Monthly Economic Update, India

Snapshot	As on 2nd January, 2015	As on 1st January, 2014
India Sovereign Rating	S&P        Moody’s         Fitch BBB-        Baa3             BBB- (stable)     (Stable)       Stable)	S&P       Moody’s           Fitch BBB-        Baa3              BBB- (-Ve)      (Stable)             (-Ve)
Bombay Stock Exchange	27,888	21,140
10 year Government yield %	7.94	8.84
10 year AAA bond spread over G-Sec in bps	34	60
Bank Rate %	9	8.75
Repo Rate %	8	7.75
Credit – Deposit Ratio %	76.13	75.77
Forex Reserve in US$ bn	319.78	293.10
USDINR	63.28	61.91
EURINR	76.30	85.27
Forward Premia of US$ in % 1 – month 3 – month 6 – month	7.63 7.90 7.42	8.91 8.97 8.30

Economic Forecasts:
	2012	2013	2014f	2015f	2016f	2017f	2018f	2019f
GDP (% yoy), expenditure	6.6	4.8	5.4	5.9	6.7	6.8	7.4	7.9
Consumer expenditure	8.3	6.4	4.8	6.3	7.1	7.0	7.6	8.1
Government expenditure	7.9	4.3	3.8	4.5	4.9	4.8	5.1	5.0
Investment	6.2	5.5	-0.1	5.8	7.4	8.6	9.1	9.6
Exports	12.6	5.1	8.4	6.9	9.4	7.6	7.6	8.0
Imports	20.3	6.0	-2.5	3.7	7.7	9.7	10.6	9.9
GDP (% yoy), income	6.3	4.5	4.7	5.5	6.5	6.8	7.1	7.7
Agriculture	5.7	1.4	4.7	2.5	3.2	3.3	2.5	2.8
Industry	6.2	1.0	0.4	4.2	6.7	6.4	6.3	7.2
Service	6.5	7.0	6.8	6.8	7.2	7.7	8.4	8.8
Nominal GDP (% yoy)	15.1	12.7	12.3	11.4	11.4	11.6	12.3	12.5
WPI headline (% yoy)	8.9	7.3	6.0	3.6	3.8	4.6	4.8	3.9
WPI core (% yoy)	7.3	4.9	2.9	3.5	2.8	2.0	2.7	2.7
CPI headline (% yoy)		10.2	9.5	6.5	5.8	5.4	5.3	5.2
Savings rate (%)	31.3	30.1	31.0	31.5	32.0	32.5	33.0	33.5
Fiscal stance* (% GDP)	-0.5	-0.4	-0.4	-0.3	-0.2	-0.2	-0.2	-0.1
Output gap (% GDP)	2.1	0.3	-1.2	-1.5	-0.7	0.2	0.6	0.5
Current account (% of GDP)	-4.2	-4.7	-1.7	-1.6	-2.0	-2.2	-2.2	-2.0
Budget balance (% of GDP)	-5.7	-4.9	-4.6	-4.1	-3.6	-3.3	-3.0	-2.7
Public Debt (% of GDP)	65.5	65.4	65.6	65.9	65.3	64.5	62.9	61.3
Repo rate	8.0	7.3	8.0	7.8	7.5	7.0	6.5	6.3
Sources: RBI, Datasteam, SG Cross Asset Research/Economics, * Net contribution to GDP growth, ** The fiscal stance is defined as the change in the cyclically-adjusted budget balance *** 2014 refers to FY2014

Ø  India registered a fiscal deficit of INR 493.83 billion during November 2014 representing a decline of 4.43% over the fiscal deficit of INR 516.71 billion in November 2013. The fiscal deficit during April-November 2014 accounted for 99% of the budgeted estimates of INR 5,311.77 billion for 2014-15.

Ø  The eight core industries with a combined weight of 37.90% in the Index of Industrial Production (IIP) expanded 6.70% in November 2014 as compared to growth of 3.20% in November 2013. Cumulative growth for April-November 2014-15 was 4.60%, as against 4.10% growth in April-November 2013-14.

Ø  The HSBC India Purchasing Managers' Index (PMI) — a composite indicator, which provides an overview of manufacturing operating conditions — climbed to two-year high of 54.5 in December, up from 53.3 in the previous month.

Ø  At 51.1, down from 52.6, the seasonally adjusted HSBC India Services PMI Index –was indicative of a moderate expansion in business activity of service companies in December. HSBC India Composite PMI Output Index at 52.9 down from 53.6, the reading was consistent with growth of private sector activity.

Ø  India’s total power generation grew at a healthy pace in November 2014. According to actual data report released by Central Electricity Authority (CEA), power stations in the country generated 85.3 billion units of power in November 2014. This was 9.9% higher compared to the corresponding month a year ago.

Ø  Government of India has advised that to avoid withholding tax, Foreign Financial Institutions (FFIs) in Model 1 jurisdictions, such as India, need to register with IRS and obtain a Global Intermediary Identification Number (GIIN) before January 1, 2015.

Ø  The year-on-year inflation measured by monthly CPI stood at 4.12% for November 2014 as compared to 4.98% for October 2014 and 11.47% during November 2013.

Ø  Wholesale inflation decelerated for the sixth consecutive month this fiscal as it came in at ZERO in November’14 (y-o-y) as against 7.5% during the corresponding period of the previous fiscal year.

Ø  FDI inflows into India rose by about 25% to US$ 17.35 billion in April-October 2014. Total FDI into India, since April 2000 and September 2014, including equity inflows, reinvested earnings and other capital, stood at US$ 345.29 billion.

Ø  Indian companies raised INR 12.01 billion through IPOs in 2014, the lowest since 2001. Overall they raised INR 390.00 billion fresh capital in the equity market through various channels.

Ø  Fund raising by Indian companies through retail issuance of NCDs plunged by 58% to about INR 73.00 billion in April-December 2014.

Ø  M&A as well as private equity deals involving Indian firms rose by 26% to US$48 billion this year.

Ø  Private equity (PE) investments in India touched a four-year high this year, with PE funds investing $10.9 billion across 436 deals, said a report released by Venture Intelligence, a research service focused on private company financials, transactions and valuations.

Ø  According to the report, the surge was led by mega deals in online services companies, especially e-commerce firm, which accounted for almost $4.1 billion (across 106 deals) or 37.6% of the investment during the year

Ø  In its latest Monetary Policy Review on 2^nd December, 2014 RBI maintained status quo in policy stance by keeping key policy repo rate under Liquidity Adjustment Facility (LAF) unchanged at 8%. Hence, the reverse repo rate and Marginal Standing Facility (MSF) remained unchanged at 7% and 9% respectively. Though RBI has indicated a dovish tone with expectation of rate cut likely in next review in February 2015.

Ø  Cash reserve ratio (CRR) remained at 4.0%, whereas Statutory Liquidity Ratio (SLR) at 22%.

Trends in Major Monetary Indicators (%)

Indicators	Jan-14	Jan-15
SLR	23.00	22.00
CRR	4.00	4.00
Repo	8.00	8.00
Reverse Repo	7.00	7.00

                          Source: Reserve Bank of India

Highlights of India's International Investment Position (IIP) for the quarter-ended September 2014:

Ø  Net claims of non-residents on India (as reflected by the net IIP) increased by US$ 6.8 billion over the previous quarter to US$ 353.7 billion as at end-September 2014 reflecting a US$ 3.5 billion increase in the value of foreign-owned assets in India vis-à-vis a US$ 3.3 billion decrease in the value of Indian Residents' financial assets abroad.

Ø  The fall in Indian residents' financial assets abroad was mainly due to a decrease of US$ 2.3 billion in Reserve assets. Foreign-owned assets in India increased mainly due to increase in direct investment in India and portfolio investment in India.

Ø  Among other investment liabilities, currency and deposits increased by US $2.5 billion and loans (mainly external commercial borrowings) decreased by US$ 0.9 billion.

Ø  The ratio of India's international financial assets to international financial liabilities stood at 58.0% in September 2014 (58.6% in June 2014).

Ø  Reserve Assets continued to have the dominant share (64.2%) in India's international financial assets in September 2014, followed by direct investment abroad (26.5%).

Ø  Direct Investment (30.0%), portfolio investment (24.4%), loans (21.2%), and currency and deposits (12.9%) were the major constituents of the country's financial liabilities.

Ø  The share of non-debt liabilities decreased marginally to 45.5% as at end-September 2014 from 46.1% at end-June 2014.

 India's External Debt as at End-September 2014 Highlights:

Ø  At end-September 2014, India's total external debt stock stood at US$ 455.9 billion, recording an increase of US$ 13.7 billion (3.1%) over the level at end-March 2014. The rise was due to long-term external debt particularly commercial borrowings and Non Resident Indians (NRI) deposits.

Ø  Long-term debt was US$369.5 billion at end-September 2014, an increase of 4.7% over the end-March 2014 level, while short-term debt declined by 3.2% to US$ 86.4 billion.

Ø  Short-term debt accounted for 18.9% of India's total external debt at end-September 2014, while the remaining (81.1%) was long-term debt. Component-wise, the share of commercial borrowings stood highest at 35.4% of total external debt, followed by NRI deposits (23.8%) and multilateral debt (11.7%).

Ø  Government (Sovereign) external debt stood at US$ 88.4 billion, (19.4% of total external debt) at end-September 2014 vis-à-vis US$ 81.5 billion (18.4%) at end-March 2014.

Ø  The share of US dollar denominated debt continued to be the highest in external debt stock at 60.1% at end-September 2014, followed by the Indian rupee (24.2%), SDR (6.5%), Japanese yen (4.5%), and euro (3.0%).

Ø  India's foreign exchange reserves of US$ 320 bn provided a cover of 68.9% to the total external debt stock at end-September 2014 vis-à-vis 68.8% at end-March 2014.

Recent Regulatory/Policy Development

Cabinet approves ordinance route to amend land takeover act

In a move aimed at faster completion of projects, the cabinet on December 29 approved an ordinance to amend the Land Acquisition Act (LAA) to remove "procedural difficulties" in acquiring land for national projects and to "further strengthen" provisions concerning "affected families".

According to the amended LAA, compensation will remain high as per the act and rehabilitation and resettlement norms will be followed but the procedure for acquiring land for projects will be easier by removing steps like social impact assessment, impact on food security, and consent of 80% land owners.

The changes will allow a fast track process for defence and defence production, rural infrastructure including electrification, housing for poor including affordable housing, industrial corridors and infrastructure projects including projects taken up under Public Private Partnership mode where ownership of the land continues to be vested with the government.

Section 105 of the Act has kept 13 most frequently used legislations used for land acquisition for central projects out of its purview. These are applicable for projects including national highways, metro rail, atomic energy projects and electricity.

According to the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2013, the process for land acquisition involves a social impact assessment survey, preliminary notification stating the intent for acquisition, a declaration of acquisition, and compensation to be given by a certain time. All acquisitions require rehabilitation and resettlement of the affected people while compensation to the owners will be four times the market value in rural areas and twice in urban areas.

President re-promulgates coal ordinance

President approved the Coal Ordinance (Special Provisions) Act, 2013. Initiating the coal block re-allocation process, without waiting for the Rajya Sabha approval.

The government, in October, had promulgated special ordinance for re-allocation of coal blocks, cancelled by the Supreme Court in its judgment in September. The apex court had set a deadline of March 31 for reallocation of 42 producing coal mines through the bidding process. Under the Indian Constitution, the government is empowered to enact a law through an ordinance signed by the President, without going through the legislative process.

The ordinance will address issues related to coal supply to companies of central and state governments, as well as private companies in the cement, steel and power businesses. It will also address valuation of the land to be taken over from those who have lost coal blocks.

Government approves ordinance for mines allocation

The government approved amendments to the near six-decade-old mining and minerals development and regulation (MMDR) act through the ordinance route, paving the way for auction of minerals such as iron ore, bauxite and limestone.

The auction route first introduced in coal mining does away with the traditional method of granting mineral licences on a case-to-case basis. While it maximises the revenue potential and is believed to be more transparent, the industry has been opposed to it since it is not a global practice.

To fast-track over 60,000 pending applications with state governments, the ordinance also expanded the area for mineral leases from 10 sq kilometres to 100 sq kilometres to facilitate large-scale mining. Further, mines would be auctioned for 50 years with no further clause for renewal. They would be re-auctioned after 50 years.

The ordinance, however, introduces some contentious clauses in the Act that sets different rules for public and private sector mining companies and between captive and non-captive mining firms, moves that are likely to act as stumbling blocks in the reform process. For existing mining leases for example, the moratorium for captive mining firms is 15 years while for non-captive firms it is 5 years.

Foreign holding limit in Insurance companies increased from 26% to 49%

The Cabinet, through an Ordinance, has raised the FDI limit in insurance to 49%, recommending a composite cap of 49%, which would include all forms of foreign direct investments and foreign portfolio investments. The government is now in a position to dilute its equity stake by up to 49% in five public sector general insurance companies following the promulgation of the Insurance Laws (Amendment) Ordinance, 2014. However, the clauses in the ordinance have made it impossible for foreign partners to get management control in India, Section 2.7A of the ordinance defines an Indian insurance company as “which is Indian owned and controlled in such manner as may be prescribed”. Explanation under Section 2.7A.b further elaborates Indian control.

The government has added a new section —  Section 10B — to the General Insurance (Business) Nationalisation Act (GIBNA) which says “General Insurance Corporation (GIC) and insurance companies may raise their capital for increasing their business in rural and social sectors to meet solvency margins and such other purposes as the Central government may empower in this behalf.”

Cabinet finalises reserve prices for upcoming 2G airwave auction

The cabinet on January 5, 2015 approved the proposal of the Department of Telecom (DoT) to proceed with auction in 800, 900 & 1800 (mega hertz) MHz bands and finalised its reserve prices, an official statement said. "The reserve price approved is INR 36.46 billion pan-India per MHZ in 800 MHz, INR 39.80 billion for 900 MHz band pan India excluding Delhi, Mumbai, Kolkata, and Jammu and Kashmir; INR 21.91 billion pan India (excluding Maharashtra and West Bengal) in 1800 MHz band," the statement said. The estimated revenues from this auction are INR 648.40 billion.

Medical devices sector opens up to 100% FDI

The department of industrial policy and promotion (DIPP) on 6^th January, 2015 issued a press note notifying the Cabinet's decision to open the cash-starved medical devices sector to 100% foreign direct investment through the automatic route. The Cabinet had last month cleared the proposal, which was floated by DIPP, the nodal agency for FDI policy. Earlier, there was no separate policy for medical devices, which were covered under pharmaceuticals. The pharma policy imposed stiff foreign investment conditions, including mandatory government approvals in case of brownfield investment or stake acquisition in existing Indian companies. 

Change in Defence Procurement Policy (expected)

Changes in the Defence Procurement Policy to legalise representatives from foreign defence firms will be done in another month and a half, Defence Minister Manohar Parrikar said in an interaction with journalists on December 30, he also said that the ministry is thinking of giving conditioned and limited approval to dealing with banned firms, and a ban has been lifted to get spare parts for Tatra trucks. Parrikar added that a draft of the changed policy is ready and a final draft will be ready in another 8-10 days. It will then go through further procedures before going to the union cabinet.

Goods & Service Tax (GST) Constitutional Amendment bill (Proposed)

Government has introduced the GST constitutional amendment bill in the lower house of parliament– the bill will be considered for approval in the Budget session of the parliament. Key features of the bill:

(a) A single rate GST which will subsume multiple layers of taxation such as central excise, state VAT, entertainment tax, octroi, entry tax, luxury tax and purchase tax on goods and services, and eliminate the

cascading effect of taxes.

(b) While liquor has been completely kept out of the GST, petroleum goods will be part of the GST but they will be levied at zero rate in the initial few years - implying that the states will continue to levy VAT while Centre will levy excise duty.

(c) A GST Council, which will consist of 2/3rd members from the state will decide on the tax rate as well as the date of including petroleum taxes in the GST ambit.

(d) Compensation to states for revenue loss – The centre plans to provide 100% compensation in first three years, 75% in the fourth year and 50% in the fifth year. Moreover, states where goods originate can levy 1% additional tax over GST to make up for any revenue loss for the first two years.

Impact – Once the Goods & Services Tax is implemented, it will help to create a single nationwide system of taxation and also eliminate the cascading nature of taxation. It is expected to boost competitiveness especially in the manufacturing sector and thus increase exports and output growth. Moreover, easier taxation structure will help to increase compliance and subsequently improve revenue collection. Government expects GST to be implemented from Apr-16

Macro-economic Outlook:

As India strives to be re-branded as ‘emerging’ from ‘submerging’, the government’s prime focus is to bridge the infrastructure gap. India currently invests 5% of GDP in infrastructure. This needs to increase by at least 3% in order to achieve a sustainable growth rate of 7.5- 8%. The question is – can India finance its infrastructure needs? While infrastructure investment and revival of stalled projects will help re-start the investment cycle, progress will be slow and financing needs will remain a concern in the short to medium term. However, this concern will fade in the longer term. There are certain important factors that would have significant impact on India’s ability to finance the same.

Banking sector stress: As of March 2014, stressed and restructured advances, as a proportion of gross advances, stood at 9.8%. Of this, the NPL stood at 4% of gross advances – a fifth of which is due to the infrastructure sector. As of September 2014, banks are sitting on restructured loans worth US$19bn given to various infrastructure sectors. This severely restricts the ability of the banks to finance infrastructure projects, especially in a scenario where infrastructure accounts for around 35% of their gross advances. An important reason for this is that a large number of infrastructure projects in India have been stuck over a fairly long period of time due to multiple factors. Recently, the government announced online submission of applications for environmental clearances to ensure timelines, transparency in the application process, and real-time monitoring of projects. The same process was extended to forest clearances needed by infrastructure projects as well. However, it is crucial for the government to be able to bring forward key reforms in the areas of land acquisition, coal block allocation, etc. Only these would help revive a vast chunk of stuck projects, thereby reducing banking sector stress and enhancing lending capacity.

Restructuring corporate balance sheets: Over-leveraged corporations pose an immense challenge. The previous wave of infrastructure development by the private sector ended on a sour note as stalled projects and a fast slowing economy took a huge toll on their balance sheet, as did high inflation and interest rates. Available evidence suggests that corporate balance sheet restructuring has started in earnest.

So far this year, Indian companies have sold around US$1.5bn worth of infrastructure projects in India and abroad to reduce the stress on their balance sheets. Expected monetary policy easing will also bring cheer in this respect. The process, however, will be slow.

Fiscal deficit: India’s weak fiscal situation gets in the way of government spending on infrastructure. For FY15, India’s fiscal deficit is expected to be around 4.4% of GDP however this may improve and government can achieve the targeted fiscal deficit of 4.1% if the spectrum allocation announced in January is completed before March 2015. That said, it is important to note that India’s fiscal deficit will likely be on a structural downtrend in the coming years – not the least because of the recent deregulation in diesel price. The government’s decision to opt for DBT (direct benefit transfer) could be a potential game changer. They have already identified six social sector schemes for which payments would be made directly to the intended beneficiaries. Thus far, payments were made through multiple agencies which resulted in major leakage from the system (less than 30% of funds going to the intended beneficiaries). Once fully implemented, DBT would drastically reduce waste and enable the government to spend an increasingly larger share on infrastructure.

Domestic savings: The recent sharp fall in the savings rate is a reflection of the impact of policy missteps over the years. It was due to reduced public (higher fiscal deficit) and corporate (lower earnings growth) savings, as well as lower household savings (high inflation and negative real rate). As India’s investment

needs grow, savings also need to increase to ensure that India’s CAD remains sustainable. With the recent easing of inflation assuming structural proportions, household savings are expected to pick up. This process will be facilitated by India’s favourable demographics, with a rising proportion of high income earners in the population and a rapidly expanding middle class.

Recent steps in infrastructure financing: The lack of a well-developed and deep corporate bond market has resulted in high dependency on domestic lenders. Given the near-term public spending constraint, the government and RBI have made efforts to improve the flow of private capital into the infrastructure sector. RBI has allowed lenders to raise longer term resources by selling infrastructure bonds that are exempt from regulatory requirements like the cash reserve ratio (CRR), the statutory liquidity ratio (SLR) and priority sector lending (currently banks with more than 20 branches are required to lend 40% of their loans to sectors such as agriculture and small business units). Also, with an aim to reduce stress on infrastructure companies, RBI has allowed bank loans to infrastructure for 25 years or more, with periodic refinancing every five to seven years, with appropriate terms and conditions.

Improving Macro Fundamentals

Investment-led recovery theme playing out, though slowly: Expectation of an investment-led recovery appears to be playing out, as we see some progress in the government’s effort to provide momentum to stalled projects. The latest data from the CMIE shows that, of the infrastructure projects (for which implementation was stalled) tracked since July, 27 projects have moved from being classified as ‘stalled’ to being classified as ‘under implementation’. While being under implementation does not mean that these projects are now up and running, the visible momentum is encouraging.

Big improvements expected in India’s fiscal deficit over the longer term: Deregulation of diesel prices and the renewed focus on direct benefit transfer (DBT) will ensure that India’s fiscal deficit will decline substantially longer term to a level that will be more manageable and one that can be easily sustained.

Growth forecast revised up from FY16 onward: India, it seems, has finally stopped disappointing the international investor. India’s 2015 growth outlook has not only stabilised but has actually started to improve, while the growth outlook has been falling for other large emerging markets, especially the commodity exporters who have been badly affected by weak oil and other commodity prices. India, on the other hand, has benefited greatly through easing inflation. In fact, India is among the few nations who are enjoying an enviable combination of rising growth and falling inflation. Even on the current account balance front, India’s CAD expectation for 2015 is on a clearly improving path, which is not the case for other developing countries. For oil consumer, lower oil prices bring a welcome boost.

A strong government adds to the shine: Among the five major developing countries that went to election, i.e. Brazil, India, Indonesia, South Africa and Turkey, India turned out to be the only country that elected a reform-oriented leader with a clear political mandate. While Turkey remained under the control of Recep Tayyip Erdogan, in South Africa, the ANC maintained its 20- year dominance. In Brazil, the incumbent president retained her position, much against market expectations and by a very narrow margin. Indonesia did manage to elect a reformist president like Jokowi but the political mandate in his favour was very weak. This leaves Modi as the only leader with reformist credentials, who the market was overwhelmingly in favour of, and who came to power with a huge political mandate. The continued success of the BJP in state-level elections would ensure that the government (that has so far been focussing on painless reforms) will soon embark on the more painful reforms.

What Do Lower Oil Prices Mean for India?

As India is a net oil importer, a significant reduction in oil prices will have the following four key implications:

1. Positive Terms of Trade Impact: Given that India is a net oil importer, a decline in oil prices will result in a positive terms of trade impact and will provide support to reduce current account deficit pressures. Indeed, India’s net oil import balance has reduced to 4.9% of GDP for 12 months ending Nov-14 from 5.3% of GDP for the 12 months ending Nov-13.

2. Lower Inflation Pressure: A fall in oil prices would help to quicken the pace of reduction in inflationary pressures. Wholesale price fuel inflation fell to -4.9% YoY in Nov-14 from 11.1% in Nov-13. In retail basket, fuel inflation lowered to 3.3% in Nov-14 from 7% 12 months earlier.

3. Monetary Policy Implications: Lower inflation will create more room for policy-makers to ease monetary policy.

4. Reduced Fiscal Burden, Positive for Public Saving: Fuel prices of cooking gas, kerosene and until recently diesel have been regulated in India. Diesel accounted for nearly 50% of overall oil subsidy burden; however, with periodic price rise since Jan-13, prices of diesel were marked up to the market prices and in Oct-14, the government formally announced diesel price de-regulation. Moreover, the government has put a cap of 12 subsidized cooking gas (LPG) cylinders to be available per family per year. In this context, oil

subsidy is expected to reduce to 0.6% of GDP in F2015 from 1.2% of GDP in F2015. Moreover, with lower oil prices, oil subsidy is expected to be 0.4% of GDP in F2016, with the governments share in subsidy at near zero level.

Index of Industrial Production (IIP)

Industrial Output Growth Slumps: The Index of Industrial Production (IIP) for the first time in the current fiscal contracted 4.2% yoy in October 2014. Cumulatively the industrial output growth for April-October FY15 now stands at 1.9%. Although industrial output growth numbers on a monthly basis do not indicate any trend, the fact that they contracted significantly in the month which is considered to be the beginning of the festive season, indicates that consumption demand is still weak and fragile. However, we expect IIP to recover somewhat in the second half and grow faster than the first half of FY15.

Manufacturing output contracted by a substantial 7.6% in October 2014 as compared to a 2.9% growth in September 2014 in y-o-y terms, partly on account of a truncated work calendar owing to an earlier onset of the festive season. Additionally, while domestic demand conditions remained sluggish, merchandise exports displayed a 5.0% y-o-y decline in October 2014. In April-October 2014, manufacturing output increased by 0.7% as compared to the 0.1% contraction in the same months of 2013.

16 sub-sectors of the manufacturing sector, with a significant weight of 50.1% in the IIP Index, underwent a contraction in October 2014. Notably, 10 of these sub-sectors (with a weight of 33.3% in the IIP Index) had recorded an expansion in the previous month.

Chemicals and chemical products, accounting for 10% of the IIP index, recorded a considerable 10.3% contraction in October 2014. While output of vitamins and ayurvedic medicaments expanded by 53% and 30%, respectively, that of antibiotics and its preparation and ethylene contracted by 41% and 29%, respectively in October 2014.

Additionally, furniture; manufacturing contracted by 24.7% in October 2014, reflecting the y-o-y decline in output of wood furniture (31%) and gems & jewellery (50%). The latter is surprising given the impending wedding season and considerable gold imports in October 2014.

Tobacco products recorded a contraction of 4.7% in October 2014, partly led by the 22% fall in output of cigarettes in October 2014. The latter may have been on account of the proposal by the Central Government to ban the sale of loose cigarettes, which was later withdrawn. Moreover, food products and beverages displayed a contraction of 6.9% in October 2014.

Radio, TV & communication equipment & apparatus displayed a sharp contraction of 70.2% in October 2014, with a 78% fall in output of telephone instruments, partly on account of a fall in production at of Nokia’s Chennai factory.

Wood & products of wood & cork except furniture; articles of straw & plating materials recorded a y-o-y decline of 7.5% in October.

Core sector growth continued with dream run:  Core sector comprising eight sectors and has a weightage of 39% of total industrial output grew by 6.7% in November 2014. This is the highest rate of growth in the last five months. The sectors that drove the growth include coal, cement and electricity, which grew in double-digits.

Coal production grew by 14.5% in November 2014. Output of Coal India, which accounts for 80% of India’s coal output, grew by 13.3% to 44.4 million tonnes in November from a year earlier.

An increase in production of coal also improved the generation of electricity. Electricity generation grew by 10.2% in November 2014. The growth came over a growth of 6.3% in the year-ago month. It was driven by strong performance of thermal power stations. Electricity generation of thermal power plants grew by 13.8% in November. All regions recorded an increase in thermal power generation in November from a year earlier.

Cement production grew by 11.3% in November 2014. This is its highest level of growth recorded in the last four months. The growth came over and above a 3.9% growth in cement production in November 2013.

Growth in output of the steel sector however slowed to 1.3% in November 2014. This is its lowest level in the last four months. An oversupply of steel from China impacted the demand for domestically manufactured steel. According to the data from Joint Plant Committee (JPC), India’s imports of finished steel grew by 49.2% to 5.6 million tonnes in November 2014 from a year earlier. Production of steel manufacturers like Steel Authority of India (SAIL), Rashtriya Ispat Nigam (RINL) and Jindal Steel & Power (JSPL) contracted in November.

Output of refinery products grew by 8.1% in November 2014. This is the highest level of growth in the last 20 months. According to data from Petroleum Planning and Analysis Cell (PPAC), refinery throughput of Indian Oil refineries grew by 8.2% to 19.2 million tonnes in November 2014. Oil refineries also exceeded their planned target for November 2014 by 7.6%. Essar Oil recorded the highest increase of 26.6% followed by Hindustan Petroleum, which recorded an increase of 18.5%.

To put it in a nutshell, the growth of the eight core industries continued with its upward momentum in November primarily because of improved performance of three main sectors - coal, cement and electricity. The refinery products recorded a healthy growth of 8.1%. But the other sectors continue to lag behind.

Purchasing Manager Index (PMI), Manufacturing

Indian goods producers ended 2014 in a higher gear, with business conditions improving at the quickest pace in two years in December. Accelerated growth of the manufacturing sector was reflected by faster expansions in output, new business and foreign orders. Latest data also painted a brighter picture in terms of prices, as inflationary pressures eased during the month.

Adjusted for seasonal factors, the headline HSBC India Purchasing Managers’ Index –climbed to a two-year high of 54.5 in December, up from 53.3 in the prior month. Business conditions improved at a faster pace in all three market groups during the month, with the sharpest expansion seen in consumer goods.

Latest data reflected reports of improving demand in December, as new orders increased for the fourteenth consecutive month. Moreover, the rate of expansion was marked overall and the fastest since the end of 2012. Similarly, Indian manufacturing companies registered a further rise in new export business in December. New work from abroad expanded at the quickest pace since April 2011.

Reflective of further growth of output and new orders, input buying among Indian goods producers increased in December. The rate of expansion accelerated to the most marked in the current 14-month sequence of growth. Subsequently, the pace of pre-production inventory building picked up to the sharpest in more than two years. Furthermore, stocks of finished goods held by Indian manufacturers rose at the fastest rate since the survey began in April 2005.

Meanwhile, contrasting with continued growth of production and incoming new work, staffing levels in India’s manufacturing economy declined in December. That followed two successive months of slight job creation, although the pace of contraction was fractional overall. Job losses were evident in two of the three surveyed sub-sectors, with the exception being intermediate goods.

PMI Services

At 51.1, down from 52.6, the seasonally adjusted HSBC India Services PMI Business Activity Index was indicative of a moderate expansion in business activity in December. Despite slowing since November, the rise remained stronger than the average observed for 2014. As per Markit, “Anecdotal evidence linked rises in service sector output to improvements in demand”. ‘Other Services’ was the best performing of the six monitored sub-sectors, while the sharpest contraction occurred in Financial Intermediation.

The overall slowdown in activity growth was mirrored by a weaker expansion in service sector new business in December. The latest increase was the eighth in as many months and moderate overall. Across the private sector as a whole, growth of new work inflows remained solid, led by a further acceleration at manufacturers.

Volumes of outstanding business at Indian service providers continued to rise in December, as has been the case in nine of the past ten months. That said, the rate of backlog accumulation slowed to the weakest in three months and was marginal overall. Growth of backlogs also eased across the private sector as a whole.

Following the first monthly fall in more than five-and-a-half years in November, input costs faced by Indian services firms rose in December. However, the rate of cost inflation was only modest overall and mild in the context of historic survey data. Meanwhile, cost pressures in the manufacturing industry eased to the weakest in the current 69-month sequence of inflation.   Consequently, private sector input costs rose at a historically muted pace.

Overall, Output in the Indian private sector continued to rise in December, as signalled by the headline HSBC India Composite PMI Output Index posting above the neutral 50.0 threshold for the eighth month in a row. At 52.9, down from 53.6, the reading was consistent with solid growth of private sector activity. The latest rise was driven by manufacturing output, which rose at the quickest pace in two years. Meanwhile, growth of service sector activity moderated during the month.

Fiscal Deficit

India’s gross fiscal deficit (GFD) reached 98.9% of the annual budget estimates by November 2014. The deficit during April-November 2014 amounted to INR 5.3 trillion. At the same time last year, the deficit had amounted to 93.9% of the budgeted target for 2013-14.

Government expenditure rose by 5.2% to INR 10.2 trillion during April-November 2014, as compared to its year-ago level. Non-plan expenditure rose by 6.9% to INR 7.8 trillion, while plan expenditure remained flat at INR 2.9 trillion.

Net tax revenue collections of the government rose by a mere 4.3% cent to just about INR 4 trillion during April-November 2014. India’s FY15 budget was made with the assumption of the oil price averaging US$ 105/bbl. Up until mid–November, the government imposed a combined custom and excise duty on petrol at around INR 20/ltr plus 2.5%, while the equivalent for diesel was around INR 10/ltr plus 2.5%. With crude prices falling over 40% since June, indirect tax collection took a major hit. Weak IP data further added to the woes.  Not surprisingly, since mid–November, the government raised the excise duty on petrol and diesel on three different occasions to bridge the gaping fiscal hole rather than passing on the benefit of falling crude prices to consumers. Clearly, the so-called deregulation of diesel and petrol prices does not mean that these prices are market determined. As can be seen from the chart above, retail petrol and diesel prices have changed at a moderate pace compared to the fall in the crude price.

The government also did not make much progress on the disinvestment front by November 2014. Its disinvestment receipts amounted to a meagre INR 2.2 billion during April-November 2014, as against an annual target of INR 634.3 billion. Net recoveries of loans, which is another large component of non-debt capital receipts, amounted to INR 71.7 billion during April-November 2014, as compared to INR 73.6 billion a year ago. The government financed 69.1 per cent of its fiscal deficit through market borrowings.

Policy bullets at the government’s disposal to meet the deficit target

In order to keep the fiscal deficit within the budgeted target, we expect the government to embark on the following strategies:

• Force oil companies to share a larger proportion of the subsidy burden than is currently the case. Despite this, the absolute subsidy burden on oil companies would still be lower than it was in FY14.

• Postpone some of the subsidy payout to FY16, as was successfully done by Mr. Chidambaram on previous two occasions.

• Force cash-rich state-owned companies to pay significantly higher dividends.

• Get state-owned financial institutions, led by Life Insurance Corporation (LIC), to bail out the government with regard to the sale of the ONGC and CIL stakes. In FY12, for example, LIC had invested around INR 120 bn and picked up over 90% of the shares on offer in ONGC, the largest offering of that year’s disinvestment programme.

• Curtailment of expenditure. Like in FY14, we expect the government to come up with major fiscal surplus during the month of March through expenditure contraction.

Current Account Deficit (CAD)

CAD Rises: Current account deficit (CAD) is expected to widen to US$ 48.7 bn (2.3% of GDP) in FY15 from US$ 32.7 bn (1.7% of GDP) in FY14. India’s CAD came in at US$ 10.1 bn (2.1% of GDP) in 2QFY15 (period ending September 2014). This is higher than in both preceding quarter (1QFY15: 1.7% of GDP) and the same quarter previous fiscal (2QFY14: 1.2% of GDP). The key reason for deterioration in CAD is a 15.8% yoy increase in trade deficit to US$ 38.6 bn because of deceleration in export growth and acceleration in imports growth. Although the acceleration in imports growth is in line with market expectation, the reason for acceleration is different. Imports instead of growing in response to a recovering economy grew due to a sharp rise in gold imports.

Merchandise Exports Growth Decelerates: The performance of advanced economies continues to weigh on export growth as recovery across these economies remains fragile and uneven. After an encouraging 1QFY15, exports growth decelerated to 4.9% in 2QFY15. Even, services exports grew only 3.9% yoy to US$ 17.6 bn in 2QFY15. Services exports were unchanged on sequential basis. Even World Trade Organisation has cut its estimate for global trade growth to 3.1% for 2014 from 4.7%. Although India’s look-east policy has helped the country diversify its exports basket both in terms of items and destination, it still has to fully substitute the export demand coming from advanced economies.

Imports Growth Accelerates: Market expects only a modest pick-up in imports this fiscal due to lower crude prices and limited upside to GDP growth. After witnessing a contraction of 6.5% yoy in 1QFY15, merchandise imports increased 8.1% yoy to US$ 123.8 bn in 2QFY15. The rise in imports is mainly due to a sharp rise in gold imports to USD 8.9 bn in 2QFY15 from US$ 1.0 bn in 1QFY15. Excluding gold, imports in fact grew 3.3% yoy in 2QFY15 compared with 1.3% yoy in 1QFY15. This shows that gold import significantly impacts the overall import bill and resulted in a higher trade deficit.

Remittances Remain Flat: Remittances from aboard have ranged between US$ 15 bn to US$ 17 bn since 2QFY12 and were US$ 16.3 bn for 2QFY15. Even, net invisibles at USD28.5bn in 2QFY15 were nearly of the same level of US$ 28.1 bn as witnessed in 2QFY14.

Net Capital Inflow: On a net basis, the capital account witnessed an inflow of US$ 18.7 bn in 2QFY15 compared with US$ 19.8 bn in 1QFY15. Both major heads of capital account - foreign direct investment and portfolio investment - witnessed a net inflow. In 2QFY15, net inflow under foreign direct investment was US$ 8.0 bn (1QFY15: US$ 8.2 bn) and under portfolio investment was US$ 9.8 bn (US$ 12.4 bn).

Inflation

Wholesale inflation decelerated for the sixth consecutive month this fiscal as it came in at nil in November’14 (y-o-y) as against 7.5% during the corresponding period of the previous fiscal year. The slowdown in price rise is a positive sign with a marked decline across the broad heads of the WPI:

- Food prices have come down

- Fuel prices continue to fall

- Manufactured goods inflation remains weak

- Some downward bias due to high base effect

The decline in WPI inflation is a welcome sign which appears to be sustainable given the direction of movement of farm and fuel prices. The only risk factor is a possible increase in agricultural product prices in the next two months as kharif crop is estimated to be lower this year. However, so far this has not manifested in any significant increase in prices. Crude oil prices are expected to supportive of lower inflation. The base effect however, is unlikely to impact the overall changes in WPI significantly and hence WPI inflation is unlikely to be a concern for the rest of the year.

Retail inflation as measured by the Consumer Price Index (CPI) was at a 4.4% on a YoY basis for the month of November 2014. The high base effect from corresponding figures last year (11.2% in November 2013) played a major role in the downward slide in prices. The all-time low growth of 4.4% came over an all-time high growth of 11.2% last year. This was thereby the fourth consecutive month where retail inflation remained downward bound.

Food Inflation: Future Trajectory

Much to everyone’s relief, inflation has begun to ease led by a sharp fall in food prices. This has sparked a clamour for monetary easing as most likely. But RBI has not yielded as yet; it remains more focused on the medium-term outlook, especially the 6% glide path target set for January 2016. Its caution is guided

by its model, which projects inflation to return to 6% levels in 2015-16 from a 4.4% low in November 2014 as base effects wane and absent any visible supply response, food prices come under renewed pressure with acceleration in aggregate demand.

Arguably however, the drivers of food inflation have so significantly weakened that suggestions of any sharp reversal in 2015-16 seem over-cautious. In addition, the declines in international food prices provide the option of augmenting domestic supplies and contain future prices. As in a recent RBI working paper, “Analytics of Food Inflation in India” (October 2014), shows the food inflation persistence in recent years is largely attributable to higher rural wages, minimum support price increases for rice and wheat and rise in agriculture input costs.

Recent data clearly shows a sharp deceleration in rural wage rate growth in the last two years, a marked weakening of a key driver of food inflation. Will the trend reverse as aggregate demand accelerates, since GDP growth is projected to rise to 5.4% to 5.5% in 2014-15 and further above 6% in 2015-16? The answer would depend on both the pace of demand acceleration and its sectoral composition. At this point of time, growth projections appear a little optimistic given the weak credit demand, investment activity and exports, apart from contractionary monetary-fiscal policies and strained public revenues.

Since rural consumption demand is facing severe headwinds from public-spending cuts, lower farm prices and slowing remittances—evidence suggests severe compression of demand for food by rural households who allocate a larger income portion to these items. On the other hand,

higher demand concentrated in services’ activities, i.e., mostly urban and semi-urban segments—also suggests that demand for non-protein foods will be weak as these households allocate relatively lower expenditure shares for these things.

Next, while agriculture input costs are expected to benefit from the fortuitous movements of global oil and fertilizer prices, it needs to be underscored that the RBI study finds the impact of MGNREGA (Government Social employment programme) on food inflation is not sustained. With spending on this programme sharply cut in the current budget, this driver has weakened even more. Topping these waning impulses is the moderation in Minimum Support Price (MSP) increases for rice and wheat in the last two years; the more notable feature here is the recent advisory by the central government that states refrain from paying additional bonuses that earlier seemed to have compounded food price increases. Future MSP hikes can reasonably be expected to be dampened as domestic prices converge to those internationally.

The above analysis suggests the three key drivers of food inflation should remain tempered, at least in the near-term. A base-line, normal monsoon scenario would therefore suggest that any sharp reversal in food prices should be a low probability outcome in 2015-16. Benign international food prices would additionally benefit the food economy in the event domestic conditions falter from monsoon uncertainties.

Monetary Policy

Rate Reduction January End: As we forecasted,  Reserve Bank of India (RBI) maintained status quo in its fifth bi-monthly policy review held on 2^nd December, 2014, keeping the policy repo rate unchanged at 8%. It stuck to its stance despite pressure from the Finance Ministry. The Finance Minister had expressed the need to lower interest rates during interaction with the media.

However, the Central Bank provided a dovish policy outlook, highlighting that a change in the monetary stance is likely early next year, including outside the policy review cycle. Given, RBI’s focus on the quality of Government of India’s fiscal consolidation suggests that a rate cut is unlikely prior to the presentation of the Union Budget for 2015-16 at the end of February 2015. RBI expects the fiscal situation to benefit from lower fuel subsidies post the fall in crude oil prices, but conceded that weak tax growth and the back-ending of disinvestment issuances have created some uncertainty about the achievement of fiscal targets, as well as the quality of eventual fiscal adjustment.

Interest Rate

The 10 year Government Security has been moving downwards so far in this fiscal. G-Sec yields have fallen from 8.16% on to 7.94%% on 31^st November 2014. The G-Sec yield has been moving downwards owing to excess liquidity in the system and an expectation of rate cut in the coming policy review on account of declining inflation.

Deposit rates are likely to decline sharply – Deposit rates in India are still very high at ~8.5% (SBI’s 1-year rate). Rates had to be high last year, given the high inflation. However, with inflation coming under control – the last CPI print was 4.4% – real deposit rates have moved up materially. We expect inflation to rise from current levels, but even on normalized inflation, real deposit rates are 250-300bp. We expect banks to cut deposit rates by another 100-150bp over the next 12 months. If inflation stays near current levels deposit rates can drop by >200bp.

Credit Market

The financial sector to a very large extent reflects the developments taking place in the real sector. While the growth in industry and GDP do appear to be better than that of last year, there are no firm signs of resurgence in either consumption or investment in the economy. The government too is not in a position to spend owing to the fiscal deficit target that has to be honored and hence the picture is somewhat mixed. Do the developments in the financial sector tell a different story?

a. Bank credit

 Growth in bank credit has been slower this year so far compared to that last year.

There has been a slowdown in growth in credit and deposits so far this year with even the absolute increase in value terms being lower than that of last year. Investment however has grown at a marginally higher rate leading to a higher increase in monetary terms which has also supported government borrowing.

Further, while overall credit growth has slowed down, particular trends emerged under the sectoral deployment of bank credit:

Ø  The retail and agricultural segments witnessed higher growth in credit.

Ø  Credit off take in Industry and services witnessed a slowdown in growth.

Ø  Growth in credit to agriculture was 11.2% (5%) and retail 8.8% (8.1%) while that to industry was 0.7% (5.7%) and services 1.5% (8.3%).

 b. Commercial Paper (CP) market

There has been buoyancy in the operation of the CP market with the issuances increasing by 55.9% from INR 4,990 bn to INR 7,777 bn during this period. A reason for the growing popularity of CPs was admittedly the lower rates at which they could be issued which ranged from 9.7% -10.9% on an average basis as interest rates tended to be sticky during the year. However, this does not change the overall bank lending scenario as incremental credit plus incremental CPs still showed a decline over last year by 13%. Also the total flow of funds to the commercial sector defined as credit and credit like instruments i.e. CPs grew by 6.8% as against 9.8 % during the period April-December 15th. Hence, while there was some substitution between bank credit and CPs, however the overall offtake was lower in FY15.

c. Corporate Deposit (CD) market

The CD market was muted as it registered a decline in growth relative to last year. While this is a typical

trend as CD issuances and outstanding peak towards the end of the financial year, the decline was sharper in 2014 relative to 2013. As bank credit growth was tardy relative to growth in deposits, there was less need to raise funds through CDs.

d. Corporate bonds: Public issue

The public issue market for corporate debt was subdued in 2014 with there being a little less than half of the funds raised compared with 2013 for the period April-November. While there were more issuances from relatively higher number of companies, the quantity raised was lower.

e. Corporate bonds: Private placement

The private placement market was active with the total value of funds mobilized increasing by 12% in the first 8 months (April to November) of the year, with the number of issues rising by 33%. However, this was lower than that raised in 2012 i.e. FY13 when INR 2,374.1 bn was raised in the first 8 months of the year. The secondary market in corporate debt was comparable during this period to 2013, with overall volumes of INR 7,153 bn compared with INR 7,013 bn in 2013.

Some conclusions that may be drawn:

1. Bank credit growth has been lower relative to last year, and while the CP market has shown higher issuances, growth of the combined has been still lower relative to last year.

2. The private placement route has been preferred to the public issues route by corporates. This segment has been more buoyant relative to last year, with more issuances. The public issues market has been downbeat so far. However within this segment, normally around 2/3 of the funds raised are by the financial sector which gets on-lent by banks and NBFCs.

3. Therefore, it can be inferred that the overall flow of funds has been lower through the credit and debt markets this year during April-November relative to last year.