India Business Intelligence July 2010
Content
Business India Intelligence
For tnightly repor t on business developments in India
July 28th 2010 Vol XVII, No. 15 Automotive Will diesel-powered cars keep their price advantage? Pages 1-2 The secret to Suzuki’s success Pages 2-3 Finance The outlook for the rupee, interest rates and bonds Pages 3-4 Country risk Still stable
Developing diesel
Diesel cars are just starting to take off in India. But the government’s recent move to liberalise fuel markets could be a setback India’s car market is strikingly one-dimensional, with new sales dominated by small, fuel-efficient cars with small engines. Most of these are petroldriven, but both domestic and global carmakers are now racing to increase the number of diesel models they sell in this critical market. However, price remains a key issue. Any changes to the cost of fuel— policy-driven or otherwise—could quickly send sales back the other way. India’s reliance on petrol engines is largely thanks to its fondness for small cars, which account for two-thirds of domestic sales. Furthermore, it is the small-car market that offers the most promising prospects for volume growth as rising affluence enables more Indians to trade up from motorcycles. By default, most small cars—wherever they are sold in the world—are fuelled by petrol. Diesel engines typically cost between 1.5 and two times as much to build as petrol engines, thanks to the addon components and technology needed to clean up their dirtier emissions. It is far harder for carmakers to hide these costs in a small car than in larger, more expensive vehicles. And buyers of small cars are usually very alert to any extra costs. Yet despite this basic impediment, diesel’s proportion of the Indian market is growing. In 2006, it stood at 15%. By 2009, this had risen to 25% and in some months of 2010, it has reached 35%.Traditionally, 75% of the cars sold by MarutiSuzuki—which leads the Indian market with over 50% of new car sales—have been fuelled by petrol. But Maruti reveals that recently, in those models that are sold with both petrol and diesel variants, such as the Swift, Dzire and Ritz cars, between 55% and 60% of buyers have voted in favour of diesels. One reason behind diesel’s rising popularity in India is the improved technology of diesel engines. Diesel also scores highly on fuel economy, which is second on Indian car buyers’ list of considerations, after purchase price. But the main reason why diesel is taking off is lower pump prices. Indeed, the big gap between the price of petrol and diesel has been
© The Economist Intelligence Unit Limited 2010
widening for several years as a result of Indian government policy, which until very recently dictated pump prices.
Jumping on the diesel bandwagon
The growing number of diesel cars available to buy on the market has also enhanced diesel’s prevalence in India. In turn, as more and more buyers switch to the fuel, the number of diesel models launched there increases—and so the cycle goes on. Maruti Suzuki has recently said it will start to offer even more diesel models in India, having already benefited greatly from its relationship with one of the world’s diesel-engine specialists, Fiat of Italy. Maruti has been using Fiat’s 1.3 multi-jet diesel engine for some time and may start also sourcing Fiat’s 700cc diesel engine to put in some of its smallest cars. There has also been speculation that German carmaker Volkswagen’s acquisition of a 19.9% stake in Suzuki may benefit Maruti in the future, with VW becoming a future supplier of diesel engines. South Korea’s Hyundai, which is India’s second most popular brand, is also stepping up its dieselengine activities, and is even considering building diesel engines locally. “Currently we import diesel engines. To have them in small cars it has to be costeffective,” one Hyundai India director recently said. Meanwhile, Japan’s Honda, which to date has only sold petrol cars in the country, is developing a small diesel engine specifically for India, while its compatriot Toyota recently launched its first diesel in that market in its popular Corolla Altis car. Meanwhile, a diesel version of the Tata Indica is one of India’s best-selling diesel cars.
Pages 5-6
Sections Quick views . . . . . . . . . . . .7 Indicators: Demographics . . . . . . . . . .8
Cautious outlook
Yet despite these moves, carmakers remain cautious. “While we will develop diesel engines, Maruti’s strength will continue to be gasoline as we make fuelefficient petrol engines,” the company recently stated. Maruti’s marketing manager Mayank Pareek clarified this when he commented on India’s low diesel prices:
Internet delivery Business India Intelligence is available over the Internet. The content is the same as the printed version, and you receive all the benefits of Internet delivery. Simply go to www.store.eiu.com
Business India Intelligence July 28th 2010 1
Automotive
“Certainly, the price differential is the prime mover for diesel. So there would be some impact if its price goes up further.” His counterpart at General Motors India agrees. “If the price of diesel moves up again and comes closer to petrol, there would certainly be an immediate shift in buying behaviour.” That now looks likely to happen. In late June, the Indian government finally took the step of deregulating and “de-controlling” petrol prices, allowing them to be linked to market demand. At the same time it increased fuel rates, raising petrol rates by Rs3.5 (around 7.5 US cents) per litre, and diesel rates by Rs2 per litre. Although the price of diesel remains partially controlled, some pricing controls have already been removed and the government is expected to go the whole way soon and fully deregulate it. Corporate profile The upshot has so far been twofold. Fuel prices in general (of both petrol and diesel) have increased, and the gap between petrol and diesel has begun narrowing again, as it has been slowly doing for some time now. Back in 2002, petrol in India cost 38% more per litre than diesel. Currently, that price differential is 22%. Once diesel prices are fully deregulated, experts say the gap will become even smaller—possibly as little as 12.5%—as the cost of diesel per litre at the pump increases in line with increased Indian demand for the fuel. In a country which is so very focused on price, that could make a huge difference, especially when petrol cars remain around 10–15% cheaper to buy.
The government has finally “de-controlled” fuel prices
Suzuki’s star turn
Suzuki’s success in India has been a godsend, not only boosting its sales and profits, but also helping it to attract investment In recent years, Japan’s Suzuki Motor has been a star of the otherwise lacklustre global automotive industry, producing inexpensive, economical, well-engineered cars and sports utility vehicles. But unquestionably its most important decision was taken 25 years ago, when it teamed up with the Indian government to create an indigenous small-car producer, Maruti Suzuki. Indian car sales took off in recent years and proved impervious to the downturn in the global automotive industry which began in 2008. Maruti Suzuki is now majority-owned by the Japanese parent. A market leader in India, with a 50% share of the domestic market, it has seen growth in both car sales and profits in fiscal 2010 (year-end March 31st). In calendar 2009, Maruti’s unit sales were up 20% year on year. In its fiscal fourth quarter, Maruti’s profits more than doubled from the first three months of 2009. Having posted strong export growth, both across Asia and in Western Europe, where it now spearheads the growth of the parent’s brand, Maruti has become a larger automotive company than Suzuki. It is upgrading its two plants in India to boost capacity, which will definitively push Suzuki vehicle production there above that in Japan. Suzuki is using India as a production base, taking advantage of far lower costs, but also as model development site for its global operations. More to the point, Maruti is responsible for some 80% of Suzuki profits. Thanks to its Indian subsidiary, Suzuki has not only stayed profitable throughout the recent tough economic times but increased its operating and net income in fiscal 2010. Even so, sales declined by nearly 20% last year, and by a cumulative margin of nearly one third from fiscal 2008. Some of Suzuki’s problems were in its domestic market, where Suzuki holds a one-third market share in the mini-vehicle segment. Sales there were down by 8%. But exports from Japan were halved during 2009, and even after a rise in the first quarter posted a 36% drop in fiscal 2010. As a result, Japanese production, which accounts for roughly half of Suzuki’s overall production, dropped by a quarter to less than a million units. That compares with a 9% fall in Suzuki’s global production. Weak sales in the US were also a problem, although that market is not as important for Suzuki as for larger Japanese manufacturers. Despite a moderate recovery in overall US auto sales since the introduction of the “cash for clunkers” scrappage programme financed by the federal government, Suzuki continues to suffer in 2010. In May, its unit sales in the US were down by a quarter on a yearon-year basis. It has not seen year-on-year sales growth in this market since mid-2008. Along with Mitsubishi, Suzuki may soon withdraw from the US market completely.
Suzuki‘s Indian offspring has outgrown its parent
The lure of India
With such disappointments elsewhere, it is little wonder that Suzuki has been keen to shore up its position in India, where the world’s largest automakers are converging to take advantage of market growth. They are bringing out a large number of small models. To counteract this assault on the low-end, thin-profitmargin, overcrowded segment, Suzuki plans to sell
© The Economist Intelligence Unit Limited 2010
2 Business India Intelligence July 28th 2010
Automotive/Finance
larger vehicles in India to take advantage of the rising incomes of India’s middle class. To help it push through this plan, Suzuki has recently increased its ownership share in its Indian subsidiary by 0.8%, which brought it over the 55% mark. At this level of ownership, Suzuki will be required to launch a bid for an additional 20% of the company, completing a full takeover. Maruti will then be de-listed from the Mumbai stockmarket at a cost of US$5bn. India is also a key bargaining chip in the quest to find a strong partner amid ongoing consolidation in the global motor vehicles industry. While the Indian market has bolstered Suzuki, the company knows that it will be hard-pressed to remain successful in a troubled industry that is suffering from global overcapacity and is undergoing a gradual consolidation. Over the years, it has had partnerships with a variety of Japanese and foreign companies. Until its current problems came to a head, US-based General Motors held a substantial share in Suzuki, which it has now completely sold off. In December 2009, the Japanese company forged a partnership with Germany’s Volkswagen, now the world’s largest automotive company in terms of sales volume. VW bought a 19.9% stake in Suzuki. The deal will give Suzuki added weight in the global auto industry, including the benefit of pooling technology and suppliers. For VW, the benefits are also tangible. Along with Italy’s Fiat, Suzuki has proved that it is possible to make money out of small cars. It can also offer a useful emerging markets presence, particularly in India. Yet the link-up with VW does pose some problems. Along with the shift in production and model development in India, it throws Suzuki’s Hungarian operation into question. With the introduction of the A-Star city car, Maruti has resumed exports to Western Europe after a break in the middle of this decade. Meanwhile, Hungary has recently joined the peripheral euro-zone economies Portugal, Italy, Greece and Spain in the financial doghouse. Even if Outlook
Suzuki: Financial results
Year ended 31-Mar-10 JPY (m) Revenue/sales Operating/trading income Net income Shareholders’ equity Long-term debt Market capitalisation Employees (number) Ratios (%) Operating profit margin Return on equity Debt to equity
Sources: Company reports, Financial Times.
Year ended 31-Mar-09 3,004,888 48,518 27,429 639,432 252,732 801,509 50,613 1.6 4.3 39.5
Year ended 31-Mar-08 3,502,419 140,350 80,255 778,607 254,265 1,195,619 52,994 4.0 10.3 32.7
Year ended 31-Mar-07 3,163,669 131,215 75,009 741,522 238,308 1,379,898 45,510 4.1 10.1 32.1
2,469,063 78,900 28,913 951,983 286,079 1,152,717 51,258 3.2 3.0 30.1
concerns about fiscal discipline undermine the Hungarian forint, reducing the cost of production in Hungary, the company’s Hungarian operation is in danger of becoming unviable. The same may be true of its operations in Thailand, where Suzuki established its first plant outside Japan in 1967 and where it recently invested nearly US$300m in a new production facility. There are some big questions over China, too, where VW is the biggest foreign carmaker. Changes are already under way at Suzuki’s operations in China, where the government is gradually implementing an orderly industry consolidation. State-owned Chang’an Auto Corp, the thirdlargest automotive company in China, merged with Aviation Industry Corp of China, which includes automotive company Changhe. Both are Suzuki’s joint-venture partners in China. Chang’an Suzuki produced 150,000 Suzuki vehicles last year. The two Suzuki joint ventures have the capacity to make 400,000 cars and minibuses annually, as well as 350,000 engines. China and India may become the two main manufacturing hubs for Suzuki worldwide.
Overheating?
India will continue to tighten monetary policy amid a build-up of inflationary pressures. The rupee has lost some momentum and government bond yields are rising CURRENCY: After rising in the first half of June, the rupee has been in a renewed decline over the past month, revisiting its 2010 lows and trading at around Rs47:US$1 as of July 27th. The dollar has been driven higher across the boards by safe-haven considerations in the aftermath of the euro-zone debt crisis in the second quar© The Economist Intelligence Unit Limited 2010
ter. More recently, the greenback has sagged under the wait of unfavourable economic news at home and fears that the US economy might slide into another recession. But the rupee, which regained some strength in June, has been falling once more over the past month. Higher domestic interest rates provided little
The rupee regained strength in June
Business India Intelligence July 28th 2010 3
Finance
Latest data
Rs:US$1 (av) Rs: ¥100 (av) Repurchase rate (end-period) Reverse repurchase rate (end-period) Lending rate Jan 2010 45.96 50.31 4.75 3.25 12.00 Feb 46.33 51.31 4.75 3.25 12.00 Mar 45.50 50.21 5.00 3.50 12.00 Apr 44.50 47.63 5.25 3.75 12.00 May Jun 45.80 46.56 49.68 51.24 5.25 5.25 3.75 3.75 12.00 12.00
Currency forecasts*
Rs:US$1 (av) Rs:US$1 (end-period) Rs: ¥100 (av) Rs: ¥100 (end-period)
* Fiscal years (beginning April 1st of year indicated)
2010 46.2 46.1 49.6 49.3
2011 46.0 45.5 49.5 48.9
2012 45.0 44.5 48.6 48.4
2013 44.0 43.5 47.8 47.3
2014 43.0 42.5 47.0 46.7
Interest-rate forecasts
Lending rate (av; %) Deposit rate (av; %) Money-market rate (av; %)
* Fiscal years (beginning April 1st of year indicated)
2010 12.5 7.5 5.8
2011 12.7 7.8 6.5
2012 12.7 7.5 6.5
2013 13.0 7.8 6.8
2014 13.0 8.0 7.2
Debt forecasts*
Budget balance (% of GDP) Public debt (% of GDP)
* Fiscal years (beginning April 1st of year indicated)
Source: Economist Intelligence Unit
2010 -5.5 55.7
2011 -5.3 55.3
2012 -4.9 54.5
2013 -4.3 52.8
2014 -3.9 50.9
The rupee will strengthen in the third quarter
protection for the currency. On the contrary, the fact that inflationary pressures continue to increase may actually now be counterproductive for the rupee, since further rate increases could begin to choke the buoyant domestic economy at a time when demand in key export markets is widely expected to slow. The recent depreciation of the rupee has taken consensus forecasters by surprise. The Economist Intelligence Unit’s consensus forecast sees the rupee at a higher level at the end of the third quarter, with only the bearish fringe of the forecast range predicting that it will trade at its current levels over the near term. The forecast mean sees the Indian currency in the Rs45:US$1 range three months hence. Over the longer term, we expect the rupee to average Rs46.2:US$1 in fiscal 2010/11 (April-March) and Rs46:US$1 in 2011/12. Although these are slightly weaker levels than what we were forecasting earlier this year, they still represent a year-on-year nominal appreciation of nearly 5% in 2010/11 and 0.4% in 2011/12. Given India’s high inflation rate, this will represent an annual average appreciation of 11% in real terms over the two-year period. INTEREST RATES: The key policy rate was hiked between central bank meetings, going up by 25 basis points, to 5.50%, on July 3rd. It was raised
again, to 5.75% at the central bank’s quarterly meeting on July 27th. The Reserve Bank of India (RBI, the central bank) began to tighten monetary policy in January, announcing that it would increase the cash reserve ratio in two stages, by a total of 75 basis points, to 5.75% by end-February. The RBI then raised the repurchase (repo) rate—the interest rate at which it adds funds to the banking system—in mid-March, to 5%, and increased it again in mid-April, to 5.25%. While the euro zone debt crisis was expected to make the RBI to hold fire between meetings, fears of inflationary pressures prevailed. Wholesale price inflation continued to increase in June, rising to 10.6% year on year from 10.2% in May. Inflation has been in double digits for five straight months, with prices taking off extremely fast over the past year. Even non-food inflation has been strong, contributing to more than 70% of the overall level of wholesale price inflation. The central bank therefore tightened in July 3rd, and again on July 27th. Most economists were expecting another 25 basis point rate increase at the RBI’s June 27th monetary-policy meeting. The repo rate was raised by 25 basis points, but the reverse repo rate was raised by 50 basis points, to 4.5%. This was a sharper increase than the three preceding rate hikes. We forecast that the repo rate will rise to 6.25% by the end of 2010 and to 6.5% by the end of 2011. This should be sufficient to turn real interest rates positive in 2011, assuming that the current inflationary surge abates. However, the RBI will be mindful that higher interest rates could undermine the government’s fiscal-consolidation plan, encourage volatile capital inflows and exert upward pressure on the rupee. Inflation should begin to moderate in the second half of 2010 as the impact of last year’s poor monsoon on food prices begins to dissipate. BONDS: The yield on the rupee-denominated government benchmark bond due May 2020 rose to its highest level since mid-June and stood at 7.69% as of July 21st. Bond yields have been rising more recently in light of higher inflation and expectations that the central bank would effect its fourth interest-rate increase since the start of the year. Government bond yields, however, remain relatively low, providing a negative return in inflation-adjusted terms. While public spending remains high, and the budget deficit will surpass 5% of GDP both this year and next, strong domestic economic growth in the face of a global downturn has required only modest loosening of fiscal policy. At the same time, with GDP expanding rapidly and deficit spending declining, we expect the debt-to-GDP ratio to keep sliding from over 55% currently into the 50% range by the end of the 2010-14 forecast period.
© The Economist Intelligence Unit Limited 2010
4 Business India Intelligence July 28th 2010
Country risk
Risk assessment
Stable outlook
The Economist Intelligence Unit’s latest evaluation of country risk maintains India’s “BB” rating India’s country risk rating is derived by taking a simple average of the scores for sovereign risk, currency risk and banking sector risk. In each case, India’s outlook is stable. Government borrowing on international markets will remain limited, but high levels of domestic public debt are a concern. Inflationary and fiscal risks present the possibility of downward pressure on the rupee in 2010, but their influence is likely to be offset by higher capital inflows. The non-performing loan (NPL) ratio is relatively low, and the risk of a systemic banking crisis is small. However, the NPL ratio would be much higher if India used internationally accepted criteria to define bad loans. SOVEREIGN RISK: There is little likelihood that India will experience an external-debt crisis in the forecast period. Foreign-exchange reserves were estimated at more than double the value of India’s gross financing requirement in 2009. The country’s external debt is equivalent to around 15.6% of GDP, compared with a median for other BB-rated countries of 25.3%. The low level of external debt is the main structural factor that supports a sanguine outlook for sovereign risk. Nevertheless, the rating is constrained by poor standards of fiscal management and the high level of domestic public debt. The median gross public debt to GDP ratio of BB-rated countries is 39.2%, which is lower than India’s 56.1%. Partly as a consequence of its high debt level, the Indian government spends 28.9% of its revenue on debt interest payment—a far larger proportion than the median of BBrated countries of 9.1%. In a positive development, the budget for fiscal year 2010/11 (April-March) was the first to include an explicit target to reduce the debt to GDP ratio. Contingent liabilities would rise significantly if the government had to bolster the balance sheets of private-sector banks (not the Economist Intelligence Unit’s central forecast) amid a rise in NPLs.
Rating outlook
Stable. The deterioration in external trade conditions in 2009 had a negative impact on India’s sovereign rating, as economic contractions in the OECD and the subsequent collapse of demand exacted a toll on India’s export-oriented industries. However, exports are now recovering in line with a rise in global demand, and a strong domestic economic recovery will also support India’s sovereign rating. The current-account deficit is forecast to average 1.8% of GDP a year in 2010-11. The biggest risk to the outlook is the government’s weak fiscal position; the fiscal deficit widened sharply in 2008/09 and is estimated to have expanded further in 2009/10. The 2010/11 budget includes a strong emphasis on fiscal consolidation, and government revenue in the first few months of the current fiscal year has exceeded expectations. Nevertheless, expenditure pressures remain strong, so although we expect the government to meet its fiscal target, progress in this regard could easily be reversed. On balance, India’s ability to service its sovereign debt is expected to remain stable. CURRENCY RISK: India’s foreign-exchange markets have become more volatile as the country’s international trade has expanded and it has moved closer to full capital account convertibility. India’s reliance on foreign capital inflows means that sharp swings in the level of the rupee against the US dollar have become more frequent over the past few years. The rupee depreciated against the US dollar in 2008, in part reflecting a general flight from risky assets, the liquidation of holdings of Indian equities by foreign investors and growing concerns about the severity of the economic slowdown in India. For most of 2008 the Reserve Bank of India (RBI, the central bank) allowed the market to determine the exchange rate, but in September of that year it began to intervene to prop up the currency in order to ensure that the rate of depreciation was not excessively rapid. It had less need to do so in 2009, as the rupee stabilised in April and appreciated by 9.1% against the US dollar in the last nine months of that year. Nevertheless, the currency’s average level against the US dollar in 2009 as a whole was 10.1% weaker than it was in 2008.
Exports are recovering
Positive factors
Foreign direct investment—a more stable form of financing than short-term inflows such as portfolio investment—covers nearly one-half of the gross financing requirement. Foreign-exchange reserves are almost equivalent to five times the value of external short-term debt. This helps to assure debt-repayment capacity, even in the event that overseas credit lines cannot be rolled over.
The rupee’s volatility has increased
Negative factors
The fiscal position has deteriorated sharply because of increased spending on public-sector wages and economic stimulus measures, combined with slow growth in revenue from corporate and customs taxes.
© The Economist Intelligence Unit Limited 2010
Business India Intelligence July 28th 2010 5
Country risk
India: Country risk
July 2010
Source: Economist Intelligence Unit
Sovereign risk BB
Currency risk BB
Banking sector risk BB
Country risk BB
Positive factors
Higher interest rates will attract more capital inflows The rupee is not very overvalued relative to the currencies of competing countries. The real trade-weighted exchange rate has risen by 11.4% in the past 48 months, faster than the median for BB-rated countries of 9.9%, but less rapid than the median for the BRIC countries (Brazil, Russia, India and China) of 16%. The RBI has started tightening monetary policy and is expected to continue to raise interest rates throughout 2010. This is likely to attract more foreign capital inflows, which would support the rupee.
Negative factors
Wholesale price inflation rose to 10.6% year on year in June and consumer price inflation also remains high. High inflation is typically accompanied by depreciation of the rupee.
degree of protection (as it is likely that the government would bail out banks in the event of a crisis), but it also leads to inefficiency. Government intervention in the banking sector is extensive. This is most clearly manifested in the practice of directed lending, whereby banks are obliged to devote around 40% of total loans to priority sectors (including agriculture, small industry and disadvantaged sections of society) and around 12% to export financing. Banks are heavily exposed to the sovereign: over 35% of the banking system’s assets consist of government debt.
Positive factors
Moves towards the liberalisation of the capital account have been steady but slow. India will probably strengthen its financial regulatory system sufficiently before opening up the capital account. Growth in per-head income is set to strengthen in 2010-11 as economic expansion accelerates. This will lead to a rise in the number of bankable households.
Rating outlook
Stable. Inflationary and fiscal risks present the possibility of downward pressure on the rupee in 2010, but they are likely to be offset by higher capital inflows. We expect the currency to average Rs46.2:US$1 in 2010/11. However, this will represent a nominal appreciation of 4.8%, compared with the average value of the rupee the year before. The currency should continue its appreciating trend in 2011/12, to average Rs46:US$1 in that year. Given India’s high rate of inflation, this gentle nominal appreciation will represent a strengthening of 15.8% and 6.1%, respectively, in real terms.
Negative factors
The stock of domestic credit grew by an annual average of 19.8% in 2005-09. This rapid growth means that there may have been a deterioration in the quality of lending, which would increase the risk of a rise in defaults. The RBI has moved the focus of its policy from boosting economic growth to containing inflation. We expect the RBI to continue to raise interest rates throughout 2010. Tighter monetary policy will make it harder for borrowers to service their debt and will increase the likelihood of a rise in NPLs.
Foreign-exchange regime
India maintains a managed float with capital controls. The rupee is freely traded on the current account, but not on the capital account. Indian companies, individuals and pension funds face restrictions when attempting to move capital abroad. The government is committed to liberalising the capital account, especially as Indian companies have begun to expand overseas, but the process will be a gradual one. Local asset markets have seen sustained improvement since 2008 BANKING SECTOR RISK: The sustained improvement in local asset markets relative to 2008 and the positive economic outlook support the BB rating for banking sector risk. India’s banking sector is generally cautious and is conservatively regulated. In recent years banks have diversified from corporate lending into consumer finance, including car loans and mortgages. Although this has helped banks to diversify their income streams, supervision in this area has yet to be fine-tuned. Over 75% of banking assets are controlled by state-owned banks. This provides a high
Rating outlook
Stable. The rapid expansion of consumer credit in India has taken place from a very low base. This means that it does not pose as high a risk to the banking system as it would in a more mature market, as the level of debt per bank customer remains relatively low. The extremely low level of bank penetration also provides a means for banks to expand their business without turning to complex, high-risk products. Nevertheless, there are a number of downside risks for the sector. A rise in NPLs is still likely as the RBI continues to tighten monetary policy. The continued prevalence of state-directed lending also increases the risk of a rise in NPLs, particularly in periods of weak economic growth. Corruption is endemic in India, including in the banking sector; this will continue to undermine profitability.
© The Economist Intelligence Unit Limited 2010
6 Business India Intelligence July 28th 2010
Quick views
Relentless price pressures
India’s wholesale price inflation rate climbed to 10.6% year on year in June, up from 10.2% in May and marking the fifth consecutive month of doubledigit expansion. The cost of manufactured products increased by 6.7% year on year after hitting a fivemonth low of 6.4% in May. This was owing to faster price growth for wood, rubber and plastics, chemicals, machinery and transport equipment. By contrast, the cost of non-metallic minerals fell (by 1.2%) for the first time in four months, while the cost of manufactured food and beverages rose by the same amount (7.5%) as in May. Inflation in the fuel, power and light component also accelerated, to 14.3% from 13.1% in May; the government raised petroleum product prices on June 25th. By contrast, prices of primary food articles (this sub-category holds the largest weighting in the wholesale price index) increased by 14.6%, the slowest pace of expansion in eight months. begin to moderate in the second half of this year, as the impact of last year’s poor monsoon on food prices begins to dissipate. The Economist Intelligence Unit forecasts that wholesale price inflation will average 8.9% for 2010 as a whole, before easing to 5% in 2011. Given the persistence of strong inflationary pressures, the Reserve Bank of India (RBI, the central bank) is being placed under increasing pressure to raise interest rates again. The RBI first began tightening monetary policy in January, when it raised the cash reserve ratio. It then raised its repurchase (repo) rate in March and April, and again, before a scheduled meeting, in early July. We forecast that the repo rate will reach 6.25% by end-2010 and 6.5% by the end of 2011. Inflation will ease in 2011
India: Wholesale price inflation
(% change, year on year)
Dec 09 8.1 Jan 10 9.4 Feb 10 10.1 Mar 10 11.0 Apr 10 9.6 May 10 10.2 Jun 10 10.6
The EIU view
Although inflation has remained stubbornly high, the Economist Intelligence Unit forecasts that it will
Source: Ministry of Commerce and Industry; Haver Analytics
Industrial growth starts to slow
India’s industrial production growth hit a sevenmonth low of 11.5% year on year in May. The April growth figure was pared back to 16.5% from 17.6%. Manufacturing continued to lead output growth in May, expanding by 12.3% year on year, while output from the mining and electricity sectors rose by 8.7% and 6.4% respectively. By category of goods, production of capital goods remained far higher than last year, expanding by 34.3%, showing that investment continues to expand strongly. Production of consumer durable goods—which are largely bought by India’s 300m-strong middle class—also continued to expand rapidly, by 23.7% year on year. This marks the 13th consecutive month of double-digit gain. Similarly, production of intermediate goods rose by 10.2%, virtually unchanged from the previous month’s level of 10.6%. Output of basic goods increased by 7.9%, while production of non-durable items (which tend to be purchased by a broader section of the population) grew by just 2.4% (down from 4.5% a month earlier). ereign debt crisis is unlikely to have any major effect on India’s manufacturing sector, given that production is mainly destined for the domestic economy. Indeed, private consumption and investment are expected to rise steadily—the former thanks to improved confidence and credit conditions, and the latter by better access to both domestic and foreign sources of financing and a recovery in investment prospects in many consumer sectors. Although the HSBC Purchasing Manager’s Index (PMI) fell to 57.3 in June from a two-year plus high of 59 in May, it has held above its long-term average (55.9) since the beginning of this year. The statistical boost from the low output levels in 2009 will start to fade in the July-September quarter, which combined with the lagged effect from further interest rate hikes in 201011, will slow industrial activity growth to a forecast 9.4% in 2011. The European debt crisis is unlikely to affect Indian manufacturing
India: Industrial production
(% change, year on year)
Nov 09 12.0 Dec 09 17.7 Jan 10 16.3 Feb 10 15.1 Mar 10 13.9 Apr 10 16.5 May 10 11.5
The EIU view
Industrial production has been very strong in India and the Economist Intelligence Unit forecasts that it will grow by an average of 13.7% this year (the average in January-May came to 14%). The euro zone sov© The Economist Intelligence Unit Limited 2010
Source: Ministry of Statistics and Programme Implementation; Haver Analytics
Business India Intelligence July 28th 2010 7
Indicators: Demographics
Population advantage?
India is expected to overtake China as the world’s most populous country in the mid-2020s, with a population approaching 1.5bn. Governments have shifted away from sterilisation as the cornerstone of family planning to an emphasis on improving female social and economic welfare. This, coupled with rising living standards, particularly in urban areas, is leading to a fall in the population growth rate. Nevertheless, although strong economic growth is slowing the fertility rate, at 3.1 children per woman, it is one-third above the official target of replacement-level fertility. The rising population will lead to opportunities and costs. Increased environmental degradation and a growing strain on water and food resources appear inevitable. The gender distribution of India’s population is disturbing and has equally important implications for stability. Historically, countries with severe gender disparities suffer from rising disorder. India will, however, enjoy a growing working-age population at a time when other countries (including China) will face increasing dependency ratios. If India can put in place an education system that ensures its working-age population meets global demands, then it will perform well. But if its education system fails to adapt, a large underemployed population is likely to result in increased social instability.
July 28th 2010 Vol XVII No. 15 ISSN: 1468-120X
PUBLISHER Charles Goddard EDITOR Jacob Hamstra PRODUCTION Gaddi Tam EDITORIAL QUERIES Tel: (852) 2585 3861 Fax: (852) 2802 7638
Published 22 times a year for subscribers only
[email protected]
India: Demographics and income
Population, income and market size Population (m) GDP (US$ bn at market exchange rates)d GDP per head (US$ at market exchange rates)d Private consumption (US$ bn)d Private consumption per head (US$)d GDP (US$ bn at PPP)d GDP per head (US$ at PPP)d Personal disposable income (Rs bn)d Personal disposable income (US$ bn)d Growth of real disposable income (%)d Memorandum items
2006a 2007a
2008b
2009b
2010c
2011c
2012c
2013c
2014c
1,112 1,130 1,148 1,166 1,184 1,202 1,220 1,238 1,256 958.1 1,187.3 1,260.0a 1,296.2a 1,585.1 1,820.1 2,121.4 2,483.1 2,905.3 860 1,050 1,100 1,110 1,340 1,510 1,740 2,010 2,310 a 743.1a 882.3 971.6 1,094.6 1,233.8 1,391.3 554.0 675.7 727.4 500 2,855 2,570 728.9 6.8 600 3,220 2,850 901.1 9.0b 17.13 2.20 4.83 1.05 630 3,457a 3,010 640 3,766a 3,230 750 4,1088 3,470 810 4,498 3,740 900 4,952 4,060 1,000 5,488 4,430 1,110 6,081 4,840
As well as being available to subscribers in print, Business India Intelligence is available electronically via the Internet. For more information please visit www.store.eiu.com or contact your nearest Economist Intelligence Unit office. London 26 Red Lion Square London WC1R 4HQ United Kingdom Tel: (44-20) 7576 8000 Fax: (44-20) 7576 8500 E-mail: [email protected] New York Tel: (1.212) 698 9745 Fax: (1.212) 586 0248 E-mail: [email protected] Hong Kong Tel: (852) 2802 7288/2585 3888 Fax: (852) 2802 7368/7720 E-mail: [email protected] © 2010 The Economist Intelligence Unit Limited. All rights reserved under the International and Pan-American Copyright Conventions. Reproduction and transmission in any form without prior permission is prohibited. All information in this report is verified to the best of the authors’ and the publisher’s ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. Printed by Chris Fowler International (Asia) Ltd
33,026 37,260
43,964 52,393 58,855 65,622 72,722 80,471 88,945 1,010.5 1,082.4 1,274.4 1,426.6 1,616.0 1,828.9 2,068.5 10.3 17.21 2.13a 4.98a 1.25a 12.0 17.29 2.30a 5.40a 1.30a 4.9 17.38 2.65 5.58 1.34 8.5 17.45 2.91 5.83 1.43 7.6 17.53 3.19 6.08 1.48 7.4 17.60 3.47 6.34 1.56 6.9 17.67 3.76 6.58 1.66
Share of world population (%) 17.05 Share of world GDP (% at market exchange rates) 1.99 Share of world GDP (% at PPP) 4.62 Share of world exports (%) 1.00
Source: Economist Intelligence Unit
a Actual b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Fiscal years (beginning April 1st of year indicated).
Dependency ratios: How India compares
% 60 Young-age dependency* Old-age dependency**
40
20
0 China India 2005 Japan China India 2010 Japan China India 2015 Japan
*Ratio of those people younger than 15 to those aged 15-64 **Ratio of those people older than 64 to those aged 15-64
Source: Economist Intelligence Unit
8 Business India Intelligence July 28th 2010
© The Economist Intelligence Unit Limited 2010
For tnightly repor t on business developments in India
July 28th 2010 Vol XVII, No. 15 Automotive Will diesel-powered cars keep their price advantage? Pages 1-2 The secret to Suzuki’s success Pages 2-3 Finance The outlook for the rupee, interest rates and bonds Pages 3-4 Country risk Still stable
Developing diesel
Diesel cars are just starting to take off in India. But the government’s recent move to liberalise fuel markets could be a setback India’s car market is strikingly one-dimensional, with new sales dominated by small, fuel-efficient cars with small engines. Most of these are petroldriven, but both domestic and global carmakers are now racing to increase the number of diesel models they sell in this critical market. However, price remains a key issue. Any changes to the cost of fuel— policy-driven or otherwise—could quickly send sales back the other way. India’s reliance on petrol engines is largely thanks to its fondness for small cars, which account for two-thirds of domestic sales. Furthermore, it is the small-car market that offers the most promising prospects for volume growth as rising affluence enables more Indians to trade up from motorcycles. By default, most small cars—wherever they are sold in the world—are fuelled by petrol. Diesel engines typically cost between 1.5 and two times as much to build as petrol engines, thanks to the addon components and technology needed to clean up their dirtier emissions. It is far harder for carmakers to hide these costs in a small car than in larger, more expensive vehicles. And buyers of small cars are usually very alert to any extra costs. Yet despite this basic impediment, diesel’s proportion of the Indian market is growing. In 2006, it stood at 15%. By 2009, this had risen to 25% and in some months of 2010, it has reached 35%.Traditionally, 75% of the cars sold by MarutiSuzuki—which leads the Indian market with over 50% of new car sales—have been fuelled by petrol. But Maruti reveals that recently, in those models that are sold with both petrol and diesel variants, such as the Swift, Dzire and Ritz cars, between 55% and 60% of buyers have voted in favour of diesels. One reason behind diesel’s rising popularity in India is the improved technology of diesel engines. Diesel also scores highly on fuel economy, which is second on Indian car buyers’ list of considerations, after purchase price. But the main reason why diesel is taking off is lower pump prices. Indeed, the big gap between the price of petrol and diesel has been
© The Economist Intelligence Unit Limited 2010
widening for several years as a result of Indian government policy, which until very recently dictated pump prices.
Jumping on the diesel bandwagon
The growing number of diesel cars available to buy on the market has also enhanced diesel’s prevalence in India. In turn, as more and more buyers switch to the fuel, the number of diesel models launched there increases—and so the cycle goes on. Maruti Suzuki has recently said it will start to offer even more diesel models in India, having already benefited greatly from its relationship with one of the world’s diesel-engine specialists, Fiat of Italy. Maruti has been using Fiat’s 1.3 multi-jet diesel engine for some time and may start also sourcing Fiat’s 700cc diesel engine to put in some of its smallest cars. There has also been speculation that German carmaker Volkswagen’s acquisition of a 19.9% stake in Suzuki may benefit Maruti in the future, with VW becoming a future supplier of diesel engines. South Korea’s Hyundai, which is India’s second most popular brand, is also stepping up its dieselengine activities, and is even considering building diesel engines locally. “Currently we import diesel engines. To have them in small cars it has to be costeffective,” one Hyundai India director recently said. Meanwhile, Japan’s Honda, which to date has only sold petrol cars in the country, is developing a small diesel engine specifically for India, while its compatriot Toyota recently launched its first diesel in that market in its popular Corolla Altis car. Meanwhile, a diesel version of the Tata Indica is one of India’s best-selling diesel cars.
Pages 5-6
Sections Quick views . . . . . . . . . . . .7 Indicators: Demographics . . . . . . . . . .8
Cautious outlook
Yet despite these moves, carmakers remain cautious. “While we will develop diesel engines, Maruti’s strength will continue to be gasoline as we make fuelefficient petrol engines,” the company recently stated. Maruti’s marketing manager Mayank Pareek clarified this when he commented on India’s low diesel prices:
Internet delivery Business India Intelligence is available over the Internet. The content is the same as the printed version, and you receive all the benefits of Internet delivery. Simply go to www.store.eiu.com
Business India Intelligence July 28th 2010 1
Automotive
“Certainly, the price differential is the prime mover for diesel. So there would be some impact if its price goes up further.” His counterpart at General Motors India agrees. “If the price of diesel moves up again and comes closer to petrol, there would certainly be an immediate shift in buying behaviour.” That now looks likely to happen. In late June, the Indian government finally took the step of deregulating and “de-controlling” petrol prices, allowing them to be linked to market demand. At the same time it increased fuel rates, raising petrol rates by Rs3.5 (around 7.5 US cents) per litre, and diesel rates by Rs2 per litre. Although the price of diesel remains partially controlled, some pricing controls have already been removed and the government is expected to go the whole way soon and fully deregulate it. Corporate profile The upshot has so far been twofold. Fuel prices in general (of both petrol and diesel) have increased, and the gap between petrol and diesel has begun narrowing again, as it has been slowly doing for some time now. Back in 2002, petrol in India cost 38% more per litre than diesel. Currently, that price differential is 22%. Once diesel prices are fully deregulated, experts say the gap will become even smaller—possibly as little as 12.5%—as the cost of diesel per litre at the pump increases in line with increased Indian demand for the fuel. In a country which is so very focused on price, that could make a huge difference, especially when petrol cars remain around 10–15% cheaper to buy.
The government has finally “de-controlled” fuel prices
Suzuki’s star turn
Suzuki’s success in India has been a godsend, not only boosting its sales and profits, but also helping it to attract investment In recent years, Japan’s Suzuki Motor has been a star of the otherwise lacklustre global automotive industry, producing inexpensive, economical, well-engineered cars and sports utility vehicles. But unquestionably its most important decision was taken 25 years ago, when it teamed up with the Indian government to create an indigenous small-car producer, Maruti Suzuki. Indian car sales took off in recent years and proved impervious to the downturn in the global automotive industry which began in 2008. Maruti Suzuki is now majority-owned by the Japanese parent. A market leader in India, with a 50% share of the domestic market, it has seen growth in both car sales and profits in fiscal 2010 (year-end March 31st). In calendar 2009, Maruti’s unit sales were up 20% year on year. In its fiscal fourth quarter, Maruti’s profits more than doubled from the first three months of 2009. Having posted strong export growth, both across Asia and in Western Europe, where it now spearheads the growth of the parent’s brand, Maruti has become a larger automotive company than Suzuki. It is upgrading its two plants in India to boost capacity, which will definitively push Suzuki vehicle production there above that in Japan. Suzuki is using India as a production base, taking advantage of far lower costs, but also as model development site for its global operations. More to the point, Maruti is responsible for some 80% of Suzuki profits. Thanks to its Indian subsidiary, Suzuki has not only stayed profitable throughout the recent tough economic times but increased its operating and net income in fiscal 2010. Even so, sales declined by nearly 20% last year, and by a cumulative margin of nearly one third from fiscal 2008. Some of Suzuki’s problems were in its domestic market, where Suzuki holds a one-third market share in the mini-vehicle segment. Sales there were down by 8%. But exports from Japan were halved during 2009, and even after a rise in the first quarter posted a 36% drop in fiscal 2010. As a result, Japanese production, which accounts for roughly half of Suzuki’s overall production, dropped by a quarter to less than a million units. That compares with a 9% fall in Suzuki’s global production. Weak sales in the US were also a problem, although that market is not as important for Suzuki as for larger Japanese manufacturers. Despite a moderate recovery in overall US auto sales since the introduction of the “cash for clunkers” scrappage programme financed by the federal government, Suzuki continues to suffer in 2010. In May, its unit sales in the US were down by a quarter on a yearon-year basis. It has not seen year-on-year sales growth in this market since mid-2008. Along with Mitsubishi, Suzuki may soon withdraw from the US market completely.
Suzuki‘s Indian offspring has outgrown its parent
The lure of India
With such disappointments elsewhere, it is little wonder that Suzuki has been keen to shore up its position in India, where the world’s largest automakers are converging to take advantage of market growth. They are bringing out a large number of small models. To counteract this assault on the low-end, thin-profitmargin, overcrowded segment, Suzuki plans to sell
© The Economist Intelligence Unit Limited 2010
2 Business India Intelligence July 28th 2010
Automotive/Finance
larger vehicles in India to take advantage of the rising incomes of India’s middle class. To help it push through this plan, Suzuki has recently increased its ownership share in its Indian subsidiary by 0.8%, which brought it over the 55% mark. At this level of ownership, Suzuki will be required to launch a bid for an additional 20% of the company, completing a full takeover. Maruti will then be de-listed from the Mumbai stockmarket at a cost of US$5bn. India is also a key bargaining chip in the quest to find a strong partner amid ongoing consolidation in the global motor vehicles industry. While the Indian market has bolstered Suzuki, the company knows that it will be hard-pressed to remain successful in a troubled industry that is suffering from global overcapacity and is undergoing a gradual consolidation. Over the years, it has had partnerships with a variety of Japanese and foreign companies. Until its current problems came to a head, US-based General Motors held a substantial share in Suzuki, which it has now completely sold off. In December 2009, the Japanese company forged a partnership with Germany’s Volkswagen, now the world’s largest automotive company in terms of sales volume. VW bought a 19.9% stake in Suzuki. The deal will give Suzuki added weight in the global auto industry, including the benefit of pooling technology and suppliers. For VW, the benefits are also tangible. Along with Italy’s Fiat, Suzuki has proved that it is possible to make money out of small cars. It can also offer a useful emerging markets presence, particularly in India. Yet the link-up with VW does pose some problems. Along with the shift in production and model development in India, it throws Suzuki’s Hungarian operation into question. With the introduction of the A-Star city car, Maruti has resumed exports to Western Europe after a break in the middle of this decade. Meanwhile, Hungary has recently joined the peripheral euro-zone economies Portugal, Italy, Greece and Spain in the financial doghouse. Even if Outlook
Suzuki: Financial results
Year ended 31-Mar-10 JPY (m) Revenue/sales Operating/trading income Net income Shareholders’ equity Long-term debt Market capitalisation Employees (number) Ratios (%) Operating profit margin Return on equity Debt to equity
Sources: Company reports, Financial Times.
Year ended 31-Mar-09 3,004,888 48,518 27,429 639,432 252,732 801,509 50,613 1.6 4.3 39.5
Year ended 31-Mar-08 3,502,419 140,350 80,255 778,607 254,265 1,195,619 52,994 4.0 10.3 32.7
Year ended 31-Mar-07 3,163,669 131,215 75,009 741,522 238,308 1,379,898 45,510 4.1 10.1 32.1
2,469,063 78,900 28,913 951,983 286,079 1,152,717 51,258 3.2 3.0 30.1
concerns about fiscal discipline undermine the Hungarian forint, reducing the cost of production in Hungary, the company’s Hungarian operation is in danger of becoming unviable. The same may be true of its operations in Thailand, where Suzuki established its first plant outside Japan in 1967 and where it recently invested nearly US$300m in a new production facility. There are some big questions over China, too, where VW is the biggest foreign carmaker. Changes are already under way at Suzuki’s operations in China, where the government is gradually implementing an orderly industry consolidation. State-owned Chang’an Auto Corp, the thirdlargest automotive company in China, merged with Aviation Industry Corp of China, which includes automotive company Changhe. Both are Suzuki’s joint-venture partners in China. Chang’an Suzuki produced 150,000 Suzuki vehicles last year. The two Suzuki joint ventures have the capacity to make 400,000 cars and minibuses annually, as well as 350,000 engines. China and India may become the two main manufacturing hubs for Suzuki worldwide.
Overheating?
India will continue to tighten monetary policy amid a build-up of inflationary pressures. The rupee has lost some momentum and government bond yields are rising CURRENCY: After rising in the first half of June, the rupee has been in a renewed decline over the past month, revisiting its 2010 lows and trading at around Rs47:US$1 as of July 27th. The dollar has been driven higher across the boards by safe-haven considerations in the aftermath of the euro-zone debt crisis in the second quar© The Economist Intelligence Unit Limited 2010
ter. More recently, the greenback has sagged under the wait of unfavourable economic news at home and fears that the US economy might slide into another recession. But the rupee, which regained some strength in June, has been falling once more over the past month. Higher domestic interest rates provided little
The rupee regained strength in June
Business India Intelligence July 28th 2010 3
Finance
Latest data
Rs:US$1 (av) Rs: ¥100 (av) Repurchase rate (end-period) Reverse repurchase rate (end-period) Lending rate Jan 2010 45.96 50.31 4.75 3.25 12.00 Feb 46.33 51.31 4.75 3.25 12.00 Mar 45.50 50.21 5.00 3.50 12.00 Apr 44.50 47.63 5.25 3.75 12.00 May Jun 45.80 46.56 49.68 51.24 5.25 5.25 3.75 3.75 12.00 12.00
Currency forecasts*
Rs:US$1 (av) Rs:US$1 (end-period) Rs: ¥100 (av) Rs: ¥100 (end-period)
* Fiscal years (beginning April 1st of year indicated)
2010 46.2 46.1 49.6 49.3
2011 46.0 45.5 49.5 48.9
2012 45.0 44.5 48.6 48.4
2013 44.0 43.5 47.8 47.3
2014 43.0 42.5 47.0 46.7
Interest-rate forecasts
Lending rate (av; %) Deposit rate (av; %) Money-market rate (av; %)
* Fiscal years (beginning April 1st of year indicated)
2010 12.5 7.5 5.8
2011 12.7 7.8 6.5
2012 12.7 7.5 6.5
2013 13.0 7.8 6.8
2014 13.0 8.0 7.2
Debt forecasts*
Budget balance (% of GDP) Public debt (% of GDP)
* Fiscal years (beginning April 1st of year indicated)
Source: Economist Intelligence Unit
2010 -5.5 55.7
2011 -5.3 55.3
2012 -4.9 54.5
2013 -4.3 52.8
2014 -3.9 50.9
The rupee will strengthen in the third quarter
protection for the currency. On the contrary, the fact that inflationary pressures continue to increase may actually now be counterproductive for the rupee, since further rate increases could begin to choke the buoyant domestic economy at a time when demand in key export markets is widely expected to slow. The recent depreciation of the rupee has taken consensus forecasters by surprise. The Economist Intelligence Unit’s consensus forecast sees the rupee at a higher level at the end of the third quarter, with only the bearish fringe of the forecast range predicting that it will trade at its current levels over the near term. The forecast mean sees the Indian currency in the Rs45:US$1 range three months hence. Over the longer term, we expect the rupee to average Rs46.2:US$1 in fiscal 2010/11 (April-March) and Rs46:US$1 in 2011/12. Although these are slightly weaker levels than what we were forecasting earlier this year, they still represent a year-on-year nominal appreciation of nearly 5% in 2010/11 and 0.4% in 2011/12. Given India’s high inflation rate, this will represent an annual average appreciation of 11% in real terms over the two-year period. INTEREST RATES: The key policy rate was hiked between central bank meetings, going up by 25 basis points, to 5.50%, on July 3rd. It was raised
again, to 5.75% at the central bank’s quarterly meeting on July 27th. The Reserve Bank of India (RBI, the central bank) began to tighten monetary policy in January, announcing that it would increase the cash reserve ratio in two stages, by a total of 75 basis points, to 5.75% by end-February. The RBI then raised the repurchase (repo) rate—the interest rate at which it adds funds to the banking system—in mid-March, to 5%, and increased it again in mid-April, to 5.25%. While the euro zone debt crisis was expected to make the RBI to hold fire between meetings, fears of inflationary pressures prevailed. Wholesale price inflation continued to increase in June, rising to 10.6% year on year from 10.2% in May. Inflation has been in double digits for five straight months, with prices taking off extremely fast over the past year. Even non-food inflation has been strong, contributing to more than 70% of the overall level of wholesale price inflation. The central bank therefore tightened in July 3rd, and again on July 27th. Most economists were expecting another 25 basis point rate increase at the RBI’s June 27th monetary-policy meeting. The repo rate was raised by 25 basis points, but the reverse repo rate was raised by 50 basis points, to 4.5%. This was a sharper increase than the three preceding rate hikes. We forecast that the repo rate will rise to 6.25% by the end of 2010 and to 6.5% by the end of 2011. This should be sufficient to turn real interest rates positive in 2011, assuming that the current inflationary surge abates. However, the RBI will be mindful that higher interest rates could undermine the government’s fiscal-consolidation plan, encourage volatile capital inflows and exert upward pressure on the rupee. Inflation should begin to moderate in the second half of 2010 as the impact of last year’s poor monsoon on food prices begins to dissipate. BONDS: The yield on the rupee-denominated government benchmark bond due May 2020 rose to its highest level since mid-June and stood at 7.69% as of July 21st. Bond yields have been rising more recently in light of higher inflation and expectations that the central bank would effect its fourth interest-rate increase since the start of the year. Government bond yields, however, remain relatively low, providing a negative return in inflation-adjusted terms. While public spending remains high, and the budget deficit will surpass 5% of GDP both this year and next, strong domestic economic growth in the face of a global downturn has required only modest loosening of fiscal policy. At the same time, with GDP expanding rapidly and deficit spending declining, we expect the debt-to-GDP ratio to keep sliding from over 55% currently into the 50% range by the end of the 2010-14 forecast period.
© The Economist Intelligence Unit Limited 2010
4 Business India Intelligence July 28th 2010
Country risk
Risk assessment
Stable outlook
The Economist Intelligence Unit’s latest evaluation of country risk maintains India’s “BB” rating India’s country risk rating is derived by taking a simple average of the scores for sovereign risk, currency risk and banking sector risk. In each case, India’s outlook is stable. Government borrowing on international markets will remain limited, but high levels of domestic public debt are a concern. Inflationary and fiscal risks present the possibility of downward pressure on the rupee in 2010, but their influence is likely to be offset by higher capital inflows. The non-performing loan (NPL) ratio is relatively low, and the risk of a systemic banking crisis is small. However, the NPL ratio would be much higher if India used internationally accepted criteria to define bad loans. SOVEREIGN RISK: There is little likelihood that India will experience an external-debt crisis in the forecast period. Foreign-exchange reserves were estimated at more than double the value of India’s gross financing requirement in 2009. The country’s external debt is equivalent to around 15.6% of GDP, compared with a median for other BB-rated countries of 25.3%. The low level of external debt is the main structural factor that supports a sanguine outlook for sovereign risk. Nevertheless, the rating is constrained by poor standards of fiscal management and the high level of domestic public debt. The median gross public debt to GDP ratio of BB-rated countries is 39.2%, which is lower than India’s 56.1%. Partly as a consequence of its high debt level, the Indian government spends 28.9% of its revenue on debt interest payment—a far larger proportion than the median of BBrated countries of 9.1%. In a positive development, the budget for fiscal year 2010/11 (April-March) was the first to include an explicit target to reduce the debt to GDP ratio. Contingent liabilities would rise significantly if the government had to bolster the balance sheets of private-sector banks (not the Economist Intelligence Unit’s central forecast) amid a rise in NPLs.
Rating outlook
Stable. The deterioration in external trade conditions in 2009 had a negative impact on India’s sovereign rating, as economic contractions in the OECD and the subsequent collapse of demand exacted a toll on India’s export-oriented industries. However, exports are now recovering in line with a rise in global demand, and a strong domestic economic recovery will also support India’s sovereign rating. The current-account deficit is forecast to average 1.8% of GDP a year in 2010-11. The biggest risk to the outlook is the government’s weak fiscal position; the fiscal deficit widened sharply in 2008/09 and is estimated to have expanded further in 2009/10. The 2010/11 budget includes a strong emphasis on fiscal consolidation, and government revenue in the first few months of the current fiscal year has exceeded expectations. Nevertheless, expenditure pressures remain strong, so although we expect the government to meet its fiscal target, progress in this regard could easily be reversed. On balance, India’s ability to service its sovereign debt is expected to remain stable. CURRENCY RISK: India’s foreign-exchange markets have become more volatile as the country’s international trade has expanded and it has moved closer to full capital account convertibility. India’s reliance on foreign capital inflows means that sharp swings in the level of the rupee against the US dollar have become more frequent over the past few years. The rupee depreciated against the US dollar in 2008, in part reflecting a general flight from risky assets, the liquidation of holdings of Indian equities by foreign investors and growing concerns about the severity of the economic slowdown in India. For most of 2008 the Reserve Bank of India (RBI, the central bank) allowed the market to determine the exchange rate, but in September of that year it began to intervene to prop up the currency in order to ensure that the rate of depreciation was not excessively rapid. It had less need to do so in 2009, as the rupee stabilised in April and appreciated by 9.1% against the US dollar in the last nine months of that year. Nevertheless, the currency’s average level against the US dollar in 2009 as a whole was 10.1% weaker than it was in 2008.
Exports are recovering
Positive factors
Foreign direct investment—a more stable form of financing than short-term inflows such as portfolio investment—covers nearly one-half of the gross financing requirement. Foreign-exchange reserves are almost equivalent to five times the value of external short-term debt. This helps to assure debt-repayment capacity, even in the event that overseas credit lines cannot be rolled over.
The rupee’s volatility has increased
Negative factors
The fiscal position has deteriorated sharply because of increased spending on public-sector wages and economic stimulus measures, combined with slow growth in revenue from corporate and customs taxes.
© The Economist Intelligence Unit Limited 2010
Business India Intelligence July 28th 2010 5
Country risk
India: Country risk
July 2010
Source: Economist Intelligence Unit
Sovereign risk BB
Currency risk BB
Banking sector risk BB
Country risk BB
Positive factors
Higher interest rates will attract more capital inflows The rupee is not very overvalued relative to the currencies of competing countries. The real trade-weighted exchange rate has risen by 11.4% in the past 48 months, faster than the median for BB-rated countries of 9.9%, but less rapid than the median for the BRIC countries (Brazil, Russia, India and China) of 16%. The RBI has started tightening monetary policy and is expected to continue to raise interest rates throughout 2010. This is likely to attract more foreign capital inflows, which would support the rupee.
Negative factors
Wholesale price inflation rose to 10.6% year on year in June and consumer price inflation also remains high. High inflation is typically accompanied by depreciation of the rupee.
degree of protection (as it is likely that the government would bail out banks in the event of a crisis), but it also leads to inefficiency. Government intervention in the banking sector is extensive. This is most clearly manifested in the practice of directed lending, whereby banks are obliged to devote around 40% of total loans to priority sectors (including agriculture, small industry and disadvantaged sections of society) and around 12% to export financing. Banks are heavily exposed to the sovereign: over 35% of the banking system’s assets consist of government debt.
Positive factors
Moves towards the liberalisation of the capital account have been steady but slow. India will probably strengthen its financial regulatory system sufficiently before opening up the capital account. Growth in per-head income is set to strengthen in 2010-11 as economic expansion accelerates. This will lead to a rise in the number of bankable households.
Rating outlook
Stable. Inflationary and fiscal risks present the possibility of downward pressure on the rupee in 2010, but they are likely to be offset by higher capital inflows. We expect the currency to average Rs46.2:US$1 in 2010/11. However, this will represent a nominal appreciation of 4.8%, compared with the average value of the rupee the year before. The currency should continue its appreciating trend in 2011/12, to average Rs46:US$1 in that year. Given India’s high rate of inflation, this gentle nominal appreciation will represent a strengthening of 15.8% and 6.1%, respectively, in real terms.
Negative factors
The stock of domestic credit grew by an annual average of 19.8% in 2005-09. This rapid growth means that there may have been a deterioration in the quality of lending, which would increase the risk of a rise in defaults. The RBI has moved the focus of its policy from boosting economic growth to containing inflation. We expect the RBI to continue to raise interest rates throughout 2010. Tighter monetary policy will make it harder for borrowers to service their debt and will increase the likelihood of a rise in NPLs.
Foreign-exchange regime
India maintains a managed float with capital controls. The rupee is freely traded on the current account, but not on the capital account. Indian companies, individuals and pension funds face restrictions when attempting to move capital abroad. The government is committed to liberalising the capital account, especially as Indian companies have begun to expand overseas, but the process will be a gradual one. Local asset markets have seen sustained improvement since 2008 BANKING SECTOR RISK: The sustained improvement in local asset markets relative to 2008 and the positive economic outlook support the BB rating for banking sector risk. India’s banking sector is generally cautious and is conservatively regulated. In recent years banks have diversified from corporate lending into consumer finance, including car loans and mortgages. Although this has helped banks to diversify their income streams, supervision in this area has yet to be fine-tuned. Over 75% of banking assets are controlled by state-owned banks. This provides a high
Rating outlook
Stable. The rapid expansion of consumer credit in India has taken place from a very low base. This means that it does not pose as high a risk to the banking system as it would in a more mature market, as the level of debt per bank customer remains relatively low. The extremely low level of bank penetration also provides a means for banks to expand their business without turning to complex, high-risk products. Nevertheless, there are a number of downside risks for the sector. A rise in NPLs is still likely as the RBI continues to tighten monetary policy. The continued prevalence of state-directed lending also increases the risk of a rise in NPLs, particularly in periods of weak economic growth. Corruption is endemic in India, including in the banking sector; this will continue to undermine profitability.
© The Economist Intelligence Unit Limited 2010
6 Business India Intelligence July 28th 2010
Quick views
Relentless price pressures
India’s wholesale price inflation rate climbed to 10.6% year on year in June, up from 10.2% in May and marking the fifth consecutive month of doubledigit expansion. The cost of manufactured products increased by 6.7% year on year after hitting a fivemonth low of 6.4% in May. This was owing to faster price growth for wood, rubber and plastics, chemicals, machinery and transport equipment. By contrast, the cost of non-metallic minerals fell (by 1.2%) for the first time in four months, while the cost of manufactured food and beverages rose by the same amount (7.5%) as in May. Inflation in the fuel, power and light component also accelerated, to 14.3% from 13.1% in May; the government raised petroleum product prices on June 25th. By contrast, prices of primary food articles (this sub-category holds the largest weighting in the wholesale price index) increased by 14.6%, the slowest pace of expansion in eight months. begin to moderate in the second half of this year, as the impact of last year’s poor monsoon on food prices begins to dissipate. The Economist Intelligence Unit forecasts that wholesale price inflation will average 8.9% for 2010 as a whole, before easing to 5% in 2011. Given the persistence of strong inflationary pressures, the Reserve Bank of India (RBI, the central bank) is being placed under increasing pressure to raise interest rates again. The RBI first began tightening monetary policy in January, when it raised the cash reserve ratio. It then raised its repurchase (repo) rate in March and April, and again, before a scheduled meeting, in early July. We forecast that the repo rate will reach 6.25% by end-2010 and 6.5% by the end of 2011. Inflation will ease in 2011
India: Wholesale price inflation
(% change, year on year)
Dec 09 8.1 Jan 10 9.4 Feb 10 10.1 Mar 10 11.0 Apr 10 9.6 May 10 10.2 Jun 10 10.6
The EIU view
Although inflation has remained stubbornly high, the Economist Intelligence Unit forecasts that it will
Source: Ministry of Commerce and Industry; Haver Analytics
Industrial growth starts to slow
India’s industrial production growth hit a sevenmonth low of 11.5% year on year in May. The April growth figure was pared back to 16.5% from 17.6%. Manufacturing continued to lead output growth in May, expanding by 12.3% year on year, while output from the mining and electricity sectors rose by 8.7% and 6.4% respectively. By category of goods, production of capital goods remained far higher than last year, expanding by 34.3%, showing that investment continues to expand strongly. Production of consumer durable goods—which are largely bought by India’s 300m-strong middle class—also continued to expand rapidly, by 23.7% year on year. This marks the 13th consecutive month of double-digit gain. Similarly, production of intermediate goods rose by 10.2%, virtually unchanged from the previous month’s level of 10.6%. Output of basic goods increased by 7.9%, while production of non-durable items (which tend to be purchased by a broader section of the population) grew by just 2.4% (down from 4.5% a month earlier). ereign debt crisis is unlikely to have any major effect on India’s manufacturing sector, given that production is mainly destined for the domestic economy. Indeed, private consumption and investment are expected to rise steadily—the former thanks to improved confidence and credit conditions, and the latter by better access to both domestic and foreign sources of financing and a recovery in investment prospects in many consumer sectors. Although the HSBC Purchasing Manager’s Index (PMI) fell to 57.3 in June from a two-year plus high of 59 in May, it has held above its long-term average (55.9) since the beginning of this year. The statistical boost from the low output levels in 2009 will start to fade in the July-September quarter, which combined with the lagged effect from further interest rate hikes in 201011, will slow industrial activity growth to a forecast 9.4% in 2011. The European debt crisis is unlikely to affect Indian manufacturing
India: Industrial production
(% change, year on year)
Nov 09 12.0 Dec 09 17.7 Jan 10 16.3 Feb 10 15.1 Mar 10 13.9 Apr 10 16.5 May 10 11.5
The EIU view
Industrial production has been very strong in India and the Economist Intelligence Unit forecasts that it will grow by an average of 13.7% this year (the average in January-May came to 14%). The euro zone sov© The Economist Intelligence Unit Limited 2010
Source: Ministry of Statistics and Programme Implementation; Haver Analytics
Business India Intelligence July 28th 2010 7
Indicators: Demographics
Population advantage?
India is expected to overtake China as the world’s most populous country in the mid-2020s, with a population approaching 1.5bn. Governments have shifted away from sterilisation as the cornerstone of family planning to an emphasis on improving female social and economic welfare. This, coupled with rising living standards, particularly in urban areas, is leading to a fall in the population growth rate. Nevertheless, although strong economic growth is slowing the fertility rate, at 3.1 children per woman, it is one-third above the official target of replacement-level fertility. The rising population will lead to opportunities and costs. Increased environmental degradation and a growing strain on water and food resources appear inevitable. The gender distribution of India’s population is disturbing and has equally important implications for stability. Historically, countries with severe gender disparities suffer from rising disorder. India will, however, enjoy a growing working-age population at a time when other countries (including China) will face increasing dependency ratios. If India can put in place an education system that ensures its working-age population meets global demands, then it will perform well. But if its education system fails to adapt, a large underemployed population is likely to result in increased social instability.
July 28th 2010 Vol XVII No. 15 ISSN: 1468-120X
PUBLISHER Charles Goddard EDITOR Jacob Hamstra PRODUCTION Gaddi Tam EDITORIAL QUERIES Tel: (852) 2585 3861 Fax: (852) 2802 7638
Published 22 times a year for subscribers only
[email protected]
India: Demographics and income
Population, income and market size Population (m) GDP (US$ bn at market exchange rates)d GDP per head (US$ at market exchange rates)d Private consumption (US$ bn)d Private consumption per head (US$)d GDP (US$ bn at PPP)d GDP per head (US$ at PPP)d Personal disposable income (Rs bn)d Personal disposable income (US$ bn)d Growth of real disposable income (%)d Memorandum items
2006a 2007a
2008b
2009b
2010c
2011c
2012c
2013c
2014c
1,112 1,130 1,148 1,166 1,184 1,202 1,220 1,238 1,256 958.1 1,187.3 1,260.0a 1,296.2a 1,585.1 1,820.1 2,121.4 2,483.1 2,905.3 860 1,050 1,100 1,110 1,340 1,510 1,740 2,010 2,310 a 743.1a 882.3 971.6 1,094.6 1,233.8 1,391.3 554.0 675.7 727.4 500 2,855 2,570 728.9 6.8 600 3,220 2,850 901.1 9.0b 17.13 2.20 4.83 1.05 630 3,457a 3,010 640 3,766a 3,230 750 4,1088 3,470 810 4,498 3,740 900 4,952 4,060 1,000 5,488 4,430 1,110 6,081 4,840
As well as being available to subscribers in print, Business India Intelligence is available electronically via the Internet. For more information please visit www.store.eiu.com or contact your nearest Economist Intelligence Unit office. London 26 Red Lion Square London WC1R 4HQ United Kingdom Tel: (44-20) 7576 8000 Fax: (44-20) 7576 8500 E-mail: [email protected] New York Tel: (1.212) 698 9745 Fax: (1.212) 586 0248 E-mail: [email protected] Hong Kong Tel: (852) 2802 7288/2585 3888 Fax: (852) 2802 7368/7720 E-mail: [email protected] © 2010 The Economist Intelligence Unit Limited. All rights reserved under the International and Pan-American Copyright Conventions. Reproduction and transmission in any form without prior permission is prohibited. All information in this report is verified to the best of the authors’ and the publisher’s ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. Printed by Chris Fowler International (Asia) Ltd
33,026 37,260
43,964 52,393 58,855 65,622 72,722 80,471 88,945 1,010.5 1,082.4 1,274.4 1,426.6 1,616.0 1,828.9 2,068.5 10.3 17.21 2.13a 4.98a 1.25a 12.0 17.29 2.30a 5.40a 1.30a 4.9 17.38 2.65 5.58 1.34 8.5 17.45 2.91 5.83 1.43 7.6 17.53 3.19 6.08 1.48 7.4 17.60 3.47 6.34 1.56 6.9 17.67 3.76 6.58 1.66
Share of world population (%) 17.05 Share of world GDP (% at market exchange rates) 1.99 Share of world GDP (% at PPP) 4.62 Share of world exports (%) 1.00
Source: Economist Intelligence Unit
a Actual b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Fiscal years (beginning April 1st of year indicated).
Dependency ratios: How India compares
% 60 Young-age dependency* Old-age dependency**
40
20
0 China India 2005 Japan China India 2010 Japan China India 2015 Japan
*Ratio of those people younger than 15 to those aged 15-64 **Ratio of those people older than 64 to those aged 15-64
Source: Economist Intelligence Unit
8 Business India Intelligence July 28th 2010
© The Economist Intelligence Unit Limited 2010
