26be8379325d4f8c9939b6df4605283d

India: Post-Election Credit Outlook

MAY, 2014ATSI SHETH, VICE PRESIDENT SENIOR CREDIT OFFICER, SOVEREIGN RISK GROUP

2India Post-Election Credit Outlook 2014

Agenda

1. Credit implications of BJP/NDA parliamentary majority

2. What underpins current market expectations?

3. Moodys Baseline Scenario: Slow improvement in overall credit metrics

4. Credit implications of Alternative Scenarios

5. Key Takeaways

3India Post-Election Credit Outlook 2014

Credit Implications of BJP/NDA Parliamentary Victory

Source: Election Commission of India

While Lok Sabha majority supports implementation of cohesive policy agenda:

-- BJP/NDA majority in Lok Sabha is not replicated in Rajya Sabha-- Several policy measures require state government cooperation

182 182138 116

282

72 88

4343

54141 114

145 206

44

3 2173

56 14

147 140 144 122 149

1998 1999 2004 2009 2014

BJP Other NDA INC Other INC Allies/UPA Other

4India Post-Election Credit Outlook 2014

Market Expectations Are HighComparing Economic Performance Across Regimes

Source: Haver Analytics, Reserve Bank of India, Moodys

NDA UPA 1 UPA 2Average % change, unless otherwise noted 1998 - 2004 2005 - 2009 2010 - 2013Growth and Inflation Real GDP 5.97 8.59 6.60Per Capita Income (PPP) 6.56 9.03 6.76Gross Fixed Capital Formation 9.38 11.48 6.05Personal Consumption 5.13 8.22 6.77Exports 16.03 12.45 12.04Imports 11.92 16.97 10.40Wholesale Price Index Inflation 4.95 5.31 8.23Agricultural Output 2.52 3.20 4.92Industrial Output 5.27 9.15 3.82Service Output 7.96 10.19 7.19Fiscal MetricsFiscal Deficit/GDP (average over the period) 5.18 4.45 5.14Central Government Debt (average annual increases in INR) 10.31 11.87 12.70ExternalForeign Direct Investment (increase over period, US$ mn.) 29,032 125,397 21,146Portfolio Investment (increase over period, US$ mn.) 32,857 69,751 10,221External Debt (% yoy, US$) 5.45 14.84 14.36INR/USD (% yoy) -1.62 -1.99 -7.67Change in 10 Yr Gov't Bond Yield (in real terms) -3.68 1.52 1.41Change in Banks' Prime Lending Rate (in real terms) -2.05 2.82 2.87

5India Post-Election Credit Outlook 2014

Market Expectations Are HighGujarats Performance vs All-India Average

Source: Haver Analytics, Reserve Bank of India, Central Statistics Office

Gujarat IndiaReal GDP Growth (2000-11) 10.2 7.4Real Agriculture (2005-11) 8.0 4.2Real Industry (2005-11) 11.1 8.6Real Services (2005-11) 11.3 9.6CPI Inflation (2010-2013 CAGR) 12.2 9.8Government Debt/GDP (end March 2013) 23.5 45.4Gross Fiscal Deficit/GDP (2004-13) 2.7 4.7Foreign Direct Investment (avg. growth 2010-13) 10.6 18.9

6India Post-Election Credit Outlook 2014

Baseline Forecasts: Indias Credit Metrics will Improve Slowly

Source: Haver Analytics, Reserve Bank of India, Ministry of Finance, Moodys

2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15F 2015/16FReal GDP Growth (% yoy) 6.7 8.6 8.9 6.7 4.5 4.9 5.0 5.6CPI Inflation (% change, end-March) [2] 8.0 11.9 9.7 9.4 10.4 8.3 8.2 8.0General Government Balance/GDP (%) -8.3 -9.4 -6.8 -8.1 -7.2 -7.6 -7.8 -7.4General Government Debt/GDP (%) 72.2 70.6 65.6 65.3 65.4 68.7 67.9 67.2General Government Debt/Revenues (%) 359.0 367.7 316.5 328.3 313.7 335.4 325.3 314.7General Government Interest Payments/Gen. Gov. Rev 25.0 25.3 21.6 22.6 22.1 24.1 25.3 24.3Current Acct. Bal./GDP (%) -2.3 -2.8 -2.8 -4.2 -4.7 -1.7 -2.8 -3.0External Debt/Current Account Receipts (%) 62.9 75.4 68.5 65.3 76.3 74.1 74.3 74.6External Vulnerability Indicator [3] 32.2 43.7 46.1 53.4 65.1 83.9 78.5 82.5[1] Fiscal years beginning April 1[2] CPI for Inbdustrial Workers[3] (Short-term External Debt + Currently Maturing Long-Term Debt + Nonresident Deposits Over One Year)/ Official Foreign Exchange Reserves

7India Post-Election Credit Outlook 2014

What Would Support Credit Improvement? Lower Fiscal Deficits and Government Debt Ratios

Source: National Sources, Moodys

General Government Debt (2013) General Government Fiscal Deficit (2010-13 Avg.)

0

10

20

30

40

50

60

70

80

India (Baa3) Philippines (Baa3)

Turkey (Baa3)

Baa3 Median

Indonesia (Baa3)

% o

f GDP

0

1

2

3

4

5

6

7

8

India (Baa3) Baa3 Median

Philippines (Baa3)

Turkey (Baa3)

Indonesia (Baa3)

% o

f GD

P

8India Post-Election Credit Outlook 2014

Macro-Economic Balance, Not Growth Alone, Determines Credit Profile

Source: Haver Analytics, Moodys

CPI InflationCurrent Account

Balance/GDP

External Debt/GDP

External Vulnerability

Indicator

Net International Investment

Position/GDP

Real Effective Exchange Rate

Domestic Credit Growth

Domestic Credit/GDP

Real GDP Growth

Avg. 2010-13 Avg. 2010-13 2013 2013 2013 Avg. 2010-13 Avg. 2010-13 2013 Avg. 2010-13India (Baa3) 9.4 -3.4 21.8 83.9 -16.8 -1.7 14.1 73.9 6.2Indonesia (Baa3) 5.6 -1.3 30.4 51.9 -41.3 2.5 19.1 40.1 6.2Philippines (Baa3) 3.7 3.1 28.8 28.7 -13.6 -4.7 9.9 51.9 6.3Turkey (Baa3) 7.6 -7.5 47.3 163.1 -47.5 -1.8 20.4 79.0 6.0Colombia (Baa3) 2.8 -3.2 24.3 46.9 -24.5 3.2 14.3 45.4 4.7Romania (Baa3) 4.5 -3.6 70.1 103.0 -63.8 1.0 4.1 42.2 1.3Uruguay (Baa3) 7.9 -4.0 42.9 82.9 -14.5 7.8 20.4 36.5 6.0Baa3 Median 5.1 -3.4 30.4 75.5 -20.6 2.6 13.2 46.6 5.3

9India Post-Election Credit Outlook 2014

Key Takeaways

Indias Baa3 and stable outlook anticipates economic recovery Growth could accelerate in FY 2016 based on:

Global growth recovery + improved sentiment + policy actions

But growth alone is unlikely to drive the rating outlook Fiscal, inflation, and balance of payments metrics key to the credit profile

A significant increase in government and external debt ratios would be credit negative

Credit profile improvements depend on Measures that will lower fiscal deficits and government debt over the long term

Alleviation of supply constraints that limit investment and fuel inflation

10India Post-Election Credit Outlook 2014

Atsi ShethVice President Senior Credit OfficerSovereign Risk [email protected]

Andrew SchneiderAssociate AnalystSovereign Risk Group [email protected]

11India Post-Election Credit Outlook 2014

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ICRA Limited

India Post-ElectionSignificant Improvement in Sentiments;

Macroeconomic Fundamentals to Pickup

May, 2014Aditi Nayar- Senior Economist, ICRA Limited

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Agenda

Is a sharp revival in GDP growth anticipated in 2014-15?

What is the likely macroeconomic impact of a potentiallyunfavorable monsoon?

Are external sector concerns expected to resurface inthe near term?

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Structural Constraints to Impede Immediate Return to High GDP Growth in 2014-15

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Investment activity remains sluggish so far in 2014

Positives Project implementation relatively healthy in some

sectors, driven by State Governments: Statehighways, metro rail, urban infrastructure, powertransmission.

Few attempts by private sector to deleveragethrough divestment of assets, exit fromaggressively bid projects.

Clearances from Cabinet Committee onInvestments (CCI), Ministry of Environment.

Activity held back by model code of conduct topickup post elections.

-30%

-20%

-10%

0%

10%

20%Growth of Capital Goods Output

2012-13 2013-14

Source: CSO; ICRA Research

-5%

0%

5%

10%

15%

20% Growth of Gross Fixed Capital Formation

Negatives Contraction in capital goods output: key

lead indicator. Fiscal tightening by the Central

Government to comply with its fiscaldeficit target for 2013-14.

Y-o-y decline in new projectannouncements, slow progress ofongoing projects.

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CCI clearances partly de-clogged project pipeline

431 projects with cost of Rs. 21.2 trillion accepted by CCI; all issues resolved for 155 projects. Majority of projects for which concerns have been resolved belong to power sector. Availability of feedstock (domestic or imported coal, natural gas) continues to be a constraint.

o Policy actions required: allocation of coal blocks; reorganization of Coal India Limited; natural gas pricing. Offtake by Discoms remains a risk

o Weak finances of Discoms; setting of remunerative tariffs by ERCs; ability and willingness of consumers to absorb sustained tariff increases.

All Issues Resolved* Number of Projects Cost (Rs. billion) Cost (% of Total)Total 155 5,390 100%Power 89 4,018 75%Steel 4 258 5%Petroleum 9 180 3%Commerce & Industry 4 117 2%Coal 23 116 2%Mines 2 118 2%Civil Aviation 1 120 2%Railways 5 114 2%Road Transport and Highways 7 96 2%Shipping 6 84 2%Chemicals 1 50 1%Source: CCI; ICRA Research; *: As per CCI

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Pace of pickup in project implementation to take a cue from resolution of structural hurdles

Clearances required from State Governments. Availability of contiguous tracts of land at viable cost post enactment of new Land Acquisition

Act (Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation andResettlement Act, 2013).

Ability of Corporates to take on debt-funded capex:o High leverage levels.o Firm domestic interest rates; high hedging costs related to foreign currency borrowings. o Risk aversion of some Banks to infrastructure lending; concerns regarding asset quality.

Issues Unresolved Number of Projects Cost (Rs. billion) Cost (% of Total)Total 276 15,821 100%Power 76 5,190 33%Steel 44 4,662 29%Petroleum 36 3,431 22%Coal 41 616 4%Roads 28 428 3%Mines 6 344 2%Railways 19 327 2%Commerce & Industry 12 330 2%Chemicals 4 282 2%Shipping 10 211 1%Source: CCI; ICRA Research

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Fiscal space needs to be created to stimulate economy Fiscal space needs to be created for

implementation of new projects and schemes,as well as capital infusion into Banks, whileadhering to fiscal consolidation path.

Moderate uptick in GDP growth to limit rise inFY15 tax revenue.o Clarity on approach to tax reform and

disinvestment awaited. Salaries, pensions, interest form substantial

share of revenue expenditure, which is largelyinflexible.

Reorganization of schemes to reduceexpenses needs to be prioritized.

Fuel subsidies to depend on global crude oilprices, policy on diesel price revision, cappingof subsidized LPG.

Fertilizer subsidies to take a cue from naturalgas pricing.

Pan-India rollout of National Food Security Actto add to food subsidy bill.

Performance/ Targets in Budget

2014-15

Targets set in October 2012

2012-13 -4.9% -5.3% 2013-14 -4.6% -4.8% 2014-15 -4.1% -4.2% 2015-16 -3.6% -3.6% 2016-17 -3.0% -3.0%

Composition of Revenue Expenditure in 2014-15 Interim Budget

Interest PensionsSubsidies DefenceGrants for capital assets BalanceSource: GoI; ICRA Research

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Agricultural growth to range between 0-2% in 2014-15, depending on monsoon dynamics. High food inflation to keep interest rates sticky, limit improvement in consumption demand and

delay capacity expansion in consumer-oriented sectors. o Caveat: PV, M&HCV, gems & jewellery likely to record a positive growth in FY15 following

sustained contraction in FY14, and support mild improvement in manufacturing growth. Strengthening global growth to support exports in FY15; however, elevated inflation may erode

competitiveness. Broad-based investment revival to be influenced by pace of resolution of aforementioned

concerns.

GDP growth likely to improve somewhat to 5.0-5.5% in FY15, factoring in a mild improvement in manufacturing growth and a pickup in investment activity in H2FY15.

5.0-5.5% economic growth likely in 2014-15

Source: CSO; ICRA Research

2013-14 2014-15Q4 (exp.) FY (exp.) H1(exp.) H2 (exp.) FY (exp.)

Agriculture 2.5% 3.3% 0.0-2.0% 0.0-2.0% 0.0-2.0%

Industry 0.4% 0.5% 2.0-2.5% 4.0-4.5% 2.5-3.5%

Services 6.6% 6.7% 6.5-7.0% 7.2-7.7% 6.7-7.2%

GDP at factor Cost 4.4% 4.5-4.6% 4.8-5.2% 5.5-6.0% 5.0-5.5%

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Unfavorable Monsoon may Inflame Food Prices, delay Monetary Easing

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Below normal monsoon emerges as key risk Higher-than-normal temperatures of water in

equatorial Pacific Ocean, termed El Nino.

IMD forecast 60% likelihood of EL Nino in 2014.

El Nino years often but not always associated with deficient or below-normal rainfall in India.

In April 2014, IMD forecast south west monsoon rainfall in 2014 at 95% +/- 5%.

This is similar to its April 2009 forecast of 96% +/-5%. However, actual rainfall in 2009 was 22% below LPA.

Accordingly, macro-economic concerns arising from possibility of weaker-than-anticipated monsoon not fully assuaged.

Monsoon Remains Vital Given Moderate Irrigation Coverage.

YearEl Nino

(Yes/No)

IMD AprilForecast for

SW Monsoon

Actual Rainfall

(% of LPA)

2003 No 96% +/-5% of LPA 102% Normal

2004 No 100% +/-5% of LPA 86% Deficient

2005 No 98% +/- 5% of LPA 99% Normal

2006 Yes 93% +/- 5% of LPA 100% Normal

2007 No 95% +/- 5% of LPA 106% Above Normal

2008 No 99% +/- 5% of LPA 99% Normal

2009 Yes 96% +/- 5% of LPA 78% Deficient

2010 No 98% +/- 5% of LPA 102% Normal

2011 No 98% +/- 5% of LPA 101% Normal

2012 No 99% +/- 5% of LPA 92% Below Normal

2013 No 98% +/- 5% of LPA 105% Above NormalSource: Indian Meteorological Department (IMD); Australian Meteorological Bureau; ICRA Research^ LPA: Long Period Average

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Limited impact of weak monsoon on GDP growth

Source: CSO; IMD; ICRA Research

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

2005-06 2007-08 2009-10 2011-12 9M 2013-14

Agri, Consumption Growth Positive even in Years of Below Normal Monsoon

Monsoon Variation from Normal Agriculture & Allied Activities Private Final Consumption Expenditure GDP Growth

First Round Impact Limited:o Share of Agriculture in GDP low at ~14%.o Agricultural output growth while low, was not

sub-zero, in years of below-normal monsoon. Second Round Impact: Other factors bolstered

consumption in years of unfavourable monsoon.o Pay Commission 2008-10;o High growth of minimum support prices (MSP) in

some years;o Automatic stabilisers such as employment under

National Rural Employment Guarantee Act(NREGA).

Despite good monsoon, consumption growth eased in9MFY14; differentiated impact on rural and urbanconsumers.o Rural consumption demand picked up post 2013

kharif harvest, as evidenced by trends for tractors,two-wheelers in H2FY14.

o However, high food prices squeezed disposableincome for urban consumers.

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substantial impact on food inflation

9.6%7.0%

9.1%

15.3% 15.6%

7.3%9.9%

12.8%

0%

5%

10%

15%

20%

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Annual Average WPI Inflation

WPI Core Inflation Primary Food Inflation

Food inflation accelerated in 2009-10 and 2012-13. However, food inflation was in double-digits even in years when monsoon was above LPA: 2010-11, 2013-14. Factors Imparting Rigidity to WPI and CPI Food Inflation:

o Increase in MSP- cereals, pulses, oilseeds, sugarcane.o Rising demand for food products with greater nutritional content following growth of incomes - protein

items (pulses, milk and non-vegetarian products), fresh produce (vegetables and fruit). Inadequate supply response of former and substantial wastages of latter impart rigidity to prices.

o Inadequate storage infrastructure and cold chains- prices of perishables follow seasonal trends. Even small, short-lived supply disruptions cause large price spikes, e.g. Aug-Nov 2013.

o Import dependence for pulses and edible oils- exposure to forex variations.

Source: Office of the Economic Advisor, Government of India (GoI); ICRA Research

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Food, beverages & tobacco account for ~50% of CPI basket, will crucially impact headline CPI inflation,designated as nominal anchor for monetary policy.

Certain factors may cushion impact of weak monsoon rainfall:o Adequate rainfall in June-July may lessen impact of overall monsoon deficiency.o Enhanced moisture in sub-soil;o Relatively healthy reservoir levels; o Considerable buffer stocks of cereals.

However, prices may rise in the event of sizable MSP hikes. Pan-India rollout of entitlements under National Food Security Act may boost prices of non-cereals. Additionally, temporary spikes in prices of perishables cant be ruled out.

Factors other than food also impart rigidity to CPI.o Generalization of higher food prices to wages. o Non-tradable nature of some services affords higher pricing power to producers. o Likely rise in electricity tariffs to reduce gap between cost of supply and revenues.o Expectation of continued hikes to offset under-recoveries on sale of diesel.

CPI food inflation elevated at ~10% in April 2014

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CPI to be reduced from current 8.6% along Glide Path described by Dr. Patel Committee to 8% byJanuary 2015 and 6% by January 2016.

In April 2014, RBI signaled end to further tightening if CPI moderates along glide path. Expectation of below-average rainfall in conjunction with structural factors that exert stickiness on

food and non-food CPI inflation, suggest that containing CPI inflation below 8% by January 2015would be challenging.

Accordingly, the most likely scenario appears to be an extended pause for policy rates, withmonetary easing delayed until at least early-2015.

Inherent rigidities suggest CPI may miss Jan15 target

Source: RBI; ICRA Research

22%

23%

24%

25%

3%4%5%6%7%8%9%

10%11%

Apr

-13

May

-13

Jun-

13

Jul-1

3

Aug

-13

Sep

-13

Oct

-13

Nov

-13

Dec

-13

Jan-

14

Feb-

14

Mar

-14

Apr

-14

May

-14

Movement in Key Rates

CRR Repo MSF SLR (Right Scale)

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Indias External Sector unlikely to Pose Substantial Concerns in FY15

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Current account deficit may widen in FY15

Current account deficit eased to ~USD 31-33 billion in 2013-14 (exp.) from USD 88 billion in 2012-13. Even if gold imports restrictions continue, current account deficit may widen to USD 40-45 billion in FY15.

o Capacity constraints, high inflation to cap merchandise exports growth; weak monsoon clouding outlook for exports of agricultural & allied products.

o Energy imports (crude oil, coal) to remain substantial.o Revival in domestic consumption or investment in H2FY15 would boost growth of non-oil, non-gold

imports.

10.3%11.3% 11.9%

9.0%

11.3%

7.9% 6.9%

4.0% 4.9%6.5%

3.6% 4.9%

1.2%0.9%

0%2%4%6%8%

10%12%14%

Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14

Merchandise Trade and Current Account Balances

Merchandise Trade Deficit Current Account Deficit

Source: RBI; ICRA Research

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although financing unlikely to pose much concern

Notwithstanding continuation of QE taper, FII flows in 2014-15 likely to exceed level in 2013-14. Forex reserves have risen to USD 314 billion, over 8 months of merchandise imports in 2013-14. Increase in external debt in April-December 2013 driven by NRI deposits, bulk of which have minimum

tenure of three years, limiting near-term refinancing risk.

0%20%40%60%80%100%120%140%160%

050

100150200250300350400450

External Debt

External Debt (USD billion)

Ratio of foreign Exhange Reserves to External Debt (RHS)

270275280285290295300305310315Rs. billion Foreign Exchange Reserves

2012-13 2013-14 2014-15

Source: Ministry of Finance; RBI; ICRA Research Source: RBI; ICRA Research

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Relatively high inflation to exert pressure on INR

Source: Central Statistics Office (CSO)

Source: Bloomberg; ICRA Research

Indias relatively high inflation would exert pressure on the INR, rendering a sustained appreciation in FY15 unlikely.

Sustained INR strength would reduce competitiveness of Indian exports, stoking concerns regarding size of current account deficit.

RBI may choose to utilize phases of INR appreciation to build up forex reserves further, which would also exert check on the Rupee.

5052545658606264666870 INR/USD

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Thank You

India: Post-Election Credit OutlookAgendaCredit Implications of BJP/NDA Parliamentary VictoryMarket Expectations Are HighComparing Economic Performance Across RegimesMarket Expectations Are HighGujarats Performance vs All-India AverageBaseline Forecasts: Indias Credit Metrics will Improve SlowlyWhat Would Support Credit Improvement? Lower Fiscal Deficits and Government Debt RatiosMacro-Economic Balance, Not Growth Alone, Determines Credit ProfileKey TakeawaysSlide Number 10Slide Number 11Slide Number 12Slide Number 13Slide Number 14Investment activity remains sluggish so far in 2014CCI clearances partly de-clogged project pipelinePace of pickup in project implementation to take a cue from resolution of structural hurdlesFiscal space needs to be created to stimulate economy5.0-5.5% economic growth likely in 2014-15Slide Number 20Below normal monsoon emerges as key riskLimited impact of weak monsoon on GDP growth substantial impact on food inflationCPI food inflation elevated at ~10% in April 2014Inherent rigidities suggest CPI may miss Jan15 targetSlide Number 26Current account deficit may widen in FY15although financing unlikely to pose much concernRelatively high inflation to exert pressure on INRSlide Number 30