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Perspectives on the Indian Economy and the Financial Sector Renny Thomas, Partner McKinsey & Company
Perspectives on the Indian
Economy and the Financial Sector
Renny Thomas, Partner McKinsey & Company
October 2007
This report is solely for the use of client personnel. No part of it may be
circulated, quoted, or reproduced for distribution outside the client
organization without prior written approval from McKinsey & Company.
This material was used by McKinsey & Company during an oral
presentation; it is not a complete record of the discussion.
CONTENTS • Perspectives on Indian Economy – Context of Indian economy – Forces likely to
CONTENTS
• Perspectives on Indian Economy
– Context of Indian economy
– Forces likely to propel India ahead
– Challenges for the growth
Perspectives on Indian Financial Sector
1
INDIA’s GDP HAS RISEN STEADILY SINCE THE Real GDP growth* US$ billion 7.3% 709 Average
INDIA’s GDP HAS RISEN STEADILY SINCE THE
Real GDP growth*
US$ billion
7.3%
709
Average growth
rate of 8.6% over
the last 4 years
5.2%
464
4.4%
279
3.4%
118
60
1950
1970
1990
2000
2006
Population
365
548
850
1,016
1,112
(Million)
* Base year = 2002
Source: Global Insight; Economic Survey of India; Team Analysis
2
AS GROWTH HAS INCREASED VOLATILITY HAS DECREASED Per cent 7 10-year 6 mean growth 5
AS GROWTH HAS INCREASED VOLATILITY HAS DECREASED
Per cent
7
10-year
6
mean growth
5
4
3
2
10-year
1
volatility of
GDP growth
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Source: RBI; EIU
3
AND TRANSFORMED INDIA FROM AN AGRARIAN TO A SERVICES-LED ECONOMY Value added to GDP (Per
AND TRANSFORMED INDIA FROM AN AGRARIAN TO A
SERVICES-LED ECONOMY
Value added to GDP (Per cent)
India
China
25.0
Services**
39.0
40.0
55.0
46.0
Industry*
24.0
50.0
27.0
Agriculture
37.0
29.0
18.0
10.0
1980
2006
1980
2005
* Industry includes Mining, Manufacturing, Electricity ,Gas & Water and Construction **Services includes Whole & retail Trade, Restaurants &
Hotels, Transportation & Communications, Finance, Insurance, Real Estate & Business Services and Community, Social & Personal Services
Source: Global Insight; Team Analysis
4
SEVERAL MEGA INFRASTRUCTURE PROJECTS ARE SET TO CHANGE THE LANDSCAPE High Low Likelihood of Project
SEVERAL MEGA INFRASTRUCTURE PROJECTS
ARE SET TO CHANGE THE LANDSCAPE
High
Low
Likelihood of
Project
completion
Planned spending
(timeframe)
Details
US$ billion
2 (2006-07)
National Rural Health Mission*
• Providing basic healthcare services to the rural
population
National Urban Renewal
Mission*
1 (2006-07)
• Developing urban infrastructure and providing
basic services to the urban poor in ~ 63 cities
2 (2006-07)
Sarva Shiksha Abhiyan*
• Extending primary education to all children,
especially in rural India
National Rural Employment
Guarantee Scheme*
3.2
(2006-07)
• Providing income security to the poor and
bridging the rural poverty gap
1.1
(2006-07)
Mid-day Meal Scheme*
• Providing free mid-day meals to all children in
government, corporation, panchayat and
municipal schools
Rajiv Gandhi Drinking Water
Mission*
1.1
(2006-07)
• Supplying safe drinking water in the rural areas
0.2
(2006-07)
• Extending sanitary facilities in rural India
Total Sanitation Campaign*
Integrated Child Development
Services*
0.9
(2006-07)
• Improving the nutritional and health status of
children in the age group of 0-6 years and
reducing the incidence of infant mortality
4 (2010)
Commonwealth Games 2010
• Upgrading Delhi’s infrastructure in preparation
for games
* Government Flagship Programmes
Source: Economist; Press-articles; Government Budget Speech 2006-07; Analyst Reports; Team Analysis
5
CONTENTS • Perspectives on Indian Economy – Context of Indian economy – Forces likely to
CONTENTS
• Perspectives on Indian Economy
– Context of Indian economy
– Forces likely to propel India ahead
– Challenges for the growth
Perspectives on Indian Financial Sector
6
A GROWING WORKING AGE POPULATION WILL PROPEL GROWTH TILL 2035 LATER THAN CHINA Working age
A GROWING WORKING AGE POPULATION WILL PROPEL
GROWTH TILL 2035 LATER THAN CHINA
Working age population (age 15-60)
Per cent of total population
72%
- Average no. of
people per
household in 2007
70%
68%
India
5.5
66%
Brazil
4.0
64%
62%
China
3.7
60%
Russia
2.8
G6
58%
2000
2005
2010
2015
2020
2025
2030
2035
2040
Source: Global Insight; Team Analysis
7
HOUSEHOLD INCOMES WILL ACCELERATE ACROSS INDIA Average household disposable income Thousand; Indian rupees; 2000
HOUSEHOLD INCOMES WILL ACCELERATE ACROSS INDIA
Average household disposable income
Thousand; Indian rupees; 2000
Compound annual
growth rates
1985-2005
2005-2025
Actual
Forecast
Urban
500
400
All India
300
5.8%
200
5.3%
Rural
3.6%
4.6%
3.6%
100
2.8%
0
1985
1990
1995
2000
2005
2010
2015
2020
2025
Source: McKinsey Global Institute
8
THE SHAPE OF INDIA’s INCOME PYRAMID WILL CHANGE DRAMATICALLY AS INCOMES GROW Household income brackets
THE SHAPE OF INDIA’s INCOME PYRAMID WILL CHANGE
DRAMATICALLY AS INCOMES GROW
Household income
brackets
Number of
Aggregate
households
consumption
Thousand, Indian
rupees, 2000
Million
Trillion, Indian rupees,
2000
Globals (>1,000)
1.2
1.2
• Middle class to
swell from just
Strivers (500–1,000)
2.4
1.0
under 50 million
Seekers (200–500)
10.9
2.1
today to about
583 million by
Aspirers (90–200)
91.3
8.5
2025
Deprived (<90)
101.1
4.1
• By 2025, India will
Globals (>1,000)
3.3
4.1
produce 2 million
Strivers (500–1,000)
5.5
2.7
globals annually
Seekers (200–500)
55.1
11.8
• Share of incomes
Aspirers (90–200)
106.0
12.2
of the middle
class and globals
Deprived (<90)
74.1
3.3
will rise from less
Globals (>1,000)
9.5
14.1
than 30% today to
more than 80% by
Strivers (500–1,000)
33.1
16.5
2025
Seekers (200–500)
94.9
24.6
Aspirers (90–200)
93.1
11.9
Deprived (<90)
49.9
2.4
Source: MGI India Consumer Demand Model, v1.0
9
200520152025
CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$585 BILLION DURING 2007-12 (1/2) Expected Area spend
CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER
~US$585 BILLION DURING 2007-12 (1/2)
Expected
Area
spend
Key projects
US$ billion
Roads
96
• Six-laning of 6,500 kms and four-laning ~18,000
kms of corridors and highways
• Dedicated Freight Corridors between Mumbai-
73
Railways
Delhi and Ludhiana-Kolkatta, ~10,300 kms of new
railway lines; modernisation of 21 railway stations
Power
(generation,
transmission,
and distribution)
177
• Additional generation capacity of ~70,000 MW
(includes rural areas)
21
Ports
• Capacity addition of 485 million MT in major
Ports; 345 million MT in minor Ports
• Modernisation and redevelopment of 4 metro and
10
Airports
35 non-metro airports
• Construction of 7 green-field airports in North
East
Source: Planning commission;
10
CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$585 BILLION DURING 2007-12 (2/2) Expected Area spend
CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER
~US$585 BILLION DURING 2007-12 (2/2)
Expected
Area
spend
Key projects
US$ billion
Communi-
• Growing subscriber base to 600 million, including
200 million rural telephone connections
77
cation
• Providing broadband access to 20 million and 40
million internet connections
Water
57
• Water supply and sanitation projects
Irrigation
62
• Developing 16 million hectares through major,
medium and minor irrigation works
• Gas distribution infrastructure
Gas
6
– LNG terminals, gas transmission lines, city gas
distribution
• Storage to support agricultural development
6
Storage
Total
585
Source: Planning commission;
11
A ROBUST AND HIGH-GROWTH PRIVATE SECTOR CONTINUES TO BOOST CONFIDENCE LEVELS The transformation Local corporates
A ROBUST AND HIGH-GROWTH PRIVATE SECTOR
CONTINUES TO BOOST CONFIDENCE LEVELS
The transformation
Local corporates expanding overseas
Number of billion dollar companies
Spurt in number of cross-border deals by Indian
companies
2006
2007*
175%
88
Deals #
163
143
increase
5
Value
$23 bn
$18 bn
9
Some success stories
30
• Incorporated in 1995, world's 5th
leading & Asia's leading manufacturer
of wind turbines
• Current sales of US$1.7 billion and
market cap of US$9.8 billion
32
>US$10 bn
1
• Became a bank in 2000; 2 nd largest bank
in India today
US$5-10 bn
4
• 30-50% market share across classes
6
44
US$2-5 bn
• Current market cap* US$24 billion
• (US$0.6 billion in 2000**)
US$1-2 bn
21
• India's largest automobile company,
with revenues of US$6.9 billion 2006-07
1998
2007
• World's fifth largest medium and heavy
commercial vehicle manufacturer
• Current market cap of US$6.6 billion
* As on 14 Sep 2007
** As on year end
*** Not all deals mentioned disclose deal financials. Deal values are the sum of only those deals
where financials were publicly announced (90 deals in 2006 and 87 deals in 2007)
Source: Press articles; CMIE; Dealogic; Prowess; Team Analysis
12
INDIAN COMPANIES ARE AGGRESSIVELY ESTABLISHING GLOBAL FOOTPRINT Cross-border M&A by Indian companies The recent
INDIAN COMPANIES ARE AGGRESSIVELY ESTABLISHING
GLOBAL FOOTPRINT
Cross-border M&A by Indian companies
The recent spurt in
outward FDI is caused
by:
Number of
Average
Deals*
Deal Size**
250
350
• Regulatory changes:
Indian companies can now
make overseas
investments equal to 300%
of their net worth on an
automatic approval basis
300
200
250
143
150
200
• Easy access to capital
– Decline in interest rates
coupled with liberal
lending policies adopted
by banks
150
100
100
50
50
– Active participation by PE
firms – Nearly 20% of the
deals were backed by
private funds in 2006
50
0
0
2000
2007***
* Number of deals for calendar year 2000, and till Sep 2007
** Average deal size is based on deals for which the values has been disclosed
*** As on 13 September, 2007
Source: Dealogic; Team Analysis
13
SIMILARLY, MNCs ARE ACTIVELY SEEKING THE INDIA OPPORTUNITY… Acquisitions of Indian companies by MNCs No.
SIMILARLY, MNCs ARE ACTIVELY SEEKING THE INDIA
OPPORTUNITY…
Acquisitions of Indian companies by MNCs
No. of
166
131
110
195
301
250
Break-up by sector
Deals*
Per cent of Total Deal Value, 2007^
27.442
Others
16 Services**
Telecom
35
4
Cons- 10
truction
10.969
13
Hi-Tech
22
5.748
Manufacturing***
3.030 2.268
2.502
Value
US$ billion
2002 2003
2004
2005
2006
2007^
^ 2007: As on Sep 2007
*Includes all completed deals even where deal value is not available
** Includes Finance, Insurance, Leisure & Recreation, Professional Services, Healthcare, Transportation and Publishing
*** Includes Chemicals, Machinery, Auto / Truck, Consumer Products, Textile and Food & Beverage Manufacturing
Source: Dealogic; Press articles; Company website; Team Analysis
14
THERE ARE 7 MANTRAS FOR SUCCESS IN INDIA… 1 Strong India Commitment and local team
THERE ARE 7 MANTRAS FOR SUCCESS IN INDIA…
1 Strong India Commitment
and local team
Leverage India’s resources
for global requirements
5
2 Create & Shape the Market
Redesign supply chain to
profitably deliver value
6
3 Acquire if necessary, but re-
assess cost of capital
Actively shape and manage
perception and regulation
7
4
Indianise product and get
the price-value equation right
Source: McKinsey team analysis
15
IN SUMMARY, INDIA IS ON COURSE TO BE AN ECONOMIC SUPER POWER OF THE 21
IN SUMMARY, INDIA IS ON COURSE TO BE AN ECONOMIC
SUPER POWER OF THE 21 ST CENTURY
India – most rapid growth potential of the BRICs
Real GDP growth (Per cent)
9
8
Fastest growing global
economy by 2012
India – will contribute
a giant share of the
incremental GDP growth
of major world economies*
7
Per cent
20.1
6
India
5
China
4
Brazil
3
5.0
2
Russia
2.1
1
0
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
2000
2020
2050
• 11 th largest economy today (GDP US$560 billion)
• 4 th largest by 2025 (GDP US$3,200 billion, six-fold increase)
* Major world economies considered are the BRIC and G6 countries
Source: Goldman Sachs BRIC report 2003
16
AND GROWTH IN INDIA IS AT AN INFLECTION POINT, SIMILAR TO CHINA 15 YEARS AGO
AND GROWTH IN INDIA IS AT AN INFLECTION POINT, SIMILAR
TO CHINA 15 YEARS AGO
Real GDP growth PPP adjusted*
Triggers behind growth
inflection in India
US$ billion
Inflection
8,000
scenario
7,000
• Taxes: Laws simplified
resulting in better
compliance and ease of
tax payment
China
CAGR = 10.1%
6,000
(1990-2005)
5,000
Inflection in
China GDP
• Infrastructure: Increased
investment in
infrastructure e.g., Ultra
Mega Power Projects
Conservative
4,000
growth
estimates
3,000
India
1990-2005
2,000
CAGR = 5.98%
• Liberalisation: FDI in key
sectors like airports,
NBFCs, Insurance,
electrical equipments,
telecommunications,
construction etc allowed
1992: India
1,000
1978: China
liberalizes
liberalizes
“Lead indicators”
“Lead indicators”
0
of of inflection inflection
1980
1985
1990
1995
2000
2005
2010
visible in India
visible in India
* Base year: 2002
Source: Global Insight; Team Analysis
17
CONTENTS • Perspectives on Indian Economy – Context of Indian economy – Forces likely to
CONTENTS
• Perspectives on Indian Economy
– Context of Indian economy
– Forces likely to propel India ahead
– Challenges for the growth
Perspectives on Indian Financial Sector
18
THERE ARE CHALLENGES THAT COULD DETER GROWTH Risks (in decreasing order of likelihood) Description Mitigating
THERE ARE CHALLENGES THAT COULD DETER GROWTH
Risks (in decreasing
order of likelihood)
Description
Mitigating factors
• Large number of parties
1. Internal political
• Universal adult suffrage - a correction
mechanism
complexities
• Differing ideologies
(high)
• Regional agendas influence
national policy
• "Public stance" guarded – but parties
realize liberalisation imperatives
2. Socio -
• Highly fragmented country
geographically
• Few budgetary, fiscal and supply side
measures announced by the Govt.
economic factors
(moderate)
• Risk of social unrest, resulting
from increasing income divide
• Numbers below poverty line reducing
– urban and rural India
– rich states and poor states
• Realization (in last election) that only
broad-based economic reform is
sustainable
• Higher inflation
• US economy slows down
• Low interest rates
3. External
factors
• Rising oil prices
(moderate)
• Measures to increase FDI inflows and
competitiveness to capture a larger
share of world trade
4. Military conflict
• Border tensions with Pakistan
and China
• Strong progress in Pakistan relations
across two different governments
(low)
• Instability in Nepal
• China border issue (Sikkim) resolved
recently
Source: Team Analysis
19
2. Socio-economic factors INDIA IS A LARGE COUNTRY WITH HUGE GEOGRAPHIC FRAGMENTATION Total land Arable
2. Socio-economic factors
INDIA IS A LARGE COUNTRY WITH HUGE
GEOGRAPHIC FRAGMENTATION
Total land
Arable land
2006; Million Hectare; per cent
Arable land as a proportion to total land across most
countries range between 4 – 10%
However in India land used
for agricultural purposes its
as high as 48%
Country
Land acreage
% arable
963
17.8%
US
329
48.5%
171
846
7.09%
Brazil
60
161
998
Canada
4.6%
46
960
China
15.4%
148
Total
Arable
land
land
768
Australia
6%
46
1,710
Russia
7%
Arable land in India is the
highest and almost as
much as that available in
the US in absolute terms
121
Source: Euro Monitor
20
1. Internal political complexities THE BIGGEST RISK IS POLITICAL INDECISION WHICH COULD PREVENT INDIA FROM
1. Internal political complexities
THE BIGGEST RISK IS POLITICAL INDECISION WHICH COULD
PREVENT INDIA FROM CAPTURING ITS POTENTIAL
• Lack of nationwide VAT coupled with
lower indirect taxes
• Urban land ceiling act
• Small scale reservations
• Unclear land titles
• Poor regulation in power sector
• Tenancy laws
Reforms completed
Reforms pending
Reforms under
consideration/
work under way
• High import duties
• Central PSUs
• FDI restrictions (e.g., retail)
• Delicensing key sectors (e.g. coal,
fertiliser, retail, mining, railways)
• Low property taxes
and low user charges
• Urban transportation
infra-structure
• State PSUs
including power
• Municipal services
0.3
10.1
0.7
1.3
Last 2 years
7% GDP growth
2.3
5.5
Overall downside in India is limited.
Biggest risk is un-captured potential
India (growth
rate in 2000-
Product
India
market
01)
barriers
Land market
barriers
(affects real
estate and
retail sectors)
Government
ownership
Others
barriers, e.g.,
labor market
(complete
reforms)
* Public sector unit (i.e., government owned enterprises)
Source: McKinsey Global Institute Study on Indian Economy (2001); Team Analysis
21
2. Socio-economic factors LOW CONCENTRATION OF POPULATION IN TOP 5 CITIES Population living in the
2. Socio-economic factors
LOW CONCENTRATION OF POPULATION IN TOP 5 CITIES
Population living in the top 5 countries is very fragmented in Asian countries
vis-à-vis its global counterparts, but in absolute terms it more than equates the
top 5 cities population of the US
2006; Million; per cent
100% =
21 189
303
142 1,136
1,322
7 5
25
22 16
Population
living in top
5 cities
65
94 95
84
75
79
Rest of
35
population
Australia
Brazil
US
Russia
India
China
Source: Web search; Census
22
2. Socio-economic factors INCREASING INCOME DIVIDE COULD LEAD TO RISK OF SOCIAL UNREST Urban income
2. Socio-economic factors
INCREASING INCOME DIVIDE COULD LEAD TO RISK OF
SOCIAL UNREST
Urban income is 2.3X
.and income of rich states is 2.2X that of poor states
Rs. ‘000, 2006 prices
Rs. ‘000, current prices
49.8
+2.3X
21.7
28.5
+2.2X
12.9
Urban average*
per capita income
Rural average*
per capita income
Per capita income
average* of rich
states#
Per capita income
average* of poor
states#
* Average over 2002-2005
# Rich states are ones having higher per capita income than the All-India average, poor states are all others
Source: Market Skyline 2006 – Indicus Analytics; Global Insight; CSO; Team Analysis
23
CONTENTS • Perspectives on Indian Economy Perspectives on Indian Financial Sector 24
CONTENTS
• Perspectives on Indian Economy
Perspectives on Indian Financial Sector
24
KEY MESSAGES • Indian financial sector has grown rapidly and recorded strong performance on back
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded
strong performance on back of continued reforms
• However, financial deepening has to be acclerated,
else it could constrain the full potential of the Indian
economy going forward
• Pursuing a continued integrated reform agenda for the
financial system can help support and enable India’s
high GDP growth trajectory
25
KEY MESSAGES • Indian financial sector has grown rapidly and recorded strong performance on back
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded
strong performance on back of continued reforms
• However, financial deepening has to be accelerated,
else it could constrain the full potential of the Indian
economy going forward
• Pursuing a continued integrated reform agenda for the
financial system can help support and enable India’s
high GDP growth trajectory
26
INDIA’s FINANCIAL DEPTH HAS GROWN RAPIDLY SINCE 2001 Equity Corporate debt Government debt Bank deposits
INDIA’s FINANCIAL DEPTH HAS GROWN RAPIDLY
SINCE 2001
Equity
Corporate debt
Government debt
Bank deposits
Financial depth
CAGR 1
Financial stock as a percent of GDP
Per cent
1994-
2001-
CAGR
2001
2006
195
14.1%
No
172
deepening
160
-7.5
31.5
146
89
70
56
122
116
47
5.9
33.9
98
95
110
106
108
26
2
2
93
94
2
3
5
5.2
6.5
23
1
41
32
1
39
1
34
31
25
33
34
36
34
30
1
30
2
27
2
2
24
2
22
19
20
20
17
18
3.2
2.1
64
65
68
66
64
57
51
53
46
40
44
44
48
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Note: Umbers may not add due to rounding
1 Compound annual growth rate
Source: McKinsey Global Institute Global Financial Stock Database; team analysis
27
BANKING SECTOR HAS BEEN AT THE CORE OF FINANCIAL SECTOR GROWTH AND HAS CREATED SIGNIFICANT
BANKING SECTOR HAS BEEN AT THE CORE OF FINANCIAL
SECTOR GROWTH AND HAS CREATED SIGNIFICANT WEALTH
FOR INVESTORS
Contribution to economy of banking
sector has improved over the years
Indian banks have outperformed share indices in last few years
New Private
Per cent
TRS CAGR Jan 01 – Oct 07
~3.5
PSU Banks
Banking
Indian
1 value add
Indian Market: 29.63%
1.6
Banking
to GDP
1400
Bank index: 40.54%
Old Private
Indian
Old Private: 38.92%
Market
1994
2007
1200
New Private: 44.17%
Rs billion
Public Sector Banks: 42.67%
1000
16.7
26,237
800
2 Deposits
3,500
600
1994
2007
400
Rs billion
19,496
20.6
200
3 Advances
0
1,700
1994
2007
Sources: RBI; national income statistics; Datastream; team analysis
28
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
FINANCIAL PERFORMANCE OF INDIAN BANKING SECTOR IS AMONG THE BEST IN THE REGION Per cent,
FINANCIAL PERFORMANCE OF INDIAN BANKING SECTOR IS
AMONG THE BEST IN THE REGION
Per cent, FY 2006
Asset quality
Profitability
NPL/GDP
NPL/Net loans
Pretax ROA
Pretax ROE
Weak
Malaysia
8.5
Philippines
15.1
Korea
0.1
Thailand
9.1
Singapore
6.7
Malaysia
8.5
Thailand
0.8
Philippines
10.1
China
5.9
Thailand
8.2
China
0.8
Singapore
12.4
Thailand
5.8
China
7.1
Philippines
1.2
Korea
14.9
Philippines
5.7
Singapore
6.7
Malaysia
1.3
China
15.1
Korea
2.1
Korea
1.6
Singapore
1.3
Malaysia
16.3
India
1.3
India
17.9
India
0.5
Strong
* Data for all Scheduled commercial banks in India
Source: Central banks of each country; Bankscope; CMIE, McKinsey analysis
29
OTHER FINANCIAL MARKETS HAVE BEEN ON AN ACCELERATED GROWTH TRAJECTORY OVER PAST FEW YEARS Life
OTHER FINANCIAL MARKETS HAVE BEEN ON AN
ACCELERATED GROWTH TRAJECTORY OVER PAST FEW
YEARS
Life insurance
Equity
Mutual Fund
New business premium
(APE)*; $ bn
Market capitalization; $ bn
AUM; $ bn
9.9
816
75
+295%
+519%
+677%
19
1.6
105
2000-01
2006-07
2000-01
2006-07
2000-01
2006-07
Over the past few years the Indian market has
witnessed accelerated growth across financial services
* Based on full credit for regular premium + 10% credit for single premium
Source: IRDA; AMFI; SEBI; McKinsey analysis
30
HOWEVER, JUST 3-4 YEARS OF HIGH ECONOMIC GROWTH SEEMS TO HAVE LED TO A SITUATION
HOWEVER, JUST 3-4 YEARS OF HIGH ECONOMIC GROWTH
SEEMS TO HAVE LED TO A SITUATION OF TIGHT LIQUIDITY
AND RISING INTEREST RATES
Rapid credit expansion in past few years…
… resulting in tightening liquidity
Outstanding advances; US$ billion
Credit/deposits ratio; Per cent
75
448
59
55 61 72
+30%
341
Mar
Mar
Mar
Mar
Mar
’03
’04
’05
’06
’07
252
… and rising interest rates
196
10 year G Sec rates; Per cent
157
7.8
6.2
6.7 7.5
5.2
Mar
Mar
Mar
Mar
Mar
Mar
Mar
Mar
Mar
Mar
’03
’04
’05
’06
’07
’03
’04
’05
’06
’07
Source: RBI; Bloomberg; McKinsey analysis
31
KEY MESSAGES • Indian financial sector has grown rapidly and recorded strong performance on back
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded
strong performance on back of continued reforms
• However, financial deepening has to be accelerated,
else it could constrain the full potential of the Indian
economy going forward
• Pursuing a continued integrated reform agenda for the
financial system can help support and enable India’s
high GDP growth trajectory
32
OVERALL FRAMEWORK FOR ANALYZING FINANCIAL SYSTEM IN INDIA International financial system Domestic financial system
OVERALL FRAMEWORK FOR ANALYZING FINANCIAL SYSTEM
IN INDIA
International financial system
Domestic financial system
Savers
Borrowers
Banking
Bond
Equity
system
markets
market
1
3
2
Informal finance
4
1 Supply of funds from savers
3 Efficiency of each market
2 Allocation of funds to borrowers
4 Regulatory environment
Source: McKinsey Global Institute analysis
33
BUT INDIA’s FINANCIAL DEPTH IS LOW COMPARED TO OTHER ASIAN NATIONS Government debt Bank deposits
BUT INDIA’s FINANCIAL DEPTH IS LOW
COMPARED TO OTHER ASIAN NATIONS
Government debt
Bank deposits
Equity
Private debt
Financial depth, 2006
Financial assets as a percent of GDP
504
427
369
104
281
45
155
254
243
220
209
195
92
43
145
51
119
65
13
78
138
89
14
43
22
60
10
42
70
5
37
36
56
32
150
6
134
129
24
85
94
64
70
58
39
Indonesia
India
Thailand
China
Philip-
South
Malaysia
Japan*
Singapore
pines
Korea
Note: Numbers may not add due to rounding*Japan number is for 2005
Source: McKinsey Global Institute Global Financial Stock Database; McKinsey analysis
34
THIS IS DESPITE INDIA’S HOUSEHOLDS BEING AMONGST THE HIGHEST SAVERS IN THE WORLD Household savings
THIS IS DESPITE INDIA’S HOUSEHOLDS BEING AMONGST
THE HIGHEST SAVERS IN THE WORLD
Household savings as a share of gross national savings rates, 2005
Per cent
69
55
44
37
24
20 16
India
France
China*
Mexico
Japan
South
United
Korea
States
Gross national
savings rates
% of nominal
GDP, 2005
32.4
18.0
50.4
21.2
26.4
32.8
12.9
* MGI estimate based on 2005 GDP and estimates of flow-of-funds information.
Source: Country National Accounts; IMF; McKinsey Global Institute
35
LARGE PROPORTION OF HOUSEHOLD SAVINGS NOT ACCESSIBLE TO FINANCIAL SYSTEM Distribution of household savings by
LARGE PROPORTION OF HOUSEHOLD SAVINGS NOT
ACCESSIBLE TO FINANCIAL SYSTEM
Distribution of household savings by asset type
$ billion, per cent
100% =
Machinery and
equipment
66
96
132
13
19
18
Construction
28
32
35
Financial assets
59
50
47
FY 1995
FY 2000
FY 2005
Note: Numbers may not add due to rounding
Source: CSO; McKinsey Global Institute analysis
36
GOLD CONTINUES TO BE USED AS A SAVINGS VEHICLE DESPITE NEGATIVE RETURNS SINCE 1990 Index,
GOLD CONTINUES TO BE USED AS A SAVINGS VEHICLE
DESPITE NEGATIVE RETURNS SINCE 1990
Index, adjusted for inflation
Gold was an attractive investment in the
1970s and 1980s
but has offered negative real returns
in recent years
450
160
400
140
Bank
Gold
deposits
350
120
300
100
250
80
200
Gold
60
150
Bank
deposits
40
100
20
50
0
0
1970
1974
1978
1982
1986
1990
1985
1988
1991
1994
1997
2000
Source: Press Trust of India; Bombay Bullion Association; McKinsey Global Institute analysis
37
ACCESS TO QUALITY BANKING PRODUCTS AND SERVICES IN INDIA IS LIMITED Access to banking products
ACCESS TO QUALITY BANKING PRODUCTS AND SERVICES IN
INDIA IS LIMITED
Access to banking products is significantly
lower in India
and is limited to large cities
2006; per cent
2006; per cent
Card
ATM penetration
penetration*
Per million people
Per cent of
population
100% =
70,776
20,911
15,138
Rs bn
Metro centers
17
Australia
1,240
199
Top 100
Korea
755
362
centers
17.9
54.1
Singapore
477
excluding
65.4
335
metro centers
Thailand
330
76
Poland
261
63
Mexico
246
51
20.6
Other
65.1
centers
16.2
Malaysia
229
130
Brazil
193
142
25.3
18.3
Philippines
81
15
China
51
61
Number
Deposits
Credit
of bank
India
19
7
branches
* Includes both debit and credit cards; ** India Data as on March 2006 ; Mexico only credit cards
Source: Febraban; IBGE; Brazilian Central Bank; FSS; BOK; Bank of Thailand (BOT); NESDB; National Banking and Securities Commission;
Bank of Mexico; China Unionpay; Lit search; RBI; Venture Infotek
38
INDIA’s GOVERNMENT CONSUMES 70 PERCENT OF NET SAVINGS INJECTED INTO THE FINANCIAL SYSTEM Net contributions
INDIA’s GOVERNMENT CONSUMES 70 PERCENT OF NET
SAVINGS INJECTED INTO THE FINANCIAL SYSTEM
Net contributions to the financial system 1
ESTIMATED
Per cent of GDP, average FY 1995-2005
Household net
contributions
to the financial system 2
9.0
Foreign capital
inflows
1.2
Private sector
borrowing
3.2
Public sector
borrowing
7.0
1 Computed as sector specific savings minus investment
2 To balance with the current account, we subtract all errors and omissions (E&O) between savings, investments, and capital flows from
household savings (equivalently add it to household investment). Investment in valuables are added to E&O for the years 2000–2005.
E&O average 1.4% of GDP over the period implying unadjusted household savings investment balance is 10.4% of GDP.
Source: CSO; McKinsey Global Institute analysis
39
MORE THAN 80 PERCENT OF GOVERNMENT SECURITIES ARE HELD BY FINANCIAL INSTITUTIONS THAT ARE REQUIRED
MORE THAN 80 PERCENT OF GOVERNMENT SECURITIES ARE
HELD BY FINANCIAL INSTITUTIONS THAT ARE REQUIRED TO
HOLD THEM
Ownership of central government securities
100% = $ 306 billion, FY 2007 1
Public sector banks
45.5
Financial institutions required to hold
government securities
Other banks
9.0
Insurance companies
25.0
Employee provident
fund organization
6.0
• Statutory liquidity ratio requires banks
to hold 25% of assets in government
securities; actual holdings are higher
• Life insurance companies must hold
50% of their assets in government or
other approved securities; additional
15% must be invested in infrastructure
and social sectors
• Provident regulations cause 90% of
Total regulated
holdings
85.5 assets to be held in government
securities
RBI own account
8.0
Other
6.5
Total
100.0
1 Latest available data. * Using Rs. 41 as Rupee to dollar rate
Source: RBI; McKinsey Global Institute analysis
40
INDIAN BANKS HAVE RELATIVELY A HIGH PORTION OF ASSETS IN GOVERNMENT SECURITIES Asset breakdown of
INDIAN BANKS HAVE RELATIVELY A HIGH PORTION OF
ASSETS IN GOVERNMENT SECURITIES
Asset breakdown of banks
Per cent, 2006
2
Fixed/other assets
Other securities
and cash
5
12
10
8 13
16
16
18
0
18
25
18
Government
25
0.8
15
12
securities
16
81
68
57
57
54
54
Loans
India
China
Japan
South
United
United
Korea
States
Kingdom
(2004)
Source: RBI; bank financial statements; Financial Supervisory Service (South Korea); PBOC; Bank of England; Federal Reserve Bank of the
US; McKinsey Global Institute analysis
41
MORE THAN HALF OF COMMERCIAL CREDIT GOES TO SECTORS WITH LOW INVESTMENT EFFICIENCY Priority sector
MORE THAN HALF OF COMMERCIAL CREDIT GOES
TO SECTORS WITH LOW INVESTMENT EFFICIENCY
Priority sector
Public sector
Private corporate
sector
Distribution of commercial credit 1
Amount of investment needed to
generate $1 of additional output 2
$ billion, per cent, FY 2005
FY 2000-2005
100% =
211
Private corporate
Private corporate
discretionary
2.8
30
sector
Private corporate
priority
Agriculture
Household
enterprises and
proprietorships
Public sector
enterprises
13
Household
enterprises and
proprietorships
3.9
11
7
Public sector
6.8
39
Agriculture
15.0
1 Gross bank credit to non-financial companies, corporate bonds and private placements, and loans and investments from the government to public
sector enterprises.
2 The incremental capital output ratio is defined as the sum of gross investment divided by the total change in GDP over the period.
Source: CSO; RBI; Public Enterprise Survey; McKinsey Global Institute analysis
42
PRIORITY SECTOR ACCOUNTS FOR NEARLY A THIRD OF TOTAL LENDING, LIMITING ACCESS TO THE PRIVATE
PRIORITY SECTOR ACCOUNTS FOR NEARLY A THIRD OF
TOTAL LENDING, LIMITING ACCESS TO THE PRIVATE SECTOR
Distribution of gross bank credit outstanding 1
$ billion, per cent
Priority sector
lending
100% =
87
323
4
Other
Mortgages
Consumer credit
Other priority sectors 2
Agriculture
Small scale industry
6
4
8
13
9
12
12
16
14
14
Medium and large
enterprises
and other private
sector 3
7
48
32
FY 2000
FY 2007
1 Excludes public food procurement credit
2 Small businesses determined by either amount of capital, sales, or employees. Now includes small loans to software industry and
investment in venture capital funds registered with SEBI.
3 Includes wholesale trade, tourism, and non-bank financial companies.
Source: RBI; CSO; McKinsey Global Institute analysis
43
PRIORITY SECTOR LOAN DEFAULT RATE IS ~40 PERCENT HIGHER THAN THE NON-PRIORITY SECTOR Nonperforming assets
PRIORITY SECTOR LOAN DEFAULT RATE IS ~40 PERCENT
HIGHER THAN THE NON-PRIORITY SECTOR
Nonperforming assets relative to gross bank credit outstanding
Per cent, FY 2007
Agriculture
3.5
Small scale
8.3
industry
Other priority
sectors 1
4.6
Priority
4.9
sector total
Non-priority
sector total 2
2.7 1.8x
1 Small businesses determined by either amount of capital, sales or employees. Now includes small loans to software industry and
investment in venture capital funds registered with SEBI.
2 Includes non-priority sector commercial credit, mortgages, consumer loans, and other.
Source: RBI; CSO; McKinsey Global Institute analysis
44
SMALL CORPORATE BOND MARKET LIMITS ACCESS TO OTHER FUNDING SOURCES Corporate bonds Per cent of
SMALL CORPORATE BOND MARKET LIMITS ACCESS TO
OTHER FUNDING SOURCES
Corporate bonds
Per cent of GDP, 2005 1
143
102
85
74
64
48
45
39
28
27
21
15
13
10
8
3
2
1
1 India as of March, 2005; If bonds issued by development banks were included, China’s corporate bond market would be 11% of GDP
Source: McKinsey Global Institute Global Financial Stock Database
45
United States
Germany
United Kingdom
Malaysia
Korea, Rep.
Singapore
Japan
Canada
Thailand
Chile
Brazil
South Africa
China
Philippines
Czech Republic
India
Poland
Turkey
INDIAN COMPANIES HAVE VERY LOW LEVELS OF DEBT Corporate bonds Corporate bank loans Corporate borrowing
INDIAN COMPANIES HAVE VERY LOW LEVELS
OF DEBT
Corporate bonds
Corporate bank loans
Corporate borrowing
Corporate borrowing
Per cent of GDP, 1999
Per cent of GDP, 2004
Malaysia
89
68
157
51
74
125
Singapore
119
27
146
74
50
123
United
22
117
139
31
143
174
States
China
109
10
119
113
13
126
Hong Kong
83
34
118
85
50
135
South Korea
22
56
78
40
68
108
Chile
48
23
71
51
31
82
2
2
India 1
13
14
16
17
0
50
100
150
200
0
50
100
150
200
Note: Numbers may not add due to rounding
1 as of March 2000 and 2005
Source: Central banks of respective countries; EIU; McKinsey Global Institute Global Financial Stock Database; McKinsey Global Institute analysis
46
INDIAN FIRMS RELY HEAVILY ON RETAINED EARNINGS Sources of funds raised $ billion; percent, 2000–05
INDIAN FIRMS RELY HEAVILY ON RETAINED EARNINGS
Sources of funds raised
$ billion; percent, 2000–05 1
100% =
204
1,916
40
562
89
91
100 393
2
2
3
3
4
Equity
6
6
10
Debt
20
26
34 39
40
35
47
52
Internal
78
funds
72
63
59
55 55
47
42
India
Japan
Indonesia
South
Singapore Malaysia
United
Hong
Korea
States
Kong
1 Based on sample of 160 companies per country outside of United States. Companies were ranked by gross sales, and 40 companies from
each quartile were taken as the sample. US sample includes all listed companies with revenues exceeding $500 million, 1995 to 2004.
Source: Bloomberg; McKinsey Global Institute analysis
47
~ 55% OF EQUITY SHARES ARE HELD BY CORPORATE INSIDERS Shareholding of NSE equity listings
~ 55% OF EQUITY SHARES ARE HELD BY CORPORATE
INSIDERS
Shareholding of NSE equity listings
Per cent, December 2006
Institutional Investors
100
3
6
11
5
6
14
54
“Insiders” 1
Indian
Private
NRI’s,
Foreign
FIs, banks,
Mutual
public
corpora-
foreign
institu-
insurance
funds
tions
corpora-
tional
compa-nies
tions
investors
1 Includes all those who, in bringing into existence a company or converting their private business into a company, secure control of the
management of such company through shareholding and/or otherwise
Source: ISMR; SEBI
48
KEY MESSAGES • Indian financial sector has grown rapidly and recorded strong performance on back
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded
strong performance on back of continued reforms
• However, financial deepening has to be acclerated,
else it could constrain the full potential of the Indian
economy going forward
• Pursuing a continued integrated reform agenda for the
financial system can help support and enable India’s
high GDP growth trajectory
49
INCREASING FINANCIAL DEPTH IS A KEY IMPERATIVE FOR THE FINANCIAL SECTOR Financial system problems Key
INCREASING FINANCIAL DEPTH IS A KEY
IMPERATIVE FOR THE FINANCIAL SECTOR
Financial system
problems
Key outcomes
Suboptimal
distribution of
capital in the
economy
Root causes:
• Cumbersome
issuance
Root causes:
• Lack of
competition in
banking and
high state
ownership
Low lending
rates and
conservative
approach in
banking
procedures
Very small
corporate bond
market
• Lack of investor
demand
• Statutory
liquidity ratio and
directed lending
policies
• Poor bankruptcy
procedures and
lack of creditor
rights
Underdeveloped
Underdeveloped
consumer
finance market
Root causes:
domestic
institutional
investors
• Restrictions on
asset holdings
Limited
household
participation in
capital markets
• Government
ownership of
intermediaries
• Above-market
deposit accounts
Source: McKinsey Global Institute analysis
50
DOMESTIC INSTITUTIONAL INVESTORS ARE UNDERDEVELOPED IN INDIA Total assets as percent of GDP, 2005 Registered
DOMESTIC INSTITUTIONAL INVESTORS ARE
UNDERDEVELOPED IN INDIA
Total assets as percent of GDP, 2005
Registered
Life insurance
pensions
Mutual funds
France
60.3
3.5
61.2
US
33.1
66.0
69.9
Korea
22.8
3.9
25.3
Chile
18.7
59.4
11.1
Thailand
6.2
8.0
10.0
China 1
6.3
1.7
2.5
Mexico
3.8
0.2
6.1
Poland
4.6
9.5
4.6
Brazil
1.2
20.4
39.6
India
13.3
4.2*
6.0**
0
50
100
0
50
100
0
50
100
* Includes only provident funds ** as on March 2006
Source: Financial institution regulators; industry groups; and central banks of respective countries
51
A PHASED APPROACH HAS TO BE ADOPTED FOR A TRANSFORMATION OF THE INDIAN BANKING SECTOR
A PHASED APPROACH HAS TO BE ADOPTED FOR A
TRANSFORMATION OF THE INDIAN BANKING SECTOR
1
2 Apply competitive pressure
to local banks
3 Move towards freer
structure
Build infrastructure and
capabilities
• Ease capital restrictions
Industry
• Provide more operational
freedom to public sector banks
• Encourage market driven
consolidation
structure
• Create 3-4 global sized
institutions, 6-8 national
champions
• Develop blue print for sector
• Reduce government
participation in the sector
• Allow greater access to foreign
banks
Social
• Offer market based incentives
for under-penetrated segments
• Remove directed lending and
branch restrictions
development
Unified regulator
• Remove regulatory arbitrage
across different entities
• Move to a coordinated regulator
model
• Separate central bank and
regulator roles
Corporate
governance
• Effectively implement
principles of good corporate
governance
Supporting
• Accelerate credit bureau and
payment infrastructure
• Support creation of industry
utilities for processing
infrastructure
Labour reforms
• Enrich human capital and
support re-skilling of
employees
Source: McKinsey analysis
52
FINANCIAL SYSTEM REFORMS ARE WORTH US$48 BILLION ANNUALLY Direct impact of financial system reform Indirect
FINANCIAL SYSTEM REFORMS ARE WORTH US$48 BILLION
ANNUALLY
Direct impact of financial system reform
Indirect impact
US$ billion, FY 2005
21.8
25.5
2.3
0.3
5.1
Improved
allocation
18.9
of capital
7.8 6.3
Capturing
more
6.6
savings
Improved
Fully
Migrate
Reduce
Shift in
Direct
banking
imple-
informal
corporate
financing
impact
efficiency
ment
lending
bond
mix from
of financial
to best
electronic
to
default
bank
system
practice
payment
formal
rates to
loans to
reform
system
banks
bench-
bonds
mark
Percent
1.1
0.9
0.7
0.1
0.3
3.2
3.5
of GDP
Source: RBI; CSO; McKinsey Global Institute Analysis
53
MORE EFFICIENT INVESTMENT AND FINANCIAL MARKET REFORMS CAN BOOST INDIA’S GROWTH RATE TO 9.4 PERCENT
MORE EFFICIENT INVESTMENT AND FINANCIAL MARKET
REFORMS CAN BOOST INDIA’S GROWTH RATE TO 9.4
PERCENT
Real GDP
CAGR 1
US$ billion 2000, fiscal year
2005–2015
1,600
2015 per capita
Baseline
9.4%
income: US$
1,400
Efficient investment and
financial market reform
1,203
1,200
2015
per capita
6.5%
income: US$
1,000
919
800
600
400
CAGR 1
1995–2005
200
5.9%
0
1995
2000
2005
2010
2015
1 Compound annual growth rate.
Source: CSO; RBI; Oxford Economics; McKinsey Global Institute analysis
54