Indian Macro Outlook Amidst Global

and Domestic Uncertainties

Ashutosh Bhargava

What matters for an economy?

An economys growth trajectory depends on a combination of
structural and cyclical factors

Structural Factors

Demographics: It is necessary for an economy not to have adverse

demographics (Japan)

Productivity (Both labour and capital): The higher the levels of

productivity, the more difficult it is to generate a positive delta due
to diminishing returns (DM productivity growth lower than EM)

Cyclical Factors An inter-play of 5 Balance Sheets

Given the structural factors, an economys growth is a direct

function of the strength and slack (capacity) in five balance sheets:

Government B/S

Corporate B/S

External B/S

Household B/S

Domestic Financials (Banks) B/S

What happened in India in last 5 yearsBalance

sheet of all stakeholders came under pressure..
Government Fiscal stimulus in order to support the economy during
the financial crisis led to a burgeoning fiscal deficit. Although the
government has been on a fiscal consolidation path since FY12, Indias
public debt at 66% of GDP continues to be one of the highest among
EMs
Private Corporates Overleveraged, rising debt-to-GDP amidst
falling profitability
External Decline in household financial savings rate along with an
increase in government dis-savings led to a precipitous increase in
CAD (which peaked to 4.7% in FY13)
Banking - No financial slack - Credit to deposit ratio hit all time high
levels. Asset quality concerns

This
resulted in....
Households
have been the most resilient. Least affected
Consumptions share in GDP increasing at the expense of investments
and net exports..
Increased reliance on external sources of funding (ECB)..
Domestic liquidity remaining tight despite subdued demand for
liquidity..
RBI becoming the largest supplier of domestic liquidity (base money)

India Macro-Snapshot..From Peak to Trough

Real GDP
growth
(%yoy)

Valuation

Year

Indi Glob
Trailin
a
al EM g P/E RoE

Country fundamentals
Banking
Markets
Priva
te
Stresse
Secto
SBI 1
d
FX
r
Yr Assets
CPI
Reser Fiscal DebtDepo (NPA +
M3
(%yo
ve(US Defici toCD
sit Restruc SBI Growt SENSE CNX
y) CAD $Bn)
t
GDP Ratio Rate tured) PLR
h
X
Bank

200304

8.0

4.0

6.4

13.2

20.0

4.1% 2.2%

113

-4.3% 35% 55.9% 5.0%

8.2%

10.3% 16.7% 6,603 3,497

200405

7.1

5.4

8.0

12.9

20.9

4.0% -0.4% 142

-3.9% 38% 63.0% 5.5%

6.8%

10.3% 12.0% 9,398 4,534

200506

9.5

4.9

7.2

15.4

21.4

3.7% -1.2% 152

-4.0% 43% 71.5% 6.0%

4.0%

10.8% 21.1% 13,787 6,009

200607

9.6

5.5

8.2

18.0

21.9

6.8% -1.0% 199

-3.3% 48% 73.9% 8.3%

3.0%

12.3% 21.7% 20,287 9,863

200708

9.3

5.7

8.6

18.9

20.8

5.9% -1.3% 310

-4.0% 50% 73.9% 8.8%

2.9%

12.3% 21.4% 9,647 5,002

200809

6.7

3.0

5.8

13.3

19.9

9.2% -2.3% 252

-6.0% 55% 72.4% 8.1%

4.3%

12.3% 19.3% 17,465 9,030

200910

8.6

0.0

3.1

21.3

17.3

10.6
% -2.8% 279

-6.5% 53% 72.2% 6.0%

5.2%

11.8% 16.9% 20,509

201011

8.9

5.4

7.4

20.0

16.0

9.5% -2.8% 305

-4.8% 56% 75.7% 8.3%

3.8%

13.0% 16.1% 15,455 7,969

11,79
1

How have things changed?

Macro repair work is underway (UPA II initiated repair)

8000
7000
6000

Balance Sheet deleveraging / Asset Sale / Monetization Corporate

deleveraging has started with a number of stressed firms going for asset monetization
and getting rid of non core businesses.
Fund raising has eased meaningfully Resource raising from capital markets in
particular had dried up in 2013. However, there is a huge demand for both equity and
debt infusion in the last 12 months (Even in mid size firms)
Project clearances The Government is making an effort s to de-bottle stuck
projects in order kick-start the capex cycle. FY15 saw a significant reduction in stalled
projects and revival of old projects
Business performance - Corporate margins - Corporate margins fell to record
lows due to lower asset turnover and rising input cost (including cost of capital).
Recent quarterly trend indicate stabilizing
2500 business fundamentals. Turnaround in profit
Revived Projects (4-quarter trailing sum, Rs. Bn)
growth
expected
in next
2 years
Projects
under
implementation
which
are stalled (Rs. Bn)
Most importantly there seems to be an 2000
improvement in business and consumer
Government
Private
sentiment

5000
4000
3000
2000
1000
0

Government
Private

1500
1000
500
0

Total

The New NDA Government moving in the right direction

The Modi led government has been moving in the direction of fulfilling its election manifesto of
Minimum Government, Maximum Governance. The governments reformist credentials are
clearly visible in the following areas:

Improving Business Climate / Ease of Doing Business

Make in India Campaign for import substitution
Increase in FDI Limits: FDI in defense sector increased from 26% to 49%, FDI in
insurance increased from 26% to 49% and 100% FDI allowed in railway infrastructure
Increasing availability and production of key inputs like coal (record coal production in
last 12 months) and electricity (power generation grew by 8.4% in FY15).
Committed to rolling out GST from Apr-2016

Infrastructure Push
There has been a clear thrust on infrastructure spending in the FY16 Budget. The main
focus areas of the government are roads and railways
100 smart cities

Other Reforms
Jan Dhan Yojana to provide basic banking accounts with a debit card to every
household in India
Digital India - To digitally connect all the villages in the country by 2018 with high
speed internet and provide most govt. services electronically; target net zero electronic
imports
Food Supply Management Actively liquidate excess food stocks to manage
volatility in food prices; muted hike in MSPs
Direct Benefit Transfer Direct cash transfer of LPG subsidies and move towards
direct cash transfer of food subsidy

For financial markets, the credibility of the Central bank is equally if not

Increased credibility of the RBI under Dr. Rajan

more important than the credibility of the Government.

In the last few years the RBIs credibility in managing a complex Indian
macro was challenged. Thats why INR was one of the worst performer
among EMs.

Dr Rajan is far more proactive than its predecessor. His past experience
helps him in better understanding of importance of markets to the
economy.

RBI under Rajan has ably supported the reforms process. There has been
clear communication of intent:

Formalization of a new monetary policy framework with flexible

inflation targeting

Curbing volatility of INR (rather than strong INR)

Restoring faith of foreign investors (To build war chest for future
headwinds)

External factors have been extremely favourable

While domestic factors are definitely helping in Indias turn around story, the biggest role
(1/2)
has been played by external factors

Being a capital and oil deficit economy, Indias fortunes are far more closely linked to the
global macro-environment than what most people think. In fact, Indias merchandise tradeto-GDP is an overwhelming 53%!!
India has posted the second highest BoP surplus (USD60bn) in FY15 . This has helped the RBI
recoup much of the lost fx reserves and build a war chest against an impending Fed hike.
The fall in crude has significantly reduced fuel subsidies which in turn has provided much
needed fiscal space to the government to give infrastructure spending a major push
Fall in commodity prices have kept CAD in check despite strengthening non-oil non-gold
imports. We expect the CAD to remain benign in FY16 if oil prices remain supportive
Falling global commodity prices has also helped in reigning in inflation (in fact WPI is now in
outright deflation!!)
Net FDI inflows hit a record high of US$35bn
in FY15

370
350
330
310
290
270
250

Much bigger firewall of fx reserves

Total Foreign Exchange
Reserves (Rs. Bn)

India Macro Outlook

Domestic demand slowdown has

bottomed.Signs
of stability
High frequency indicators
have been emerging.(1/2)
showing some signs of
recovery, although the recovery continues to remain tepid
Urban consumers (both goods and services) and supply side areas

(coal and power) are showing noticeable strength

However, unlike general perception, growth recovery is likely to be

led by consumption in the near term and not so much by capex

In fact, consumptions share in GDP is likely to keep increasing for

the next 2 years. That said, exports and capex which are at very
depressed levels is likely to see a small bump-up (short-lived) in
coming months

Domestic demand slowdown has bottomed.Signs of

stability emerging.(2/2)

Consumption
Activity

Feb14

Mar14

Apr14

Non-oil Non-gold
12.1 -5.5% 0.4%
Imports
%
Passenger Vehicle
-0.5% -5.0% 11.0
Sales
%
MHCV
17.5 13.1 11.8
%
%
%
21.0 11.9
2 Wheeler Sales
9.3%
%
%
Business

Activity
IIP
-2.0% -0.5% 3.7%
Rail Cargo Volume 4.0% 2.2% 6.1%
11.5 11.8
Steel Production
6.9%
%
%

May14

JunAug- Sep14 Jul-14 14

14

1.5% 1.0% 2.3% 7.0%

0.2%

-4.6% 2.4% -1.1%

Jan15

Feb15

Mar15

Apr15

May15

21.5
26.1
4.4%
9.4% 3.0% 8.1% 1.1% 6.3% -6.6%
%
%

22.4
%

23.6
-1.0% 7.9% 5.5% 1.6% -1.3% -1.5% -0.8% -1.2%
%

13.9
%

17.2
%

19.0
%

26.0
%

43.5
%

17.7
18.9
5.5% 4.3% -1.9%
7.8%
%
%

12.1
%

19.0
%

60.3
%

36.1
%

31.9
%

16.5
%

22.2
23.2%
%

5.6% 4.3% 0.9% 0.5% 2.6% -2.7% 5.2% 3.6% 2.8% 4.9% 2.5% 4.1%
4.2% 2.6% 4.3% 6.0% 2.2% 8.4% 8.5% 3.6% 1.4% 3.1% 1.1% 1.1%

3.3% 4.2% -3.4% 9.1% 4.0% 2.3% 1.3% -2.4% 1.6% -4.4% -4.4% 0.6% 2.6%

1.0% 0.6% 6.3% 5.6% 8.2% 6.0%

Electricity
Generation
Monetary
Indicators

11.5
11.9
15.7
5.4%
6.7%
%
%
%

Non-Food Credit
Growth

Nov- Dec14
14

14.0
11.3
1.2% 5.6% -3.4% -1.6%
%
%

Coal Production

Deposit Growth

Oct14

11.8
%

15.4
%
16.1
%

11.1
%
14.1
%

14.7
%
14.2
%

13.4
%
12.8
%

12.4
%
13.0
%

13.0
%
12.8
%

13.3
16.4
7.3%
%
%
12.9
13.7
3.9%
%
%

13.6 13.4 13.5

%
%
%
10.5
11.7
9.7%
%
%

14.5
11.5
7.6% 1.8%
6.0% 7.9% 7.7%
%
%
10.2
3.8% 2.7% 5.2% 1.7% -1.1% 5.5%
%

11.7
%
10.9
%

11.5 11.6 11.9 11.4 11.4

11.5%
%
%
%
%
%
10.3
10.2
9.6% 9.7% 7.1%
10.0%
%
%

Capex unlikely to be a growth driver

There is a rising perception that Indian cyclical recovery is going to gain strength on
the back of capex recovery.
While the hopes are running high the prerequisites for sustainable capex recovery are
missing. Our assessment of 5 Cs which are essential for capex is as follows:

Capacity: The Capacity utilisation rates across sectors remains low. Asset
turnover ratio of Indian non financial corporates have seen deceleration in the
last two years.

Cost of capital: Remains high. Real interest rates are quite high while cost of
equity is high for those who are into asset creation businesses.

Confidence: Poor profitability has been a concern. The gap between RoEs and
Cost of capital remains quite narrow. Confidence has also likely been dented
owing to reduced visibility on medium term local and global growth

Capability: Corporate B/S remains stressed on aggregate. With muted P&L

recovery the capability of relevant corporates remains challenged.

Capital availability: Financial slack in the system to fund the capex remains
limited. Impaired bank B/S is a prime concern. While foreign savings has
remained supportive, the more important variable i.e. domestic savings are slow
to recover.
The burden to kick start capex is on the government. Public sector capex will certainly
provide a near term bumpup. The push may come from Quasi Govt entities. That said,
states which are primarily responsible to do public capex have limited bandwidth
and resources to pursue meaningful capex.
That said, we acknowledge that in 2HCY15, there is going to be some pickup in capex 13

Inflation Can Monsoon Ruin the Party?.......(1/2)

The absolute levels of monsoon do not matter. What really matters is:

Spatial Distribution (Geographic Spread): The spatial distribution has

significantly weakened in July. The lesser irrigated areas like Central India,
South Peninsula and Bihar have moved into deficit zone

Temporal Distribution: A first-half deficiency (until the middle or end of

July) affects sowing of the long-cycle crops like cereals, pulses and oilseeds.
On the other hand, if rainfall recovers in the second half, it facilitates
widespread sowing of short-cycle crops, mainly vegetables

Although rains have been very weak in July and there is no cumulative surplus left
as of yesterday, area under cultivation (especially of pulses and oilseeds) has
progressed very well up till now

Whatever may be the outcome of monsoons, inflation is unlikely to surprise

negatively anytime soon because:

MSP hikes for the Kharif marketing season has been muted

The government has substantial buffer stocks of rice and wheat

Inflation Can Monsoon Ruin the Party?.......(2/2)

Spatial Distribution of Rainfall has
weakened

Region
East & North
East

% Departure from
Normal
-4%

North West India

12%

Central India

-5%

South Peninsula
Country as a
Whole

-4%
-2%

Global Food Inflation is contained

450.00
400.00
350.00
300.00
250.00
200.00
150.00
100.00
50.00

Food Price
Index
Cereals Price
Index
Oils Price Index

But Sowing has progressed well

Crop Area Under Cultivation (As of
Jul 3)

Area Typically
Covered in Full
Season (Mn
2014Y 2015Y

Hectares)
TD
TD
YoY%
Rice
39.2
5.4
5.4
0.9%
Coarse
Cereals
21.3
2.9
4.4
51.2%
Pulses
11
1
2.3 132.6%
Oilseeds
17.9
1.5
7.4 403.5%
Sugarcane
4.7
4.4
4.4
-0.5%
Cotton
11.8
3.5
6
69.8%
Grand Total
105.9
18.6
29.8 60.2%
The government has sufficient buffer stocks
of rice and wheat

Mn Tonnes
Actual Stock
Norm (July1)
Operational
Stock
Strategic
Reserve

Rice
16.4
13.5

Wheat
40.3
27.5

11.5

24.5

System Liquidity likely to turn favourable

One of the most important data point to ascertain whether macro recovery will
take place is the growth in reserve money
Reserve money growth has been abysmal in the last 3 years, resulting in
extremely tight domestic liquidity, even at a time when investment demand has
been very subdued
However, going forward, we expect system liquidity to improve materially. This is
because, despite weak exports, we believe BoP is likely to post ~US$40bn worth
of surplus in the next 12 months
Given the large BoP surplus and the consequent forex reserve accretion, there is
a genuine case of adequate and better quality reserve money creation in the
next 12 months
Moreover, there are initial signs that financial
slack is being created in the
80
India reserve money growth: One 30of the most important datapoint to ascertain whether macro recovery would take place Some financial slack being created in the system
system (falling CD ratio)
75
As a result,
25
we are likely to see a significant improvement in systematic liquidity
70
which in 20turn will allow
banks to pass on the
rate cuts, thereby aiding corporate
Reserve Money
balance sheet
repair
Growth (%YoY)
65
15

10

60

55

50

CD Ratio

The Composition of Savings Investment gap which

had Deteriorated Materially in the last few years..

The gap between savings and gross capital formation of different

sectors
Private
Errors & Current
Corporate
Public
Omission Account
Household*
Sector
Sector
s
Balance#

2000-01

9.2%

-1.2%

-8.5%

-0.2%

-0.6%

2001-02

9.9%

-1.9%

-8.8%

1.3%

0.6%

2002-03

9.5%

-1.8%

-6.7%

0.2%

1.1%

2003-04

10.2%

-2.0%

-5.3%

-0.6%

2.2%

2004-05

8.8%

-3.8%

-5.1%

-0.4%

-0.4%

2005-06

10.7%

-6.1%

-5.5%

-0.4%

-1.2%

2006-07

10.1%

-6.6%

-4.7%

0.2%

-1.1%

2007-08

10.6%

-7.9%

-3.9%

-0.1%

-1.3%

2008-09

8.9%

-3.9%

-8.5%

0.6%

-2.9%

2009-10

10.2%

-3.8%

-9.0%

-0.2%

-2.8%

2010-11

7.8%

-4.8%

-5.8%

0.1%

-2.7%

2011-12

4.8%

-3.6%

-6.2%

0.9%

-4.2%

2012-13

4.6%

-3.5%

-5.5%

-0.3%

-4.7%

2013-14

6.2%

-1.7%

-6.4%

0.2%

-1.7%

Note: FY11-FY13 figures based on new GDP series

*Household gross capital formation includes valuables
#Current Account Balance = total savings total investments + errors and omissions

 Is Likely to Recover, Albeit at a Slow Pace

The process of high economic growth hinges critically on the generation of greater savings
and its channelization into productive investments
Indian households, who are traditionally the largest suppliers of capital to the economy, have
in recent years been using the capital to fund their own unproductive investments needs
rather than providing it to the corporate sector
This has been the primary cause of the sharp fall in Indias potential output and tight
domestic liquidity in the last few years
However, going forward, we believe that this aberration in household behaviour is likely to
reverse as financial assets become more attractive viz-a-viz gold and real estate
Although the headline savings-investment gap may not alter drastically, the composition is
likely to turn far more favourable
Moreover, while consumption is likely to be the primary driver of the economy for the next
12 months, this is likely to come on back of an improving household savings-investment
profile rather than a deteriorating profile as has been the case in the last few years.
50%
40%
30%
20%
10%
0%

-10%
-20%
-30%

Real Return on
Gold (% YoY)

Rate Cycle Headed Downwards

We expect another 50bps of rate cut by the RBI in FY16
Easing inflation expectations and tapering net supply means that the 10
year bond yield currently offers an extremely attractive entry point
While we expect a downward shift of the yield curve, we believe that there
is a small probability of the yield steepening

Data as of 7th July 2015

Currency Volatility is Here to Stay

INR continues to be overvalued in REER terms although the extent of

overvaluation has reduced in recent months
The consensus has long maintained the view that INR is likely to remain stable,
trading in a compressed range of 62-64. This group thinking on the level of INR
was quite pronounced
However, we believe that INR volatility is hear to stay as we are at the fag end of
the very easy global liquidity cycle.
While we believe that in the short term, INR is unlikely to exceed 65, our medium
INR
has outperformed
its peers in the
term outlook is bearish since we are extremely
bullish
on the DXY
INR overvalued in REER terms

115
Mean+stdev
110

105

100

95

10-Year Average

Mean-stdev

3d last
1w1

year
1m

3m

Currency
Emerging
Markets

Last

Brazilian Real
Mexican Peso
Russian Ruble
S. African
Rand
Indonesian
Rupiah
Polish (Poland)
Zloty

3.2 (0.8) (2.7) (6.8)

15.4 (0.5) (0.7) (1.0)
52.3 (2.9) (4.5) (2.5)

12.2 (0.6) (2.1) (3.0)

1322
4
(0.0) (0.5) (2.2)
3.7

2.0

(0.3) (3.7)

Turkish Lira
2.7 (0.8) (2.4) (0.1)

Composite
Index

(0.5) (1.9) (2.8)

Indian Rupee
Spot
63.8 0.2 (0.5) (0.8)
Relative perf
of INR
0.7
1.4
1.9

6m

1 yr

YTD

(19.4
(8.9)
)
(30.0) (16.4)
(2.4) (9.0) (16.5) (4.1)
19.5 (1.3) (33.8) 16.0
(3.1) (9.6) (14.3)

(4.8)

(1.9) (7.1)
(10.5
(0.6)
)
(16.8
(5.5)
)

(10.5
(0.4)
)

(12.0)

(6.3)

(18.6)

(5.3)

(21.0)

(4.7)

(3.1) (2.8)

(7.5)

(1.2)

(2.6)

13.5

3.520

7.7

(21.6) (12.3)

Indian Macro Outlook in Summary:

Growth inflation tradeoff will continue to improve

Inflation is not a major risk

Growth recovery will be uneven but the tilt is up

The quality of growth is improving as the growth is becoming more

domestic demand driven

B/S of all stakeholders need further adjustments so capex is unlikely to be a

prime growth driver for sometime to come

Productivity improvement will drive the growth rather than large

investments

Consumption will remain the prime growth driver at least for the next 12
months

Initial signs of terms of trade shifting from rural to urban are quite visible

Large BoP surplus and the consequent forex accretion will help system

Key Risks for the Economy

Balance sheet repair for the various stakeholders continues to be at a
nascent stage and thus the economy still needs considerable time to
return to its potential. Some of the factors which could derail the
recovery process are:

Global:
Sharp rise in global interest rates leading to huge outflows
Firming up of global commodity prices (crude in particular)

Local:
Slower pace of reforms irrespective of the reasons
Very poor monsoon
Rural stress and State Elections (Bihar) forcing the government to turn populist,
thereby derailing the reforms process
No further rate cuts by the RBI
RBI and its stance on liquidity they do not seem to be in a mood to let
systematic liquidity to turn into surplus which could make monetary transmission
extremely difficult

Long Term Structural Factors in Indias favour

India - Best demographics story in the world

In an increasingly aging world, Indias demographic profile stands out.

The factor of production which the world lacks, India has in abundance.
This places India in a sweet spot
Indias demographic dividend represents a sizeable pool of potentially
employable labour, which if adequately skilled, could make the country
the factory of the world
A rising working-age population also results in substantial savings,
which is critical to financing investments
75.00%

Working Age Population as a % of Total Population

70.00%
65.00%
60.00%
55.00%
50.00%

US

EU

OECD Countries

India

Japan

Indias massive potential in productivity improvements

Indias value addition lowest in manufacturing vs China, Japan & peers

Tremendous labour productivity scope led by increasing urbanization
Indias capital productivity too has massive improvement potential

Urbanization rate

Key macro trends in coming years..

Terms of trade to continue to shift from rural to urban India

Consumer credit will continue to expand as % of GDP

Availability of power will materially improve and cost of power

may remain comfortable for years (this scenario will take a couple
of years to properly materialize). India can potentially become
coal exporter in next 5 years

Intermediation across sectors should come down

Import substitution will gain traction

Railways/Defense/Tourism/Roads/Hotels

THANKS