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Connecting Markets East & West

Global Markets Research

India: A bumpy ascent


Sonal Varma
Chief India Economist
Nomura Financial Advisory and Securities (India) Private Limited.

+91 22 4037 4087


sonal.varma@nomura.com

Aman Mohunta - NFASL


aman.mohunta@nomura.com
+91 22 6617 5595
Neha Saraf - NFASL
neha.saraf@nomura.com
+91 22 4037 4218
See Appendix A-1 for analyst certification, important
disclosures and the status of non-US analysts.

May 2015

Any authors named on this report are research


analysts unless otherwise indicated.

Summary: ST bumps, MT positive

Big picture view: 2014 was an inflection year for India owing to a strong political mandate, growth bottoming out and the RBIs
increased credibility. Prudent macro policies should usher in a Goldilocks period of higher growth amid stable inflation in 2015-17.
Lower commodity prices are a positive externality.

Short-term bumps: Market sentiment has soured over uncertainty whether foreign investors will be subject to the minimum
alternative tax (MAT). A confluence of potential macro developments could further weigh on sentiment in the near term: (1) a setback
on reforms (land, GST); (2) a wider trade deficit (higher oil, REER appreciation); (3) weather-related risks (rural stress = populism?);
and (4) FII outflows (MAT related or global factors).

Why the medium-term positive story is still intact: The near-term risks do not alter our fundamental view that India will be
the biggest EM turnaround story in the next three years owing to: (1) a multi-year growth recovery; (2) low and stable inflation; (3)
macro stability as the RBI shifts to flexible inflation targeting; (3) incremental supply-side reforms focused on public infrastructure
spending and easing constraints to doing business; and (4) stable funding of the current account deficit through rising FDI inflows.

How we are different: (1) Despite current skepticism, we expect growth to recover cyclically; (2) after a 25bp rate cut in June, we
expect the RBI to stay on hold through 2016; and (3) relative INR outperformance to continue.

Nomuras strategy view: Equity - Dec 2015 Sensex target of 33500 (~20% upside). O/W sectors: financials, autos, industrials
and technology. U/W: Consumer staples, pharmaceuticals, metals and telecoms. FX - USD/INR (current: 63.5) to depreciate to 64.4
in Q3 2015, appreciate to 63.3 in Q4 2015 and further to 62.9 in end-2016. Rates - 10yr bond yields (cur: 7.85%) to fall to 7.5% by Q2
2015 and 7.2% by end-2015, staying unchanged thereafter in 2016. On swaps, we hold a flattener view.

India outlook at a glance


% y-o-y growth unless otherwise stated
Real GDP

3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16
7.6
7.2
8.0
8.2
8.5
8.6
8.1
8.1
8.2
7.5

2014
7.2

2015
7.8

2016
8.3

Agriculture

2.0

-0.4

0.4

2.4

4.4

5.0

4.0

4.0

4.0

4.0

2.2

3.1

4.0

Industry

5.5

4.6

5.6

7.0

7.3

7.6

4.8

7.5

7.2

6.8

5.5

6.9

6.6

Services (incld Construction)

9.8

11.7

9.5

8.9

9.3

9.3

9.3

9.3

9.9

9.5

8.8

9.3

9.5

Private consumption
Government consumption
Fixed investment
Exports (goods & services)
Imports (goods & services)

8.7
5.8
2.8
-3.8
1.2

3.5
31.7
1.6
-2.8
1.1

6.8
10.8
7.0
2.1
-0.6

6.7
9.0
7.2
7.5
8.0

8.0
9.0
7.5
7.5
8.0

8.3
9.0
8.5
7.5
8.0

8.3
9.0
10.0
7.0
8.0

8.5
8.0
10.2
7.0
7.8

8.5
8.0
9.8
7.0
9.0

9.0
8.0
10.0
6.5
9.5

5.8
5.5
2.5
3.8
-2.2

7.4
9.4
7.5
6.1
5.8

8.6
8.2
10.0
6.9
8.6

Wholesale price index


Consumer price index

3.8
6.7

0.6
4.1

-1.8
5.2

-1.3
4.8

-1.8
4.9

-0.6
5.3

1.0
5.3

2.3
5.3

2.1
4.7

2.4
5.0

3.9
6.7

-1.4
5.0

2.0
5.1

Current account balance (% GDP)


Fiscal balance (% GDP)

-2.0

-1.6

0.4

-1.2

-1.5

-1.7

-1.1

-2.3

-2.1

-1.5

-1.4
-4.1

-1.0
-3.9

-1.8
-3.5

Repo rate (%)


Reverse repo rate (%)
Cash reserve ratio (%)
10-year bond yield (%)
Exchange rate (INR/USD)

8.00
7.00
4.00
8.51
60.9

8.00
7.00
4.00
7.85
62.6

7.50
6.50
4.00
7.74
62.5

7.25
6.25
4.00
7.50
63.6

7.25
6.25
4.00
7.30
64.4

7.25
6.25
4.00
7.20
63.4

7.25
6.25
4.00
7.20
62.9

7.25
6.25
4.00
7.20
62.9

7.25
6.25
4.00
7.20
62.9

7.25
6.25
4.00
7.20
62.9

8.00
7.00
4.00
7.85
62.6

7.25
6.25
4.00
7.20
63.4

7.25
6.25
4.00
7.20
62.9

2
Source: CEIC and Nomura Global Economics estimates.

The framework: Growth with macro stability


Medium-term India view

We believe India is heading into a period of growth with macroeconomic stability. Tighter fiscal and monetary policies
and a correct growth mix (pro-investment and less entitlement-based consumption) have corrected Indias imbalances.
The growth recovery is likely to be gradual (no-Vs), but this environment should result in a steady and more
sustainable growth uptick, with lower inflation and higher productivity in the medium term.
3
Source: Nomura Global Economics.

The near-term bumps


A number of factors can weigh on sentiment in the near-term
1.

Uncertainty surrounding minimum alternative tax

2.

Setback on legislative reforms (land, GST)

3.

A wider current account deficit in Q2 2015

4.

Weather vagaries: unseasonable rains and a below-normal monsoon season

5.

Political fallout of weak rural demand amid upcoming state elections

6.

FII outflows due to global or domestic factors

1. The MAT ruckus - Background


Background
What is MAT? MAT is applicable on companies earnings a profit in India. Current MAT rate is 18.5% on book profits.
Applicability of MAT on foreign companies: This came into being through an order of Advance Authority Ruling (AAR) on a
company called Castleton. The Castleton case was for a restructuring of Glaxo Smith Klines holding in a Mauritius entity to a
Singapore entity. It approached the AAR to get clarity on the capital gains tax. AAR held that the transfer did not attract capital
gains (under the tax treaty with Mauritius), but held that the section pertaining to MAT did not distinguish between Indian
companies and foreign companies. It thus held that the capital gains arising out of this transfer would attract MAT. This
happened in 2012. This case is now pending before the Supreme Court of India. This has essentially meant that 1)foreign
companies are subject to MAT and 2) MAT has to be paid on capital gains.
Confusion created in the budget due to exemption provided to FPIs (no MAT prospectively). The Tax office has presumed
this means past MAT is applicable and it issued tax demands on FIIs while closing tax assessments FY 2010-11/2011-12,
taking support from the Castleton case. There are two claims MAT on LTCG and MAT on STCG (investors have been
paying tax @ 15% on ST capital gains).

Governments stated stance


Initially, combative: I can change the face of India's irrigation with that Rs 40,000 crore if I waive off, we will be like a tax
haven.
AAR has judicial status, so the government is not in a position to provide retrospective exemptions. In the Castleton case,
special leave petition has been filed and admitted by the Supreme Court, but yet to be taken up for the hearing.
Governments hands are tied. Responsibility with FIIs. Governments intention is clear (as stated in the finance bill)

Next steps

FPIs to file a petition in Supreme Court to get the matter expedited for early hearing
For DTAA countries, treaty benefits will be applicable
Clarification on applicability of MAT on coupon interest on bonds from April 2015 is likely in early May
Good scenario: Supreme Court verdict in favour of FPIs
Bad scenario: Verdict against FPIs. Then, government to make retrospective amendments?

5
Source: Nomura Global Economics.

The MAT ruckus: What is at risk?


Equity outstanding (USD bn)
Incremental
Mar-15
Jan-12
Equity inflow
1
2
3
4
5
6
7
8
9
10

US
MAURITIUS
SING
LUXEMBOURG
UK
UAE
NETHERLANDS
CANADA
IRELAND
Other
Total
Total (ex-Sing, Maur)

106.8
73.0
27.9
28.2
16.5
10.2
6.2
7.3
6.7
39.0
322
221

43.1
39.8
6.8
12.4
7.9
5.4
2.4
2.9
2.5
15.7
139
92

63.7
33.2
21.1
15.8
8.6
4.8
3.9
4.4
4.2
23.3
183
129

Debt outstanding (USD bn)


Incremental
Mar-15
Jan-12
Debt inflow
6.3
10.7
18.5
4.2
0.2
0.1
1.5
0.2
0.4
7.0
49
20

0.2
6.8
12.1
0.5
1.0
0.0
0.2
0.0
0.0
2.6
23
5

6.1
3.9
6.4
3.7
-0.8
0.1
1.3
0.2
0.4
4.4
26
15

Data on incremental money into debt and equity between Jan 2012 and March 2015 (i.e. the contentious period) from
different countries show total inflows of USD183bn in equity and USD26bn in debt.
Excluding Mauritius and Singapore (DTAA benefit), total equity inflows are USD129bn and USD5bn in debt, with most inflows
from the US.

6
Source: NSDL and Nomura Global Economics.

2. Setback on legislative reforms


Land acquisition bill

Why the bill: The old land bill (1894 Act) provided
compensation to farmers, but did not give rehabilitation &
resettlement (R&R).
2013 land bill: (1) Increased compensation (1.3x to 2x in urban
and 2-4x in rural), (2) provides R&R, (3) mandated Social
Impact Assessment (SIA) except urgent projects, (4) consent
(80% for private, 70% for PPP, none for govt. projects), (5)
irrigated multi-cropped land acquisition prohibited.
Amendments suggested: Exemption from SIA, consent and
acquiring of multi-cropped land for (i) defence, (ii) rural
infrastructure, (iii) affordable housing, (iv) industrial corridors
and (v) infrastructure projects. Land for private hospitals and
private educational institutions included under public purpose.

GST constitutional amendment bill

Why the bill: GST to replace plethora of central (excise,


services, customs) and state (CST, VAT, entertainment tax,
entry tax, octroi, luxury tax, purchase tax) taxes. However,
this requires an amendment to enable states to tax services
Why the opposition: States fear revenue loss, even though
the centre has promised compensation
Status: Opposition opposing without reason. To be taken up
in the monsoon session. Once passed, it needs ratification by
more than 50% of the states in their individual assemblies,
deciding the revenue neutral GST rate, setting up of a GST
Council and putting the relevant IT infrastructure in place. Not
enough time to implement it from April 2016.

Why the opposition: The five exempted categories cover a


majority of the projects and will hurt the poor.
Status: Large opposition means difficulty in passing the bill in
the current format. Either amendments are removed or the BJP
will have to call a joint session.

7
Source: Nomura Global Economics, PRS.

3. A wider trade deficit in Q2


Import volumes are rising

Weak global demand hurting exports

Price Effect

Volume Effect

%
30

Volume Effect

Price Effect
25

Export Value growth y-o-y

20
10

15

Import growth y-o-y

-10
-5
-20
-30
Jul-12

Mar-13

Nov-13

Jul-14

Mar-15

due to REER appreciation and faster domestic growth


% y-o-y, 3mma
60

Non oil non gold imports, lhs


REER (36 country), rhs

3mma
117

50

115

40

113

30

111

20

109

10

107

105

-10

103

-20

101

-30

99

-40
Mar-09

Mar-11

Mar-13

Source: Ministry of Finance, CEIC and Nomura Global Economics

97
Mar-15

-15
Jul-12

Mar-13

Nov-13

Jul-14

Mar-15

A wider current account deficit in Q2 2015

We expect the trade deficit to widen from USD27bn in Q1


2015 to USD35bn in Q2 2015 owing to (1) higher oil prices (2)
seasonal deterioration in April/May (3) REER appreciation and
strong domestic growth (on imports) (4) weak exports and (5)
higher net agriculture imports owing to a bad-crop year. This
will result in the current account balance moving from a
seasonal surplus in Q1 (0.2% of GDP) to a deficit of 1.8% in
Q2.

4. Unseasonable rains 30% of winter crop destroyed


The damage

Impact on agri output

Crop-wise
Crop
Wheat
Coarse cereal
Pulses
Oilseeds
Total

Area sown
mn hectare
30.6
5.7
14.3
8.0
58.6

Damage
mn hectare
6.3
0.3
1.1
1.8
10.7

%
of area sown
20.6
4.9
7.9
22.2
18.2

Damage
% of area under Rabi
Haryana
65.6
Rajasthan
33.6
Uttar Pradesh
78.5
Punjab
8.2
Madhya Pradesh
5.0

Rulling party

FY13

10

6.4

6.1

6
3.7
2.6

0.8

0.4 0.3
BJP
BJP
SP
SAD/BJP
BJP

0
-2
-2.6

-4
Vegetables

FY14
FY15 (1st adv)
9.5

State-wise
State

% y-o-y

Fruits

Rabi food grain

According to the Ministry of Agricultures initial assessment, the unseasonal rains damaged around 18.9 mn hectares of land,
which comprises about 31% of the total winter (rabi) crop sown area (of 60.6mn hectares).
Within rabi crops, the maximum damage has been inflicted on wheat (20% of total area sown damaged), oilseeds (22%) and
pulses (8%).
Among fruits, mangos and grapes are some of the fruits that have been damaged. The northern states of Haryana, Uttar
Pradesh, Rajasthan were hit particularly hard.
9
Source: Ministry of Finance, CEIC and Nomura Global Economics

Lessons from past episodes of unseasonable rains


CPI inflation around unseasonable rains

Fruit & vegetable prices remain contained so far

% m-o-m, sa
1.8

Important
vegetables
Potato

1.6
1.4

Start of
unseasonal
rains

Weight

Feb

March

April

March

(% in CPI) INR/qtl INR/qtl INR/qtl % m/m

April
% m/m

1.0

1416

1262

1165

(10.9)

(7.7)

Onion

0.6

2431

2309

2131

(5.0)

(7.7)

1.2

Tomato

0.6

2257

2292

2342

1.5

2.2

1.0

Brinjal

0.4

2398

2307

2173

(3.8)

(5.8)

0.8

Cauliflower

0.2

1841

2155

2434

17.0

13.0

0.6

Green Chillies

0.3

4853

4743

4651

(2.3)

(1.9)

0.4

Lady's Finger

0.3

4578

4230

3747

(7.6)

(11.4)

0.2

Vegetables

6.0

(3.9)

(3.9)

Banana

0.6

3441

3207

3202

(6.8)

(0.2)

Apple
Fruits

0.5

10055

11201

10532

11.4

(6.0)

1.5

(4.5)

0.0
t-3

t-2

t-1

t+1

t+2

t+3

t+4

t+5

t+6

Impact on vegetable prices


Index (t=100)
135
130

t = Start of
unseasonal rain

125
120
Veg
115
110

Fruits

105

Cereals
Pulses

2.9

During the past episodes, CPI inflation rose by an average of 1.4% m-o-m,
seasonally adjusted, in the immediate 3 months following the unseasonable
rains, as compared with an average of 0.7% m-o-m, sa, in the three months
preceding the unseasonable rains. However, this rise is transitory and tends
to fade from the fourth month onwards. Not surprisingly, much of the upside
in food price inflation has been driven by a sharp acceleration in vegetable
price inflation, which picks up substantially (20-30% rise) in the two months
following unseasonable rains. Plus, fruits and, to some extent, pulses
registered a faster pace of price increase following unseasonable rains.
However, there has not been any visible price impact thus far.

100
95
t-3

t-2

t-1

t+1

t+2

Source: Ministry of Finance, CEIC and Nomura Global Economics

t+3

t+4

t+5

t+6

10

IMD predicts below-normal monsoons in 2015


IMD forecast vs actual rainfall

Southern Oscillator Index

% of long period average

125

Index

Forecast
Actual

115

La Nina (favourable for


Monsoons )

25

Normal monsoon range


15

105
5

95
-5

85
-15

75

1990

1995

2000

2005

2010

2015

The IMD expects rainfall at 7% below normal. It assigns


only a 28% probability to rains being normal, while the
probability of below-normal or deficient rains is high at
69% (36% below normal + 33% deficient). Historically,
the IMD's monsoon predictions have often diverged
from actual rainfall, but we view this forecast as
relatively realistic, considering the rising risk of an El
Nio.

-25
Mar-05

El Nino (unfavourable
for Monsoons )
Mar-07
Mar-09
Mar-11

Mar-13

Mar-15

Australian Commonwealth Bureau of Meteorology pegs


the likelihood of El Nio conditions (unfavourable for
rains) developing in 2015 at 70%. Below-normal rains
could hurt agriculture output and depress rural
incomes, which are already reeling under consecutive
bad kharif (summer) and rabi (winter) seasons .

Source: Indian Meteorological Department, Commonwealth Bureau of Meteorology, Bloomberg and Nomura Global Economics

11

What if: Below-normal monsoon rains


Macro impact of past droughts (>20% below normal)

Macro impact of poor monsoons (10-15% below normal)

12
Source: CEIC and Nomura Global Economics

5. Rural demand is already quite weak


Two Wheeler sales
%, y-o-y
25.0

Tractor sales
%, y-o-y
40

Two Wheeler sales, 3MMA

20.0

Tractores sales

20

15.0
0

10.0

-20

5.0
0.0

-40
Apr-11

-5.0
-10.0
Apr-11

Jan-12

Oct-12

Jul-13

Apr-14

Jan-15

Minimum support prices - paddy

Jan-12

Oct-12

Apr-14

Jan-15

Rural wages
Rural wages

%, y-o-y
30

% y-o-y
35

Jul-13

25

30

20

20

15

15

10

10

5
Feb-15

Mar-14

Apr-13

May-12

Jun-11

Jul-10

-5

Aug-09

FY15

Sep-08

FY10

Oct-07

FY05

Nov-06

FY00

Dec-05

FY95

Jan-05

FY90

Feb-04

0
Mar-03

4.0

Apr-02

25

Rural incomes are reeling under consecutive bad kharif season in 2014 and unseasonable rains in March. There is a
13
risk of higher MSP increases in 2015 given political constraints.
Source: RBI, SIAM, CEIC and Nomura Global Economics.

which could become a political risk


State elections in the next few years

Most Rajya Sabha seats are up for re-election in 2016


No of seats up for re-election

60
Others
INC
BJP+

50
40

MH, BR, UP, OR,


PB

30
20

KL, PB, AS

GJ, WB
Delhi

Goa

SK

State elections at end-2015 will be an important political event. With 16 seats in the Rajya Sabha (5 of which
are due for re-election in 2016), Bihar will be in focus in the coming months. Seeing the rising clout of BJP,
smaller regional parties have come together to form a coalition and thus BJP may find it difficult to win the
state and repeat its performance of 2014.

Given the ongoing rural stress, the risk of a populist decision (higher MSP, farm loan waiver) remains.

Source: ECI and Nomura Global Economics.

Apr-18

Nom.

Mar-16

Pud.

Nov-15

KL

Oct-15

Nom.

Feb-18

10

Apr-15

2017

Uttarakhand (Mar), Manipur (Mar), Goa


(Mar), UP (May), Himachal Pradesh
(Dec+), Gujarat (Dec+)

TN. MP, KR, AP,


KL

Jan-18

Kerala (May), West Bengal (May), Tamil


Nadu (May), Assam (Jun)

Aug-17

2016

Jul-17

Bihar (Nov)

MH, BR, UP,


MP, GJ, AP, WB

Jul-16

2015

70

Jun-16

State going to polls

Apr-16

Year

14

6. The key risk for India: Debt capital outflows


Equity inflows: India
USD bn

Debt inflows: India


USD bn

FII equity flows (12m sum)

35

FII debt flows (12m sum)

30

30

25

25
20
20
15

15
10

10

0
0
-5
-5

-10

-15
Apr-05

Apr-07

Apr-09

Apr-11

Apr-13

Apr-15

-10
Apr-05

Apr-07

Apr-09

Apr-11

Apr-13

Apr-15

15
Source: EPFR, CEIC and Nomura Global Economics.

Why the medium-term story is positive


We see a number of factors supporting Indias fundamentals in the medium term

A multi-year growth recovery

Low and stable inflation

A regime shift towards flexible inflation targeting

Incremental supply-side reforms to continue

A stable external sector

16

Why the medium-term story is positive


We see a number of factors supporting Indias fundamentals in the medium term

A multi-year growth recovery

Low and stable inflation

A regime shift towards flexible inflation targeting

Incremental supply-side reforms to continue

A stable external sector

17

Leading indicators pointing to a sustained recovery


OECDs composite leading index for India
Index
103

OECD's composite leading index for India


Long-run trend

Nomuras composite leading index for India


Index

104

Non-agriculture GDP (2qma), rhs

% y-o-y

Nomura's composite leading index, lhs

12

102
10
101
102
8
100
6

99

100

98

97
Feb-97 Feb-00 Feb-03 Feb-06 Feb-09 Feb-12 Feb-15

98
2
Sep-97 Sep-00 Sep-03 Sep-06 Sep-09 Sep-12 Sep-15

Even though IP data have been volatile, leading indicators suggest that growth momentum will continue to
pick up. We expect real GDP growth to rise to ~8.0% y-o-y in FY16 from 7.4% in FY15.
Note: The constituents of our CLI are real M2 money supply, non-oil imports, equity returns, the repo rate, real bank credit, industrial output and visitor arrivals. Data for Q2 2015 are provisional estimates.
Source: CEIC and Nomura Global Economics.

18

Growth: Where are the green shoots?


Monthly real activity data heat map
% y-o-y, 3mma

2012

2013

2014

2015

Q1
8.9
7.0
8.3

Q2
-19.6
1.2
2.1

Q3
-15.1
1.4
-9.7

Q4
-29.2
-0.2
-8.8

Q1
-39.7
-1.2
-0.5

Q2
-8.2
1.7
0.7

Q3
-32.2
3.7
13.6

Q4
-33.6
0.1
6.9

Q1
-6.5
1.3
1.4

Q2
-2.4
3.3
7.5

Q3
23.3
6.3
14.3

Q4
51.9
8.1
14.5

Jan
59.7
6.3
15.8

Feb
50.6
4.6
18.5

Mar
32.2
3.6
20.9

Capital Goods
Imports (ex-oil, gold)

-4.1
16.1

-19.3
5.0

-7.9
-4.2

-0.9
-3.2

5.4
3.9

-3.5
-3.6

2.5
-5.0

0.1
-7.4

-11.0
-7.5

13.6
-1.4

-0.2
10.1

3.0
14.6

8.3
13.9

8.9
7.7

4.3

Passenger cars
Diesel consumption

10.5
9.9

5.0
10.3

-8.3
10.8

4.5
4.2

-13.7
2.7

-12.5
0.7

13.7
-2.6

-6.5
-1.1

-7.2
-1.5

1.6
0.3

1.7
2.5

6.0
1.0

12.5
3.1

10.2
4.6

7.9
2.5

Coal
Electricity generation

11.0
4.8

8.0
6.7

12.0
2.9

3.5
4.4

-0.1
2.1

-1.7
3.2

6.9
8.4

0.3
5.1

0.9
7.8

5.6
11.4

8.9
9.5

12.8
9.5

7.9
6.0

7.0
4.6

3.6

6.4
9.3

3.4
12.5

1.8
5.8

3.8
5.4

7.6
7.2

13.4
3.4

12.3
5.9

8.8
2.0

9.2
1.5

1.8
9.6

3.2
10.0

0.4
4.7

0.2
5.2

-1.7
2.3

2 wheelers

11.7

10.4

-2.5

0.7

1.0

-3.6

7.2

13.9

12.0

15.7

20.2

4.0

5.4

1.9

0.2

Visitor arrivals
Exports

10.4
5.0

1.6
-3.7

1.6
-8.5

2.1
0.7

4.1
4.4

5.4
-0.1

7.9
12.9

7.1
7.4

7.9
-0.4

7.2
7.7

13.0
0.5

6.2
0.7

4.3
-0.7

3.7
-8.3

3.3
-14.8

Deposits
Bank Credit

14.6
16.4

14.7
18.1

14.0
16.8

13.0
16.5

13.5
15.5

13.8
14.4

13.0
16.3

13.3
14.8

12.5
14.1

11.0
13.1

10.5
10.8

11.1
10.8

11.1
10.3

11.4
10.2

12.0
11.1

MHCVs
Railway traffic: Net tonne km
Aviation: Passenger traffic

Steel
Cement

Green shoots are currently visible in the following categories:


1. Transportation sector - MHCV sales, railway freight traffic and aviation passenger traffic
2. Consumer discretionary demand cars
3. Upstream infrastructure sector electricity, coal
4. Investment capital goods, imports (ex-oil, gold)

Weaker segments
1. Rural demand
2. Exports
3. Bank credit
Source: CEIC and Nomura Global Economics. Heat map based on 3-month moving average.

19

Investment outlook gradually improving


New investment projects announced
INR trn

25

Chemicals & chemical products

Metals & machinery

Electricity

Transport services

Construction & real estate

Others

Stalled vs. revised investment projects


INR bn

3500

Stalled investment projects


Investment projects revived

3000
20
2500

15

2000

1500
10
1000
5
500

Investments are key to a sustainable growth pickup. New investments announced are still at a nascent
stage, but are inching higher. Meanwhile, stalled projects are lower and the revival in projects has been
much higher in FY15, suggesting de-bottlenecking is underway.
Source: CMIE and Nomura Global Economics.

20

Government efforts to drive investment


De-bottlenecking of stuck projects

Civil Aviation
Coal
Commerce
Industry
Mines
Petroleum
Power
Railways
Roads
Shipping
Steel
Textiles
Total

Number of
projects
cleared
2
29
2
4
3
17
100
9
15
8
7
1
197

Value of
projects cleared
(INR bn)
24
12
10
14
9
41
451
19
20
11
39
1
653

Reduced policy uncertainty to further help


% y-o-y
30

Index

GFCF, lhs

Economic policy uncertainity, 2 qtr lead, rhs


inverted scale

25
50

20

15
100
10
5
150
0
-5

200

-10
-15
Sep-05

Jun-07

Mar-09

Dec-10

Sep-12

Jun-14

250

Lower policy uncertainty bodes well for investments

Source: Economic Times, Cabinet Secretariat, www.policyuncertainity.com, CEIC and Nomura Global Economics.

21

Stalled projects: The reasons


Reasons for stalled projects

Top reasons for stalling across industries

Unfavourable market conditions

12.1%

Lack of non-environmental
clearance

11.8%

Lack of promoter interest

11.7%

Lack of funds

No. of
projects

Top reasons

Manufacturing

212

Unfavourable market conditions

Mining

40

Lack of non-environmental
clearance

Electricity

80

Fuel/feedstock/raw material supply


problem

Services

283

Lack of promoter interest

Construction & Real


Estate

143

Lack of non-environmental
clearance

10.4%

Land acquisition issues

8.2%

Raw material linkages

4.6%

Lack of environmental clearance


Natural calamity

Industry

4.2%
1.0%

Stalled investments: Only 8% of stalled projects are stuck because of land acquisition issues. With rising demand,
lower policy uncertainty, and better raw material linkages (coal auctions) existing stalled projects can be revived.

New investments: However, the stalling of the land bill could hurt new investment pipeline in roads/highways,
viewed as major drivers of growth for the next 2-3 years.

Source: Economic Times, India budget and Nomura Global Economics.

22

Banking system vs. economic cycle


Total stressed assets

Impaired assets vs. real growth

% of total assets
18

% y-o-y
12
GNPAs

16

Restructuring

Real GDP growth (ex-agri), lhs


Impaired assets (% of total), inverted, rhs

% of total assets
0
F

10
4

14
8

12

6
8

10
6

10

8
4

12
14

Higher NPA

16

2
0

0
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015F 2017F

1997

2000

2003

2006

2009

2012

2015F

18

Nomuras banking analysts expect impaired assets (NPA + restructured) to have peaked in FY15. As growth improves
and government policy actions focus on de-bottlenecking, we expect stressed assets to gradually fall.
The causality between growth and impaired assets is unclear. High growth during 2005-07 was coincident with falling
NPAs, but reasonable growth was achieved during 1997-00 with high NPAs. Of course, this does put a constraint on
private-sector led investment revival, i.e. most of the recovery to be led by the public sector at this stage.
Source: Nomura, Bloomberg

23

Potential growth likely to rise


Estimates of potential growth
% y-o-y

12

Real GDP
Potential GDP (growth accounting)

pp
10

TFP

Labour

Capital Stock

Real GDP, % y-o-y

10
F

Real investment
(% CAGR)

Potential
growth
(% CAGR)

0%

4.8

3%

5.3

5%

5.6

10%

6.5

15%

7.4

20%

8.5

8
7

8
6
5

4
3

1
0

1988 1993 1998 2003 2008 2013 2018

FY81-FY90 FY90-FY03 FY03-FY08 FY08-FY14 FY14-FY19 FY14-FY19


baseline accelerate
reform

In our base case, we expect reforms to revitalise real investment growth to 10% per annum,
pushing potential output growth to 6.5% (old series) in the next five years. If reforms are fasttracked, real investment growth could hit 15% pa, in our view, thus lifting potential growth to 7.5%.
24
Source: CEIC and Nomura Global Economics.

Why the medium-term story is positive


We see a number of factors supporting Indias fundamentals in the medium term

A multi-year growth recovery

Low and stable inflation

A regime shift towards flexible inflation targeting

Incremental supply-side reforms to continue

A stable external sector

25

Underlying inflation lower at about 5.5%


What drove CPI from 8% in Q1 2014 to 5% in Q1 2015?

CPI inflation and CPI ex-vegetables, T&C


% y-o-y

0.5

CPI ex-vegetables, T&C

0.0

14
CPI

0.0

12

-0.5

10

-1.0

-0.6

Lower oil
prices

-0.4
-1.5
-0.1

8
6

Lower
MSP

-0.7

-2.5

-0.1
-0.7

-3.0
Statistical issues

Mar-13

Sep-13

Mar-14

Sep-14

Mar-15

T&C

Fuel and
Light

Housing

Clothing

Intoxicants

Misc ex T&C

Sep-12

F&B
ex-cereals

Cereals

2
0
Mar-12

-0.3

-3.5

-3.0
Total (CPI)

-2.0

Excluding vegetables (volatile) and transport and communications (lower oil prices), CPI inflation is tracking 5.4%. Of
the 3.0pp fall in CPI inflation, 2.0pp (housing, oil, MSP) is unlikely to moderate any further.
26
Source: CEIC and Nomura Global Economics

CPI more sensitive to wages


Sensitivity of CPI is very high to rural wages
Correlation between macro variables and CPI inflation components

Expected
sign

Inflation nominal rural wages

% y-o-y
Positive
Inflation
Expectations

Positive
MSP

Positive Positive Negative Negative


Nominal
wages

Output
Gap

Rainfall Repo rate

% y-o-y

CPI inflation, lhs


Nominal rural wages, rhs

16

30

25
CPI

0.6

0.5

0.9

0.3

0.1

(0.2)

CPI food

0.1

0.5

0.8

0.1

0.1

(0.3)

CPI Core

0.8

0.4

0.8

0.4

0.1

(0.2)

12

20
15

8
10
5

0
0
Mar-03

Mar-06

Mar-09

Mar-12

(5)
Mar-15

27
Source: CEIC and Nomura Global Economics

Rural wages: supply versus demand


Nominal rural wages and labour force participation rate

% y-o-y

30
25

per 1000

Nominal agri wages, lhs

Labour force participation rate,


rhs (inverse scale)

% y-o-y

370

30

380

25

390

20

Nominal rural wages and output gap


% y-o-y

Nominal agri wages, lhs


Output Gap, rhs

3.0
2.0

20

1.0

15

0.0

10

(1.0)

(2.0)

400
15
410

10

420

5
0
Mar-02

430
Mar-06

Mar-10

Mar-14

440
Mar-18

0
Mar-02

Mar-06

Mar-10

Mar-14

(3.0)
Mar-18

After the sharp fall in rural wages in 2014, we expect rural wages to stabilise around 5-7% y-o-y in 2015-16 as improving
economic activity should be offset by an increase in labour supply (labour force participation rate).
28
Source: NSSO,CEIC and Nomura Global Economics

Low rural wages + low MSPs = Low CPI


Nominal rural wages projection

MSPs are important in the long run

% y-o-y

30
25

% y-o-y, 2ya

25

Nominal rural wages (Actual)


Nominal rural wages (Model Forecast)

Minimum support prices

Forecast

CPI inflation
20

20
15

15

10
10

5
0

5
-5
-10
Mar-02

0
Mar-05

Mar-08

Mar-11

Mar-14

Mar-17

FY87

FY91

FY95

FY99

FY03

FY07

FY11

FY15

Rural wages should consolidate in 2015. If the MSP increase is kept at 3% p.a. over the next three years (and there are no
adverse supply shocks), the MSP-food-wage spiral could be gradually circumvented. However, with the rural economy
reeling under a consecutive below-normal monsoon in 2014 and unseasonal rains in 2015, there is risk of higher MSP
29
increases (8-10%) in 2015, particularly with elections approaching in Bihar.
Source: CEIC and Nomura Global Economics.

CPI inflation likely to stabilise ~ 5%


CPI inflation: Actual versus fitted
% y-o-y
16

CPI Actual

CPI Forecast

Forecast

14
12

10
8
6
4
2
0
Dec-01

Dec-03

Dec-05

Dec-07

Dec-09

Dec-11

Dec-13

Dec-15

Dec-17

30
Note: The CPI model uses nominal rural wage, minimum support prices , output gap, repo rate and rainfall as explanatory variables.
Source: CEIC and Nomura Global Economics.

Why the medium-term story is positive


We see a number of factors supporting Indias fundamentals in the medium term

A multi-year growth recovery

Low and stable inflation

A regime shift towards flexible inflation targeting

Incremental supply-side reforms to continue

A stable external sector

31

A new monetary policy framework


Past framework

New framework

Multiple-indicator

Flexible inflation targeting (FIT)

Nominal anchor: WPI target

Nominal anchor: CPI target

5% target (implicit)

6% by March 2016; 4% (+/- 2%) from March 2018 onwards

Governor veto

Monetary policy committee vote

Operative rate: Repo

Operative rate: Repo; 14-day term repo


Publicly available inflation model
Monetary policy reports

Publishing RBI policy minutes

Source: CEIC and Nomura Global Economics.

32

New monetary policy framework = higher real rates


Real policy rates
% pa

Real Repo rate

Average

4
2003-06: 2.2%
2014-15: 1.5%

2
0
-2
-4
-6

2006-13: -2.3%

-8
-10
Mar-03

Mar-05

Mar-07

Mar-09

Mar-11

Mar-13

Mar-15

After nearly a decade of low to negative readings, real policy rates are finally positive. The non-inflationary
growth period (2003-06) witnessed an average real rate of ~2.2%. We expect the RBI to target higher positive
real rates to boost macro stability. The volatile global funding environment also calls for higher real rates. As
growth recovers, real rates will need to be higher to balance demand and supply of funds.
Source: CEIC and Nomura Global Economics.

33

New monetary policy framework = Policy orthodoxy


We estimate equilibrium nominal rate at ~7.25%
Optimal versus actual policy rate
%
25

Optimal policy rate (Taylor rule)

Repo rate
Forecast

20

15

10

0
Mar-03

Mar-06

Mar-09

Mar-12

Mar-15

Note: Optimal rate = Neutral real rate + * (Inflation gap) + *(Output gap), where neutral real rate is assumed as 2% and the inflation and growth co-efficients are taken as 0.5.
Source: CEIC and Nomura Global Economics.

Mar-18

34

RBIs policy stance to stay neutral-to-tight


RBIs policy stance vs. realised CPI inflation
%
20

CPI inflation: Scenario analysis


% y-o-y

Policy stance, lhs

16.0

CPI Inflation (actual)

% y-o-y
9

Repo @ 8%
Forecasts

14.0

15

Repo @ 8.5%
Repo @ 7.5%

Repo @ 7%

12.0

Repo@6.5%
7

10

10.0

8.0
6.0

4.0
-5

2.0

4
R2 of the model = 0.88

-10
Mar-02

Mar-05

Mar-08

Mar-11

Mar-14

0.0
Mar-17

3
Mar-14

Mar-15

Mar-16

Mar-17

Mar-18

If the RBI is serious about achieving 4% (from March 2018 onwards), then we believe that the policy stance has to
be tight. Currently, we do not expect 4% inflation on a sustainable basis.
35
Source: CEIC and Nomura Global Economics

Why the medium-term story is positive


We see a number of factors supporting Indias fundamentals in the medium term

A multi-year growth recovery

Low and stable inflation

A regime shift towards flexible inflation targeting

Incremental supply-side reforms to continue

A stable external sector

36

Compendium of reforms so far


Execution

Ease of doing business

Abolished all EGoMs,


Skill devt: amendment to
Groups of Ministers (GoMs) Apprentice Act

Better inter-ministerial coordination

Infrastructure
To set up InvIT
(Infrastructure Investment
Trust); incentivise REITs

Validity of Industrial License Banks to issue long-term


extended from two years to infra bonds with no statutory
three years
pre-emption
Sagarmala project
Self-certification by citizens
Monthly meetings & targets
instead of affidavits
National fibre optic grid
Bullet train
Online clearances:
Plannig Commission
Environmental & forest
100 smart cities; Urban
replaced with NITI Aayog
clearance online; 16 states
renewal scheme (AMRUT)
also online
Labour laws: Considering
amendments in the Child
Labour Act, Factories Act,
Minimum Wages Act

E-auction of coal mines;


commercial coal mining

To allow women to work


on night shifts in a
factory; raise overtime
hours limit

Land acquisition laws


amended

Fiscal

FDI

Potatoes and onions under Domestic natural gas prices


Defense to 49% (from 26%)
Essential Commodities Act reviewed

Less regulation: Scrap


Roads Ministry empowered Minimum support prices
obsolete laws such as Boiler
to amend the Model
raised by around 2.5%
(Inspection) Act & move to
Concession Agreement
vs.15% (6-yr CAGR)
self-certification

Focus on deliverables

Government agreed to
reduce government stake in
PSU banks to 52% and
reduce government
interference

Food inflation

Diesel price deregulated

To restructure Food
10% blanket cut in
Corporation of India; set up discretionary spending
a price stabilization fund
announced.
States urged to remove
vegetables, fruits from
APMC Act

Expenditure management
commission constituted

To make hoarding nonbailable offence

Goods and Services Tax bill


tabled in the Lok Sabha

Rail infrastructure to 100%

Parliament passed a law to


increase FDI limit in
Insurance to 49%

Set up first of many food


parks under the PPP model
in Karnataka

Imposed restrictions on
states to announce
additional mark-up over
MSP
Proposed restricting
Single web portal for online Amended mining laws to
NREGA to tribal areas and
registration of units,
allow auctioning of non-coal
thus make wages more
reporting of inspections
mines
market determined.

37
Source: Nomura Global Economics.

Modi governments report card


Hits

Coal mine auctions and resolution of power sector


issues.

Telecom auction

FDI in insurance and defense manufacturing hiked to


49% and in rail infra to 100%

Proactive measures to control inflation

Lower MSP

Check on hoarding

Lot of small steps to improve the ease of doing business

Increase in public expenditure on capex with focus on


railways

Jan Dhan Yojana (bank accounts for all)

Differentiated banking licenses

Flexible inflation targeting monetary policy framework

Deregulation of diesel prices

Decentralization with greater involvement of states

Misses

Delay in changes to the land acquisition bill

Lack of progress on GST implementation

Subsidy rationalization (kerosene, urea, food)

Lack of a swift action plan to improve agricultural


productivity

Lack of swift reform in the public sector banks

Education sector reforms

38
Source: Nomura Global Economics.

Reform agenda and timeline


Focus area

Measure

Timeline

Fiscal

Expenditure Reforms (rationalisation of welfare schemes)

Q4 2015

Infrastructure
Agriculture
Ease of doing
business

LPG subsidy cap


GST Bill
E-auction of coal blocks
Land acquisition ordinance to law
Restructure Food Corporation of India
Price stabilization fund
Repeal 72 archaic laws

2016
Q3 2015
Underway
Q3 2015
H2 2015
H2 2015
Q2 2015

Amend labour laws

Underway

Monetary Policy

Setting of MPC

Banking

On-tap/differentiated bank licenses


Lower govt. stake and other reforms in public sector banks

Rural

Reduce MGNREGA coverage

H2 2015
Underway
2015
Unlikely

Key themes

Better governance and higher productivity

An improvement in the ease of doing business

Infrastructure development

Indigenous production (Make in India)

Digital India

Financial inclusion

Source: Nomura Global Economics.

39

FY16 budget: Credible but expansionary


Much more credible assumptions

Fiscal impulse of Central Government spending

FY14

FY15

FY15

FY16

Actual
15635

BE
17949

RE
16812

BE
17775

9.9

19.8

9.9

15.8

Corporation tax (% yy)

10.8

14.3

8.0

10.5

Income tax (% yy)

21.1

16.5

14.2

17.5

Customs (% yy)

4.1

17.2

9.6

10.4

Union Excise Duties (% yy)

-4.0

22.2

9.4

23.9

Service Tax (% yy)

16.6

39.7

8.7

24.8

Non-tax revenue

1992

2125

2178

2217

Disinvestment

276

634

314

695

Capital expenditure

1879

2268

1924

2414

Revenue expenditure

13756

15681

14888

15360

Food subsidy

927

1150

1227

1244

Fertiliser subsidy

680

730

710

730

Oil subsidy

855

634

603

300

Interest payments

3775

4270

4114

4561

5081

5312

5126

5556

Fiscal deficit (% of GDP)

4.5

4.1

4.1

3.9

Revenue Deficit (% of GDP)

3.2

2.9

2.9

2.8

Primary Deficit (% of GDP)

1.2

0.8

0.8

0.7

Net market borrowing

4689

4612

4532

4564

Gross market borrowing

5639

6000

5920

6000

Redemption

950

1388

1388

1436

Fiscal deficit financed through


dated securities

92

87

88

82

INR bn
Total receipts/expenditure
Gross tax revenues

Fiscal deficit

Source: CEIC and Nomura Global Economics.

% of GDP
3
2
1
0
-1
-2

FY05

FY07

FY09

FY11

FY13

FY15

While the assumptions underlying the governments


FY16 budget estimates are more credible, the
government has deviated from the fiscal consolidation
path stated earlier and is now targeting a fiscal deficit
of 3.9% of GDP in FY16 versus earlier target of 3.6%.
Consequently, the fiscal impulse of the budget is likely
to be expansionary.
The government has argued that it is 1) spending
more money on capex and 2) transferring higher
resources to states and there may be consolidation at
40
the aggregate level.

Push towards greater public investment


Public investment (% of GDP)
% of GDP

Capex proposed in FY16 budget


INR bn

Public investment

6.5

6.0
5.5
5.0

FY15RE

FY16BE

Capex on the budget

1924

2414

Capex by CPSEs

2370

3179

Defense

820

820

Total Public capex ex-defence

3475

4774

2.7

3.4

% of GDP

4.5

Multiplier effect of public spending

4.0

Impact
Multipliers

3.5

Combined
Revenue Expenditure
Capital Outlay
Non-defence capital outlay

3.0

Long run
Peak year
Multipliers

0.37
1.29
1.81

0.37
3.56
5.88

1
4
5

0.19
0.39
2.1

0.09
0.85
3.84

1
4

0.6
2.13

0.6
7.61

1
3

2.5
2.0

1967

1975

1983

1991

1999

2007

2015

Centre
Revenue Expenditure
Capital Outlay
Non-defence capital outlay
States
Revenue Expenditure
Capital Outlay

Public investment has fallen in recent years, which the government aims to reverse given private sector balance sheet issues.
Studies have shown strong positive multiplier effect of capex spending especially over four years.
Source: Indian railways, CEIC and Nomura Global Economics.

41

Proposed public investment


Railways proposed investment plan (2015-19)

Roads & urban development


Investment
(INR bn)

INR bn
3500

Roads (Bharat Mala - East to West)

140

100 smart cities - Water, sanitation,


efficient urban mobilit, affordable
housing

480

Urban renewal (AMRUT) - water


supply, sewerage, water drains,
transport

500

Funding for railways

3000

Public sector co.s (1.5)

2500
2000
1500

3000

1000
1500

500

1500

1500
1000

0
Government

LIC

Private sector Tax free bonds/ Public sector


IDF
firms

Railways likely to be a key focus area of the government. Roads and urban development are also likely to remain in focus.
Source: Indian railways, CEIC and Nomura Global Economics.

42

Why the medium-term story is positive


We see a number of factors supporting Indias fundamentals in the medium term

A multi-year growth recovery

Low and stable inflation

A regime shift towards flexible inflation targeting

Incremental supply-side reforms to continue

A stable external sector

43

Overall a problem of plenty on the external sector


BoP forecasts currently tracking a USD45bn surplus in FY16
USD bn
A Current Account
1 Merchandise
Exports
Oil
Non-oil
Imports
Oil
Gold
Non-oil/non-gold
2 Invisibles
Services
Transfers
Income
B Capital Account
3 Foreign Direct Investment (net)
4 Portfolio Investment
Equity (SEBI)
Debt (SEBI)
5 Loans
External Assistance
Commercial Borrowings
Short Term Credit to India
6 Banking Capital
7 Rupee Debt Service
8 Other Capital
C Overall Balance
Current account (% of GDP)

FY13
(88.2)
(195.7)
306.6
60.9
245.7
502.2
164.0
53.8
284.4
107.5
64.9
64.0
(21.5)
89.3
19.8
26.9
25.8
5.2
31.1
1.0
8.5
21.7
16.6
(0.1)
(5.0)
3.8
(4.7)

FY14
(32.4)
(147.6)
318.6
62.7
255.9
466.2
165.2
28.9
272.2
115.2
73.0
65.3
(23.0)
48.8
21.6
4.8
13.5
(4.5)
7.8
1.0
11.8
(5.0)
25.4
(0.1)
(10.8)
15.5
(1.7)

FY15F
(24.1)
(141.3)
318.4
56.1
262.3
459.7
138.3
34.3
287.1
117.2
77.9
65.6
(26.3)
88.2
31.5
42.5
18.4
27.3
6.4
1.4
9.2
(4.2)
12.0
(0.1)
(4.1)
60.1
(1.2)

FY16F
(29.5)
(148.9)
320.9
48.1
272.8
469.8
110.0
35.3
324.5
119.4
82.6
66.3
(29.5)
77.4
32.0
25.0
20.0
8.0
17.5
1.5
12.0
4.0
7.0
(0.1)
(4.0)
45.9
(1.4)

FY17F
(43.9)
(165.9)
339.8
56.1
283.7
505.7
120.0
35.3
350.4
122.0
87.5
66.9
(32.4)
65.4
36.0
20.0
15.0
8.0
22.5
1.5
13.0
8.0
(9.0)
(0.1)
(4.0)
18.5
(1.8)

Improved basic BoP suggests less vulnerability


% of GDP

Basic BoP (CA+ net FDI)

3
2
1
0
-1
-2
-3
-4

FY93

FY97

FY01

FY05

FY09

FY13 FY17E

We expect the current account deficit to remain at sustainable levels (<2% of GDP) and an overall
balance of payments surplus of around USD45bn; the basic BoP has improved sharply.
Source: CEIC and Nomura Global Economics estimates.

44

The good news: Indias love for gold is cooling off


Running an annualized run rate of USD37bn

FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14

Gold
import
volume
mt
612
878
826
818
797
880
982
1106
1219
1141
731

Gold price
$/oz
378
414
477
628
766
868
1024
1295
1647
1654
1328

Gold import
value
USD bn
7
10
11
14
16
21
29
41
56
54
28

FY15

890

1240

35.5

USD bn

RBI imposes restriction


on gold imports

RBI eases
restrictions on
imports

7
6

Avg: 4.9bn

Gold imports

4
Avg: 3.1.bn

3
Avg: 1.3.bn

2
1
0
Mar-13

Sep-13

Mar-14

Sep-14

Mar-15

Gold imports rose sharply in March but since there were no major policy changes to drive gold imports higher, the
pickup in gold imports could be a one-off, in our view.
Despite the sharp rise in March, the monthly run rate is still contained at USD3.1bn (annualized: USD 37.2bn, since
the easing of gold import restrictions in June 2014).
Overall, with gold prices in check and inflation under control, we expect investment and inflation hedge-related
demand for gold to remain contained.
The upcoming gold monetisation scheme aimed at increasing the domestic recycling of gold is likely to further
reduce reliance on imported gold.

Source: CEIC and Nomura Global Economics estimates.

45

FDI inflows surge sharply this year


Net FDI inflows tracking >USD30bn in FY15
USD bn
40

USD bn, lhs

Where has the incremental FDI flown in?


FDI inflows (USD mn)

% of GDP
2.0

% of GDP, rhs

35

1.8

Power

2014

1.6
Mining

30

2012-13 (Avg)

1.4
25
20
15

1.2

Computer Software &


Hardware

1.0

Auto

0.8

Oil & Gas

0.6
10

Trading (wholesale cash &


carry)

0.4
5

Telecom

0.2
0

1000

2000

3000

A substantial portion of the current account deficit is being financed through more stable net FDI
inflows. FDI inflows are up sharply led by investment in telecom, wholesale trading, oil & gas, auto,
power and mining sectors.
Source: CEIC and Nomura Global Economics estimates.

4000

0.0

46

Why is India better placed this time?


Much bigger firewall of FX reserves

Better placed than peers


% of GDP (4-qtr sum)
0
-1
-2
-3
-4
-5
Sep-13
-6
-7
Sep-14
-8
India
Indonesia

USD bn
400
FX reserves
350

300

250

200

150

100
Apr-05

Apr-07

Apr-09

Apr-11

Apr-13

Apr-15

India
China
Indonesia
Russia
South Africa
Turkey
Brazil

GDP growth
2014 2015
% y-o-y
7.2
7.6
7.4
6.8
5.0
5.2
0.6
-4.4
1.6
1.9
2.9
3.4
0.1
0.0

South
Africa

CPI inflation
2014 2015
% y-o-y
7.2
5.4
2.0
1.5
6.4
7.1
7.8
13.1
6.1
4.4
8.9
6.5
6.4
7.0

Brazil

Turkey

Policy rate
FX
2014 2015 2014 2015
% pa
against USD
7.00
7.25
63.4
62.9
2.75
2.50
6.1
6.1
7.75
7.00 12650 13100
17.00 12.00 60.5
65.0
5.75
6.50
11.6
11.3
8.25
7.00
2.4
2.4
11.75 13.00
3.0
3.1

India is much better placed to manage any volatility in the financial markets owing to Fed
interest rates liftoff owing to 1) much higher reserves and 2) better fundamentals as compared
with 2013 and as compared with peers.
47
Note: 2015 are Nomura forecasts. Source: Bloomberg, CEIC and Nomura Global Economics.

Why is RBI not defending the topside?


Real Effective Exchange Rate

Import cover

Index
130

36 countries

FCA (Months of import cover)

Months

6 countries

Threshold

18

125
120

16

115

14

110
12
105
10

100

95
90

85
Mar-07

Mar-09

Mar-11

Mar-13

Reason 1: Fair valuation


On a REER basis, INR is around 8-15% overvalued
currently. Adjusting for productivity differentials, the
overvaluation is around 4-6%.

Mar-15

4
Mar-95

Mar-99

Mar-03

Mar-07

Mar-11

Mar-15

Reason 2: Reserve adequacy


Assuming a comfortable threshold of nine months,
India needs to add ~USD20bn to its reserves from
current levels (USD340bn).

48
Source: CEIC and Nomura Global Economics.

Nomura strategy views


Long equity, relative INR outperformance and long bonds

Equity: Dec 2015 Sensex target of 33500 (~20% upside). O/W sectors: Financials, autos, industrials and
technology. U/W: Consumer staples, pharmaceuticals, metals and telecoms.

FX: USD/INR (current: 63.5) to depreciate to 64.4 in Q3 2015, appreciate to 63.3 in Q4 2015 and further to 62.9

in end-2016.

Rates: 10yr bond yields (cur: 7.77%) to fall to 7.5% by Q2 2015 and 7.2% by end-2015, staying unchanged
thereafter in 2016. On swaps, we hold a flattener view.

49

Equity Strategy: Out of the pit stop (Prabhat Awasthi)


Rate and growth cycles improving together
35
Sensex 12-m Forward P/E

30
25

15.6x as on
29 Apr '15

20
15
10
5

End-Dec 2015 Sensex target of 33,500 implies ~20% potential upside


Five reasons for our positive stance: falling cost of capital; cyclical and structural improvement in growth; a positive terms-of-trade
shock; a right-of-centre governance; support from rising profitability on increasing asset utilisations, and rising margins on lower raw
material and interest costs.

We value the market on a one-year forward P/E of 16.6x, a 10% premium to its five-year average of 15.1x.
Over-weights: Financials, autos, industrials and technology.
Under-weights: Consumer staples, pharmaceuticals, metals and telecoms.
Our top five stock picks for 2015 are AXSB, HCLT, MSIL, NBCC and UNBK.
Source: Nomura Research

50

FX Strategy: INR outperformance to continue (Craig Chan)


Foreign equity flows vs. RBI intervention

Favourable FEER model valuation


Extent of overvaluation
%
India

-9.6

Indonesia

3.6

Taiwan

-48.6

Korea

-7.5

Thailand

-6.3

Hong Kong

1.1

Philippines

-12.3

Malaysia

-3.2

China

-4.9

Singapore

-24.3

Our view on the RBIs FX interventionist stance remains unchanged, in that while we believe the RBI still has a bias to
accumulate USDs it has become less aggressive. We measure this by looking at the RBIs spot and FX forward actions against
net foreign bond and equity inflows. This ratio has fallen from 4.1 in mid-2014 to around 1.6 in February 2015.

Our current account-based FX valuation model (FEER) shows INR is actually undervalued by around 9.6%. This macro balance
approach calculates FX valuation through the structural and equilibrium current account gap.

Overall, we continue to expect INR outperformance against the NDF and within the Asia region.

Near-term risks: Some possible disappointments on the land acquisition bill and the Minimum MAT issue.

Source: Nomura and Bloomberg

51

Rates Strategy : Long India bonds (Vivek Rajpal)


10yr bond yields and repo rate

OIS curve pricing in aggressive rate cuts

%
9.5

IGB 10yr generic yield

bp

Repo rate

0
-10
-20
-30
-40
-50
-60
-70
-80
-90
-100

9.0
8.5
8.0
7.5
7.0
Apr-12

-31
-51

Apr-13

Oct-13

Apr-14

Oct-14

-58

-87
0m

Oct-12

Latest (28-Apr-15)

3m

6m

12m

24m

Apr-15

Target 10yr bond yield at 7.20% due to lower inflation, tapering net supply and easing expectations. We continue
to hold the IGB 8.12 2020 (current: 7.75%; target: 7.30%) and IGB 8.28 2027 (current: 7.77%; target: 7.30%).
On swaps, we hold our 3mfwd1s5s flattener as we expect the swap curve to flatten as front-loading of rate cut
expectations are pushed back.
However, OIS curve is still pricing in approximately ~58bp of an equivalent cut within one year and ~90bp of rate
cutting in two year time. The aggressive pricing in front-end rates makes forward curves steeper relative to spot
curve.
52
Source: Nomura, Bloomberg

Appendix

The new GDP puzzle


Changes in real growth
FY13

FY14

FY15

Old

New

Delta

Old

New

Delta

New

Agriculture, forestry and fishing

1.4

1.2

(0.2)

4.7

3.7

(1.0)

1.1

Mining and quarrying

(2.2)

(0.2)

2.0

(1.4)

5.4

6.8

2.3

Manufacturing

1.1

6.2

5.1

(0.7)

5.3

6.0

6.8

Electricity, gas, w ater supply

2.3

4.0

1.7

5.9

4.8

(1.1)

9.6

Construction

1.1

(4.3)

(5.4)

1.6

2.5

0.9

4.5

Trade, repair, hotels and restaurants

4.5

10.3

5.8

1.0

13.3

12.3

9.7

Transport, storage, communication

6.0

8.4

2.4

6.1

7.3

1.2

6.0

Financial, real estate & business services

10.9

8.8

(2.1)

12.9

7.9

(5.0)

13.7

Community, social & personal services

5.3

8.8

3.5

5.6

7.9

2.3

9.0

Total gross value added

4.5

4.9

0.4

4.7

6.6

1.9

7.5

% y-o-y
12

GDP_new base

10
8
6
4
2
0

GDP_old base

1990

1995

2000

2005

2010

2015

What: GDP growth revised up by ~2pp in FY14 and FY15. Led by manufacturing and trade sectors
Why?

Better coverage

Consistent with SNA 2008

Local bodies (60-70%) captured

Wider data coverage (MCA21 database): 0.5 million companies (85% of companies) up from 2500 earlier

Volume versus value addition

Enterprise vs establishment-level data: Now captures services by manufacturing firms

Service/sales tax growth for capturing value addition


54

Source: CEIC and Nomura Global Economics.

Weak PSB = An opportunity for other banks?


Share in gross NPA (% of total)

Capital requirements for public sector banks

100

INR bn
700

90
80

SBI/BOB/PNB

600

70

Total ex
SBI/BOB/PNB

500

60

Total PSUs

50

400

40

300

30
20

200
10
0

100
FY10

FY11

Public sector banks

FY12

FY13

Private sector banks

FY14

FY15

Foreign banks

FY15

FY16

FY17

FY18

FY19

PSU banks require INR1649bn as capital between FY15 and FY19. Worryingly most of the capital requirement
comes from banks other than the big 3, whose ability to raise and lend capital is likely to be relatively weaker.
This is likely to be a constraint on the transmission of monetary policy easing and thus may reduce the efficacy of
rate cuts on boosting capital flows to the economy.

Opportunity: For private banks, and also for reforms in public sector banks.
Source: Nomura, Bloomberg

55

Leveraged balance sheets a hurdle


Debt-equity ratio
%
130

BSE500 Ex Banks

Sectoral debt-equity ratio


Debt to Equity Ratio (%)

Mar-91

Mar-06

Mar-10

Mar-14

Automobile

125.8

75.3

110.9

82.2

120

Capital Goods - Elec Equipment

111.0

42.3

60.5

59.8

110

Cement

91.9

64.3

43.0

70.4

100

Chemicals

122.9

55.7

46.7

56.6

Construction

148.8

123.8

191.2

272.8

91.3

41.5

55.2

75.5

107.4

48.8

76.6

97.2

87.0

62.2

89.4

154.0

153.4

283.5

57.8

66.3

73.3

48.6

56.7

70.7

Telecomm-Service

198.7

57.9

53.2

136.1

Textiles

142.5

104.4

119.3

100.1

BSE500 Ex Banks

110.0

57.3

73.6

95.7

90

FMCG

80

Metals/Steel & Mining

70

Power Generation & Distribution

60

Realty

Refineries

50
40

Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar- Mar92
94
96
98
00
02
04
06
08
10
12
14

Leverage has been building since the financial crisis. Infrastructure developers, power generation, steel and
telecoms have experienced a significant debt buildup.
While rising equity markets and monetary easing may help improve the stressed balance sheets, the pace has
been very gradual.
Thus, monetary easing at this stage is likely to push credit flow towards retail sector and may reignite the
imbalances in the economy.
Source: Media reports, CapitalLine and Nomura Global Economics.

56

The role of inflation expectations


but what happens if crude oil prices move higher?

Inflation expectations have fallen

3-months ahead

% y-o-y

% y-o-y

USD/bbl

14

140

14

12

120

12

10

100

80

60

Inflation expectations, lhs

16

12-months ahead

10
8
6

Inflation expectations, lhs


4

4
2
Mar-07

Mar-09

Mar-11

Mar-13

Mar-15

2
Sep-06

40

Global crude oil prices, rhs

Oct-08

Nov-10

Dec-12

Jan-15

20

57
Source: CEIC and Nomura Global Economics

Impending inflationary fiscal impulses


7th Pay Commission

Goods and Services Tax

% of GDP

% of GDP
2.4
5th CPC

6th CPC

7th CPC

2.2

11.1

Services (exHousing)

18.2

Housing

2.0

Goods

10.1

1.8
Food

1.6

Fuel

45.9

14.7

1.4
1.2

Weight in the CPI basket (%)


FY96

FY99

FY02

FY05

FY08

FY11

FY14

FY17

The government is due to implement the 7th Pay


Commission recommended hikes sometime in
FY17. Past wage hikes had a substantial fiscal
impact and also increased the disposable income of
government employees.
Source: Ministry of Finance, CEIC and Nomura Global Economics

The near- term impact of GST may be inflationary


given that 1) services will be taxed at higher rate
compared to current rate of 14%; 2) increased tax
compliance may mean increased tax incidence on
the customers.

58

Political strategy: Consolidate in Rajya Sabha


Lok Sabha (lower house); total seats: 543
NDA
UPA
AITMC
BJD
Others
AIADMK

AIADMK, 37

Others, 56

Rajya Sabha (upper house); total seats: 245

Others, 71

NDA, 65

NDA
UPA
AIADMK
AITMC
BSP
Others

BJD, 20

AITMC, 34

BSP, 14

UPA, 60

UPA, 77

NDA, 336

AITMC, 12
AIADMK, 11

BJP has an outright majority in the Lok Sabha (lower house), but lacks majority in the Rajya
Sabha (upper house)

Source: ECI and Nomura Global Economics.

59

Monetary policy transmission weak so far


Policy rate and lending rates
Repo rate

Base rate

Transmission in previous cycles

Deposit rate

%
11

bps
2001-2005
2005-2008
2008-2009
2010-2011
2012 - Jun 2013
2013 Jul - 2014 Mar
2014 Apr -date

10
9
8

Repo
rate
(300)
300
(425)
375
(125)
75
(50)

Base
rate

263
(33)
20
(14)

PLR
(190)
460
(163)
292
(28)
13
(10)

Deposit
rate
(438)
388
(288)
225
(63)
38
(25)

7
6
5
4
Mar-07

Mar-09

Mar-11

Mar-13

Mar-15

Monetary policy transmission has been weak due to high NPAs in the banking system
Only half of the 50bp rate cut since January has been transmitted so far
Source: Nomura, Bloomberg

60

Still significant scope for an equity catch-up


Equity index versus market cap
% of GDP
160

M-Cap (% of GDP), lhs


Sensex, rhs

140
120

Cross-country market-cap comparison


Index
35000

% of GDP
160

30000

140

25000

120

100
20000
80

India

Philippines

Korea

Indonesia

Thailand

100
80

15000
60

60

10000

40

40

5000

20
0
Apr-99

Apr-03

Apr-07

Apr-11

0
Apr-15

20
0
Mar-03

Mar-07

Mar-11

Mar-15

Indias equity market capitalisation remains well below both its own historical average and most of
its Asian peers, which indicates significant upside potential.
Source: CEIC and Nomura Global Economics.

61

Where is the bonanza given to states?


Net resource transfer to states

Aggregate budget of the 16 states

INR bn

FY14

FY15BE

FY15RE

FY16BE

States' share of taxes and Duties

3182

3822

3378

5240

Total Grants & Loans

2100

4056

3552

3283

Recovery of Loans & Advances


(less)

101

88

90

93

Net Resources transferred to


States & UT

5181

% of GDP

4.6

7790
6.1

6840
5.4

Windfall from the coal mine auctions


Over the lifetime
of the mines
INR bn

In first year (10


% of total)
INR bn

M Pradesh

355.9

35.6

Jharkhand

126.2

12.6

Chattisgarh

336.8

33.7

5.2

0.5

West Bengal

112.0

11.2

Total

936.1

93.6

Orissa

8430
6.0

% of GDP

FY14

FY15BE

FY15RE

FY16BE

Revenue receipts

8.6

10.4

10.3

10.3

Transfer from center

3.3

4.9

4.8

4.6

States own

5.2

5.5

5.5

5.7

Capital Receipts

1.6

1.7

2.0

1.8

Non -debt

0.0

0.0

0.1

0.0

Debt receipts
Total
expenditure/receipts
Revenue expenditure

1.6

1.7

1.9

1.7

10.2

12.1

12.2

12.1

8.6

10.1

10.2

10.0

Capital expenditure

1.6

2.0

2.0

2.1

Fiscal Deficit

1.6

1.6

1.9

1.7

Primary Deficit

0.5

0.6

0.8

0.6

Revenue Deficit

0.0

(0.3)

(0.3)

(0.4)

State-wise fiscal deficit

62
Source: Nomura Global Economics.

Fiscal stance is expansionary


Cyclically adjusted fiscal balance
% of GDP
4

Fiscal impulse
% of GDP
3

Cyclical fiscal balance (a-b)


Structural fiscal balance (b)

State

Center

Combined

Actual fiscal balance (a)

1
-2

-4
-6

-1

-8

-2

-10

FY05

FY07

FY09

FY11

FY13

FY15

-3

FY06

FY08

FY10

FY12

FY14

FY16

We estimate that the cyclically-adjusted fiscal balance (centre + 16 states) will worsen from an
estimated 5.9% of GDP in FY15 to 6.2% in FY16, leading to a positive fiscal impulse of 0.3-0.4pp after
three consecutive years of a negative fiscal impulse.
Overall, our analysis suggests that the general governments fiscal stance is mildly expansionary in
FY16 and positive for growth, which reduces the need for an accommodative monetary policy at the
margin.

63
Source: Nomura Global Economics.

Sensitivity of trade to REER


Imports are more sensitive to REER than exports
10% appreciation in
REER

Import growth

Sensitivity

Export growth
-1.6% (Not
significant)

11.8%

Lag

1-2 Quarters

2 Quarters

Within imports, consumption goods are more sensitive to REER and demand than capital
10% appreciation
goods
1% increase in demand
REER

Import growth

Sensitivity

Consumption
goods
Capital goods

16.7%
9.8%

Lag
(Quarters)
2
2

Sensitivity
3.3%
1.4%

Lag
(Quarters)
2
1

Both exports and imports are sensitive to demand (world and domestic, respectively)
1% increase in demand
Sensitivity
Lag

Import growth Export growth


4.1%
2 Quarters

6.0%
0

64
Source: CEIC and Nomura Global Economics

Appendix A-1
Analyst Certification
I, Sonal Varma, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report,
(2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any
specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

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Valuation methodology - Fixed Income
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