Perspectives on the Indian

Economy and the Financial Sector

Renny Thomas, Partner McKinsey & Company
October 2007

This report is solely for the use of client personnel. No part of it may be
circulated, quoted, or reproduced for distribution outside the client
organization without prior written approval from McKinsey & Company.
This material was used by McKinsey & Company during an oral
presentation; it is not a complete record of the discussion.
CONTENTS

• Perspectives on Indian Economy

– Context of Indian economy

– Forces likely to propel India ahead

– Challenges for the growth

Perspectives on Indian Financial Sector

1
 INDIA’s GDP HAS RISEN STEADILY SINCE THE 1950’s. . .

Real GDP growth*

US$ billion
7.3%
Average growth 709
rate of 8.6% over
the last 4 years 5.2%
464

4.4%
279
3.4%
118
60

1950 1970 1990 2000 2006

Population
365 548 850 1,016 1,112
(Million)

* Base year = 2002

Source: Global Insight; Economic Survey of India; Team Analysis

2
 AS GROWTH HAS INCREASED VOLATILITY HAS DECREASED
Per cent

7
10-year
6 mean growth

2 10-year
volatility of
1 GDP growth

0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Source: RBI; EIU

3
 AND TRANSFORMED INDIA FROM AN AGRARIAN TO A
SERVICES-LED ECONOMY
Value added to GDP (Per cent)

India China

25.0
Services** 39.0 40.0
55.0

46.0
Industry* 24.0

50.0
27.0

Agriculture 37.0
29.0
18.0
10.0
1980 2006 1980 2005
* Industry includes Mining, Manufacturing, Electricity ,Gas & Water and Construction **Services includes Whole & retail Trade, Restaurants &
Hotels, Transportation & Communications, Finance, Insurance, Real Estate & Business Services and Community, Social & Personal Services
Source: Global Insight; Team Analysis

4
 SEVERAL MEGA INFRASTRUCTURE PROJECTS High Low

ARE SET TO CHANGE THE LANDSCAPE

Likelihood of Planned spending
Project completion (timeframe) Details
US$ billion
2 (2006-07) • Providing basic healthcare services to the rural
National Rural Health Mission* population

National Urban Renewal 1 (2006-07) • Developing urban infrastructure and providing

Mission* basic services to the urban poor in ~ 63 cities
2 (2006-07) • Extending primary education to all children,
Sarva Shiksha Abhiyan* especially in rural India

National Rural Employment 3.2 (2006-07) • Providing income security to the poor and
Guarantee Scheme* bridging the rural poverty gap

1.1 (2006-07) • Providing free mid-day meals to all children in

Mid-day Meal Scheme*
government, corporation, panchayat and
municipal schools
Rajiv Gandhi Drinking Water 1.1 (2006-07) • Supplying safe drinking water in the rural areas
Mission*
0.2 (2006-07) • Extending sanitary facilities in rural India
Total Sanitation Campaign*

Integrated Child Development 0.9 (2006-07) • Improving the nutritional and health status of
Services* children in the age group of 0-6 years and
reducing the incidence of infant mortality
4 (2010) • Upgrading Delhi’s infrastructure in preparation
Commonwealth Games 2010 for games
* Government Flagship Programmes
Source: Economist; Press-articles; Government Budget Speech 2006-07; Analyst Reports; Team Analysis

5
CONTENTS

• Perspectives on Indian Economy

– Context of Indian economy

– Forces likely to propel India ahead

– Challenges for the growth

Perspectives on Indian Financial Sector

6
 A GROWING WORKING AGE POPULATION WILL PROPEL
GROWTH TILL 2035 LATER THAN CHINA
Working age population (age 15-60)
Per cent of total population - Average no. of
people per
72% household in 2007

70%

68% India 5.5

66%
Brazil 4.0
64%

62% China 3.7

60%
Russia 2.8
58% G6
2000 2005 2010 2015 2020 2025 2030 2035 2040

Source: Global Insight; Team Analysis

7
 HOUSEHOLD INCOMES WILL ACCELERATE ACROSS INDIA
Average household disposable income
Compound annual
Thousand; Indian rupees; 2000 growth rates
1985-2005
2005-2025

Actual Forecast Urban

500

400

All India
300 5.8%

200 5.3% Rural

4.6% 3.6%
100 3.6%

2.8%
0
1985 1990 1995 2000 2005 2010 2015 2020 2025

Source: McKinsey Global Institute

8
 THE SHAPE OF INDIA’s INCOME PYRAMID WILL CHANGE
DRAMATICALLY AS INCOMES GROW
Household income Number of Aggregate
brackets households consumption
Thousand, Indian Million Trillion, Indian rupees,
rupees, 2000 2000
• Middle class to
Globals (>1,000) 1.2 1.2 swell from just
Strivers (500–1,000) 2.4 1.0 under 50 million
2005

Seekers (200–500) 10.9 2.1 today to about

Aspirers (90–200) 91.3 8.5 583 million by
2025
Deprived (<90) 101.1 4.1
• By 2025, India will
Globals (>1,000) 3.3 4.1 produce 2 million
Strivers (500–1,000) 5.5 2.7 globals annually
2015

Seekers (200–500) 55.1 11.8 • Share of incomes

Aspirers (90–200) 106.0 12.2 of the middle
Deprived (<90) 74.1 3.3 class and globals
will rise from less
Globals (>1,000) 9.5 14.1 than 30% today to
Strivers (500–1,000) 33.1 16.5 more than 80% by
2025

2025
Seekers (200–500) 94.9 24.6
Aspirers (90–200) 93.1 11.9
Deprived (<90) 49.9 2.4
Source: MGI India Consumer Demand Model, v1.0

9
 CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER
~US$585 BILLION DURING 2007-12 (1/2)
Expected
Area spend Key projects
US$ billion
• Six-laning of 6,500 kms and four-laning ~18,000
Roads 96 kms of corridors and highways

• Dedicated Freight Corridors between Mumbai-

73 Delhi and Ludhiana-Kolkatta, ~10,300 kms of new
Railways
railway lines; modernisation of 21 railway stations

Power
(generation, • Additional generation capacity of ~70,000 MW
transmission, 177
(includes rural areas)
and distribution)

21 • Capacity addition of 485 million MT in major

Ports Ports; 345 million MT in minor Ports

• Modernisation and redevelopment of 4 metro and

Airports 10 35 non-metro airports
• Construction of 7 green-field airports in North
East
Source: Planning commission;

10
 CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER
~US$585 BILLION DURING 2007-12 (2/2)
Expected
Area spend Key projects
US$ billion • Growing subscriber base to 600 million, including
Communi- 200 million rural telephone connections
cation 77 • Providing broadband access to 20 million and 40
million internet connections

Water 57 • Water supply and sanitation projects

• Developing 16 million hectares through major,

Irrigation 62 medium and minor irrigation works

• Gas distribution infrastructure

Gas 6 – LNG terminals, gas transmission lines, city gas
distribution
• Storage to support agricultural development
Storage 6

Total 585
Source: Planning commission;

11
 A ROBUST AND HIGH-GROWTH PRIVATE SECTOR
CONTINUES TO BOOST CONFIDENCE LEVELS
The transformation Local corporates expanding overseas
Number of billion dollar companies Spurt in number of cross-border deals by Indian
companies
2006 2007*
175% 88 Deals # 163 143
increase 5 Value $23 bn $18 bn
9
Some success stories
• Incorporated in 1995, world's 5th
30 leading & Asia's leading manufacturer
of wind turbines
• Current sales of US$1.7 billion and
market cap of US$9.8 billion

>US$10 bn 32 • Became a bank in 2000; 2nd largest bank

1 in India today
US$5-10 bn 4 • 30-50% market share across classes
6 44
US$2-5 bn • Current market cap* US$24 billion
• (US$0.6 billion in 2000**)
US$1-2 bn 21 • India's largest automobile company,
with revenues of US$6.9 billion 2006-07
• World's fifth largest medium and heavy
1998 2007 commercial vehicle manufacturer
• Current market cap of US$6.6 billion
* As on 14 Sep 2007 ** As on year end *** Not all deals mentioned disclose deal financials. Deal values are the sum of only those deals
where financials were publicly announced (90 deals in 2006 and 87 deals in 2007)
Source: Press articles; CMIE; Dealogic; Prowess; Team Analysis

12
 INDIAN COMPANIES ARE AGGRESSIVELY ESTABLISHING
GLOBAL FOOTPRINT
Cross-border M&A by Indian companies

The recent spurt in Number of Average

outward FDI is caused Deals* Deal Size**
by:
250 350
• Regulatory changes:
Indian companies can now
make overseas
300
200
investments equal to 300%
of their net worth on an 250
automatic approval basis 143
150 200
• Easy access to capital
– Decline in interest rates
100 150
coupled with liberal
lending policies adopted
by banks 50 100
– Active participation by PE 50
firms – Nearly 20% of the 50
deals were backed by
private funds in 2006 0 0
2000 2007***

* Number of deals for calendar year 2000, and till Sep 2007
** Average deal size is based on deals for which the values has been disclosed
*** As on 13 September, 2007
Source: Dealogic; Team Analysis

13
 SIMILARLY, MNCs ARE ACTIVELY SEEKING THE INDIA
OPPORTUNITY…
Acquisitions of Indian companies by MNCs
No. of
166 131 110 195 301 250 Break-up by sector
Deals*
27.442 Per cent of Total Deal Value, 2007^

Others
Services**
16
Telecom 35
4
Cons-
10
truction
10.969
13
Hi-Tech 22
5.748
3.030 2.268 2.502 Manufacturing***
Value
US$ billion

2002 2003 2004 2005 2006 2007^

^ 2007: As on Sep 2007

*Includes all completed deals even where deal value is not available
** Includes Finance, Insurance, Leisure & Recreation, Professional Services, Healthcare, Transportation and Publishing
*** Includes Chemicals, Machinery, Auto / Truck, Consumer Products, Textile and Food & Beverage Manufacturing
Source: Dealogic; Press articles; Company website; Team Analysis

14
 THERE ARE 7 MANTRAS FOR SUCCESS IN INDIA…

Strong India Commitment Leverage India’s resources

1 and local team for global requirements
5

Redesign supply chain to

2 Create & Shape the Market profitably deliver value
6

Acquire if necessary, but re- Actively shape and manage

3 assess cost of capital perception and regulation
7

Indianise product and get

4 the price-value equation right

Source: McKinsey team analysis

15
 IN SUMMARY, INDIA IS ON COURSE TO BE AN ECONOMIC
SUPER POWER OF THE 21ST CENTURY

India – most rapid growth potential of the BRICs India – will contribute
Real GDP growth (Per cent) a giant share of the
incremental GDP growth
9 Fastest growing global of major world economies*
8 economy by 2012
7 Per cent 20.1
6 India
5 China
4 Brazil
3
2 5.0
Russia 2.1
1
0
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2000 2020 2050

• 11th largest economy today (GDP US$560 billion)

• 4th largest by 2025 (GDP US$3,200 billion, six-fold increase)
* Major world economies considered are the BRIC and G6 countries
Source: Goldman Sachs BRIC report 2003

16
 AND GROWTH IN INDIA IS AT AN INFLECTION POINT, SIMILAR
TO CHINA 15 YEARS AGO
Triggers behind growth
Real GDP growth PPP adjusted* inflection in India
US$ billion Inflection • Taxes: Laws simplified
8,000 scenario resulting in better
compliance and ease of
7,000 China tax payment
CAGR = 10.1% • Infrastructure: Increased
6,000 (1990-2005) investment in
5,000
infrastructure e.g., Ultra
Inflection in Conservative Mega Power Projects
4,000 China GDP growth • Liberalisation: FDI in key
estimates sectors like airports,
3,000 India NBFCs, Insurance,
1990-2005 electrical equipments,
2,000 CAGR = 5.98% telecommunications,
1992: India construction etc allowed
1,000 1978: China liberalizes
liberalizes
0 “Lead indicators”
1980 1985 1990 1995 2000 2005 2010 of inflection
visible in India
* Base year: 2002
Source: Global Insight; Team Analysis

17
CONTENTS

• Perspectives on Indian Economy

– Context of Indian economy

– Forces likely to propel India ahead

– Challenges for the growth

Perspectives on Indian Financial Sector

18
 THERE ARE CHALLENGES THAT COULD DETER GROWTH
Risks (in decreasing
order of likelihood) Description
1. Internal political • Large number of parties
complexities • Differing ideologies
(high) • Regional agendas influence
national policy
2. Socio - • Highly fragmented country
economic factors geographically
(moderate) • Risk of social unrest, resulting
from increasing income divide
– urban and rural India
– rich states and poor states
• Higher inflation
3. External • US economy slows down
factors • Rising oil prices
(moderate)
• Border tensions with Pakistan
4. Military conflict and China
(low)
• Instability in Nepal
Source: Team Analysis
Mitigating factors
• Universal adult suffrage - a correction
mechanism
• "Public stance" guarded – but parties
realize liberalisation imperatives
• Few budgetary, fiscal and supply side
measures announced by the Govt.
• Numbers below poverty line reducing
• Realization (in last election) that only
broad-based economic reform is
sustainable
• Low interest rates
• Measures to increase FDI inflows and
competitiveness to capture a larger
share of world trade
• Strong progress in Pakistan relations
across two different governments
• China border issue (Sikkim) resolved
recently
19
 2. Socio-economic factors
INDIA IS A LARGE COUNTRY WITH HUGE Total land

GEOGRAPHIC FRAGMENTATION Arable land

2006; Million Hectare; per cent

Arable land as a proportion to total land across most However in India land used
countries range between 4 – 10% for agricultural purposes its
Country Land acreage % arable as high as 48%

963 17.8%
US
171 329 48.5%

846 7.09%
Brazil
60
161
998
Canada 4.6%
46

960
China 15.4%
148 Total Arable
land land
768
Australia 6%
46 Arable land in India is the
highest and almost as
1,710 much as that available in
Russia 7%
121 the US in absolute terms

Source: Euro Monitor

20
 1. Internal political complexities
THE BIGGEST RISK IS POLITICAL INDECISION WHICH COULD
PREVENT INDIA FROM CAPTURING ITS POTENTIAL
Reforms completed
• Lack of nationwide VAT coupled with Reforms pending
lower indirect taxes • Urban land ceiling act Reforms under
• Small scale reservations • Unclear land titles consideration/
• Poor regulation in power sector • Tenancy laws work under way
• High import duties • Low property taxes • Central PSUs
• FDI restrictions (e.g., retail) and low user charges • State PSUs
• Delicensing key sectors (e.g. coal, • Urban transportation including power
fertiliser, retail, mining, railways) infra-structure • Municipal services

0.7 0.3 10.1

Last 2 years 1.3
7% GDP growth
2.3
5.5
Overall downside in India is limited.
Biggest risk is un-captured potential

India (growth Product Land market Government Others India

rate in 2000- market barriers ownership barriers, e.g., (complete
01) barriers (affects real labor market reforms)
estate and
retail sectors)

* Public sector unit (i.e., government owned enterprises)

Source: McKinsey Global Institute Study on Indian Economy (2001); Team Analysis

21
 2. Socio-economic factors

LOW CONCENTRATION OF POPULATION IN TOP 5 CITIES

Population living in the top 5 countries is very fragmented in Asian countries

vis-à-vis its global counterparts, but in absolute terms it more than equates the
top 5 cities population of the US
2006; Million; per cent

100% = 21 189 303 142 1,136 1,322

7 5
25 22 16
Population
living in top 65
5 cities
94 95
75 79 84
Rest of
35
population

Australia Brazil US Russia India China

Source: Web search; Census

22
 2. Socio-economic factors
INCREASING INCOME DIVIDE COULD LEAD TO RISK OF
SOCIAL UNREST
Urban income is 2.3X rural. . . . . .and income of rich states is 2.2X that of poor states
Rs. ‘000, 2006 prices Rs. ‘000, current prices
49.8

+2.3X

21.7 28.5
+2.2X

12.9

Urban average* Rural average* Per capita income Per capita income
per capita income per capita income average* of rich average* of poor
states# states#

* Average over 2002-2005 # Rich states are ones having higher per capita income than the All-India average, poor states are all others
Source: Market Skyline 2006 – Indicus Analytics; Global Insight; CSO; Team Analysis

23
CONTENTS

• Perspectives on Indian Economy

Perspectives on Indian Financial Sector

24
KEY MESSAGES

• Indian financial sector has grown rapidly and recorded

strong performance on back of continued reforms

• However, financial deepening has to be acclerated,

else it could constrain the full potential of the Indian
economy going forward

• Pursuing a continued integrated reform agenda for the

financial system can help support and enable India’s
high GDP growth trajectory

25
KEY MESSAGES

• Indian financial sector has grown rapidly and recorded

strong performance on back of continued reforms

• However, financial deepening has to be accelerated,

else it could constrain the full potential of the Indian
economy going forward

• Pursuing a continued integrated reform agenda for the

financial system can help support and enable India’s
high GDP growth trajectory

26
 INDIA’s FINANCIAL DEPTH HAS GROWN RAPIDLY Equity
Corporate debt
SINCE 2001 Government debt
Bank deposits

Financial depth
Financial stock as a percent of GDP CAGR1
Per cent
1994- 2001-
CAGR 2001 2006
14.1% 195
No 172
deepening 160
146 -7.5 31.5
89
56 70
122 5.9 33.9
98 116 110 47
106 95 108
2 2 26 2 5.2 6.5
93 94 1 3 5
41 32 23 1
39 31 25 1 30 33 34 34 36
34 30 2 1
2 2 24 27
2 20 22
19 20 17
18
3.2 2.1
57 64 65 68 66 64
46 44 44 48 51 53
40

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Note: Umbers may not add due to rounding
1 Compound annual growth rate
Source: McKinsey Global Institute Global Financial Stock Database; team analysis

27
 BANKING SECTOR HAS BEEN AT THE CORE OF FINANCIAL
SECTOR GROWTH AND HAS CREATED SIGNIFICANT WEALTH
FOR INVESTORS
Contribution to economy of banking
sector has improved over the years Indian banks have outperformed share indices in last few years
Per cent New Private
TRS CAGR Jan 01 – Oct 07
~3.5 PSU Banks
Banking
Indian
1 value add Indian Market: 29.63%
1.6 Banking
to GDP 1400
Bank index: 40.54% Old Private
Old Private: 38.92% Indian
1994 2007 1200 Market
New Private: 44.17%
Rs billion
1000 Public Sector Banks: 42.67%
16.7
26,237

2 Deposits 800

3,500
600

1994 2007
400
Rs billion

20.6 19,496 200

3 Advances
0
Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07
1,700

1994 2007
Sources: RBI; national income statistics; Datastream; team analysis

28
 FINANCIAL PERFORMANCE OF INDIAN BANKING SECTOR IS
AMONG THE BEST IN THE REGION
Per cent, FY 2006
Asset quality Profitability
NPL/GDP NPL/Net loans Pretax ROA Pretax ROE
Weak

Malaysia 8.5 Philippines 15.1 Korea 0.1 Thailand 9.1

Singapore 6.7 Malaysia 8.5 Thailand 0.8 Philippines 10.1

China 5.9 Thailand 8.2 China 0.8 Singapore 12.4

Thailand 5.8 China 7.1 Philippines 1.2 Korea 14.9

Philippines 5.7 Singapore 6.7 Malaysia 1.3 China 15.1

Korea 2.1 Korea 1.6 Singapore 1.3 Malaysia 16.3

India 0.5 India 1.4 India 1.3 India 17.9

Strong
* Data for all Scheduled commercial banks in India
Source: Central banks of each country; Bankscope; CMIE, McKinsey analysis

29
 OTHER FINANCIAL MARKETS HAVE BEEN ON AN
ACCELERATED GROWTH TRAJECTORY OVER PAST FEW
YEARS
Life insurance Equity Mutual Fund
New business premium Market capitalization; $ bn AUM; $ bn
(APE)*; $ bn
9.9 816 75

+295%
+519% +677%

19
1.6 105

2000-01 2006-07 2000-01 2006-07 2000-01 2006-07

Over the past few years the Indian market has

witnessed accelerated growth across financial services
* Based on full credit for regular premium + 10% credit for single premium
Source: IRDA; AMFI; SEBI; McKinsey analysis

30
 HOWEVER, JUST 3-4 YEARS OF HIGH ECONOMIC GROWTH
SEEMS TO HAVE LED TO A SITUATION OF TIGHT LIQUIDITY
AND RISING INTEREST RATES
Rapid credit expansion in past few years… … resulting in tightening liquidity..
Outstanding advances; US$ billion Credit/deposits ratio; Per cent
72 75
448 59 55 61

+30%
341
Mar Mar Mar Mar Mar
’03 ’04 ’05 ’06 ’07
252
… and rising interest rates
196
10 year G Sec rates; Per cent
157

6.7 7.5 7.8

6.2 5.2

Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar
’03 ’04 ’05 ’06 ’07 ’03 ’04 ’05 ’06 ’07
Source: RBI; Bloomberg; McKinsey analysis

31
KEY MESSAGES

• Indian financial sector has grown rapidly and recorded

strong performance on back of continued reforms

• However, financial deepening has to be accelerated,

else it could constrain the full potential of the Indian
economy going forward

• Pursuing a continued integrated reform agenda for the

financial system can help support and enable India’s
high GDP growth trajectory

32
 OVERALL FRAMEWORK FOR ANALYZING FINANCIAL SYSTEM
IN INDIA

International financial system

Savers Domestic financial system Borrowers

Banking Bond Equity
system markets market

1 3 2

Informal finance

4
1 Supply of funds from savers 3 Efficiency of each market
2 Allocation of funds to borrowers 4 Regulatory environment

Source: McKinsey Global Institute analysis

33
 BUT INDIA’s FINANCIAL DEPTH IS LOW Government debt
Bank deposits
COMPARED TO OTHER ASIAN NATIONS Equity
Private debt
Financial depth, 2006
Financial assets as a percent of GDP
504

427
369
104 281

155 45
243 254
209 220
195 92 145
43 51
65 119 78
138 89 14 13 43
22 10 60
70 5 37 42
36 150 56 32
6 134 129
24 85 94
64 58 70
39

Indonesia India Thailand China Philip- South Malaysia Japan* Singapore

pines Korea

Note: Numbers may not add due to rounding*Japan number is for 2005
Source: McKinsey Global Institute Global Financial Stock Database; McKinsey analysis

34
 THIS IS DESPITE INDIA’S HOUSEHOLDS BEING AMONGST
THE HIGHEST SAVERS IN THE WORLD
Household savings as a share of gross national savings rates, 2005

Per cent
69

55

44
37

24
20
16

India France China* Mexico Japan South United

Korea States
Gross national
savings rates
32.4 18.0 50.4 21.2 26.4 32.8 12.9
% of nominal
GDP, 2005
* MGI estimate based on 2005 GDP and estimates of flow-of-funds information.
Source: Country National Accounts; IMF; McKinsey Global Institute

35
 LARGE PROPORTION OF HOUSEHOLD SAVINGS NOT
ACCESSIBLE TO FINANCIAL SYSTEM
Distribution of household savings by asset type
$ billion, per cent

100% = 66 96 132
Machinery and 13
equipment 19 18

Construction 28
32 35

Financial assets 59
50 47

FY 1995 FY 2000 FY 2005

Note: Numbers may not add due to rounding
Source: CSO; McKinsey Global Institute analysis

36
 GOLD CONTINUES TO BE USED AS A SAVINGS VEHICLE
DESPITE NEGATIVE RETURNS SINCE 1990
Index, adjusted for inflation

Gold was an attractive investment in the . . . but has offered negative real returns
1970s and 1980s . . . in recent years

450 160
400 140 Bank
Gold
350 deposits
120
300
100
250
80
200
60 Gold
150 Bank
100 deposits 40

50 20
0 0
1970 1974 1978 1982 1986 1990 1985 1988 1991 1994 1997 2000

Source: Press Trust of India; Bombay Bullion Association; McKinsey Global Institute analysis

37
 ACCESS TO QUALITY BANKING PRODUCTS AND SERVICES IN
INDIA IS LIMITED
Access to banking products is significantly
lower in India . . . . . . and is limited to large cities
2006; per cent 2006; per cent
Card
ATM penetration penetration*
Per million people Per cent of 100% = 70,776 20,911 15,138 Rs bn
population
Metro centers 17
Australia 1,240 199
Top 100
Korea 755 362 17.9
centers 54.1
Singapore 477 335 excluding 65.4
metro centers
Thailand 330 76

Poland 261 63

Mexico 246 51 Other 20.6

65.1
centers 16.2
Malaysia 229 130

Brazil 193 142

25.3
18.3
Philippines 81 15

China 51 61 Number Deposits Credit

of bank
India 19 7
branches

* Includes both debit and credit cards; ** India Data as on March 2006 ; Mexico only credit cards
Source: Febraban; IBGE; Brazilian Central Bank; FSS; BOK; Bank of Thailand (BOT); NESDB; National Banking and Securities Commission;
Bank of Mexico; China Unionpay; Lit search; RBI; Venture Infotek

38
 INDIA’s GOVERNMENT CONSUMES 70 PERCENT OF NET
SAVINGS INJECTED INTO THE FINANCIAL SYSTEM
Net contributions to the financial system1
Per cent of GDP, average FY 1995-2005 ESTIMATED

Household net
contributions 9.0
to the financial system2

Foreign capital
1.2
inflows

Private sector
3.2
borrowing

Public sector
7.0
borrowing

1 Computed as sector specific savings minus investment

2 To balance with the current account, we subtract all errors and omissions (E&O) between savings, investments, and capital flows from
household savings (equivalently add it to household investment). Investment in valuables are added to E&O for the years 2000–2005.
E&O average 1.4% of GDP over the period implying unadjusted household savings investment balance is 10.4% of GDP.
Source: CSO; McKinsey Global Institute analysis

39
 MORE THAN 80 PERCENT OF GOVERNMENT SECURITIES ARE
HELD BY FINANCIAL INSTITUTIONS THAT ARE REQUIRED TO
HOLD THEM
Ownership of central government securities
100% = $ 306 billion, FY 20071
Financial institutions required to hold
Public sector banks 45.5 government securities
• Statutory liquidity ratio requires banks
to hold 25% of assets in government
Other banks 9.0 securities; actual holdings are higher
• Life insurance companies must hold
Insurance companies 25.0 50% of their assets in government or
other approved securities; additional
Employee provident 15% must be invested in infrastructure
6.0 and social sectors
fund organization
• Provident regulations cause 90% of
Total regulated
85.5 assets to be held in government
holdings securities
RBI own account 8.0

Other 6.5

Total 100.0

1 Latest available data. * Using Rs. 41 as Rupee to dollar rate

Source: RBI; McKinsey Global Institute analysis

40
 INDIAN BANKS HAVE RELATIVELY A HIGH PORTION OF
ASSETS IN GOVERNMENT SECURITIES
Asset breakdown of banks
Per cent, 2006
Fixed/other assets 5 8 2
12 10 13
Other securities 16 16
and cash 18 18 25 0
18
Government 25 0.8
16 15 12
securities

81
68
54 54 57 57
Loans

India China Japan South United United

Korea States Kingdom
(2004)
Source: RBI; bank financial statements; Financial Supervisory Service (South Korea); PBOC; Bank of England; Federal Reserve Bank of the
US; McKinsey Global Institute analysis

41
 MORE THAN HALF OF COMMERCIAL CREDIT GOES Priority sector
Public sector
TO SECTORS WITH LOW INVESTMENT EFFICIENCY Private corporate
sector

Amount of investment needed to

Distribution of commercial credit1 generate $1 of additional output2
$ billion, per cent, FY 2005 FY 2000-2005

100% = 211

Private corporate Private corporate

30 2.8
discretionary sector

Private corporate Household

priority 13 enterprises and 3.9
Agriculture proprietorships
11
Household 7
enterprises and Public sector 6.8
proprietorships
Public sector
39
enterprises
Agriculture 15.0

1 Gross bank credit to non-financial companies, corporate bonds and private placements, and loans and investments from the government to public
sector enterprises.
2 The incremental capital output ratio is defined as the sum of gross investment divided by the total change in GDP over the period.
Source: CSO; RBI; Public Enterprise Survey; McKinsey Global Institute analysis

42
 PRIORITY SECTOR ACCOUNTS FOR NEARLY A THIRD OF
TOTAL LENDING, LIMITING ACCESS TO THE PRIVATE SECTOR
Distribution of gross bank credit outstanding1
$ billion, per cent Priority sector
lending
100% = 87 323
Other 4 6
4
Mortgages 8 13
Consumer credit 9
12
Other priority sectors2 12
Agriculture 16
14
Small scale industry
14
Medium and large 7
enterprises
48
and other private
sector3
32

FY 2000 FY 2007
1 Excludes public food procurement credit
2 Small businesses determined by either amount of capital, sales, or employees. Now includes small loans to software industry and
investment in venture capital funds registered with SEBI.
3 Includes wholesale trade, tourism, and non-bank financial companies.
Source: RBI; CSO; McKinsey Global Institute analysis

43
 PRIORITY SECTOR LOAN DEFAULT RATE IS ~40 PERCENT
HIGHER THAN THE NON-PRIORITY SECTOR
Nonperforming assets relative to gross bank credit outstanding
Per cent, FY 2007

Agriculture 3.5

Small scale
8.3
industry

Other priority
4.6
sectors1

Priority
4.9
sector total

Non-priority 1.8x
2.7
sector total2

1 Small businesses determined by either amount of capital, sales or employees. Now includes small loans to software industry and
investment in venture capital funds registered with SEBI.
2 Includes non-priority sector commercial credit, mortgages, consumer loans, and other.
Source: RBI; CSO; McKinsey Global Institute analysis

44
 SMALL CORPORATE BOND MARKET LIMITS ACCESS TO
OTHER FUNDING SOURCES
Corporate bonds
Per cent of GDP, 20051

143

102
85
74
64
48 45
39
28 27
21 15 13 10 8
3 2 1
United Kingdom
United States

Czech Republic
Korea, Rep.

Japan

Poland
Philippines

India
Canada

Chile

South Africa

China
Brazil
Singapore

Thailand
Germany

Malaysia

Turkey
1 India as of March, 2005; If bonds issued by development banks were included, China’s corporate bond market would be 11% of GDP
Source: McKinsey Global Institute Global Financial Stock Database

45
 INDIAN COMPANIES HAVE VERY LOW LEVELS Corporate bonds
Corporate bank loans
OF DEBT
Corporate borrowing Corporate borrowing
Per cent of GDP, 1999 Per cent of GDP, 2004

Malaysia 89 68 157 51 74 125

Singapore 119 27 146 74 50 123

United
22 117 139 31 143 174
States

China 109 10 119 113 13 126

Hong Kong 83 34 118 85 50 135

South Korea 22 56 78 40 68 108

Chile 48 23 71 51 31 82
2 2
India1 13 14 16 17

0 50 100 150 200 0 50 100 150 200

Note: Numbers may not add due to rounding
1 as of March 2000 and 2005
Source: Central banks of respective countries; EIU; McKinsey Global Institute Global Financial Stock Database; McKinsey Global Institute analysis

46
 INDIAN FIRMS RELY HEAVILY ON RETAINED EARNINGS
Sources of funds raised
$ billion; percent, 2000–051
100% = 204 1,916 40 562 89 91 100 393
Equity 2 2 3 3 4 6 6
10
Debt 20 26
34 39
35 40
47 52

Internal
78 72
funds
63 59 55 55
47 42

India Japan Indonesia South Singapore Malaysia United Hong

Korea States Kong

1 Based on sample of 160 companies per country outside of United States. Companies were ranked by gross sales, and 40 companies from
each quartile were taken as the sample. US sample includes all listed companies with revenues exceeding $500 million, 1995 to 2004.
Source: Bloomberg; McKinsey Global Institute analysis

47
 ~ 55% OF EQUITY SHARES ARE HELD BY CORPORATE
INSIDERS
Shareholding of NSE equity listings
Per cent, December 2006 Institutional Investors
100
3
6
11
5
6
54 14

“Insiders”1 Indian Private NRI’s, Foreign FIs, banks, Mutual

public corpora- foreign institu- insurance funds
tions corpora- tional compa-nies
tions investors
1 Includes all those who, in bringing into existence a company or converting their private business into a company, secure control of the
management of such company through shareholding and/or otherwise
Source: ISMR; SEBI

48
KEY MESSAGES

• Indian financial sector has grown rapidly and recorded

strong performance on back of continued reforms

• However, financial deepening has to be acclerated,

else it could constrain the full potential of the Indian
economy going forward

• Pursuing a continued integrated reform agenda for the

financial system can help support and enable India’s
high GDP growth trajectory

49
 INCREASING FINANCIAL DEPTH IS A KEY Financial system
problems
IMPERATIVE FOR THE FINANCIAL SECTOR Key outcomes

Suboptimal
distribution of
capital in the Root causes:
economy
• Cumbersome
Root causes: issuance
Low lending procedures
• Lack of rates and Very small • Lack of investor
competition in conservative corporate bond demand
banking and approach in market
high state banking • Poor bankruptcy
ownership procedures and
• Statutory lack of creditor
liquidity ratio and rights
directed lending Underdeveloped
Underdeveloped Root causes:
policies domestic
consumer
finance market
institutional • Restrictions on
investors asset holdings
• Government
Limited ownership of
household intermediaries
participation in • Above-market
capital markets deposit accounts
Source: McKinsey Global Institute analysis

50
 DOMESTIC INSTITUTIONAL INVESTORS ARE
UNDERDEVELOPED IN INDIA
Total assets as percent of GDP, 2005
Registered
Life insurance pensions Mutual funds

France 60.3 3.5 61.2

US 33.1 66.0 69.9

Korea 22.8 3.9 25.3

Chile 18.7 59.4 11.1

Thailand 6.2 8.0 10.0

China1 6.3 1.7 2.5

Mexico 3.8 0.2 6.1

Poland 4.6 9.5 4.6

Brazil 1.2 20.4 39.6

India 13.3 4.2* 6.0**

0 50 100 0 50 100 0 50 100

* Includes only provident funds ** as on March 2006
Source: Financial institution regulators; industry groups; and central banks of respective countries

51
 A PHASED APPROACH HAS TO BE ADOPTED FOR A
TRANSFORMATION OF THE INDIAN BANKING SECTOR
Build infrastructure and
1 capabilities
• Ease capital restrictions
Industry • Provide more operational
structure freedom to public sector banks
• Develop blue print for sector
• Offer market based incentives
Social for under-penetrated segments
development
• Remove regulatory arbitrage
Unified regulator across different entities
• Effectively implement
Corporate principles of good corporate
governance governance
• Accelerate credit bureau and
Supporting payment infrastructure
infrastructure
• Enrich human capital and
Labour reforms support re-skilling of
employees
Source: McKinsey analysis
Move towards freer
Apply competitive pressure 3
2 to local banks
structure
• Encourage market driven • Create 3-4 global sized
consolidation institutions, 6-8 national
champions
• Reduce government
participation in the sector
• Allow greater access to foreign
banks
• Remove directed lending and
branch restrictions
• Move to a coordinated regulator • Separate central bank and
model regulator roles
• Support creation of industry
utilities for processing
52
 FINANCIAL SYSTEM REFORMS ARE WORTH US$48 BILLION
ANNUALLY
Direct impact of financial system reform Indirect impact
US$ billion, FY 2005
21.8 25.5
2.3
0.3
5.1 Improved
allocation 18.9
6.3 of capital
7.8
Capturing
more
savings 6.6

Improved Fully Migrate Reduce Shift in Direct

banking imple- informal corporate financing impact
efficiency ment lending bond mix from of financial
to best electronic to default bank system
practice payment formal rates to loans to reform
system banks bench- bonds
mark

Percent
1.1 0.9 0.7 0.1 0.3 3.2 3.5
of GDP

Source: RBI; CSO; McKinsey Global Institute Analysis

53
 MORE EFFICIENT INVESTMENT AND FINANCIAL MARKET
REFORMS CAN BOOST INDIA’S GROWTH RATE TO 9.4
PERCENT
Real GDP CAGR1
US$ billion 2000, fiscal year 2005–2015

1,600
Baseline 2015 per capita
1,400 Efficient investment and
9.4% income: US$
financial market reform 1,203
1,200
2015 per capita
6.5% income: US$
1,000
919
800

600

400
CAGR1
200 1995–2005
5.9%
0
1995 2000 2005 2010 2015
1 Compound annual growth rate.
Source: CSO; RBI; Oxford Economics; McKinsey Global Institute analysis

54