Economic Uncertainties. Are we still under the Weather?

Economic Uncertainties Are we still under the Weather?

Global recovery running out of steam Eurozone in recession, Growth slows down in US, China and India

US: Faltering growth US economy loses growth momentum in 1H212 U.S. GDP growth slowed to 1.5% in Q2 212, from 2% in Q1 212 Consumer spending, which contributes 7% to U.S. GDP, grew 1.5%, slowing from 2.4% in Q1 212 The unemployment rate rose to 8.3% in Jul 12, from 8.2% in Jun 12 (GDP growth,qoq,annualized, %) 5 4 3 2 1 1.4 Q3 29 4 Q4 29 2.3 2.2 2.6 2.4 2.5.1 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 GDP growth (QoQ, Annualized) 1.3 Q3 211 4.1 Q4 211 2 Q1 212 1.5 Q2 212 Source: BEA

Eurozone: Negative growth Eurozone economy heading into recession Eurozone GDP contracted.2% in Q2 212, following flat growth in Q1 212 In Q2 212, Spain's economy contracted.4% q- o-q, the third consecutive quarter of contraction (Growth,qoq, %) 1..8.6.4.2. -.2 -.4 The euro zone unemployment rate reached 11.2% in Jun 12, the highest level since the data started in 1995 Source: Eurostat.4.4.5 Q3 29 Q4 29 Q1 21.9 Q2 21.7.4.3.2.1 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 GDP growth (Q/Q) -.3 Q4 211. Q1 212 -.2 Q2 212

Emerging markets too facing a sharp growth slowdown China s economy growth down in single digit China s economy slowed down to 7.6% in Q2 212, the lowest in 13 quarters (%, yoy) 13 12 11 1 9 8 7 6 11.2 12.4 1.4 11.9 9 6.2 11.9 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 7.6 25 26 27 28 29 21 211 212 GDP growth Source: National Bureau of Statistics, China India sees a sharp growth deceleration India s real GDP growth has nose-dived to 5.3% in 4QFY12 from 9.2% in 4QFY11, following a sharp dip in investment (%) 1 9 8 7 6 5 4 8. 7.8 1QFY9 2QFY9 5.6 3QFY9 6.5 4QFY9 7.5 1QFY1 9.8 2QFY1 7.4 3QFY1 8.6 8.5 4QFY1 1QFY11 7.6 2QFY11 8.2 3QFY11 9.2 4QFY11 8. 1QFY12 6.7 6.1 2QFY12 3QFY12 5.3 4QFY12 Real GDP growth Source: Government of India

High budget deficit reduces scope for fiscal-stimulus US: Fiscal deficit at the highest levels in decades 3 US fiscal deficit has been above 7% of GDP for last three years, -3-6 -9-12 Jun-96 Oct-97 Feb-99 Jun- Oct-1 Feb-3 Jun-4 Oct-5 Feb-7 Jun-8 Oct-9 Feb-11 Jun-12 (Fiscal balance, as % of GDP) Fiscal balance (As % of GDP) Eurozone countries are following strict austerity measures to curb their fiscal deficits Source: BEA Eurozone: Adopting austerity measures to control deficit (% of GDP) -1-2 -3-4 -5-6 -7 Source: Eurostat 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 Eurozone budget deficit

Eurozone jittery: The Greek God Greece has not seen growth in industrial production since the Lehman Brother s crisis Greece current account deficit at ~12% of the GDP is one of the highest in the world If not controlled, rising debt and fiscal deficit likely to force Greece to fall out of Eurozone Greek industrial growth remains in red since Oct 8 (Growth, %) 1 5-5 -1-15 May-1 Source: Eurostat Apr-2 Mar-3 Feb-4 Jan-5 Dec-5 Industrial production growth Nov-6 Oct-7 Sep-8 Aug-9 Jul-1 Jun-11 May-12 Industrial production index (RHS) 11 15 1 95 9 85 8 75 7 (SA,Base 25=1)

Hopes are pinned on Germany While France has seen flat growth in last three quarters and Spain & Italy already in recession, Germany, continues to grow Unlike other Eurozone countries, Germany unemployment rate continues to decline for last two years, reaching the lowest level in twodecades Further slowdown in Germany would mean wide-spread recession in the Eurozone Germany s unemployment rate falls to two decades low in May 12 25 (Unemployment rate %) 2 15 1 5 Mar-6 Source: Eurostat Sep-6 Mar-7 Sep-7 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 France Germany Greece Italy Portugal Spain Mar-11 Sep-11 Mar-12

Policy makers trying to uplift sentiments U.S.: Ben Bernanke stated: we will act in an a-political, non-partisan manner to do what s best for the economy. We have said we are prepared to take more action." Eurozone: ECB chairman Draghi said his institution would do whatever it takes to preserve the euro... Believe me, this will be enough," China: The People's Bank of China (PBoC): Central bank officials promised to strengthen the fine-tuning of monetary policy in the second half of 212 India: The new finance minister, P Chidambaram: "Uppermost in my mind is the duty to regain the confidence of all stakeholders..."

India Investment growth, a must to achieve higher growth

Investment revival is a must for high Without a major contribution from investment, India has never experienced over 8% growth The increasing investment- GDP ratio over the decades had led to acceleration in GDP growth Apart from contributing to the present-period growth through capacity creation, investment improves potential for future growth growth Strong relation between investment and real growth 4 (Investment to GDP ratio, %) 35 3 25 2 15 1 195s 196s 197s 198s 199s 2s 21s Investment to GDP GDP growth 9 8 7 6 5 4 3 (Real GDP growth, %) Source: GoI

India witnessing investment slowdown During Jan-Mar 12, the amount of proposed investment has been the worst vs. comparable quarters since 27 The corporate sector, contributing nearly 4% to overall investments in India, has remained subdued since FY9 New project investment has decelerated sharply 1 (New project investment, Rs. trn) 8 6 4 2 Apr-97 May-98 Jun-99 Jul- Aug-1 Sep-2 Oct-3 Nov-4 Dec-5 Jan-7 Feb-8 Mar-9 Apr-1 May-11 Jun-12 Source: CMIE

Headwinds for India s investment revival Investment revival is faced with four major constraints

Funding Shortage Capex recovery requires accelerated bank-credit growth Despite a high deposit rate, low deposit growth raises doubts 29 11 Two-thirds of corporate funding needs are met by banks, the most stable source of funding for companies With banks facing SLR at 23% and CRR at 4.75%, even maintaining (leave apart expanding) a steady C-D ratio of 77% would be challenging (Bank deposit growth, %) 26 23 2 17 14 11 Jan- Oct- Jul-1 Apr-2 Jan-3 Oct-3 Jul-4 Apr-5 Jan-6 Oct-6 Jul-7 Apr-8 Jan-9 Oct-9 Jul-1 Apr-11 Jan-12 1 9 8 7 6 5 (Deposit rate, %) Low deposit growth to make it difficult for banks to lend aggressively Source: RBI Bank deposit growth Deposit rate

High Interest Rates are depressing investment While the RBI s aggressive monetary tightening seems to have helped ease inflation, it seems to have also considerably depressed investment demand The transmission of the recent softening of the real interest rate to provide some boost to investment by Q4 FY13 At present, the real lending rate is hovering around 6%, which, according to past patterns, is conducive to single-digit investment growth Monetary tightening impacted investment (Capital goods production, growth, %) 5 4 3 2 1-1 -2 Source: RBI Apr-93 Apr-94 Apr-95 Apr-96 Apr-97 Apr-98 Apr-99 Apr- Apr-1 Apr-2 Apr-3 Apr-4 Apr-5 Apr-6 Apr-7 Apr-8 Apr-9 Apr-1 Apr-11 Apr-12 Capital goods production Real lending rate -6-3 3 6 9 12 15 (Real lending rate, inverse scale, %)

Idle Capacity curtailing new capacity creation Production levels in the last 13 months have not bounced back to the Mar 11 level Industrial production yet to revert to the Mar 11 level 2 Despite subdued capacity addition after FY8, capacity utilization in Indian manufacturing sector is subdued Since manufacturing is the most export-oriented segment (8% export-to-gdp ratio), the overhang of excess capacity globally to keep manufacturing investment subdued (Indistrial production index) 175 15 125 1 May-5 Nov-5 May-6 Nov-6 May-7 Nov-7 May-8 Nov-8 May-9 Nov-9 May-1 Nov-1 May-11 Nov-11 May-12 Source: GoI

Political hindrances and perception of Policy Paralysis Lack of reforms and the perception it is creating is negative for investment environment Coalition politics, lack of a coherent agenda and wavering of individual political parties on crucial issues are factors thwarting even routine legislative and executive action The new finance minister Mr P. Chidambaram hints at actions to restore confidence in the economy However, there is a huge question mark on whether the government commands the political support in the present regime to go in for any kind of reforms

Inflation remains a concern Though WPI inflation has softened in recent months, it still remains out of RBI s comfort zone Inflation remains near double digits in India in FY12 14 12 The CPI inflation, which has a higher weighting for food, is running in double digits (%) 1 8 6 High food inflation domestically and high imported inflation due to the weaker rupee are keeping upside pressure on inflation 4 2 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 WPI inflation CPI-IW inflation FY1 FY11 FY12 Source: GoI

Rising oil and gold imports tilting the trade deficit figure India is one of the world s largest importers of gold; excluding gold imports, India runs a very low current account deficit India imported US$56bn worth of gold in FY12 High oil and gold imports leading to widening of the trade deficit 25 2 (US$, billion) 15 1 5 India s net import of crude oil stood at US$1bn in FY12 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 FY1 FY11 FY12 Source: GoI Trade deficit Oil+gold imports

India s long term fundamentals are intact More driven by domestic demand

Having discussed all the negatives Growth forecasts are strongly pro-cyclical -- Even the organizations such as the IMF and the RBI have been pro-cyclical in their forecasts in the past - that is they over estimate future growth in good times and underestimates future growth in bad times India not doing overtly bad from international comparison -- India s relative ranking in terms of growth at 4th in 211 is considerably better than the 14th ranking in 28 Long-term drivers of growth still intact -- India becomes the third largest economy -- Less vulnerable to external demand -- Diversified trade destinations to Asia & Middle East leading reduced trade dependence on developed world Pessimism already into the price -- Sensex has hit 165-mark every year for last six years -- Slight improvement in government policy actions have huge potentials to take the financial markets to new highs

Growth forecasts are strongly pro-cyclical Consensus could be biased Currently, the consensus estimates suggest no immediate recovery ahead and subdued growth outlook to continue during FY13 Past patterns suggest that growth forecasts are strongly pro-cyclical i.e. during the periods of low growth, estimates underestimate future growth and vice-versa Thus, the ongoing trend downward revision in the GDP forecasts by consensus might be another example of consensus being cyclical India growth: RBI estimates vs. actual 9 8 Actual Actual 7 6 Actual Actual 5 4 3 2 1 FY9 FY1 FY11 FY12 FY13 Apr-8 Jul-1 Jul-8 Oct-1 Oct-8 Jan-11 Jan-9 Apr-11 Apr-9 Jul-11 Jul-9 Oct-11 Oct-9 Jan-12 Jan-1 Apr-12 Apr-1 Jul-12 (Growth, %) Source: RBI

India not doing overtly bad from international comparison India faired relatively better in 211 vs. 28 India s global ranking in real growth has improved currently vs. the popularly known reform period during 1992-96 In terms of real growth, India s global rank improved to 4 in 211, from 14 in 28 (among top 46 major countries) Policy paralysis turning the scapegoat. The feeling that policy paralysis is the root cause seems largely misplaced (India's global rank in real growth) India global rank improved to 4 in 211, from 14 in 28 35 3 25 2 15 1 5 15 3 13 12 9 8 Source: World Bank and Anand Rathi Research 5 23 2 2 31 3 1 5 9 3 4 2 14 2 3 4 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211

India becomes the third largest economy In purchasing power parity terms, India has become the 3 rd largest economy in 211 (US$4.5trn), surpassing Japanese economy In terms of market exchange rate, at US$1.7trn, India is the 11 th largest economy in the world Likely to takeover Canada and Russia to become the 9 th largest economy in next couple of years In PPP terms, India stands at the third place in the world (Nominal GDP, US$, Trn) 16 14 12 1 8 6 4 2 Source: IMF, 15.1 US 11.3 China 4.5 4.4 India Japan On market exchange rate, India is world s 11th largest economy (Nominal GDP, US$, Trn) 16 14 12 1 8 6 4 2 15.1 US 7.3 5.9 China Japan 3.1 Germany Source: IMF, Anand Rathi Research. PPP: Purchasing Power Parity India becomes the third largest economy in PPP terms in 211 2.4 2.3 2.3 2.2 1.8 Russia 211 Brazil UK France Italy 3.6 2.8 2.5 2.4 2.2 1.9 1.7 1.7 1.5 Germany India is the 11th largest economy in the world in 211 France Brazil UK Italy Size of the economy Russia Canada India Spain

India s less vulnerable to external demand India: Exports dependence is relatively less Private consumption contributes ~6% to the GDP Total exports of goods and services are 22% of GDP, less than the world average of 28% Services sector contribution is on the rise Consumption and investment mix (% of GDP, 21) 1 9 8 7 6 5 4 3 2 1 97 Malaysia 71 Thailand 52 S. Korea 47 Germany UK 3 China 3 Canada 29 World 28 France 25 Indonesia 25 India 22 15 Japan 13 US 11 Brazil Exports of goods and services Source: GoI

India s reducing trade dependence on developed world Diversifying trade destinations India s exports to the US and Europe has been coming down in last two decades Asia has become one of India s most important destinations for exports Asia including middle east accounts for over 5% of India s exports at present, making it less vulnerable to recession in the developed world (As % of total exports) Middle East and Asia emerging as big trading partners 45 4 35 3 25 2 15 1 5 Source: GoI 3.3 8.4 16.4 1.2 9.3 2.7 4.7 21.3 25.1 33. Africa USA Middle East Europe Asia (ex. Middle East) FY92 FY11

FII inflows picked up since beginning of CY212 FII inflows have been ~US$12bn into equity since Jan 12 vs. nearly no inflows during same period last year FII inflows slowed during Apr-Jun 12 before picking up again in Jul- Aug 12 (FII investment, US$ bn) FII inflows have been ~US$12bn into equity since Jan 12 7. 6. 5. 4. 3. 2. 1.. -1. -2. Source: Sebi Jun-1 Aug-1 Oct-1 Dec-1 Feb-11 Apr-11 Jun-11 Aug-11 Equity Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Note: Aug 12 is as on 23 rd Aug 12

Current account deficit to improve Gold is the second biggest imported item in India after crude oil India imported US$56bn worth of gold in FY12 Excluding gold imports, current a/c deficit stood at 1.2% of GDP in FY12 (As % of GDP) Excluding gold, Current account deficit is very low -1. -.1 -.6.3.7 1.5 1.2 1.9 2.3 3.3 -.3 1.1-1.2.1-1..5 Excluding gold imports, current a/c deficit is low -1.3.1-2.3 -.6-2.8 -.7-2.7 -.3-1.2 Likely lower gold imports and lower oil prices would help improve the current account deficit in FY13 FY FY1 FY2 FY3 FY4 Source: GoI Current a/c balance FY5 FY6 FY7 FY8 FY9 FY1 FY11 Current a/c balance (ex. gold) -4.2 FY12

Macro Fundamentals to support the rupee In one year the rupee has depreciated by around 2% against the U.S. dollar In 212 so far, among Asian peers the rupee has been the worst performing currency Though a depreciating rupee is good for exports, since India is a net importer it has a negative impact on GDP The long term fundamentals suggest the rupee to start appreciating due to likely reduction in current account deficit and increased FII flows Sharp depreciation in the rupee versus the U.S. dollar 58 56 54 52 5 48 46 44 42 4 38 Aug-7 Source: GoI Dec-7 Apr-8 Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 Apr-1 INR/USD Aug-1 Dec-1 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12

Demographic dynamics offers huge India s population to remain young Currently, the median population age in India is 25 years while that for China is 34 years The rise in the median age in India would be a slow process as the median age would go up to 3 years by 225 opportunity India s population to remain young (Median age of population, year) 5 45 4 35 3 25 2 15 195 196 197 198 199 2 21 22 China India World 23 24 25 Source: GoI The Chinese population would age much faster

Good economics means good governance High growth in Bihar and Gujarat Bihar on high economic growth trajectory the JD(U) got second term BJP is completing its third straight term in power in Gujarat the state has been on steady growth trajectory (GDP growth, %) 15 12 9 6 3 FY3 FY4 FY5 FY6 Bihar FY7 Gujarat FY8 FY9 FY1 Source: GoI Congress has record three consecutive electoral victories in Delhi Orissa and Madhya Pradesh also enjoying stable growth and stable government (GDP growth, %) 12 9 6 3-3 FY3 FY4 FY5 FY6 FY7 FY8 FY9 FY1 Situation is similar for Delhi, MP and Orissa Delhi Madhya Pradesh Orissa Source: CEIC

The positives Summing up India remains one of the fastest growing countries in the world Strong domestic demand-driven growth; less dependence on external demand High saving-investment rates; role of foreign capital in funding investment is marginal Large forex reserves; sizable part of foreign liabilities are equity investments Major foray into knowledge-intensive services Demography strongly favors continuation of high growth The negatives Serious infrastructure bottlenecks continue Inflation becoming structural; monetary policy alone is unable to solve the problem Little reform in government expenditure; particularly the non-planed expenditure and subsidies Large-scale corruption issues shaking investor confidence Policy paralysis turning the scapegoat. The feeling that policy paralysis is the root cause seems largely misplaced