738069

Connecting Markets East & West

See Appendix A-1 for analyst certification, important

disclosures and the status of non-US analysts.

Any authors named on this report are research

analysts unless otherwise indicated.

Global Markets Research

May 2015

India: A bumpy ascent

Sonal Varma

Chief India Economist

Nomura Financial Advisory and Securities (India) Private Limited.

+91 22 4037 4087

[email protected]

Aman Mohunta - NFASL

[email protected]

+91 22 6617 5595

Neha Saraf - NFASL

[email protected]

+91 22 4037 4218

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.

Summary: ST bumps, MT positive

1

Source: CEIC and Nomura Global Economics estimates.

India outlook at a glance

2

% y-o-y growth unless otherwise stated 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 2014 2015 2016

Real GDP 8.2 7.5 7.6 7.2 8.0 8.2 8.5 8.6 8.1 8.1 7.2 7.8 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 8.7 3.5 6.8 6.7 8.0 8.3 8.3 8.5 8.5 9.0 5.8 7.4 8.6

Government consumption 5.8 31.7 10.8 9.0 9.0 9.0 9.0 8.0 8.0 8.0 5.5 9.4 8.2

Fixed investment 2.8 1.6 7.0 7.2 7.5 8.5 10.0 10.2 9.8 10.0 2.5 7.5 10.0

Exports (goods & services) -3.8 -2.8 2.1 7.5 7.5 7.5 7.0 7.0 7.0 6.5 3.8 6.1 6.9

Imports (goods & services) 1.2 1.1 -0.6 8.0 8.0 8.0 8.0 7.8 9.0 9.5 -2.2 5.8 8.6

Wholesale price index 3.8 0.6 -1.8 -1.3 -1.8 -0.6 1.0 2.3 2.1 2.4 3.9 -1.4 2.0

Consumer price index 6.7 4.1 5.2 4.8 4.9 5.3 5.3 5.3 4.7 5.0 6.7 5.0 5.1

Current account balance (% GDP) -2.0 -1.6 0.4 -1.2 -1.5 -1.7 -1.1 -2.3 -2.1 -1.5 -1.4 -1.0 -1.8

Fiscal balance (% GDP) -4.1 -3.9 -3.5

Repo rate (%) 8.00 8.00 7.50 7.25 7.25 7.25 7.25 7.25 7.25 7.25 8.00 7.25 7.25

Reverse repo rate (%) 7.00 7.00 6.50 6.25 6.25 6.25 6.25 6.25 6.25 6.25 7.00 6.25 6.25

Cash reserve ratio (%) 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00

10-year bond yield (%) 8.51 7.85 7.74 7.50 7.30 7.20 7.20 7.20 7.20 7.20 7.85 7.20 7.20

Exchange rate (INR/USD) 60.9 62.6 62.5 63.6 64.4 63.4 62.9 62.9 62.9 62.9 62.6 63.4 62.9

Source: Nomura Global Economics.

Medium-term India view

The framework: Growth with macro stability

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

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

The near-term bumps

4


1. The MAT ruckus - Background

5

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?

Source: NSDL and Nomura Global Economics.

The MAT ruckus: What is at risk?

6

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.

Mar-15 Jan-12

Incremental

Equity inflow Mar-15 Jan-12

Incremental

Debt inflow

1 US 106.8 43.1 63.7 6.3 0.2 6.1

2 MAURITIUS 73.0 39.8 33.2 10.7 6.8 3.9

3 SING 27.9 6.8 21.1 18.5 12.1 6.4

4 LUXEMBOURG 28.2 12.4 15.8 4.2 0.5 3.7

5 UK 16.5 7.9 8.6 0.2 1.0 -0.8

6 UAE 10.2 5.4 4.8 0.1 0.0 0.1

7 NETHERLANDS 6.2 2.4 3.9 1.5 0.2 1.3

8 CANADA 7.3 2.9 4.4 0.2 0.0 0.2

9 IRELAND 6.7 2.5 4.2 0.4 0.0 0.4

10 Other 39.0 15.7 23.3 7.0 2.6 4.4

Total 322 139 183 49 23 26

Total (ex-Sing, Maur) 221 92 129 20 5 15

Debt outstanding (USD bn)Equity outstanding (USD bn)

Source: Nomura Global Economics, PRS.

2. Setback on legislative reforms

7

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.

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.

Land acquisition bill 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.

3. A wider trade deficit in Q2

Source: Ministry of Finance, CEIC and Nomura Global Economics

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.

8

-15

-5

5

15

25

Jul-12 Mar-13 Nov-13 Jul-14 Mar-15

% Price Effect

Volume Effect

Import growth y-o-y

-30

-20

-10

0

10

20

30

Jul-12 Mar-13 Nov-13 Jul-14 Mar-15

% Volume Effect

Price Effect

Export Value growth y-o-y

97

99

101

103

105

107

109

111

113

115

117

-40

-30

-20

-10

0

10

20

30

40

50

60

Mar-09 Mar-11 Mar-13 Mar-15

Non oil non gold imports, lhs

REER (36 country), rhs

% y-o-y, 3mma 3mma

Weak global demand hurting exports Import volumes are rising

due to REER appreciation and faster domestic growth A wider current account deficit in Q2 2015

4. Unseasonable rains 30% of winter crop destroyed


9

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.

The damage

Crop Area sown Damage %

mn hectare mn hectare of area sown

Wheat 30.6 6.3 20.6

Coarse cereal 5.7 0.3 4.9

Pulses 14.3 1.1 7.9

Oilseeds 8.0 1.8 22.2

Total 58.6 10.7 18.2

Crop-wise

State-wise 3.7

6.4

0.8 0.4

9.5

6.1

0.3

2.6

-2.6 -4

-2

0

2

4

6

8

10

Vegetables Fruits Rabi food grain

FY13 FY14 FY15 (1st adv)% y-o-y

Impact on agri output

State Damage Rulling party

% of area under Rabi

Haryana 65.6 BJP

Rajasthan 33.6 BJP

Uttar Pradesh 78.5 SP

Punjab 8.2 SAD/BJP

Madhya Pradesh 5.0 BJP

Lessons from past episodes of unseasonable rains


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.

10

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 t+6

% m-o-m, sa

Start of

unseasonal

rains

95

100

105

110

115

120

125

130

135

t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 t+6

Index (t=100)

Fruits

Veg

Cereals Pulses

t = Start of

unseasonal rain

CPI inflation around unseasonable rains

Impact on vegetable prices

Fruit & vegetable prices remain contained so far

Weight Feb March April March April

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

Potato 1.0 1416 1262 1165 (10.9) (7.7)

Onion 0.6 2431 2309 2131 (5.0) (7.7)

Tomato 0.6 2257 2292 2342 1.5 2.2

Brinjal 0.4 2398 2307 2173 (3.8) (5.8)

Cauliflower 0.2 1841 2155 2434 17.0 13.0

Green Chillies 0.3 4853 4743 4651 (2.3) (1.9)

Lady's Finger 0.3 4578 4230 3747 (7.6) (11.4)

Vegetables 6.0 (3.9) (3.9)

Banana 0.6 3441 3207 3202 (6.8) (0.2)

Apple 0.5 10055 11201 10532 11.4 (6.0)

Fruits 2.9 1.5 (4.5)

Important

vegetables

IMD predicts below-normal monsoons in 2015

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

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 .

11

IMD forecast vs actual rainfall Southern Oscillator Index

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

-15

-5

5

15

25

Mar-05 Mar-07 Mar-09 Mar-11 Mar-13 Mar-15

IndexLa Nina (favourable for

Monsoons )

El Nino (unfavourable for Monsoons )75

85

95

105

115

125

1990 1995 2000 2005 2010 2015

Forecast

Actual

Normal monsoon range

% of long period average

What if: Below-normal monsoon rains

Source: CEIC and Nomura Global Economics

12

Macro impact of past droughts (>20% below normal) Macro impact of poor monsoons (10-15% below normal)

Source: RBI, SIAM, CEIC and Nomura Global Economics.

5. Rural demand is already quite weak

Two Wheeler sales Tractor sales

13

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

Apr-11 Jan-12 Oct-12 Jul-13 Apr-14 Jan-15

%, y-o-y Two Wheeler sales, 3MMA

-40

-20

0

20

40

Apr-11 Jan-12 Oct-12 Jul-13 Apr-14 Jan-15

%, y-o-y Tractores sales

Minimum support prices - paddy

4.0

0

5

10

15

20

25

30

35

FY90 FY95 FY00 FY05 FY10 FY15

% y-o-y

-5

0

5

10

15

20

25

30

Apr-

02

Ma

r-0

3

Feb

-04

Jan-0

5

De

c-0

5

No

v-0

6

Oct-

07

Sep-0

8

Aug-0

9

Jul-1

0

Jun-1

1

Ma

y-1

2

Apr-

13

Ma

r-1

4

Feb

-15

%, y-o-y Rural wages

Rural wages

Rural incomes are reeling under consecutive bad kharif season in 2014 and unseasonable rains in March. There is a

risk of higher MSP increases in 2015 given political constraints.

14

which could become a political risk

Source: ECI and Nomura Global Economics.

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

Year State going to polls

2015 Bihar (Nov)

2016 Kerala (May), West Bengal (May), Tamil

Nadu (May), Assam (Jun)

2017

Uttarakhand (Mar), Manipur (Mar), Goa

(Mar), UP (May), Himachal Pradesh

(Dec+), Gujarat (Dec+)

State elections in the next few years

0

10

20

30

40

50

60

70

Apr-

15

Oct-

15

No

v-1

5

Ma

r-1

6

Apr-

16

Ju

n-1

6

Ju

l-1

6

Ju

l-1

7

Au

g-1

7

Ja

n-1

8

Feb

-18

Apr-

18

Others

INC

BJP+

No of seats up for re-election

KL Pud. Nom.

Nom.

KL, PB, AS

TN. MP, KR, AP,

KL

MH, BR, UP, OR,

PB

GJ, WB

Goa Delhi

SK

MH, BR, UP,

MP, GJ, AP, WB

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: EPFR, CEIC and Nomura Global Economics.

6. The key risk for India: Debt capital outflows

Equity inflows: India

15

Debt inflows: India

-10

-5

0

5

10

15

20

25

30

Apr-05 Apr-07 Apr-09 Apr-11 Apr-13 Apr-15

FII debt flows (12m sum)

USD bn

-15

-10

-5

0

5

10

15

20

25

30

35


FII equity flows (12m sum)USD bn

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

Why the medium-term story is positive

16








17

Leading indicators pointing to a sustained recovery

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.

OECDs composite leading index for India Nomuras composite leading index for India

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. 18

2

4

6

8

10

12

98

100

102

104

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

Non-agriculture GDP (2qma), rhs

Nomura's composite leading index, lhs

Index % y-o-y

97

98

99

100

101

102

103

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

OECD's composite leading index for India

Long-run trend

Index

Source: CEIC and Nomura Global Economics. Heat map based on 3-month moving average.

Growth: Where are the green shoots?

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 19

Monthly real activity data heat map

% y-o-y, 3mma

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Jan Feb Mar

MHCVs 8.9 -19.6 -15.1 -29.2 -39.7 -8.2 -32.2 -33.6 -6.5 -2.4 23.3 51.9 59.7 50.6 32.2

Railway traffic: Net tonne km 7.0 1.2 1.4 -0.2 -1.2 1.7 3.7 0.1 1.3 3.3 6.3 8.1 6.3 4.6 3.6

Aviation: Passenger traffic 8.3 2.1 -9.7 -8.8 -0.5 0.7 13.6 6.9 1.4 7.5 14.3 14.5 15.8 18.5 20.9

Capital Goods -4.1 -19.3 -7.9 -0.9 5.4 -3.5 2.5 0.1 -11.0 13.6 -0.2 3.0 8.3 8.9

Imports (ex-oil, gold) 16.1 5.0 -4.2 -3.2 3.9 -3.6 -5.0 -7.4 -7.5 -1.4 10.1 14.6 13.9 7.7 4.3

Passenger cars 10.5 5.0 -8.3 4.5 -13.7 -12.5 13.7 -6.5 -7.2 1.6 1.7 6.0 12.5 10.2 7.9

Diesel consumption 9.9 10.3 10.8 4.2 2.7 0.7 -2.6 -1.1 -1.5 0.3 2.5 1.0 3.1 4.6 2.5

Coal 11.0 8.0 12.0 3.5 -0.1 -1.7 6.9 0.3 0.9 5.6 8.9 12.8 7.9 7.0

Electricity generation 4.8 6.7 2.9 4.4 2.1 3.2 8.4 5.1 7.8 11.4 9.5 9.5 6.0 4.6 3.6

Steel 6.4 3.4 1.8 3.8 7.6 13.4 12.3 8.8 9.2 1.8 3.2 0.4 0.2 -1.7

Cement 9.3 12.5 5.8 5.4 7.2 3.4 5.9 2.0 1.5 9.6 10.0 4.7 5.2 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 10.4 1.6 1.6 2.1 4.1 5.4 7.9 7.1 7.9 7.2 13.0 6.2 4.3 3.7 3.3

Exports 5.0 -3.7 -8.5 0.7 4.4 -0.1 12.9 7.4 -0.4 7.7 0.5 0.7 -0.7 -8.3 -14.8

Deposits 14.6 14.7 14.0 13.0 13.5 13.8 13.0 13.3 12.5 11.0 10.5 11.1 11.1 11.4 12.0

Bank Credit 16.4 18.1 16.8 16.5 15.5 14.4 16.3 14.8 14.1 13.1 10.8 10.8 10.3 10.2 11.1

2012 2013 2014 2015

Source: CMIE and Nomura Global Economics.

Investment outlook gradually improving

20

New investment projects announced

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.

0

5

10

15

20

25

Chemicals & chemical products Metals & machinery

Electricity Transport services

Construction & real estate Others

INR trn

Stalled vs. revised investment projects

0

500

1000

1500

2000

2500

3000

3500Stalled investment projects

Investment projects revived

INR bn

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

Government efforts to drive investment

Reduced policy uncertainty to further help

Lower policy uncertainty bodes well for investments

21

0

50

100

150

200

250-15

-10

-5

0

5

10

15

20

25

30

Sep-05 Jun-07 Mar-09 Dec-10 Sep-12 Jun-14

GFCF, lhs

Economic policy uncertainity, 2 qtr lead, rhsinverted scale

% y-o-y Index

De-bottlenecking of stuck projects

Number of

projects

cleared

Value of

projects cleared

(INR bn)

Civil Aviation 2 24

Coal 29 12

Commerce 2 10

Industry 4 14

Mines 3 9

Petroleum 17 41

Power 100 451

Railways 9 19

Roads 15 20

Shipping 8 11

Steel 7 39

Textiles 1 1

Total 197 653

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

Stalled projects: The reasons

Reasons for stalled projects Top reasons for stalling across industries

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.

22

12.1%

11.8%

11.7%

10.4%

8.2%

4.6%

4.2%

1.0%

Unfavourable market conditions

Lack of non-environmentalclearance

Lack of promoter interest

Lack of funds

Land acquisition issues

Raw material linkages

Lack of environmental clearance

Natural calamity

Industry

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

23

Banking system vs. economic cycle

Source: Nomura, Bloomberg 23

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.

0

2

4

6

8

10

12

14

16

18

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

GNPAs Restructuring

% of total assets

F

Total stressed assets Impaired assets vs. real growth

0

2

4

6

8

10

12

14

16

180

2

4

6

8

10

12

1997 2000 2003 2006 2009 2012 2015F

Real GDP growth (ex-agri), lhs

Impaired assets (% of total), inverted, rhs

% y-o-y % of total assets

F

Higher NPA

Potential growth likely to rise

Source: CEIC and Nomura Global Economics.

Estimates of potential growth

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 fast-

tracked, real investment growth could hit 15% pa, in our view, thus lifting potential growth to 7.5%.

24

0

1

2

3

4

5

6

7

8

9

10

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

FY14-FY19 accelerate

reform

TFP Labour Capital Stock Real GDP, % y-o-ypp

Real investment

(% CAGR)

Potential

growth

(% CAGR)

0% 4.8

3% 5.3

5% 5.6

10% 6.5

15% 7.4

20% 8.5 0

2

4

6

8

10

12

1988 1993 1998 2003 2008 2013 2018

Real GDP

Potential GDP (growth accounting)

% y-o-y

F








25

Underlying inflation lower at about 5.5%


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.

CPI inflation and CPI ex-vegetables, T&C What drove CPI from 8% in Q1 2014 to 5% in Q1 2015?

26

0

2

4

6

8

10

12

14

Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15

CPI ex-vegetables, T&C

CPI

% y-o-y

-0.6

-0.4

0.0

-0.1

-0.7

-0.1

-0.7

-0.3 -3.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

Cere

als

F&

Be

x-c

ere

als

Into

xic

an

ts

Clo

thin

g

Hou

sin

g

Fu

el an

dL

igh

t

T&

C

Mis

c e

x T

&C

To

tal (C

PI)

Lower

MSP

Statistical issues

Lower oil

prices

CPI more sensitive to wages


Sensitivity of CPI is very high to rural wages

Correlation between macro variables and CPI inflation components Inflation nominal rural wages

27

Expected

sign Positive Positive Positive Positive Negative Negative

Inflation

Expectations MSP

Nominal

wages

Output

Gap Rainfall Repo rate

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)

(5)

0

5

10

15

20

25

30

0

4

8

12

16

Mar-03 Mar-06 Mar-09 Mar-12 Mar-15

CPI inflation, lhs

Nominal rural wages, rhs

% y-o-y % y-o-y

Rural wages: supply versus demand

Source: NSSO,CEIC and Nomura Global Economics

Nominal rural wages and labour force participation rate Nominal rural wages and output gap

28

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).

370

380

390

400

410

420

430

4400

5

10

15

20

25

30


Nominal agri wages, lhs

Labour force participation rate,rhs (inverse scale)

% y-o-y per 1000

(3.0)

(2.0)

(1.0)

0.0

1.0

2.0

3.0

0

5

10

15

20

25

30


Nominal agri wages, lhs

Output Gap, rhs

% y-o-y % y-o-y

Low rural wages + low MSPs = Low CPI


Nominal rural wages projection

29

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

increases (8-10%) in 2015, particularly with elections approaching in Bihar.

MSPs are important in the long run

-10

-5

0

5

10

15

20

25

30


Nominal rural wages (Actual)

Nominal rural wages (Model Forecast)

% y-o-y

Forecast

0

5

10

15

20

25

FY87 FY91 FY95 FY99 FY03 FY07 FY11 FY15

Minimum support prices

CPI inflation

% y-o-y, 2ya

CPI inflation likely to stabilise ~ 5%

CPI inflation: Actual versus fitted

30

Note: The CPI model uses nominal rural wage, minimum support prices , output gap, repo rate and rainfall as explanatory variables.


0

2

4

6

8

10

12

14

16

Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 Dec-15 Dec-17

CPI Actual CPI Forecast

% y-o-y

Forecast








31

A new monetary policy framework

32

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


33

New monetary policy framework = higher real rates

Real policy rates


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.

-10

-8

-6

-4

-2

0

2

4

Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13 Mar-15

Real Repo rate Average% pa

2003-06: 2.2%

2006-13: -2.3%

2014-15: 1.5%

34

New monetary policy framework = Policy orthodoxy

We estimate equilibrium nominal rate at ~7.25%

Optimal versus actual policy rate

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.


0

5

10

15

20

25


Optimal policy rate (Taylor rule) Repo rate%

Forecast

RBIs policy stance to stay neutral-to-tight


RBIs policy stance vs. realised CPI inflation CPI inflation: Scenario analysis

35

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.

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

-10

-5

0

5

10

15

20


Policy stance, lhs

CPI Inflation (actual)

% % y-o-y

3

4

5

6

7

8

9


Repo @ 8%

Repo @ 8.5%

Repo @ 7.5%

Repo @ 7%

[email protected]%

% y-o-y

Forecasts

R2 of the model = 0.88








36


Compendium of reforms so far

37

Execution Ease of doing business Infrastructure Food inflation Fiscal FDI

Abolished all EGoMs,

Groups of Ministers (GoMs)

Skill devt: amendment to

Apprentice Act

To set up InvIT

(Infrastructure Investment

Trust); incentivise REITs

Potatoes and onions under

Essential Commodities Act

Domestic natural gas prices

reviewed Defense to 49% (from 26%)

Better inter-ministerial co-

ordination

Less regulation: Scrap

obsolete laws such as Boiler

(Inspection) Act & move to

self-certification

Roads Ministry empowered

to amend the Model

Concession Agreement

Minimum support prices

raised by around 2.5%

vs.15% (6-yr CAGR)

Diesel price deregulated Rail infrastructure to 100%

Focus on deliverables

Validity of Industrial License

extended from two years to

three years

Banks to issue long-term

infra bonds with no statutory

pre-emption

To restructure Food

Corporation of India; set up

a price stabilization fund

10% blanket cut in

discretionary spending

announced.

Parliament passed a law to

increase FDI limit in

Insurance to 49%

Monthly meetings & targets Self-certification by citizens

instead of affidavits

Sagarmala project

National fibre optic grid

States urged to remove

vegetables, fruits from

APMC Act

Expenditure management

commission constituted

Plannig Commission

replaced with NITI Aayog

Online clearances:

Environmental & forest

clearance online; 16 states

also online

Bullet train

100 smart cities; Urban

renewal scheme (AMRUT)

To make hoarding non-

bailable offence

Goods and Services Tax bill

tabled in the Lok Sabha

Government agreed to

reduce government stake in

PSU banks to 52% and

reduce government

interference

Labour laws: Considering

amendments in the Child

Labour Act, Factories Act,

Minimum Wages Act

E-auction of coal mines;

commercial coal mining

Set up first of many food

parks under the PPP model

in Karnataka

To allow women to work

on night shifts in a

factory; raise overtime

hours limit

Land acquisition laws

amended

Imposed restrictions on

states to announce

additional mark-up over

MSP

Single web portal for online

registration of units,

reporting of inspections

Amended mining laws to

allow auctioning of non-coal

mines

Proposed restricting

NREGA to tribal areas and

thus make wages more

market determined.


Modi governments report card

38

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

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

Hits Misses


Reform agenda and timeline

39

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

Focus area Measure Timeline

Fiscal Expenditure Reforms (rationalisation of welfare schemes) Q4 2015

LPG subsidy cap 2016

GST Bill Q3 2015

Infrastructure E-auction of coal blocks Underway

Land acquisition ordinance to law Q3 2015

Agriculture Restructure Food Corporation of India H2 2015

Price stabilization fund H2 2015

Ease of doing

business

Repeal 72 archaic laws Q2 2015

Amend labour laws Underway

Monetary Policy Setting of MPC H2 2015

Banking On-tap/differentiated bank licenses Underway

Lower govt. stake and other reforms in public sector banks 2015

Rural Reduce MGNREGA coverage Unlikely


FY16 budget: Credible but expansionary

40

Much more credible assumptions

FY14 FY15 FY15 FY16

INR bn Actual BE RE BE

Total receipts/expenditure 15635 17949 16812 17775

Gross tax revenues 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

Fiscal deficit 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 securities92 87 88 82

Fiscal impulse of Central Government spending

-2

-1

0

1

2

3


% of GDP

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

the aggregate level.

Source: Indian railways, CEIC and Nomura Global Economics.

Push towards greater public investment

41 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.

Capex proposed in FY16 budget

INR bn FY15RE FY16BE

Capex on the budget 1924 2414

Capex by CPSEs 2370 3179

Defense 820 820

Total Public capex ex-defence 3475 4774

% of GDP 2.7 3.4

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

1967 1975 1983 1991 1999 2007 2015

Public investment% of GDP

Public investment (% of GDP)

Impact

Multipliers

Long run

Multipliers Peak year

Combined

Revenue Expenditure 0.37 0.37 1

Capital Outlay 1.29 3.56 4

Non-defence capital outlay 1.81 5.88 5

Centre

Revenue Expenditure 0.19 0.09


Non-defence capital outlay 2.1 3.84 4

States

Revenue Expenditure 0.6 0.6 1


Multiplier effect of public spending

Source: Indian railways, CEIC and Nomura Global Economics.

Proposed public investment

42 Railways likely to be a key focus area of the government. Roads and urban development are also likely to remain in focus.

Railways proposed investment plan (2015-19) Roads & urban development

3000

1500 1500 1000

1500

0

500

1000

1500

2000

2500

3000

3500

Government LIC Private sector Tax free bonds/IDF

Public sectorfirms

Funding for railways

Public sector co.s (1.5)

INR bn

Investment

(INR bn)

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








43


Overall a problem of plenty on the external sector

BoP forecasts currently tracking a USD45bn surplus in FY16 Improved basic BoP suggests less vulnerability

We expect the current account deficit to remain at sustainable levels (


The good news: Indias love for gold is cooling off

Running an annualized run rate of USD37bn

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.

45

0

1

2

3

4

5

6

7

8

9

Mar-13 Sep-13 Mar-14 Sep-14 Mar-15

Gold imports

USD bn

RBI imposes restriction

on gold imports

Avg: 4.9bn

Avg: 1.3.bn

RBI eases

restrictions on

imports

Avg: 3.1.bn

Gold

import

volume Gold price

Gold import

value

mt $/oz USD bn

FY04 612 378 7

FY05 878 414 10

FY06 826 477 11

FY07 818 628 14

FY08 797 766 16

FY09 880 868 21

FY10 982 1024 29

FY11 1106 1295 41

FY12 1219 1647 56

FY13 1141 1654 54

FY14 731 1328 28

FY15 890 1240 35.5


FDI inflows surge sharply this year

Net FDI inflows tracking >USD30bn in FY15 Where has the incremental FDI flown in?

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.

46

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

0

5

10

15

20

25

30

35

40

USD bn, lhs

% of GDP, rhs

USD bn % of GDP

0 1000 2000 3000 4000

Telecom

Trading (wholesale cash &carry)

Oil & Gas

Auto

Computer Software &Hardware

Mining

Power2014

2012-13 (Avg)

FDI inflows (USD mn)

Why is India better placed this time?

Note: 2015 are Nomura forecasts. Source: Bloomberg, CEIC and Nomura Global Economics.

Much bigger firewall of FX reserves

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

Better placed than peers

-8-7-6-5-4-3-2-10

India Indonesia SouthAfrica

Brazil Turkey

Sep-13

Sep-14

% of GDP (4-qtr sum)

GDP growth CPI inflation Policy rate FX

2014 2015 2014 2015 2014 2015 2014 2015

% y-o-y % y-o-y % pa against USD

India 7.2 7.6 7.2 5.4 7.00 7.25 63.4 62.9

China 7.4 6.8 2.0 1.5 2.75 2.50 6.1 6.1

Indonesia 5.0 5.2 6.4 7.1 7.75 7.00 12650 13100

Russia 0.6 -4.4 7.8 13.1 17.00 12.00 60.5 65.0

South Africa 1.6 1.9 6.1 4.4 5.75 6.50 11.6 11.3

Turkey 2.9 3.4 8.9 6.5 8.25 7.00 2.4 2.4

Brazil 0.1 0.0 6.4 7.0 11.75 13.00 3.0 3.1

100

150

200

250

300

350

400


FX reserves

USD bn

Why is RBI not defending the topside?


Real Effective Exchange Rate

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%.

Import cover

48

Reason 2: Reserve adequacy

Assuming a comfortable threshold of nine months,

India needs to add ~USD20bn to its reserves from

current levels (USD340bn).

4

6

8

10

12

14

16

18


FCA (Months of import cover)

Threshold

Months

85

90

95

100

105

110

115

120

125

130


36 countries 6 countries

Index

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.

Nomura strategy views

49

Source: Nomura Research

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.

Rate and growth cycles improving together

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

50

0

5

10

15

20

25

30

35Sensex 12-m Forward P/E

15.6x as on29 Apr '15

51

FX Strategy: INR outperformance to continue (Craig Chan)

Favourable FEER model valuation Foreign equity flows vs. RBI intervention

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.

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

Source: Nomura and Bloomberg

Rates Strategy : Long India bonds (Vivek Rajpal)

Source: Nomura, Bloomberg

52

10yr bond yields and repo rate OIS curve pricing in aggressive rate cuts

52

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.

0

-31

-51 -58

-87 -100

-90

-80

-70

-60

-50

-40

-30

-20

-10

0

0m 3m 6m 12m 24m

bp

Latest (28-Apr-15)

7.0

7.5

8.0

8.5

9.0

9.5

Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15

%

IGB 10yr generic yield Repo rate

Appendix

The new GDP puzzle


Changes in real growth

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

0

2

4

6

8

10

12

1990 1995 2000 2005 2010 2015

GDP_old base

GDP_new base

% y-o-y 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

FY13 FY14

55

Weak PSB = An opportunity for other banks?

Source: Nomura, Bloomberg

55

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.

0

100

200

300

400

500

600

700

FY15 FY16 FY17 FY18 FY19

SBI/BOB/PNB

Total ex SBI/BOB/PNB

Total PSUs

INR bn

Share in gross NPA (% of total) Capital requirements for public sector banks

0

10

20

30

40

50

60

70

80

90

100


Public sector banks Private sector banks Foreign banks

Leveraged balance sheets a hurdle

Source: Media reports, CapitalLine and Nomura Global Economics.

Debt-equity ratio Sectoral debt-equity ratio

56

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.

40

50

60

70

80

90

100

110

120

130

Mar-92

Mar-94

Mar-96

Mar-98

Mar-00

Mar-02

Mar-04

Mar-06

Mar-08

Mar-10

Mar-12

Mar-14

BSE500 Ex Banks%

Debt to Equity Ratio (%) Mar-91 Mar-06 Mar-10 Mar-14

Automobile 125.8 75.3 110.9 82.2

Capital Goods - Elec Equipment 111.0 42.3 60.5 59.8

Cement 91.9 64.3 43.0 70.4

Chemicals 122.9 55.7 46.7 56.6

Construction 148.8 123.8 191.2 272.8

FMCG 91.3 41.5 55.2 75.5

Metals/Steel & Mining 107.4 48.8 76.6 97.2

Power Generation & Distribution 87.0 62.2 89.4 154.0

Realty 153.4 283.5 57.8 66.3

Refineries 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

The role of inflation expectations


Inflation expectations have fallen but what happens if crude oil prices move higher?

57

20

40

60

80

100

120

140

2

4

6

8

10

12

14

Sep-06 Oct-08 Nov-10 Dec-12 Jan-15

Inflation expectations, lhs

Global crude oil prices, rhs

% y-o-y USD/bbl

2

4

6

8

10

12

14

16


3-months ahead

Inflation expectations, lhs

12-months ahead

% y-o-y

Impending inflationary fiscal impulses


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. 58

1.2

1.4

1.6

1.8

2.0

2.2

2.4

FY96 FY99 FY02 FY05 FY08 FY11 FY14 FY17

% of GDP% of GDP

5th CPC 6th CPC

7th CPC

18.2

10.1

14.7 45.9

11.1

Services (ex-Housing)

Housing

Goods

Food

Fuel

Weight in the CPI basket (%)

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.

7th Pay Commission Goods and Services Tax

59

Political strategy: Consolidate in Rajya Sabha

Source: ECI and Nomura Global Economics.

Lok Sabha (lower house); total seats: 543 Rajya Sabha (upper house); total seats: 245

NDA, 336

UPA, 60

AITMC, 34

BJD, 20

Others, 56

AIADMK, 37NDA

UPA

AITMC

BJD

Others

AIADMK

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

Sabha (upper house)

NDA, 65

UPA, 77

AIADMK, 11

AITMC, 12

BSP, 14

Others, 71

NDA

UPA

AIADMK

AITMC

BSP

Others

60

Monetary policy transmission weak so far

Source: Nomura, Bloomberg 60

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

Policy rate and lending rates

4

5

6

7

8

9

10

11


%

Repo rate Base rate Deposit rate

Transmission in previous cycles

bps

Repo

rate

Base

rate PLR

Deposit

rate

2001-2005 (300) (190) (438)

2005-2008 300 460 388

2008-2009 (425) (163) (288)

2010-2011 375 263 292 225

2012 - Jun 2013 (125) (33) (28) (63)

2013 Jul - 2014 Mar 75 20 13 38

2014 Apr -date (50) (14) (10) (25)


Still significant scope for an equity catch-up

Equity index versus market cap Cross-country market-cap comparison

Indias equity market capitalisation remains well below both its own historical average and most of its Asian peers, which indicates significant upside potential. 61

0

20

40

60

80

100

120

140

160

Mar-03 Mar-07 Mar-11 Mar-15

India Philippines Thailand

Korea Indonesia

% of GDP

0

5000

10000

15000

20000

25000

30000

35000

0

20

40

60

80

100

120

140

160

Apr-99 Apr-03 Apr-07 Apr-11 Apr-15

M-Cap (% of GDP), lhs

Sensex, rhs

% of GDP Index


Where is the bonanza given to states?

62

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 7790 6840 8430

% of GDP 4.6 6.1 5.4 6.0

Net resource transfer to states

Windfall from the coal mine auctions

Over the lifetime

of the mines

In first year (10

% of total)

INR bn INR bn

M Pradesh 355.9 35.6

Jharkhand 126.2 12.6

Chattisgarh 336.8 33.7

Orissa 5.2 0.5

West Bengal 112.0 11.2

Total 936.1 93.6

Aggregate budget of the 16 states

% 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 1.6 1.7 1.9 1.7

Total

expenditure/receipts10.2 12.1 12.2 12.1

Revenue expenditure 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


Fiscal stance is expansionary

63

Cyclically adjusted fiscal balance Fiscal impulse

-10

-8

-6

-4

-2

0

2

4


Cyclical fiscal balance (a-b)

Structural fiscal balance (b)

Actual fiscal balance (a)

% of GDP

-3

-2

-1

0

1

2

3


State Center Combined% of GDP

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.

Sensitivity of trade to REER


64

Imports are more sensitive to REER than exports

Within imports, consumption goods are more sensitive to REER and demand than capital

goods

Both exports and imports are sensitive to demand (world and domestic, respectively)

10% appreciation in

REER Import growth Export growth

Sensitivity 11.8%-1.6% (Not

significant)

Lag 1-2 Quarters 2 Quarters

Import growth SensitivityLag

(Quarters)Sensitivity

Lag

(Quarters)

Consumption

goods 16.7%2

3.3%2

Capital goods9.8%

21.4%

1

10% appreciation

REER1% increase in demand

1% increase in demandImport growth Export growth

Sensitivity 4.1% 6.0%

Lag 2 Quarters 0

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,

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