reason of

sustainable

high growth

during mid-2000s was that

the key driver of economic

activity was investment

rather than consumption

The most notable feature of the boom period was

sustainable

high growth. By

sustainable,

we mean non-inflationary acceleration in real GDP growth. Although

real GDP grew at an average of 8.8% between FY04 and FY08, more than double of

that between FY01 and FY03, retail inflation averaged 4% between FY04 and FY06,

similar to the inflation rate during the slowdown (FY00-03). The key reason of

sustainable

high growth during mid-2000s was that the key driver of economic

activity was investment rather than consumption.

Exhibit 51

shows the major contributors to real GDP growth in the three episodes

we have studied in our analysis. Although the contribution of consumption (private

+ government) to real GDP growth increased from 3.4 percentage points (pp) in

early 2000s to 5.1 pp during the boom period, the contribution of investments

almost quadrupled from 1.4 pp to 5.7 pp. In other words, the average growth in

investments during the boom period was ~19% per annum, as against a meager

growth of 6% in the early 2000s

(Exhibit 52).

As the economic boom was primarily

driven by corporate investments and better capital efficiency (measured by

incremental capital-output ratio (ICOR)), the higher growth period was non-

inflationary or sustainable.

The average growth in

investments during the

boom period was ~19% per

annum, as against a meager

growth of less than 6% in

the early 2000s

June 2016

Thematic | Economy

Exhibit 51: Contributors to real GDP growth (pp)

Consumption

(5)

2000-03

2004-08

2013-16

1.5

3.4

Discrepancy

Investments

GDP growth

Net exports

Exhibit 52: Average growth in GDP components (% CAGR)

2000-03

18.7

15.4

17.8

2004-08

20.1

2013-16

5.7

5.1

1.2

4.0

6.1

6.6

3.2

2.8

4.5

7.2

6.0

(1.0)

Investments

Exports

Imports

Consumtpion

Source: RBI, CSO, MoSL

Not surprisingly then, the ratio of investment to GDP (also known as investment

rate) increased dramatically from 24.8% of GDP in FY03 to 38.1% of GDP in FY08

(Exhibit 53).

The ratio of final consumption, on the other hand, fell from 75.8% of

GDP to 67.2% in FY08

(Exhibit 54).

Exhibit 53: Investment rate increased rapidly during the Exhibit 54: …while consumption rate fell to an all-time low

boom period…

level of that period

(% of GDP)

Total investment

Up from 24.8% in FY03

to 38.1% in FY08

110

All-time lowest level

of 67.2% in FY08

(% of GDP)

Final consumption

Source: RBI, CSO, MoSL

The investment rate has

fallen from its all-time peak

of 39.6% of GDP in FY12 to

32.5% in FY16 - the lowest

since FY04, while the

consumption rate has

increased to above 70%,

marking the highest level in

12 years

Things, however, have reversed in the past few years. The investment rate has fallen

from its all-time peak of 39.6% of GDP in FY12 to 32.5% in FY16 - the lowest since

FY04, while the consumption rate has increased to above 70%, marking the highest

level in 12 years. We firmly believe that if the Indian economy has to re-witness the

boom period of 2004-08, investment is the only route. In other words, the share of

investment has to pick up again at the cost of consumption.

This brings us to the question of

“What is required for investment rate to rise in the

coming years?”

The answer lies in an identity, which we call

“The Theory of

Everything”.

Investment = Savings + Foreign borrowings

The identity, quoted above, tells us that domestic investments in an economy can

either be financed by domestic savings or through foreign borrowings. The latter is

only those foreign borrowings (or foreign capital inflows), which finance current

account deficit (CAD). If foreign capital does not finance CAD, it will add up to

June 2016

Thematic | Economy

foreign exchange reserves, which do not add anything to investments (or

consumption) of an economy. Consequently, the identity could be re-written as:

Investment = Savings + Current account deficit

Therefore, to increase investments, either domestic savings have to go up, or CAD

has to widen. Let’s look at what happened during the first decade of the 21

century.

India’s CAD moved from a deficit of 1% of GDP in FY2000 to a surplus of above 1% of

GDP in FY03. Notably, however, domestic savings were largely intact at ~25% of GDP

during the slowdown of early 2000s. As can be concluded from the above identity,

the narrowing of CAD, along with stable domestic savings led to a contraction in

investment rate from 26.5% of GDP in FY00 to 24.7% of GDP in FY03.

Nevertheless, things began to change dramatically since FY04. Although CAB

continued to improve towards the post-independence highest level of +2.3% of

GDP, total savings in the economy rose from 26% to 29% of GDP, helping to push

the investment rate higher to 27% in FY04. Further, as the economy strengthened,

current account moved from a surplus of 2.3% of GDP in FY04 to a deficit of 1.3% in

FY08 and total savings increased from 29% of GDP in FY04 to ~37% of GDP in FY08.

Domestic investments rose from 27% to 38% during the boom period

(Exhibit 55).

Exhibit 55: Financing of domestic investments in India

(% of GDP)

National savings

CAD

1.3

Domestic investments

2.8

2.7

4.3

4.8

0.9

23.2

1.0

25.5

0.5

23.7

24.8

(0.7)

25.9

(1.2)

29.0

0.4

32.4

1.2

1.0

2.3

1.7

1.3

0.8

33.4

34.6

36.8

32.0

33.7

34.6

33.8

33.0

31.8

(2.3)

-15

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15 FY16E

E = estimates

Source: RBI, CSO, MoSL

Between FY08 and FY13,

incremental domestic

investments were entirely

driven by foreign

borrowings, as the fall in

domestic savings was

completely offset by

widening CAD

Exhibit 56

on the next page compares the identity at key turnaround points in the

economy. As investments increased from ~27% of GDP in FY04 to ~38% of GDP in

FY08, national savings contributed the lion’s share of ~70% (moved from~29% of

GDP to ~37% of GDP). Foreign capital (or CAD) accounted for less than one-third of

the total increase in domestic investments during the boom period. Nevertheless,

between FY08 and FY13, incremental domestic investments were entirely driven by

foreign borrowings, as the fall in domestic savings (of 3pp) was completely offset by

widening CAD (3.5pp). This is what made the economic growth over FY09-13 highly

unsustainable. As

Exhibit 57

shows, with CAD returning to more normal levels,

domestic investments have also fallen in the recent period. In FY16, we believe the

June 2016

Thematic | Economy

investment rate has fallen further (to sub-33%), as the savings rate is estimated to

have fallen below 32% and CAD also narrowed further to sub-1% of GDP.

Exhibit 56: Contribution of savings and foreign borrowings to Exhibit 57: Contribution of savings and foreign borrowings to

domestic investments at key turnaround points

domestic investments in the recent period

National savings

(20)

FY04

FY08

FY13

FY16E

29.0

(2.3)

(% of GDP)

1.3

36.8

4.8

33.8

0.8

31.8

CAD

Domestic investments

FY12

FY13

FY14

FY15

FY16E

Source: RBI, CSO, MoSL

34.6

33.8

33.0

31.8

National savings

(% of GDP)

4.3

4.8

1.7

1.3

0.8

CAD

Domestic investments

Extending the above identity, another key feature to note is the contribution of

various institutions to economic growth. An economy has three different players –

households, private corporate sector and consolidated public sector (including

central and state governments and public enterprises). Each of these institutions

saves and invests in the economy. If an institution saves more than its investment, it

becomes a ‘net lender’ to the economy. On the contrary, higher investments than

savings imply that the institution is a ‘net borrower’. In an ideal and normal period,

households are ‘net lenders’ (save more), private corporate sector is the key ‘net

borrower’ (key investor) and the public sector is the minor ‘net borrower’. The sum

of the balances (savings - investments) of these three institutions defines the

current account balance (CAB) or the balance with the rest of the world.

During the most recent

period (FY13-16E), the fall

in national savings is

entirely driven by

households, which is

partially offset by higher

corporate savings

As the economy improved,

the corporate sector led the

investment recovery

Exhibit 58

on the next page shows the break-up of savings and investments by each

of the three institutions in the Indian economy in the past two decades. There are

two key highlights pertaining to three key periods:

Key trends on sectoral savings:

The first leg of higher savings in early 2000s

(FY01-04) was driven by households and the public sector. However, the second

leg of higher savings during the mid-2000s (FY04-08) was contributed by the

private corporate sector and the public sector. During the most recent period

(FY13-16E), the fall in national savings is entirely driven by households, which is

partially offset by higher corporate savings.

Key trends on sectoral investments:

During the early 2000s, the share of

households in total investments increased, while the share of private corporate

sector fell towards 20% of total investments in FY03. As the economy improved,

the corporate sector led the investment recovery. The share of the corporate

sector increased to 45% of total investments, while the share of households fell

from 50% of total investments to 30%. In the recent period (FY12-16E), the

share of households has fallen once again from ~45% of total investments to

sub-35%, made up by the private corporate (60%) and the public sectors (40%).

June 2016

Thematic | Economy

Exhibit 58: Details of sectoral savings and investments in India

% of GDP

Savings

Total (1)

Households

Corporate

Public

sector

1.9

-0.2

-0.5

-1.3

-1.6

-0.3

1.3

2.3

2.4

3.6

5.0

1.0

0.2

2.6

1.5

1.4

1.3

1.2

Total (2)

Investment

Households*

Corporate

8.4

6.7

7.0

4.9

5.1

5.7

6.5

10.3

13.6

14.5

17.3

11.3

12.1

12.8

13.2

13.6

13.1

14.1

13.7

E&O (3)

Public

sector

7.4

1.1

7.3

0.7

7.6

-0.2

7.1

0.1

7.2

-1.3

6.4

-0.2

6.6

0.7

7.4

0.4

7.9

0.4

8.3

-0.2

8.9

0.1

9.4

-1.2

9.2

0.2

8.4

0.0

7.5

-0.6

7.2

0.4

7.1

0.0

7.4

0.1

7.6

0.1

* Includes valuables

CAD#

1.3

0.9

1.0

0.5

-0.7

-1.2

-2.3

0.4

1.2

1.0

1.3

2.3

2.8

2.7

4.3

4.8

1.7

1.3

0.8

FY98

24.2

18.1

4.2

24.5

8.7

FY99

23.2

19.5

3.8

23.5

9.5

FY00

25.5

21.7

4.3

26.8

12.2

FY01

23.7

21.3

3.7

24.1

12.1

FY02

24.8

23.1

3.3

25.6

13.2

FY03

25.9

22.2

3.9

25.0

12.8

FY04

29.0

23.1

4.6

26.1

13.0

FY05

32.4

23.6

6.6

32.5

14.7

FY06

33.4

23.5

7.5

34.3

12.8

FY07

34.6

23.2

7.9

35.9

13.0

FY08

36.8

22.4

9.4

38.0

11.9

FY09

32.0

23.6

7.4

35.5

14.8

FY10

33.7

25.2

8.4

36.3

15.0

FY11

33.7

23.1

8.0

36.5

15.3

FY12

34.6

23.6

9.5

39.6

18.8

FY13

33.8

22.4

10.0

38.3

17.5

FY14

33.0

20.9

10.8

34.7

14.4

FY15

33.0

19.1

12.7

34.2

12.7

FY16E

31.8

17.8

12.8

32.5

11.2

E = estimates

# Current account balance = Total investments + errors & omissions (E&O) - total savings

Data on 2004-05 base is up to FY11; FY12-FY15 is on 2011-12 base;

FY16 figures are our estimates

Source: CSO, RBI, MoSL

The deterioration in CAD

between FY08 and FY13

was primarily because of

the household sector,

rather than the

consolidated public sector,

as is widely believed

From savings and investments, we derive sectoral balances (savings – investments)

of each institution and look at the contribution of each institution to the economy’s

current account balance (CAB).

Exhibit 59

on the next page shows the sectoral

balances at key turnaround points in time, while the long-term series is shown in

Exhibit 60.

As the CAB improved from -1% of GDP in FY00 to +2.3% of GDP in FY04,

the key drivers were the public sector and households. The deterioration of CAB to -

1.3% of GDP in FY08 was entirely because of the corporate sector. Another key

finding is that the deterioration in CAD between FY08 and FY13 was primarily

because of the household sector, rather than the consolidated public sector, as is

widely believed

. In the recent period, however, the improvement in CAB was

majorly driven by the corporate sector, which continued to increase its savings (see

Exhibit 58

above) and failed to match its investments with higher savings. The public

sector also continued to borrow on net basis at a higher rate, eating up a significant

portion of the low resources provided by households.

“…Juxtaposing savings with investment, it becomes clear that it was the large saving-investment gap of the consolidated public sector,

complemented by a less pronounced gap in the private corporate sector, which could not be fully defrayed by the savings of households, that

constituted the aggregate saving-investment gap…”

says the Economic Survey 2014-15 which was released on 27 February 2015.

June 2016

Thematic | Economy

Exhibit 59: Sectoral balance at key turnaround points

FY00

9.4

10.6

10.2

5.0

(0.9)

(3.6)

(8.1)

6.5

Exhibit 60: Long-term series of sectoral balances

Households

E&O

(% of GDP)

Corporate

CAB

Public

FY04

FY08

FY13

FY16E

(% of GDP)

(2.6)

(2.0)

(5.3)

(3.9)

(5.8)

(6.3)

-10

-20

(7.9)

Households

Corporate

Public

Source: RBI, CSO, MoSL

FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14 FY16E

Source: RBI, CSO, MoSL

Why does sectoral analysis matter?

As stated earlier, in an ideal and normal world, households should be the ‘net

lender’ to the economy, the private corporate sector should be the key ‘net

borrower’, while the public sector should be a minor ‘net borrower’. This is because

the private corporate sector is the most efficient investor in the economy, which

invests primarily in ‘equipment & software’, while household investments are

primarily into real estate. The former helps to increase productivity in the economy.

The corporate sector

invests almost three-fourth

of its total investments in

machinery & equipment,

while households invest

almost entirely in

construction

Exhibit 61

shows that the corporate sector invests almost three-fourth of its total

investments in machinery & equipment, while households invest almost entirely in

construction (or dwellings). Exhibit

shows that while over half the total real

estate investment in the country is by households, more than 70% of the investment

in ‘machinery & equipment’ is by the private corporate sector. Notably, the public

sector also invests more than three-fifth in the construction activities, which si also a

low-efficiency activity.

Exhibit 62: Investments in different assets by institutions

Households

(% of total)

6.2

Private corporate

Public sector

Exhibit 61: Investments by institutions in different assets

(% of total)

Construction

Machinery & equipment*

7.2

38.0

74.0

92.8

62.0

26.0

Public sector

Private corporate

Households

56.4

71.4

17.8

25.8

Construction

22.4

Machinery & equipment*

Source: RBI, CSO, MoSL

* Includes investment in cultivated biological resources and

intellectual property

June 2016

Thematic | Economy

Exhibits 63 and 64

summarize the impact of sectoral investments on the real

economy. The exhibits clearly show that real GDP growth is highly positively

correlated with corporate investments, while higher household investments (or

physical investments) coincide with a weak economy.

Exhibit 63: Real GDP growth is positively correlated with Exhibit 64: …and

corporate investments…

investments

Corporate investment

FY92 FY95 FY98 FY01 FY04 FY07 FY10 FY13 FY16E

3yma = 3-year moving average

(YoY, 3yma)

(% of total GFCF)

Real GDP (RHS)

FY92 FY95 FY98 FY01 FY04 FY07 FY10 FY13 FY16E

Source: RBI, CSO, MoSL

(YoY, 3yma)

negatively correlated

with

household

Household investment

(% of total GFCF)

Real GDP (RHS)

The analysis of the transition of the Indian economy from the low-growth period in

the early 2000s to the high-growth period in the mid-2000s gives us three lessons:

1. High growth is sustainable (non-inflationary) if driven by investment boom.

2. Recovery or turnaround in domestic investments must be financed by national

savings rather than by foreign borrowings (or CAD).

3. The more the share of the private corporate sector in total investments, the

better it is for the economy. On the contrary, higher share of real estate

investments (or household investments) coincides with a weak economy.

June 2016

Thematic | Economy

II.4. Expectations for next two years

E II.4. Expectations for next two years

Key expectations are:



A surplus monsoon could push agricultural output growth towards 6%, which may

help GDP to grow 7.8% in FY17. Non-farm GDP growth, however, could fall from 8.3%

to 8% this year.



Although we expect retail inflation to average 4.7% in FY17, it is likely to reverse the

trajectory and average 5% in FY18, primarily because of continuation of consumption-

driven recovery.



Accordingly, while we don’t expect RBI to cut policy rates substantially from the

current levels, bond yields could drop towards 7% by March 2017 due to RBI’s open

market operations worth INR1,600b.



Finally, the Indian Rupee (INR) is likely to weaken further and average 68 against the

US Dollar (USD) in FY17. However, we expect the INR to remain strong in REER terms.

As per our understanding of the Indian economy, the basis of which we have

detailed in the previous sections of Part II, this final section is devoted to the most

likely future trajectory. We have divided this section into three segments. In the first

segment, we look at the economic projections for the next two years – FY17 and

FY18. The detailed economic projections are provided in Appendix IV. In the second

segment, we give our views on the bond market and follow it up with our forecasts

for INR in the final section of this part.

II.4.1 Where do we see Indian economy moving in the next two

years?

Our expectation of better

agriculture output is based

on the IMD’s (Indian

Meteorological

Department) monsoon

projections. The higher

growth hinges on hope to

that extent

Since the 1980s, agriculture

output growth has averaged

8.4% in the years associated

with a surplus South-West

(SW) monsoon

Real GDP growth of 8% achievable in the next two years:

To begin with, we believe

that real GVA (gross value added) growth could jump from 7.2% in FY16 to 7.7% in

FY17. The biggest delta in economic growth would come from the agriculture

economy, excluding which we expect real GVA to grow 8% in FY17, lower than 8.3%

in FY16. Our expectation of better agriculture output is based on the IMD’s (Indian

Meteorological Department

) monsoon projections. The higher growth hinges on

hope to that extent. Whether the actual monsoon will be as good as the IMD

expects is for us to see; however, historical data suggests

(Exhibits 65-66)

that

agricultural output has been better than the long-term average in the years of

surplus monsoon (irrespective of the extent of the surplus). Since the 1980s,

agriculture output growth has averaged 8.4% in the years associated with a surplus

South-West (SW) monsoon. We assume real agriculture output growth of 6% in

FY17, as against a meager growth of 1.2% in FY16 and a decline of 0.2% in FY15.

http://www.imd.gov.in/pages/press_release.php

June 2016

Thematic | Economy

Exhibit 65: Agriculture output is positively impacted by good

South-West (SW) monsoon

(10)

(20)

(30)

(% deviation

from LPA)

FY2002

FY2005

FY2008

FY2011

(% YoY)

FY2014

(10)

FY2017F

SW monsoon

Agriculture output (RHS) 10

(5)

Exhibit 66: Surplus SW monsoon has ALWAYS resulted in

better agriculture output growth

(5)

Long-term average

growth of 3.4%

(% YoY)

Agriculture output

(10)

FY1981 FY1987 FY1993 FY1999 FY2005 FY2011 FY2017F

Dotted years imply surplus monsoon

Source: RBI, CSO

We believe consumption

demand would remain the

key driver of real GDP

growth. Accordingly, we

expect the share of

(nominal) consumption to

move up to 71.4% of

(nominal) GDP in FY17 and

further to ~73% in FY18

Deriving GDP (gross domestic product) numbers from GVA requires us to add in our

assumption for net indirect taxes (NIT). We believe real GDP could grow 7.8% in

FY17 and 8.1% in FY18, assuming real NIT grows 8.6% in FY17 and 9.6% in FY18. Like

in the past few years, we believe consumption demand would remain the key driver

of real GDP growth. Accordingly, we expect the share of (nominal) consumption to

move up to 71% of (nominal) GDP in FY17 and further to ~72% in FY18 (Please see

Exhibit 34

on page 23). Total investments, on the other hand, will remain a

secondary contributor to higher real GDP growth

(Exhibit 67).

Exhibit 68: Consumption to outpace investment growth

Discrepancies

165

150

135

5.3

5.9

120

105

Forecast

Real consumption

(FY12 = 100)

Real investments ex valuables

Exhibit 67: Key contributors to real GDP growth

Consumption

(3)

FY13

FY14

FY15

FY16E

FY17F

FY18F

Source: RBI, CSO

1.7

3.0

3.8

-0.4

4.8

(pp)

2.2

2.3

1.4

4.4

2.5

Investments

Net exports

Q4 FY12 Q4 FY13 Q4 FY14 Q4 FY15 Q4 FY16 Q4 FY17 Q4 FY18

Source: RBI, CSO

Net financial savings are

unlikely to rise meaningfully

and are likely to remain

broadly unchanged at 7.8%

in FY18

The widening gap between consumption and investment growth, as shown in

Exhibit 68

above, is likely to make it challenging to maintain high sustainable (or

non-inflationary) growth. If consumption continues to drive real GDP growth, it

would be primarily financed by savings, as growth in real disposable income is

unlikely to accelerate substantially in the next couple of years. Household savings

will continue to inch down from ~18% of GDP in FY16E to ~16% by FY18

(Exhibit 69).

Within household savings, net financial savings are unlikely to rise meaningfully and

are likely to remain broadly unchanged at 7.8% in FY18. If so, gross savings of the

economy will continue to shrink. As discussed in Section III, lower savings will make

pick-up in investments unlikely, as the widening CAD (as per our projections) will fail

June 2016

Thematic | Economy

to offset the fall in national savings

(Exhibit 70).

Accordingly, gross capital formation

(or total investment) is likely to fall from 32.5% of GDP in FY16 to 30.7% in FY18.

Exhibit 69: National savings likely to fall further…

(% of GDP)

Households

Private corporate

Public sector

Exhibit 70: …which implies a fall in investment rate

(% of GDP)

National Savings

CAD

Investments

9.5

10.0

10.8

12.7

12.8

11.8

11.3

4.3

4.8

1.7

33.0

1.3

33.0

0.7

31.8

1.4

29.9

2.0

28.6

23.6

22.4

20.9

19.1

34.6

17.8

33.8

16.9

16.1

FY12

FY13

FY14

FY15

FY16E

FY17F

FY18F

FY12

FY13

FY14

FY15

FY16E

FY17F

FY18F

E = MoSL's estimate

F = MoSL’s forcasts

Source: RBI, CSO

With our growth

projections and drivers, we

expect inflation to move

higher and average 5% in

FY18, with a reading of

above 5% in January 2018

However, inflation unlikely to fall to 4% by January 2018:

With higher consumption

and lagging investment, economic growth will soon become unsustainable. This

combination will prevent retail inflation from falling towards 4%, as is targeted by

the Reserve Bank of India (RBI) by January 2018. We believe retail inflation will ease

further from 4.9% in FY16 to 4.7% this year (meeting its 5% target by January 2017);

however, with our growth projections and drivers, we expect inflation to move

higher and average 5% in FY18, with a reading of above 5% in January 2018.

Accordingly, we expect the policy repo rate to fall to 6.25% by the end of 2016 and

stay unchanged for the entire 2017. With an average retail inflation of 5%, it will

imply a real policy rate of 1.25% in FY18.

June 2016

Thematic | Economy

II.4.2 Bond market: Expect 10-year yield to fall towards 7% by

March 2017

Based on our real GDP growth and core WPI forecasts (Please

see Appendix IV),

believe high-powered money supply (M0) will have to increase 12.7% in FY17. It

means that the RBI will have to inject INR2,650b (USD39b) in the form of foreign

exchange reserves (FXR) and open market operations (OMOs). Our base case

balance of payments (BoP) projection is a surplus of USD21.4b in FY17 (see

Exhibit

below), which implies that OMOs of USD17.6b (or INR1,200b) will be needed to

meet M0 requirements. Including additional OMOs of INR500b on account of RBI’s

intent to provide durable liquidity in the system, the RBI may have to conduct total

OMOs worth INR1,700b (USD25b) in FY17, implying an average monthly OMO of

INR142b (or USD2.1b). Considering the demand for central government (CG) papers

by various participants (banks’ demand will be impacted based on FCNR

redemptions), there will be an excess demand of INR770b for CG securities, which,

we believe, could pull down yields towards 7% by March 2017.

Our base case balance of

payments (BoP) projection

is a surplus of USD21.4b in

FY17 (see

Exhibit 71

below),

which implies that OMOs of

USD17.6b (or INR1,200b)

will be needed to meet M0

requirements

We believe real GDP could

grow 7.8% in FY17 and

estimate core WPI inflation

at 0.6% for FY17, which

implies 12.7% growth in the

reserve money

Base case: Excess demand of INR720b to pull yields towards 7%...

Exhibit 71

shows the entire working of the excess CG-sec demand the markets could

witness in FY17. We believe real GDP could grow 7.8% in FY17 and estimate core

WPI inflation at 0.6% for FY17, which implies 12.7% growth in the reserve money (or

high-powered money, M0). In absolute terms, this implies an injection of INR2,650b

(USD39b) in M0 by the RBI. Broadly, M0 is injected via two ways – using foreign

exchange reserves (FXR) and RBI’s open market operations (OMOs). If FXR are more

than required, RBI conducts OMO sale, implying selling of government securities to

such excess liquidity. On the contrary, if FXR are less than needed, RBI buys

government securities and injects money via OMO purchases. As per our base case,

which includes current account deficit (CAD) of 1.4% of GDP in FY17 and an outflow

of USD12b on account of FCNRB redemption, we expect a surplus of $21.4b on the

balance of payments. It implies that the RBI will have to buy government securities

worth USD17.6b (or INR1,195b) in FY17 to meet M0 demand.

Exhibit 71: Calculation of potential OMOs in FY17

Unit

Reserve money requirement* (1)

FCNR(B) redemption

BOP surplus/Forex reserves (2)

OMOs requirement (3) = (1)-(2)

Durable liquidity (4)

Total OMOs (5) = (3)+(4)

Central G-sec supply

CG-sec gap# (6)

Excess CG-sec demand (7) = (5)-(6)

% YoY

INR b

USD b

INR b

Base case

No FCNR

redemption

12.7

2,650

0.0

33.4

2,271

379

500

879

4,252

357

522

Higher FCNR

redemption

The RBI will have to buy

government securities

worth USD17.6b (or

INR1,195b) in FY17 to meet

M0 demand

-12.0

21.4

1,455

1,195

1,695

928

767

-20.0

13.4

911

1,739

2,239

1,717

522

Average USDINR rate of 68.0 assumed for FY17

* M0 growth = constant + α(real GDP growth) + β(non-food manufacturing WPI inflation) + ε,

# Please see Exhibit 72 on the next page

Source: RBI, Union Budget documents, MoSL

June 2016

Thematic | Economy

Additionally, to meet its intent of providing durable liquidity to the system, we

assume additional OMOs worth INR500b, implying total OMOs worth INR1,695b in

FY17. If so, we believe that there could be an excess demand for central government

securities, which will pull down yields towards 7% by March 2017.

The higher the redemption,

the lower will be deposit

growth, hurting banks’

ability to buy G-secs

Impact of FCNRB redemption on banks, and thus, G-secs

It is also important to note that FCNR(B) redemption would also have a direct impact

on banks’ deposits – banks are the largest holders/buyers of government securities.

The higher the redemption, the lower will be deposit growth, hurting banks’ ability

to buy G-secs.

Exhibit 72

below shows the potential buying of G-secs by commercial

banks under various scenarios – based on FCNRB redemptions. Under our base case

scenario of USD12b redemption, we assume that commercial banks (CBs) would

offset 70% of the redemption (12*68*0.7 = 571) by subscribing less to G-secs.

Accordingly, CBs will buy only INR1,147b (or 27%) of CG-secs supplied in FY17 as

against an estimated 43% in FY16. If so, there will be a gap of INR928b, which will

have to be bought by the RBI. Nevertheless, with OMOs worth INR1,695b, it implies

an excess demand for G-secs, which, we believe, will pull down yields towards 7%.

Exhibit 72: Key buyers of central government papers

Base

case

Total supply (1)

Total demand (2)

Net commercial banks’ demand = (a) - (b)

Commercial banks’ demand (a)

Impact of FCNRB redemption# (b)

FIIs

Insurance companies

Others* excluding RBI

G-sec gap = (1) – (2)

928

3,324

1,147

1,718

571

No FCNR

redemption

4,252

3,895

1,718

451

935

791

357

1,717

Higher FCNR

redemption

2,535

358

1,718

1,360

Average USDINR rate of 68.0 assumed for FY17,

Base case = $12b outflow; Higher FCNR(B) redemption = $20b,

# Assuming 70% of the reduction in deposits (USD12 bn) due to FCNR(B) redemption is financed by

subscribing to lower G-secs in Base case, 100% (of USD20 bn) in Bear case,

* Include provident funds, mutual funds, corporate etc,

Source: RBI, MoSL

Worst case may not really be worse for CG-secs

Lower FXR will require the

RBI to conduct more OMOs,

which, as per our estimate,

could be closer to

INR2,240b (or USD32.9b)

What if FCNRB redemption is much higher? Further, what if banks offset the entire

(100%) fall in deposits by CG-secs? Interestingly, it will not hurt bond markets

significantly, as we expect lower BoP surplus to be entirely offset by higher RBI

OMOs. A higher redemption (of say USD20b) on account of FCNRB this year, will

bring down BoP surplus to USD13.4b. It will also reduce the ability of banks to buy

CG-secs. However, lower FXR will require the RBI to conduct more OMOs, which, as

per our estimate, could be closer to INR2,240b (or USD32.9b) (see last column in

Exhibit 71

below). If so, even the higher G-sec gap of INR1,717b

(Exhibit 72)

will be

easily covered by higher OMOs. Therefore, even higher FCNRB redemption – the so-

called worst case scenario – may not really be worse for G-secs, which will continue

to witness excess demand, and thus, lower yield. The fall in yield, however, could be

closer to 7.1-7.2%, rather than 7%.

June 2016

Thematic | Economy

What if RBI grows reserve money (M0) by 10% instead of 12.7%?

One could argue that the real risk for G-secs in FY17 (which we otherwise believe

would be a good year for bond markets) is the possibility of RBI belief that lower

growth is required in M0. Let’s assume that RBI feels comfortable to increase

reserve money by 10% against our expectation of 12.7%. It means an increment of

INR2,100b in reserve money in FY17. As per our base case then, RBI will have to

conduct OMOs worth INR1,145b including OMOs for durable liquidity. Notably,

although there will be an excess demand for G-secs, it will be much lower at

INR217b, which may reduce the extent of fall in the benchmark sovereign yields.

Overall, we believe that FY17 will be a good year for bond markets, as the yields

could fall toward 7% due to excess demand for central government papers.

Overall, we believe that

FY17 will be a good year for

bond markets, as the yields

could fall toward 7% due to

excess demand for central

government papers

June 2016

Thematic | Economy

II.4.3 Exchange rate: Expect average of INR68/USD in FY17

We use a 6-currency (or narrow) REER (real effective exchange rate) model to

forecast INR/USD. Our INR/USD forecasts take into account movements in the

currencies of India’s other major trading partners such as the Euro (EUR) and the

Chinese Renminibi (CNY). We expect the INR to weaken 3.8% against the USD and

average at INR68/USD in FY17. It is most likely to weaken another 2.7% and average

at INR69.8/USD in FY18. (Please note that our forecasts are based on forecasts of

inflation for trading partners and the movements in EUR/USD and USD/CNY, which

we have taken from Bloomberg).

While the INR has

weakened ~37% in nominal

terms against the USD, a

large part of the weakness

has been offset by the rising

inflation differential,

leading to a minor ~7%

weakness in real terms

How much has INR weakened against USD in the past four years?

INR is down from 47.9 against USD in FY12 to 65.5 in FY16. ~37% weaker? No, INR

has weakened less than 7% since FY12. The difference between 37% and 7% is the

inflation differential between the US and Indian economies. While the INR has

weakened ~37% in nominal terms against the USD, a large part of the weakness has

been offset by the rising inflation differential, leading to a minor ~7% weakness in

real terms. The former (nominal exchange rate (NER)) is what we usually discuss in

daily work-life; however, what actually matters for the economy and investors is the

latter (real exchange rate (RER)).

Exhibit 73

below shows the movement of the INR

against the USD in nominal and real terms. Notably, INR/USD has been broadly

unchanged in real terms since 2012, as the sharp weakness in nominal terms was

largely offset by higher and rising inflation differential

(Exhibit 74).

Exhibit 74: …explained by the inflation differential

120

110

100

Mar-11

(2013-14=100)

Price differential

Exhibit 73: Differential between nominal and real USD/INR…

140

125

110

(2013-14=100)

Mar-11

Mar-12

Nominal USD/INR

Real USD/INR

Strong INR

Higher India's

inflation vis-a-vis US'

Weak INR

Mar-13

Mar-14

Mar-15

Mar-16

Mar-12

Mar-13

Mar-14

Mar-15

Mar-16

Source: RBI, Bloomberg

Though the INR has

strengthened ~10% against

the EUR in nominal terms in

the past four years, it has

strengthened ~18% in real

terms because of higher

inflation differential

What about EUR and CNY?

The US is India’s third largest trading partner. Eurozone is the largest trading

partner, followed by China. Therefore, it is important to understand the movements

in the Euro (EUR) and the Renminbi (CNY) against the INR; these are actually derived

from the movements of the EUR and CNY against the USD. Though the INR has

strengthened ~10% against the EUR in nominal terms in the past four years, it has

strengthened ~18% in real terms because of higher inflation differential

(Exhibit 75).

Moreover, like against the USD, while the INR has weakened ~37% against the CNY

in nominal terms, it has weakened ~11% in real terms

(Exhibit 76).

June 2016

Thematic | Economy

Exhibit 75: Differential between nominal and real EUR/INR…

138

126

114

102

(2013-14=100)

Mar-12

Mar-13

Mar-14

Weak INR

Mar-15

Mar-16

Nominal EUR/INR

Strong INR

Real EUR/INR

Exhibit 76: …and CNY/INR

130

120

110

100

(2013-14=100)

Mar-12

Mar-13

Mar-14

Weak INR

Mar-15

Mar-16

Nominal RMB/INR

Real RMB/INR

Strong INR

Source: RBI, Bloomberg

Expect INR to weaken against USD but strengthen in REER terms

Overall, apart from nominal exchange rate, domestic inflation also affects foreign

trade. Just like the exchange rate, understood as domestic currency relative to

foreign currency, the inflation differential between the domestic economy and the

trading partner is also important.

It is not possible to forecast

INR/USD without

accounting for other

important currencies such

as the EUR and CNY.

Therefore, we use a real

effective exchange rate

(REER) model to forecast

INR/USD

It is not possible to forecast INR/USD without accounting for other important

currencies such as the EUR and CNY. Therefore, we use a real effective exchange

rate (REER) model

to forecast INR/USD. We implicitly take into account the

movements of other important currencies against the USD. Since the narrow REER

consists of six currencies (including the USD), we use Bloomberg consensus

estimates for the remaining five currencies (USDEUR, CNYUSD, JPYUSD, HKDUSD

and GBPUSD). Further, we use Bloomberg estimates for inflation forecasts of trading

partners and merge them with our forecasts for India’s inflation to project INR/USD.

Given below

(Exhibit 77)

are our forecasts for bilateral exchange rates in nominal

terms and India’s narrow REER for FY17 and FY18.

Exhibit 77: Currency forecasts for the next two years

INR/USD

FY14

FY15

FY16

FY17F

60.5

61.1

65.5

68.0

INR/EUR

81.2

77.5

72.3

74.4

INR/CNY

9.9

10.3

REER*

99.9

106.0

109.4

109.8

FY18F

69.8

74.0

10.6

111.2

F = Forecasts

* Narrow index (against six currencies). This index is our calculation, which is insignificantly different

from official REER index.

Source: RBI, Bloomberg, MoSL

We have used forecasts for other currencies from Bloomberg as of May 31, 2016. The key assumption of our model is that INR/USD will

remain unchanged (at 100.0) in real terms in FY17 and FY18. We calculate the nominal INR/USD, using inflation forecasts for India (MoSL)

and the US (from Bloomberg) to calculate bilateral real exchange rate.

June 2016

Thematic | Economy

How do changes in foreign currency impact INR/USD?

Higher-than-expected

depreciation in any other

trading partner currency vis-

à-vis the USD will open the

room for further weakness in

INR against USD

Assuming the sanctity of Bloomberg forecasts, we do not expect the INR to weaken

towards 70 against the USD in FY17. Nevertheless, higher-than-expected

depreciation in any other trading partner currency vis-à-vis the USD will open the

room for further weakness in INR against USD.

Exhibit 78

below shows the impact of

a 10% shock (unexpected) in the five major currencies. Other factors remaining

unchanged, our analysis reveals that a 10% weakness in the EUR (average 0.99

against USD versus Bloomberg forecast of 1.10) in FY17 will allow the INR to weaken

an additional 3.5% against the USD to keep the REER level same as in our base-case

scenario. In other words, INR/USD could average 70.4 in FY17, as against 68.0, if the

EUR falls to parity against the USD.

Similarly, if the CNY weakens 10% more than current expectations, the INR will have

to weaken an additional 2.5% against the USD and average at 69.8 in FY17 to keep

the REER index unchanged at 109.8.

Exhibit 78: Impact of non-USD currency shock (10%) on INR/USD

INR/

USD

Base case

EUR

RMB

JPY

HKD

GBP

68.0

INR/

EUR

74.4

-7.3% (67.0)

INR/

CNY

10.3

-9.5%(9.3)

INR/

JPY

0.6

INR/

HKD

8.8

INR/

GBP

98.6

REER

109.8

113.7

112.7

110.5

70.4

69.8

68.4

3.5%

2.6%

0.6%

Adjusted

REER*

Adjusted Additional

INR/

weakness in

USD#

INR/USD

-1.9%(0.5)

-5.7%(8.0)

-10.1%(88.7)

The higher (lower) the

inflation in trading partner

(given India’s inflation), the

lower (higher) the nominal

depreciation needed to

maintain REER

Apart from nominal exchange rates, inflation will also tend to change REER. As a rule

of thumb, the higher (lower) the inflation in trading partner (given India’s inflation),

the lower (higher) the nominal depreciation needed to maintain REER. As a

corollary, the lower (higher) the domestic inflation (given foreign inflation), the

lower (higher) the nominal depreciation required to keep REER unchanged.

June 2016

Thematic | Economy

III. Will India be ready to grow at 10% by 2020?

Current growth model unsustainable; 10% looks challenging

We take a step forward and investigate what the Indian economy could look like in 2020.

In particular, we discuss if the economic growth could touch 10% by 2020.



We argue that it will be challenging for India to graduate from the current growth rate

of 8% per year to 10% on sustainable basis by 2020, unless there is a shift from

consumption-driven to investment-led growth.



This is primarily because we believe that the current level of retail inflation is high,

which will rise further under the existing economic model. We believe inflation must

fall towards 2-3% for at least a few quarters.



The initial phase of lower consumption growth could be painful; however, as inflation

undershoots the medium-term target of 4% and households start re-building their

savings, it will create conducive environment for investments to drive economic

recovery.



Besides, higher savings and lower inflation, global economy, and capital efficiency will

also play a key role in helping India to touch 10% growth in the 2020s.

Consumption-driven growth

will increasingly become

more destabilizing, as

inflation will face upward

pressure. Hence, India must

replace consumption with

investments as the key

growth driver

We believe that the current economic model, in which consumption continues to

outpace investments and drive real GDP growth, could remain in place for at least

the next two years (till FY18). This will help India touch 8% real GDP growth.

However, consumption-driven growth will increasingly become more destabilizing,

as inflation will face upward pressure. Hence, India must replace consumption with

investments as the key growth driver (opposite of what is recommended for China).

The issue does not seem alarming currently, especially due to the recent weakness

in inflation; however, the longer the current model continues, the more

unsustainable the economy will become. For sustainable growth, investments must

be the key driver. How does India shift from consumption to investments?

There are two ways in which India could bring investments to the forefront: First, by

increasing the investment rate (as % of GDP), and second, by increasing the

efficiency of investments (or capital). The latter is measured as incremental capital

output ratio (ICOR). Over 2004-08, the Indian economy witnessed a rise in

investment rate along with higher capital efficiency (or lower ICOR). A look at the

four Asian Tigers – Hong Kong, South Korea, Singapore and Taiwan – however,

shows that the former (higher investment rate) is an easy, convenient and more

widely established source of higher growth. The latter (higher capital efficiency) has

its limits.

There are two ways in

which India could bring

investments to the

forefront: First, by

increasing the investment

rate (as % of GDP), and

second, by increasing the

efficiency of investments

June 2016

Thematic | Economy

III.1. What does history tell us?

A comparison of Hong Kong

and Taiwan shows that

notwithstanding similar

investment rate, the

average growth rate in the

former was ~85% of that in

latter, primarily because of

better capital efficiency in

Taiwan

Exhibit 79

below shows the key economic parameters for the four Asian Tigers

between the 1960s and the 1980s, the high growth (8%+) period for these

economies. Two of the four economies – Hong Kong and Singapore – grew rapidly

without impressive capital efficiency (low ICOR). On the other hand, Korea had an

average growth of above 9% for three decades, with an investment rate of below

30% and an average ICOR of only 2.2x. A comparison of Hong Kong and Taiwan

shows that notwithstanding similar investment rate, the average growth rate in the

former was only 85% of that in latter, primarily because of better capital efficiency

in Taiwan.

Exhibit 80

compares ICORs of the Asian Tigers, reflecting different capital

efficiency in these economies during the high-growth period.

Exhibit 80: Capital efficiency in Asian Tigers

Korea

(x)

Singapore

Hong Kong

Taiwan

Exhibit 79: Summary of key parameters during 1960s-80s

Investment rate

1960s-80s

Hong Kong

Korea

Singapore

Taiwan

GDP

growth

8.2

9.2

8.7

9.7

ICOR*

7.4

2.2

5.7

3.5

Average

27.3

20.0

44.0

28.7

Min-Max

21.1-37.4

8.1-30.0

30.7-53.1

15.4-39.0

*Calculated as average investment rate in ‘t’ and ‘t-1’ period divided by

GDP growth in ‘t’ period

3-year moving average

Source: World Bank, Official sources, MoSL

Excessive reliance on either

method – higher

investment rate or better

ICOR – may make an

economy unsustainable

The history, thus, shows some economies witnessed higher growth due to better

capital efficiency and some due to higher investment rate. Excessive reliance on

either method – higher investment rate or better ICOR – may make an economy

unsustainable. The former may limit private consumption or lead to wider CAD,

while the latter may lead to underutilization of savings. A combination of the two

methods is the best way to approach sustainably higher growth. During 2004-08,

high growth in the Indian economy was driven by a rise in investment rate and

improved capital efficiency (ICOR). India must attain a similar model this time.

June 2016

Thematic | Economy

Barring the recent drop in

household savings, the

sector contributed almost

70% to the national savings

III.2. What is needed to increase investment rate in India?

For higher investments, national savings must rise. To start with, it is important to

look at the composition of total national savings. Barring the recent drop in

household savings, the sector contributed almost 70% to the national savings.

Therefore, it is imperative to understand the behavior of households. As shown in

Exhibit 81

below, household savings in India are divided into three parts – gross

financial savings (GFS), financial liabilities and physical savings (investments). Since a

large portion of financial liabilities is used to build physical savings, the former are

deducted from GFS to arrive at net financial savings (NFS). NFS, along with physical

savings, comprise total household savings.

Exhibit 81: Major contributors to India’s national savings

Household

% of GDP

Total

(1)=(4)+(5)

Gross financial

savings (2)

Financial

liability (3)

Net financial

savings

(4)=(3)-(2)

Physical

savings (5)

5.8

8.7

9.5

11.5

11.4

12.6

12.3

12.1

13.4

11.7

11.9

10.8

13.5

13.2

15.9

14.7

13.0

11.0

9.9

Private

corporate

sector (6)

4.4

4.2

3.8

4.3

3.7

3.3

3.9

4.6

6.6

7.5

7.9

9.4

7.4

8.4

8.0

9.5

10.0

10.8

12.7

12.8

Public

sector (7)

Total national

savings

(8)=(1)+(6)+(7)

FY97

15.8

11.2

1.2

10.0

FY98

18.1

10.9

1.6

9.3

FY99

19.5

11.5

1.5

10.0

FY00

21.7

11.7

1.8

10.2

FY01

21.3

11.4

1.5

9.9

FY02

23.1

12.1

2.2

10.5

FY03

22.2

12.7

2.4

10.0

FY04

23.1

13.7

2.5

11.0

FY05

23.6

13.8

3.7

10.1

FY06

23.5

15.8

5.0

11.9

FY07

23.2

17.8

6.6

11.3

FY08

22.4

15.5

3.8

11.6

FY09

23.6

12.9

2.9

10.1

FY10

25.2

15.3

3.1

12.0

FY11

23.1

13.9

3.6

9.9

FY12

23.6

10.7

3.3

7.4

FY13

22.4

10.7

3.3

7.4

FY14

20.9

10.4

2.7

7.7

FY15

19.1

10.0

2.3

7.7

FY16E

17.8

9.7

2.0

7.7

Data based on 2004-05 until FY11; 2011-12 base from FY12 onwards

2.2

22.4

1.9

24.2

-0.2

23.2

-0.5

25.5

-1.3

23.7

-1.6

24.8

-0.3

25.9

1.3

29.0

2.3

32.4

2.4

33.4

3.6

34.6

5.0

36.8

1.0

32.0

0.2

33.7

2.6

33.7

1.5

34.6

1.4

33.8

1.3

33.0

1.2

33.0

1.2

31.8

Source: RBI, CSO, MoSL

As per the recent available data, household savings declined to ~19% of GDP in FY15

(and below ~18% as per our estimate in FY16) from an all-time high of 25% in FY10.

While NFS has been unchanged at ~7.5% of GDP in the past five years, it has fallen

substantially from an average of ~11% in the first decade of the 21

century. The

latter matters because NFS is the key source of financing for non-household

domestic investments. Since NFS, however, is derived by deducting financial

liabilities from GFS, we delve deeper into household GFS and its constituents.

Overall, Indian households

prefer short-term safe

assets such as bank

deposits and resist risky

assets

A look at the composition of household GFS

(Exhibit 82)

shows that deposits (bank

and non-bank) account for more than half of total financial savings, another one-

third goes into long-term safe assets (insurance, pension and government paper),

currency accounts for another 10%, while risky assets (shares and debentures)

account for less than 5%. Overall, Indian households prefer short-term safe assets

such as bank deposits and resist risky assets. Bank deposits play a vital role in

household financial savings, and thus, India’s national savings.

June 2016

Thematic | Economy

Exhibit 82: Households’ gross financial savings (GFS) and components

% of GFS

Currency

Deposits

43.1

43.7

43.5

42.5

42.1

41.8

41.6

41.3

41.9

44.3

45.2

46.9

46.2

46.9

47.9

48.8

50.3

50.2

Life insurance

9.1

9.4

9.6

10.0

10.5

11.0

11.6

11.8

12.3

12.6

13.0

14.2

15.0

16.6

16.9

17.3

17.2

17.4

PF & pensions

17.8

17.9

18.5

19.1

19.3

18.8

18.2

17.5

16.8

15.9

14.9

14.1

13.6

13.5

13.2

13.0

12.8

13.1

Shares &

debentures

6.6

6.0

5.5

5.7

5.6

5.3

4.9

4.6

4.2

4.4

4.8

5.5

4.8

4.2

3.9

4.0

3.8

3.9

Claims on

government

Others*

FY97

11.7

FY98

11.2

FY99

11.1

FY00

10.8

FY01

10.2

FY02

10.2

FY03

10.0

FY04

10.1

FY05

9.9

FY06

9.7

FY07

9.6

FY08

9.7

FY09

10.1

FY10

10.0

FY11

10.4

FY12

10.5

FY13

10.5

FY14

10.2

FY15

10.2

* Units of UTI and trade debt (net)

8.5

3.2

9.1

2.8

9.7

2.1

10.1

1.8

10.8

1.5

11.7

1.3

12.4

1.0

13.8

0.6

15.1

0.4

15.1

0.3

13.0

0.4

10.7

0.6

9.0

0.6

8.4

0.5

7.6

0.5

6.6

0.5

5.9

0.5

5.3

0.5

4.8

Source: RBI, MoSL

Since deposits are the key saving instrument for households, it is important to

understand the role of deposits rates – nominal or real – in influencing household

deposits. To calculate interest rate on deposits, we have extracted data on maturity-

wise household term deposits from RBI’s annual publication, Basic Statistical Return

(BSR). Using the maturity-wise deposit interest rates provided by RBI, we calculate

weighted nominal deposit rate (WNDR) for households. We deflate WNDR by

consumer price index for industrial workers (CPI-IW) to calculate weighted real

deposit rate (WRDR).

Exhibit 83-84

shows the correlation between (nominal and

real) deposit rates and household deposit growth. Given below are our key findings:

We find household term

deposits are significantly

and positively correlated

with nominal deposit rate

(WNDR),

not

real deposit

rate (WRDR)

Inflation plays an important

role in determining whether

nominal or real deposit rate

matters for households

With relatively subdued

inflation, WNDR is more

relevant

1. Based on the data for the past 23 years (since mid-1990s), we find household

term deposits are significantly and positively correlated with nominal deposit

rate (WNDR),

not

real deposit rate (WRDR).

2. From mid-1990s until 2008-09, nominal deposit rates were more important

because of two reasons: (1) Limited avenues to park savings initially (1990s), and

(2) Average inflation of 4.5% between 1999 and 2007. As inflation trended

upwards and real rates turned negative in 2008, the relationship between

WRDR and household deposit growth strengthened.

3. In the past couple of years, however, as inflation has subsided and WRDR

moved into positive territory, WNDR seems more important again.

4. Accordingly, we believe that inflation plays an important role in determining

whether nominal or real deposit rate matters for households. As inflation moves

above a threshold level, WRDR becomes more important for depositors. With

relatively subdued inflation, WNDR is more relevant.

5. The inflation threshold is dynamic and determined by the level of real interest

rates (WRDR). If inflation is high enough to turn real rates negative, WRDR turns

more relevant. If inflation is low enough to keep WRDR positive, nominal rates

are more important for depositors.

June 2016

Thematic | Economy

Exhibit 83: Nominal deposit rate and household deposits

(% YoY,

3yma)

(%,

3yma)

HH term deposits

WNDR# (RHS)

Exhibit 84: Real deposit rate and household deposits

(%,

3yma)

HH term deposits

WRDR* (RHS)

(3)

(6)

(% YoY,

3yma)

# Calculated using maturity wise deposits and deposit rate

3-year moving average (3yma)

*Weighted real deposit rate is nominal rate deflated by CPI

Source: RBI, CSO, MoSL

Real deposit rates have a

negative correlation with

household deposits, which

is significant at 10% level

We also find, analytically, that nominal deposit rate and household deposits are

highly correlated (Exhibit

below). However, correlation does not imply causation,

and thus, we also look at partial correlation of household deposits with deposit

rates. Interestingly, we do not find deposit rates impacting household deposit

growth. In fact, more surprisingly, real deposit rates have a negative correlation with

household deposits, which is significant at 10% level. However, real interest rates

with a lag of one-year have shown a strong positive impact on deposit growth in the

recent years. If so, then household deposits are set to fall further in FY17, as WRDR

peaked in FY15 (exhibit

above).

Exhibit 85: Statistical inferences between deposit rates and household deposits

Pair-wise correlation

WNDR

WRDR

FY1993-FY2016

0.6364*

(0.2686)

0.5768*

(0.2509)

FY1993-FY2008

0.7965*

(0.2730)

0.9269*

(0.1610)

FY2008-FY2016

0.3350

0.2382

0.4337

0.4992

Partial correlation

WNDR

WRDR

0.2240

0.0813

0.4585

0.2564

0.7084

0.3829

(0.3318)

0.0964

0.1807

0.1139

(0.7357)**

0.9126*

Contemporaneous

One-year lag

Contemporaneous

One-year lag

Contemporaneous

One-year lag

*Significant at 1% level, ** significant at 10% level

Source: RBI, MoSL

A look at the real deposit

rates during early 2000s

(previous slowdown

episode) show that WRDR

was as high as 6% in 2000

and averaged 2.9% in the

decade ending FY08

If real interest rates do impact household deposits, what is the level of real deposit

rate needed to encourage higher deposits? Courtesy RBI, a range of 1.25%-1.5% for

real interest rates has been broadly established in the markets. However, a look at

the real deposit rates during early 2000s (previous slowdown episode) show that

WRDR was as high as 6% in 2000 and averaged 2.9% in the decade ending FY08

(Exhibit 86).

In comparison, WRDR was 2.6% and positive for the second consecutive

year in FY16 (after five years of negative WRDR since FY09).

June 2016

Thematic | Economy

Exhibit 86: Historical trend in nominal and real deposit rates

(3)

(5)

(%, 3yma)

WRDR

Exhibit 87: Repo rate and deposit rate share strong relation

(%)

Repo rate

WNDR

3-year moving average = 3yma , Source: RBI, CSO, MoSL

Substantial cut in policy

rates would tend to reduce

deposit rates too. This may

discourage households from

increasing their deposits,

and thus, financial savings

Whether India needs a real deposit rate of 2% or 5% is probably not as important for

domestic savers today, as it was a few years ago because inflation has eased. Since

we don’t expect inflation to rise substantially in the foreseeable future to make real

rates negative, we believe that nominal deposit rate will matter for household

deposits in the future. If so, this strong correlation between WNDR and household

deposit growth presents a structural constraint to reduction in policy interest rates.

Exhibit 87

above shows the close movements of policy repo rate and nominal

deposit rate (WNDR). Substantial cut in policy rates would tend to reduce deposit

rates too. This may discourage households from increasing their deposits, and thus,

financial savings.

To revive growth in household deposits, we need higher nominal deposit rate,

implying higher policy repo rate. Since we don’t see any reversal of the current

regime of accommodative monetary policy by the RBI, we don’t expect a pick-up in

household savings in the foreseeable future. Consequently, GDP growth will remain

consumption driven, as lower domestic savings and limited improvement in capital

efficiency will keep investment rate low in FY17 and FY18, as discussed in Section IV

of Part II.

revive

household financial savings, households must be incentivized to make

more bank deposits. While this may not appeal to policymakers (or bankers) today

because of the weak bank credit growth, we believe it is better to be prepared for a

pick-up in credit. As and when credit picks up, if sufficient funds or deposits are not

in place, the markets would witness shortage of liquidity, and thus, higher rates. This

is why we believe it is important to keep an eye on the crashing savings rate in the

economy. Without adequate savings, the economy will not be able to grow

sustainably.

GDP growth will remain

consumption driven, as

lower domestic savings and

limited improvement in

capital efficiency will keep

investment rate low

As and when credit picks

up, if sufficient funds or

deposits are not in place,

the markets would witness

shortage of liquidity, and

thus, higher rates

June 2016

Thematic | Economy

Box 4. Do expected interest rates matter?

One might argue that the current deposit rate may not be as useful for depositors as the expected rate of return. Hence, one

must incorporate the impact of expected real deposit rate (ERDR) to examine the impact of interest rates on household

deposits.

How does one calculate ERDR? We use household expectations of 3-month (or 12-month) inflation to deflate the nominal

deposit rate to arrive at ERDR. The RBI started conducting the inflation expectation survey of households (IESH) in September

2005, and the quarterly data is available since September 2006. Thus, we have annual data available since FY08. The exhibit

below graphs India’s ERDR (based on 3-month expectations) and one-year lagged ERDR (ERDR(-1)) with household deposit

growth.

We find that one-year lagged ERDR has a very strong correlation with household term deposits. We reached a similar

conclusion from WRDR in Exhibit 85 above.

Overall, our analysis reveals that real deposit rates (expected or current) matter for depositors if inflation is higher than a

threshold, which has been the case since FY08. Nevertheless, if inflation is expected to remain subdued, as was the case

between 2000 and 2007, nominal deposit rates matter. Thus, we expect nominal rates to become crucial than real rates in

the future, which as explained above, acts as a constraint to significant monetary easing.

Household term deposits (% YoY) and expected real deposit rate (ERDR, %)

FY07

Source: RBI, MoSL

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16E

ERDR(-1) = One-year lagged ERDR

HH term deposits

ERDR (RHS)

ERDR(-1) (RHS)

-2

-4

June 2016

Thematic | Economy

III.3. Expect limited gains from better capital efficiency

A key advantage of lower

ICOR (or better capital

efficiency) is that it is

directly leads to an increase

in the potential output, or

the maximum output that

can be achieved with a

given amount of resources

Apart from higher investment rate, economies could make their capital (or

investments) more efficient and improve their growth rates accordingly. A key

advantage of lower ICOR (or better capital efficiency) is that it directly leads to an

increase in the potential output, or the maximum output that can be achieved with

a given amount of resources. However, capital efficiency is a structural issue. Not

surprisingly then, most economies have seen higher investment rate leading to

higher growth at least in the initial period. Let’s look at India’s ICOR.

During the FY04-08 period, India’s ICOR fell towards 3.5x, the lowest level since mid-

1980s. Real GDP growth averaged ~9% per annum during the period. With an

investment rate of above 30%, an ICOR of 3.5x implies a real GDP growth of ~9.5%.

Given the same set of

resources (and same labor

productivity), India’s real

GDP growth will be 10-20%

lower that of China’s due to

inefficient capital

Exhibit 88

below compares India’s ICOR with that of China’s. Since the 1980s, India’s

ICOR has averaged above 5x as against 4.3x in China (India’s ICOR averaged 4.7x in

the post-liberalization period). In other words, given the same set of resources (and

same labor productivity), India’s real GDP growth will be ~20% lower that of China’s

due to inefficient capital. The Indian economy must work towards better capital

efficiency, not only to improve its potential output, which, according to RBI’s

working paper, has fallen in the recent period, but also to improve its actual growth

rate.

Exhibit 89: India’s capital efficiency since mid-1970s

(x, 3yma)

Exhibit 88: India v/s China’s capital efficiency

Long-term

average

India - 5.1x

China - 4.3x

(x, 3yma)

India

China

Best of 3.5x in

mid-2000s

3-year moving average = 3yma ,

Source: CSO, World Bank, MoSL

With capital efficiency

currently closer to 4x, as

against the best-ever level

of 3.5x, there is limited

gains from this avenue

Nevertheless, with capital efficiency currently closer to 4x, as against the best level

of 3.5x since 1980s, there is limited gains from this avenue

(Exhibit 89).

Further, in

the absence of high corporate investments, higher public or household investments

may limit the gains in capital efficiency.

June 2016

Thematic | Economy

III.4. How important is the global environment?

India’s economic growth is

highly correlated with other

major world economies

Apart from domestic savings and capital efficiency, we will be closely looking at the

global economic growth, which has an important role to play in shaping the Indian

economy.

Exhibit 90

below compares India’s real GDP growth with that of the world

economy’s. India’s economic growth is highly correlated with other major world

economies. This is further reinforced in

exhibit 91.

It shows that, as per partial

correlations, India’s economic growth is highly and significantly correlated with

Chinese economy. With almost all major world economies witnessing slower

growth, India’s revival in GDP growth is impressive. In fact, even if India is able to

sustain its current growth amid falling growth in most other economies, India’s

dominance will continue to increase in the world economy.

Exhibit 90: Comparison of India’s economic growth with Exhibit 91: How does India’s economic growth relate with

world economic growth

growth in other major economies?

(% YoY,

2yma)

World

India

Partial correlation

1996-2015

China

Euro zone

Japan

USA

0.4690*

0.0330

0.2401**

(0.1763)

0.2406**

2008-15

0.4329**

0.2465

0.0965

(0.0414)

0.0832

Pair-wise correlation

1996-2015

0.5429*

0.3487**

0.4608*

0.2503**

0.3016*

2008-15

0.4867*

0.6236*

0.5873*

0.4732*

0.4779*

* Significant at 1% level, ** significant at 5% level, *** significant at

10% level , Source: RBI, CSO, MoSL

Better global environment

does not only help in

increasing India’s exports,

but also in creating a

conducive environment for

investors to increase

investments

One of the key factors supporting the high growth period of the mid-2000s was the

sharp turnaround in the global economy during that period. Better global

environment does not only help in increasing India’s exports, but also in creating a

conducive environment for investors to increase investments, which, then leads to

higher income growth, and thus, sustainable economic growth.

June 2016

Thematic | Economy

III.5. Seven key things to decide Indian economic outlook in 2020

Savings behavior:

The first economic parameter on our watch will be

households’ financial savings. It is highly improbable for a developing economy

to improve its growth rate without investments. The latter must be financed

through domestic savings, rather than foreign capital, which tends to be highly

destabilizing.

Capital efficiency:

Along with higher savings, it is also imperative for the Indian

economy to reduce its ICOR or improve capital efficiency. This could be achieved

by increasing competition in some key industries, creating market-determined

environment and reducing tax-based considerations for the corporate sector.

Inflation:

By increasing competition and reducing market inefficiencies, a

substantial drop in inflation can be achieved. We believe retail inflation must fall

below the medium-term target of 4% to reduce the high ‘price gap’ the

economy has witnessed in the past decade.

Global environment:

It is highly unlikely for an economy to perform in isolation

in this globalized world. The global environment is as important as the domestic

fundamentals. Without a stronger world economy, the domestic potential will

remain capped.

Monetary policy:

In contrast to many market participants, we don’t see a need

to cut policy interest rates substantially from the current levels. To encourage

households to increase their financial savings, deposits – which account for half

of gross financial savings – must be incentivized by keeping interest rates

(nominal and real) high. This, we argue, poses a structural constraint to

significant cuts in policy rates.

Higher tax-to-GDP ratio:

From the fiscal policy side, the Indian economy cannot

remain at the bottom of the tax collection list. With gross tax receipts (central +

state) at less than 15% of GDP, the (general) government sector will always find

it difficult to support the economy (by consumption or investments) without

creating imbalances (in terms of higher fiscal deficit). Since household savings

have already fallen, the economy must make sure to apportion as low as

possible to the relatively inefficient public investments. Although the legislative

nod to goods & service tax (GST) is seen as the panacea to weak tax structure in

the country, implementation will hold the key.

Indian Rupee:

Finally, although we believe that the INR is likely to weaken

against the USD in the next two years, higher inflation differential will keep the

INR stronger in real terms, which will continue to affect India’s competitiveness.

India must bring down inflation differential to improve its competitiveness,

which will also help the INR to strengthen against the USD. A stronger currency

will also encourage savers.

Overall, we believe that achieving 10% real growth by 2020 is not going to be an

easy task. Further, unless the transition from consumption to investments is

complete, policy makers should not attempt to increase growth rates, as this may

destabilize the economy.

June 2016

Thematic | Economy

Conclusion

The objective of commissioning this research note was to share the lenses with

which we analyze the Indian economy. The report was divided into three parts. In

the first part, we compared the performance of the Indian economy with the

performance of other emerging market economies. The second part detailed our

understanding of India’s domestic fundamentals, based on which we made our

forecasts for FY17 and FY18. This part was further divided into four sections, where

we used the KURE theme. The third part looked at the key factors that will help

determine the India 2020 outlook.

In Part I, we established

the comparative

outperformance of the

Indian economy using

four key economic

parameters

In Part I, we established the comparative outperformance of the Indian economy

using four key economic parameters:

1. India’s standing in the world economy has strengthened in the past decade – it

has moved up from the world’s 12

largest economy in 2008 to the 7

largest in

2016.

2. At a time when most of the major economies (including China) are facing the

threat of a declining working population (aged 15-64 years), the Indian economy

continues to enjoy favorable demographics.

3. An index of macroeconomic vulnerability shows India’s dramatic improvement

in the past four years; this has helped to keep it at the top of investors’ minds.

Further, the rational investors’ rating index (RIRI) shows India’s outperformance

since 2012.

4. Finally, total debt in India is not anywhere close to alarming levels. In fact, the

debt intensity of GDP growth in India is one of the lowest among major

developing and emerging economies.

In Part II, we begin by discussing how the unincorporated and unregistered

corporate sector may be eating away the share of India Inc. By incorporating the

mid-level and bottom level of the corporate pyramid with the top level, we not only

established the sanctity of the new GDP series, but also concluded that the current

slowdown is not as severe as the previous slowdown in the 2000s, primarily because

of the resilient consumption demand.

In Part II, we begin by

discussing how the

unincorporated and

unregistered corporate

sector may be eating away

the share of India Inc.

We argued that

consumption is being

supported by lower

household savings, rather

than higher disposable

income.

In Section II of this Part, we discussed the three unique features – low savings,

higher inflation and incomplete adjustment in CAD, which have helped India to

become the fastest growing economy in the world. We argued that consumption is

being supported by lower household savings, rather than higher disposable income.

Consequently, retail inflation has been running higher than the optimal level. A

measure of ‘price gap’ shows that CPI is currently ~55%, implying that the actual CPI

index is 55% higher than the optimal index. Moreover, we strongly believe that

notwithstanding recent narrowing in India’s CAD, higher consumption-led deficit has

restricted the desired adjustment in CAD.

Based on these three unique features, we made an attempt to explain a large part

of the economy by revisiting an economic identity, which says that domestic

June 2016

Thematic | Economy

Indian households, unlike

their history and their

counterparts in other

economies, have reduced

their savings in the past few

years, which is one of the

key reasons for resilient

consumption demand, and

thus, GDP growth.

investments are equal to national savings and CAD. In Section III, we analyzed the

behavior of three key economic participants – households, private corporate sector,

and public sector, and compare them with their own history and their counterparts

in other economies. We concluded that Indian households, unlike their history and

their counterparts in other economies, have reduced their savings in the past few

years, which is one of the key reasons for resilient consumption demand, and thus,

GDP growth.

Finally, we detailed our projections for the next two years in Section IV of Part II. We

believe that the current economic model will continue for at least the next two

years, which will help real GDP growth touch 8% by FY18. Nevertheless, the

continued fall in national savings will put upward pressure on inflation, which, we

believe will average 5% in FY18 as against 4.7% in FY17. We do not expect RBI to cut

policy rates significantly from the current levels.

Notwithstanding the limited cuts in policy interest rates, we expect the benchmark

bond yield to move towards 7% by March 2017, primarily driven by high expected

OMOs by the RBI – to the tune of INR1,600b. Further, while we expect the INR to

weaken further and average at 68 against the USD in FY17, it is likely to strengthen

marginally in REER terms.

We concluded that the

longer the current

economic model of

consumption-driven GDP

growth remains in place,

the more likely it is to

destabilize the economy.

In Part III, we looked at the key seven factors which, we believe, would play a major

role in determining the outlook for the Indian economy in 2020. Of these seven

factors, we discussed the three most important factors – savings, capital efficiency

and global environment in greater detail. We concluded that the longer the current

economic model of consumption-driven GDP growth remains in place, the more

likely it is to destabilize the economy. India must try to shift towards investments,

for which higher savings are a pre-requisite. In the absence of significantly higher

growth in disposable income, consumption may have to be curtailed to push savings

higher. We believe that while 8% growth could be reached by FY18, the task of

reaching 10% growth by 2020 will be challenging.

June 2016

Thematic | Economy

Appendix I: Data details

The long time series of GDP is taken form Organisation for economic co-operation

and development (OECD), which provides quarterly data on India’s GDP and

components from FY97 onwards. Wherever OECD data is not available (such as

income, savings etc) we have using splicing to create a single series. Data prior to

2011-12 is on 2004-05 base, while the new series (2011-12 base) is used from 2011-

12 onwards.

Due to the availability of long time series, retail inflation refers to consumer price

index to industrial workers (IW), unless otherwise specified.

The three episodes used in this study are early 2000s, boom period and the recent

period. Each episode comprises of a five year period. ‘Early 2000s’ refers to the

period between FY99 and FY04, ‘boom period’ refers to the period between FY03

and FY08, and the current period is FY12 to FY17 (MoSL estimate). FY99, FY03 and

FY12 are the base years for the respective episodes.

As far as corporate data statistics is concerned, there is a significant change. Prior to

the new GDP series, RBI quarterly survey of ~2,700 large companies was considered

as the data source for corporate sector data. However, Ministry of corporate affairs

(MCA) started collecting data on about 500,000 companies from 2011-12

companies, which is used in the new GDP series. As against the broadly held belief

of the large companies representing the true condition of India’s corporate sector,

the inclusion of mid-tier companies from MCA database changes the picture

substantially. We have compared RBI sample with MCA database in this study.

June 2016

Thematic | Economy

Appendix II: Understanding the “Theory of Everything”

According to an identity in national accounts, current account balance could also be

defined as the difference between a nation’s savings and investments. In other

words, total domestic investments could be financed either through domestic

savings or foreign borrowings. The latter is roughly equivalent to the financial

account balance of a nation, which according to the Balance of Payments (BoP)

identity is considered to be a correspondent of the nation’s current account deficit

with a reverse sign. This is because current account deficit (surplus) is expected to

be financed (used) through capital account inflows (outflows) to keep the BoP in

equilibrium.

Thus, if a nation increases its investments, either domestic savings have to rise or

the nation will have to borrow from outsiders, which will lead to an increase in the

current account deficit. The identity can be written as:

Domestic investments = Total savings + foreign borrowings

As foreign borrowings are equivalent to current account deficit (not balance), the

equation can be re-written as:

Domestic investments = Total savings + current account deficit

Re-arranging the equation, we get

Current account deficit = Domestic investments – total savings

Thus, if a nation is investing more than its domestic savings, it will run a current

account deficit. On the contrary, if savings are higher than investments, current

account will be in surplus.

Further, any economy can be segregated into three sectors – households (HH),

business (non-public financial and non-financial corporations) and general

government (GG, including all government entities). Just like an economy, a sector

would run either a deficit – implying higher investments than savings – or a surplus,

implying higher savings (if savings are exactly equal to investments, it implies a

neutral sector).

Therefore, a nation’s current account balance can be disaggregated into the

balances of these three domestic sectors. To understand the movements in current

account in a better (and different) way, we have looked at the balances of each

sector in an economy.

June 2016

Thematic | Economy

Appendix III: Rational Investor Ratings Index (RIRI)

In its Economic Survey 2014-15, the government of India (GoI) introduced macro

vulnerability index (MVI) and rational investors’ ratings index (RIRI). We have used a

slightly modified form of these indices in our study.

The MVI assesses a country’s risk profile by combining three key macro parameters

– fiscal deficit, current account deficit and inflation. We add these three data series

to arrive at MVI index. We replace fiscal deficit with the primary deficit (fiscal deficit

excluding interest payments) of the government and use the same structure to re-

calculate MVI for several economies. The lower the MVI index is, the safer the

economy is. A reduction (increase) in MVI over time reflects improvement

(deterioration). We have used all data from International Monetary Fund (IMF) April

2016 World Economic Outlook and define emerging & developing Asia as per IMF.

Further, we have created a group of economies, which are rated the same as India

(BBB-) by Standard & Poor’s (S&P).

The RIRI, as explained by the Economic Survey, is computed by averaging a country’s

GDP growth rate and its macroeconomic indicators; the latter measured as the

average of the fiscal deficit, current account deficit, and inflation (all with negative

signs). Thus, equal weight is given to growth and macroeconomic stability (slightly

modified version of MVI). The greater the number, the better should be its investor

rating.

http://indiabudget.nic.in/budget2015-2016/vol1_survey.asp

June 2016

Thematic | Economy

Appendix IV: Detailed economic projections

Exhibit 92: Detailed projections for the real sector

Macro indicators

Nominal variables

Gross domestic product at market prices (GDP

)

GDP

Private consumption expenditure (PCE)

Government consumption expenditure (GCE)

Gross capital formation (GCF)

Exports of goods & services

Less:

Imports of goods & services

Gross Value Added at basic prices (GVA

)

Agriculture & allied activities

Industry

Services

Real variables

Real GDP

PCE

GCE

GCF

Gross fixed capital formation (GFCF)

Exports of goods & services

Less:

Imports of goods & services

Real GVA

Agriculture & allied activities

Industry

Services

Community services etc

Non-agriculture GVA

Non- agriculture non-community GVA

Other real sector

Index of industrial production (IIP)

Nominal personal disposable income (PDI)

Real PDI

2,3

Unit

US$ b

% YoY

% of GDP

% YoY

% of GVA

% YoY

unit

FY12

1,820

n/a

56.2

11.1

39.6

24.5

31.1

n/a

18.5

32.5

49.0

n/a

2.9

n/a

FY13

1,826

13.9

57.0

10.7

38.3

24.5

31.2

13.6

18.2

31.7

50.0

5.6

5.3

0.5

4.2

4.9

6.7

6.0

5.4

1.5

3.6

6.0

8.1

4.1

6.3

6.7

1.1

13.6

3.6

FY14

1,863

13.3

57.7

10.2

34.7

25.3

28.3

12.7

18.3

30.8

50.9

6.6

6.8

0.4

(1.1)

3.4

7.8

(8.2)

6.3

4.2

5.0

5.6

7.8

4.5

6.7

7.2

(0.1)

12.8

4.9

FY15

2,040

10.8

57.6

10.9

34.1

22.9

25.9

10.5

17.4

30.0

52.6

7.2

6.2

12.8

6.0

4.9

1.7

0.8

7.1

(0.2)

5.9

5.5

10.3

10.7

8.6

8.3

2.8

7.0

2.9

FY16E

2,073

8.7

59.5

10.6

32.4

19.9

22.5

7.0

17.0

29.7

53.2

7.6

7.4

2.2

3.8

5.3

(5.2)

(2.8)

7.2

1.2

7.4

9.3

8.9

6.6

8.3

8.7

2.4

8.7

4.1

FY17F

2,215

11.1

59.7

11.4

31.5

19.1

21.6

10.9

17.4

28.9

53.7

7.8

9.3

6.8

6.6

1.9

2.5

7.7

5.8

6.2

7.0

9.0

8.7

8.0

7.9

5.2

11.1

6.3

FY18F

2,413

11.9

60.3

11.9

30.8

18.6

21.2

11.8

17.3

28.3

54.4

8.1

8.3

12.7

7.3

7.1

5.8

6.5

7.9

3.8

6.9

8.2

9.7

10.8

8.7

8.3

5.8

11.9

7.0

Manufacturing

Incremental capital-output ratio (ICOR)

n/a

7.0

5.7

5.0

4.6

4.4

4.2

Industry includes mining & quarrying Manufacturing, electricity and construction

MoSL estimates, FY16 data not yet out, MOSL estimate

Nominal PDI deflated by PCE deflator

The ratio of last two years’ investments (as a percentage of GDP) and GDP growth - it is calculated using real-term data

Source: RBI, CSO, CMIE, MoSL

June 2016

Thematic | Economy

Exhibit 93: Detailed projections of Prices, rates and Money & banking

Macro indicators

Price measures

GVA

deflator

GDP

deflator

PCE deflator

Consumer price index (CPI)

Food & beverages

Fuel & light

Core CPI

Unit

% YoY

US$/bbl

US$/ounce

FY12

n/a

8.9

9.8

14.0

7.3

7.1

111.9

1,649

8.7

13.5

17.0

78.0

95.5

8.50

8.54

48.0

FY13

7.8

7.9

9.7

9.9

11.2

9.7

8.7

7.4

9.8

10.3

5.4

4.9

9.3

108.0

1,654

5.8

13.6

14.2

14.1

77.9

77.1

7.50

7.96

54.5

FY14

6.0

6.2

7.5

9.4

11.9

7.7

7.2

6.0

9.8

10.2

3.0

2.9

9.4

105.5

1,326

9.8

13.4

14.1

13.9

77.8

76.8

8.00

8.80

60.5

FY15

3.2

3.3

4.0

5.9

6.5

4.2

5.6

2.0

3.0

(0.9)

2.4

4.9

84.0

1,248

13.1

10.8

12.6

10.4

76.3

64.3

7.50

7.74

61.2

FY16

(0.1)

1.0

4.5

4.9

5.1

5.3

4.6

(2.5)

0.2

(11.7)

(1.1)

(1.5)

2.5

46.2

1,151

12.8

10.4

8.1

9.9

77.6

94.0

6.75

7.47

65.5

FY17F

3.0

3.1

4.5

4.7

4.4

5.0

5.1

1.9

4.2

0.3

1.2

0.6

5.4

45.0

1,200

15.1

11.3

8.8

11.1

79.2

97.4

6.25

~7.00

68.1

FY18F

3.6

4.6

5.0

4.8

4.5

5.3

2.9

4.7

2.5

2.0

1.2

5.9

50.0

1,200

13.1

12.3

11.7

12.0

79.4

81.0

6.25

…

70.0

Wholesale price index (WPI)

Primary articles

Fuel & power

Manufactured products

Non-food manufactured products

Food items (raw + processed)

Crude oil price

Gold price

Money & Banking

Reserve money (M0)

Bank deposit

Bank credit

Credit-deposit ratio

Incremental credit-deposit ratio

Key rates

Policy repo rate (year-end)

10-yr treasury yield (year-end)

INRUSD (average)

% YoY

% pa

unit

Broad money supply (M3)

CPI excluding ‘Food & beverages’ and ‘Fuel & light’

M0 growth = constant + α(real GDP growth) + β(non-food

manufacturing

WPI inflation) + ε

Broad money supply (M3) calculated using money multiplier

Source: RBI, CSO, CMIE, MoSL

June 2016

Thematic | Economy

Exhibit 94: Detailed projections for the external sector

Macro indicators

Current account balance

Merchandise

Invisibles

Total credit

Merchandise

Petroleum products

Valuables

Invisibles

Services

Total debit

Merchandise

Petroleum products

Valuables

Invisibles

Services

Capital and Financial account

Foreign direct investment (FDI)

Foreign portfolio investment (FPI)

Non-resident Indians (NRI) deposits

Errors & omissions

Change in forex reserves (+(withdrawal)/-

(accretion))

Current account balance (CAB)

Non-oil

Non-oil non-Gold

Forex reserves (+(withdrawal)/-(accretion))

Savings-Investments

National savings

Households

Corporate sector

Public sector

Domestic investments

Households

Corporate sector

Public sector

% of GDP

34.6

23.6

9.5

1.5

39.0

15.9

13.2

7.5

33.8

22.4

10.0

1.4

38.6

14.7

13.6

7.2

33.0

20.6

10.8

1.3

34.7

13.0

13.1

7.1

33.0

19.1

12.7

1.2

34.2

11.0

14.1

7.4

31.8

17.8

12.8

1.2

32.5

9.7

13.7

29.9

16.9

11.8

1.2

31.3

8.9

13.9

28.6

16.1

11.3

1.2

30.7

8.1

14.3

Unit

US$ b

% of GDP

FY12

(78.2)

(189.7)

111.5

527.0

309.8

55.9

46.4

217.2

140.9

605.2

499.6

155.0

90.8

105.7

76.9

67.8

22.0

16.6

11.9

(2.4)

12.8

(4.3)

1.1

4.3

0.7

FY13

(87.8)

(195.7)

107.8

530.0

306.6

60.6

43.0

223.6

145.7

618.1

502.2

164.0

83.6

115.8

80.8

89.0

19.8

26.7

14.8

2.7

(3.8)

(4.8)

0.9

3.8

(0.2)

FY14

(32.4)

(147.6)

115.3

551.4

318.6

63.1

41.1

232.8

151.5

583.7

466.2

164.8

58.2

117.5

78.5

48.7

21.6

4.8

38.9

(0.9)

(15.5)

(1.7)

3.7

5.3

(0.8)

FY15

(26.7)

(144.9)

118.2

557.8

316.5

56.9

40.6

241.2

157.7

584.5

461.5

138.3

62.0

123.0

81.1

89.4

31.6

40.9

14.1

(1.1)

(61.4)

(1.3)

2.7

4.5

(3.1)

FY16E

(17.3)

(127.9)

110.6

501.2

266.6

29.2

39.0

234.6

154.0

518.5

394.5

82.7

53.0

124.0

82.7

50.2

36.0

(2.7)

16.0

0.0

(32.9)

(0.8)

1.7

3.3

(1.5)

FY17F

(30.6)

(139.5)

108.9

510.3

275.9

29.3

43.0

234.5

157.7

540.9

415.3

88.6

57.8

125.6

85.2

52.0

35.0

15.0

2.0

0.0

(21.4)

(1.4)

1.3

2.9

(1.0)

FY18F

(47.5)

(160.7)

113.2

537.6

293.8

34.0

46.3

243.7

164.4

585.1

454.6

109.2

61.1

130.5

89.0

72.0

38.0

20.0

13.0

0.0

(24.5)

(2.0)

0.3

1.8

(1.0)

7.6

7.0

6.6

E = FY16 is MoSL estimate

Valuables include items related to gold, or any other precious metal

Source: RBI, CSO, CMIE, MoSL

June 2016

Thematic | Economy

Exhibit 95: Detailed projections for the central government finances

Macro indicators

Total receipts

Net tax collection

Direct tax receipts

Indirect tax receipts

Non-tax collection

Non-tax receipts

Non-debt capital receipts

Disinvestment

Total expenditure

Revenue spending

Interest payments

Subsidies

Pensions

Capital spending

Fiscal balance

Revenue balance

Primary balance

Net debt

Unit

INR b

% YoY

INR b

% YoY

INR b

% YoY

INR b

% YoY

INR b

% YoY

INR b

% YoY

INR b

% of GDP

INR b

% of GDP

INR b

% of GDP

INR b

% of GDP

FY12

7,884

(4.3)

6,298

4,974

10.9

3,917

13.7

1,586

1,217

369

181

13,044

8.9

11,458

10.1

2,731

2,181

612

1,586

1.3

(5,160)

(5.9)

(3,943)

(4.5)

(2,428)

(2.8)

40,880

FY13

9,202

16.7

7,419

5,624

13.1

4,738

20.9

1,783

1,374

409

259

14,104

8.1

12,435

8.5

3,132

2,571

695

1,669

5.2

(4,902)

(4.9)

(3,642)

(3.7)

(1,770)

(1.8)

46,276

FY14

10,566

14.8

8,159

6,424

14.2

4,963

4.8

2,407

1,989

419

294

15,594

10.6

13,718

10.3

3,743

2,546

749

1,877

12.5

(5,029)

(4.5)

(3,570)

(3.2)

(1,286)

(1.1)

52,302

FY15

11,529

9.1

9,036

6,989

8.8

5,459

10.0

2,493

1,979

515

377

16,637

6.7

14,670

6.9

4,024

2,583

936

1,967

4.8

(5,107)

(4.1)

(3,655)

(2.9)

(1,083)

(0.9)

58,065

FY16RE

12,503

8.4

9,475

7,560

8.2

7,036

28.9

3,028

2,586

442

253

17,854

7.3

15,477

5.5

4,426

2,578

957

2,377

20.9

(5,351)

(3.9)

(3,416)

(2.5)

(925)

(0.7)

63,537

FY17BE

14,442

15.5

10,541

8,512

12.6

7,797

10.8

3,901

3,229

671

565

19,781

10.8

17,310

11.8

4,927

2,504

1,234

2,470

3.9

(5,339)

(3.5)

(3,540)

(2.3)

(412)

(0.3)

69,901

FY18F

16,475

14.1

12,150

9,789

15.0

8,967

15.0

4,325

3,875

450

300

22,240

12.4

19,523

12.8

5,314

2,500

1,358

2,717

10.0

(5,765)

(3.4)

(3,498)

(2.1)

(451)

(0.3)

75,666

46.8

46.5

46.4

46.5

46.6

46.5

45.1

FY16 is revised estimate (RE), FY17 is budget estimate (BE) and FY18 is our forecasts (F)

Net debt for FY16 is MoSL estimate

June 2016

THEMATIC GALLERY

SECTOR

RESEARCH

SECTOR UPDATES

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