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September 01, 2010

Economics Group

Special Commentary

Jay H. Bryson, Global Economist

jay.bryson@wellsfargo.com ● 1-704-383-3518

Indian Economy Booming Again

Executive Summary
In the first of two special reports on the Indian economy, we discuss current economic
developments in India. In general, the economy is booming again. With the primary economic
risk shifting from insufficient growth to unacceptably high inflation, the Reserve Bank of India
(RBI), which has already raised rates by 100 bps, will likely tighten further in the months ahead.
We expect economic growth in India to slow modestly next year as exports decelerate and
tightening measures begin to bite. Favorable economic fundamentals, namely the country’s high
rates of domestic savings and investment and its positive population growth rate, should keep
economic growth well supported in the long run. However, a number of deep-seated problems
could prevent India from realizing its true potential. In a follow-up report, we will describe some
of the country’s longer-run opportunities and its challenges.
The Indian Economy Has Fully Recovered From Its Slowdown
Recently released data show that the year-over-year rate of real GDP growth in India edged up to
8.8 percent in the second quarter from 8.6 percent in the first quarter of 2010 (Figure 1). A
breakdown of the real GDP data by industry shows that slower growth in the goods-producing
sectors of the economy was offset by stronger growth in the service sectors and in agricultural
output (Figure 2). Mining and manufacturing showed the sharpest deceleration between the first
and second quarters of 201o. That said, year-over-year growth rates in both sectors remained well
within double-digit territory. Growth rates in the energy and construction sectors slowed
Figure 1 Figure 2
Indian Real GDP Indian GDP Growth By Industry
Year-over-Year Percent Change Year-over-year percent change
12% 12% 18% 18%
Year-over-Year Percent Change: Q2 @ 8.8% Q1-2010
16% 16%
11% 11% Q2-2010

14% 14%
10% 10%
12% 12%

9% 9%
10% 10%

8% 8% 8% 8%

6% 6%
7% 7%
4% 4%
6% 6%
2% 2%

5% 5% 0% 0%
2004 2005 2006 2007 2008 2009 2010 Total Ag. Mining Manu. Energy Const. Trade Finance Other

Source: IHS Global Insight and Wells Fargo Securities, LLC

In contrast, the year-over-year growth rate in community, social and personal services, which
accounts for 13 percent of value-added in the economy jumped to 6.7 percent in the second

This report is available on wellsfargo.com/research and on Bloomberg WFEC

Indian Economy Booming Again WELLS FARGO SECURITIES, LLC
September 01, 2010 ECONOMICS GROUP

quarter from 1.6 percent in the first quarter. The agricultural sector, which represents about
15 percent of the economy, also accelerated. 1 Agricultural output was depressed last year by the
drier-than-normal monsoon season, and the bounce-back in output this year reflects a return to
more normal weather conditions.
The Indian Although economic growth in India is still short of the nine-percent-plus rates that were
economy has registered a few years ago, the 8.8 percent year-over-year growth rate that was achieved in the
bounced back from second quarter is the strongest year-over-year growth rate since the fourth quarter of 2007, just
its marked before the global economy hit the skids. The bottom line is that the Indian economy has bounced
slowdown in 2008- back from its marked slowdown in 2008-2009.
Looking forward, we expect that the overall rate of real GDP growth in India will moderate
somewhat. 2 Although exports are less important for India than for most other Asian economies,
slower growth in the rest of the world should have an adverse impact on Indian export growth in
the quarters ahead. 3 In addition, the modest tightening measures to date by the RBI, which are
discussed in more detail below, should also lead to slower growth. That said, the balance of risks
at present appear to be skewed toward unacceptably high inflation rather than insufficient
economic growth.
Strong Growth = Higher Inflation and Wider Trade Deficit
WPI inflation has Because the weights in the consumer price index have not been updated for years, the wholesale
shot up to double- price index (WPI) is considered to be the benchmark price index in India. As shown in Figure 3,
digit rates this WPI inflation has shot up to double-digit rates this year. Although some of the acceleration in the
year. WPI reflects sharp increases in food and energy prices earlier this year, prices of manufactured
products, which make up nearly two-thirds of the WPI index, have also increased markedly.
Figure 3 Figure 4
Indian Wholesale Prices Indian Merchandise Trade Balance
Year-over-Year Percent Change Billions of Rupees, Not Seasonally Adjusted
14% 14% 100 100
Total: Jul @ 9.9%
Manufactured: Jul @ 6.1%
12% 12% 0 0

10% 10% -100 -100

8% 8% -200 -200

6% 6% -300 -300

4% 4% -400 -400

2% 2% -500 -500

0% 0%
-600 -600
Merchandise Trade Balance: Jun @ -491.5B Rupees
-2% -2%
-700 -700
2002 2004 2006 2008 2010
2002 2004 2006 2008 2010

Source: IHS Global Insight and Wells Fargo Securities, LLC

The overall rate of WPI inflation should moderate somewhat in the months ahead due to recent
declines in food and energy prices. However, acceleration in the prices of manufactured goods
this year shows that inflationary pressures are more widespread than simply in the commodities
space. Moreover, there is a risk that inflation could continue to spiral higher as workers attempt
to recoup lost purchasing power via higher wages. Although a measure of aggregate Indian wage

1 The percent of value-added in the Indian economy that is accounted for by the agricultural sector has
declined to 15 percent today from 30 percent about 20 years ago. This decline in agriculture’s share of the
economy reflects, at least in part, the reforms of the early 1990s that helped to boost growth in other
sectors. As a point of reference, agriculture accounts for only 1 percent of value-added in the U.S.
2 As shown in our Monthly Economic Outlook, which is posted at www.wellsfargo.com/economics, we
project that real GDP growth in India will slow to 7.5 percent next year from 8.5 percent in 2010.
3 The export-to-GDP ratio in India is a bit north of 20 percent, whereas the comparable ratio in China is
about 40 percent. Hong Kong, Malaysia and Singapore, which are all small open economies, have
exports-to-GDP ratios that range from 100 percent to 300 percent.

Indian Economy Booming Again WELLS FARGO SECURITIES, LLC
September 01, 2010 ECONOMICS GROUP

rates is not readily available, data from the textile industry show that wages accelerated sharply
earlier this year in conjunction with the marked increase in WPI inflation. If employers pass on
recent wage increases, prices of goods and services could accelerate even further.
The widening in the trade deficit that has occurred over the past year or so is another indication
that the economy may be running a bit hot (Figure 4). The value of the country’s exports in the
first half of 2010 grew 24 percent relative to the same period in 2009. However, import growth
was even stronger—up 34 percent on a year-ago basis—and strength in imports is often a sign that
domestic demand is growing rapidly. Although reliable data on overall retail spending are not
readily available, the 30 percent increase in auto sales this year indicates that consumer spending
is alive and well, and some of this strength in consumer spending is undoubtedly helping to drive
robust import growth.
Thus, most signs suggest that growth in domestic demand is very strong at present and that If inflation remains
inflationary pressures may be building. Consequently, the RBI has raised its main policy rate by elevated, the RBI
100 bps since mid-March (Figure 5). Although most analysts look for another 50 bps or so of could hike more
tightening by early next year, the policy rate would remain well below rates that prevailed in than most investors
2008, at the height of the last inflation scare in India. If inflation remains elevated, the RBI could currently expect.
clearly hike more than most investors currently expect.
Figure 5 Figure 6
Reserve Bank of India Repo Rate National Savings and Investment in India
Percent As a Percentage of GDP
10.00 10.00 40% 40%
Gross Domestic Investment: 2009 @ 34.3%
Gross National Saving: 2009 @ 32.5%

8.00 8.00 35% 35%

6.00 6.00 30% 30%

4.00 4.00 25% 25%

20% 20%
2.00 2.00

Repo Rate: Aug @ 5.75%

15% 15%
0.00 0.00
1980 1984 1988 1992 1996 2000 2004 2008
2007 2008 2009 2010

Source: IHS Global Insight, Institute of International Finance, and Wells Fargo Securities, LLC
Despite some slowing next year, we generally remain upbeat on India’s growth prospects, at least We generally
over the next few years. Unlike China, where population growth has slowed to a trickle, India’s remain upbeat on
population is increasing more than 1.5 percent per annum at present, and demographers project India’s growth
continued solid growth for the foreseeable future. More people mean greater demand for goods prospects.
and services. In addition, the increase in the national savings rate that has occurred over the past
decade or so has helped to finance strong rates of investment (Figure 6). Increases in the labor
force, which are associated with strong population growth, and the capital stock, which reflect
robust growth in investment spending, are the wellsprings of long-term economic growth. These
determinants of long-run economic growth should remain favorable for the foreseeable future.
That said, there is no guarantee that India will fully realize its growth potential in the long run
due to some deep-seated problems. The government has been incurring large budget deficits for
years, the country’s infrastructure is notoriously poor, the labor market is inflexible, and
corruption is endemic. However, a more thorough discussion of India’s long-term potential
versus its deep-seated problems is beyond the scope of this current report. We will address long-
term considerations in a second report that we plan to release soon.

Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg Global Head of Research (704) 715-8437 diane.schumaker@wellsfargo.com

& Economics (212) 214-5070

John E. Silvia, Ph.D. Chief Economist (704) 374-7034 john.silvia@wellsfargo.com

Mark Vitner Senior Economist (704) 383-5635 mark.vitner@wellsfargo.com
Jay Bryson, Ph.D. Global Economist (704) 383-3518 jay.bryson@wellsfargo.com
Scott Anderson, Ph.D. Senior Economist (612) 667-9281 scott.a.anderson@wellsfargo.com
Eugenio Aleman, Ph.D. Senior Economist (612) 667-0168 eugenio.j.aleman@wellsfargo.com
Sam Bullard Senior Economist (704) 383-7372 sam.bullard@wellsfargo.com
Anika Khan Economist (704) 715-0575 anika.khan@wellsfargo.com
Azhar Iqbal Econometrician (704) 383-6805 azhar.iqbal@wellsfargo.com
Ed Kashmarek Economist (612) 667-0479 ed.kashmarek@wellsfargo.com
Tim Quinlan Economist (704) 374-4407 tim.quinlan@wellsfargo.com

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