Asia Insights. India s tour de force. Game-changing election outcome reinforces our view that the economy is at an inflection point

Asia Insights ECONOMICS India’s tour de force Global Markets Research 17 May 2014 Game-changing election outcome reinforces our view that the econo...
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Asia Insights ECONOMICS

India’s tour de force

Global Markets Research 17 May 2014

Game-changing election outcome reinforces our view that the economy is at an inflection point. India's 2014 election outcome was the most decisive in three decades with the BJP-led National Democratic Alliance (NDA) government sweeping the polls with 339 seats (out of 543) and the BJP alone at 284, more than the halfway mark. This outcome is better than expected and promises a stable pro-reform government for the next five years. The focus now shifts to the composition of the key cabinet ministers (likely to be announced by end-May) and the upcoming budget (by end-June/early-July). Additionally, markets are looking forward to the reform agenda. In our view, the pace of economic reforms is likely to pick up. In the immediate to short term, the government could announce a single-window clearance mechanism for investment projects, timebound environmental clearance, restructuring of exiting ministries and a focus on improving centre-state relations. In the medium term, we expect reforms to focus on infrastructure development, boosting agriculture productivity, fiscal consolidation aided by tax reforms and urbanisation. From an economic perspective, we see the election outcome as further strengthening our view that India is at an inflection point. We believe that growth has bottomed out and better exports and a pickup in investment should drive a recovery from 2015 onwards. We are revising up our FY16 (year ending March 2016) real GDP growth forecast from 5.7% y-o-y earlier to 6.5%, from 5.0% in FY15. Faster decision making and reforms, along with prudent monetary policy should gradually correct India‘s macroeconomic imbalances. Economic fundamentals change slowly, but as they do, they should feed off each other and unleash other positive indirect effects on the economy. Hence, India appears at the cusp of a revival of the multi-year growth cycle from 2015 onwards. On equity, we believe that a strong government will help mitigate bureaucratic risk aversion, reversing policy paralysis, in addition to jumpstarting the weak investment cycle. We raise our Dec 2014-end Sensex target to 27,200 from 24,700, offering a potential ~10% from current levels. Short-term catalysts for the market will be: 1) cabinet formation; 2) the budget; and 3) potential policy announcements. Sector wise, we reiterate our preference for rate cyclicals, which we expect to benefit from higher growth expectations, a compression of credit risk premiums and potential fiscal consolidation. On FX, we believe that NDA‘s landslide win has strengthened medium-term INR appreciation prospects and recommend scaling into a medium-term long INR position. We forecast USDINR to reach 57.0 by end-2014 and 55.5 by end-2015 as beyond the strong mandate for the new government, domestic growth momentum should continue. The relaxation of gold import restrictions, below-normal rains owing to likely El Nino and unfavourable INR FX valuations are the key risks to our constructive INR view.

Research analysts Asia Economics Sonal Varma - NFASL [email protected] +91 22 4037 4087 Aman Mohunta - NFASL [email protected] +91 22 6617 5595

Senior Political Analyst Alastair Newton - NIplc [email protected] +44 20 7102 3940

India Strategy Prabhat Awasthi - NFASL [email protected] +91 22 4037 4180 Nipun Prem - NSFSPL [email protected] +91 22 4037 5030

Asia FX Strategy Craig Chan - NSL [email protected] +65 6433 6106 Prateek Gupta - NSL [email protected] +65 6433 6197

Asia Rates Strategy Vivek Rajpal - NSL [email protected] +65 6433 6555 Prashant Pande - NSL [email protected] +65 6433 6198

On rates, we believe the election results are a medium-term positive for India rates. We maintain our bull flattening view in India swaps and remain bullish on bonds. We continue to like the 3yr to 5yr part of (ND)OIS curve and 3yr-9yr as the most preferred tenors on India sovereign bonds. We suggest investors stick with our recommendation of receive 3mfwd3yr and 3mfwd1s5s flatteners. We also continue to hold IGB 8.12 2020 as a medium-term position in our strategy portfolio.

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Asia Insights

17 May 2014

Paradigm shift The outcome of India's 2014 parliamentary elections was a sweep for the opposition and the centre-right Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) government (Figure 1). Out of the 543 Lok Sabha (lower house) seats, the NDA government won (leads in) 339 seats with the BJP itself at 284 seats, more than required to form a simple majority (272). The results are a positive surprise for the markets as they are much better than the average prediction of 285 seats for the NDA in the exit polls (Figure 2). The ruling Congress-led United Progressive Alliance (UPA) government‘s seats were reduced to 58, suffering from anti-incumbency sentiment owing to high inflation, corruption and a slowing economy during its tenure (Figure 1). Fig. 1: General election 2014 (leads and wins)

Fig. 2: 2014 elections: opinion and exit polls vs results* NDA UPA AITMC BJD Others AIADMK

AIADMK, 37

Others, 57

Seats 400 350

Actual 339

300

250

BJD, 18

Opinion poll Exit poll

285 234 197

200 AITMC, 34

146

150

100

UPA, 58

154

112 105 58

50

NDA, 339

0

NDA

UPA

Others

*based on leads and wins. Source: Media reports, Election Commission of India and Nomura Global Economics. Source: Election Commission of India and Nomura Global Economics.

Among the regional parties, AIADMK (All India Anna Dravida Munnetra Kazhagam) won 37 seats, the AITMC (All India Trinamool Congress) won 34 seats, the BJD (Biju Janata Dal) won 18 seats and the TRS (Telangana Rashtra Samithi) won 11 seats (Figure 3). Among the states, the BJP saw a substantial improvement in its tally in the key states of Uttar Pradesh, Bihar and completely swept Rajasthan, Gujarat and Delhi (Figure 4). Fig. 3: Seats won/leads by party Party/Alliance NDA Of which: BJP Shiv Sena TDP LJP SAD UPA Of which: INC NCP RJD Others AIADMK BJD TRS YSRC DMK AITMC AAP SP BSP JD (U)

2014

Fig. 4: Seats won/leads by key states

Previous Elections 2009 2004 1999

339

State

Total seats

BJP

INC

Others

Uttar Pradesh

80

71

2

7

Maharashtra

48

23

2

23

Andhra Pradesh

42

3

2

37

West Bengal

42

2

4

36

Bihar

40

22

2

16

Tamil Nadu

39

1

0

38

284 19 15 6 4 58

116 11 6 0 4

138 12 5 4 8

182 15 29

Madhya Pradesh

29

27

2

0

44 5 4

206 9 4

145 9 24

114 8 7

Karnataka

28

17

9

2

Gujarat

26

26

0

0

Rajasthan

25

25

0

0

10 10 12 8 26 14 21

Odisha

21

2

0

19

Kerala

20

0

8

12

Assam

14

7

3

4

Jharkhand

14

13

0

1

Punjab

13

2

3

8

Chhattisgarh

11

10

1

0

Haryana

10

7

1

2

Delhi

7

7

0

0

37 18 11 9 0 34 4 5 0 2

9 14 2 18 19 23 21 20

0 11 5 16 2 36 19 8

2

Source: Election Commission of India and Nomura Global Economics.

Source: Election Commission of India and Nomura Global Economics.

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Nomura | Asia Insights

17 May 2014

In our forward look at India‘s 2014 general election, India‘s defining moment published on 8 April 2014, we confidently predicted a solid win for the National Democratic Alliance (NDA) coalition led by the centre-right Bharatiya Janata Party (BJP), putting a 50% probability on a plurality of better than 220 seats. We did add that we could not ―categorically rule out‖ an outright majority for the NDA. However, we did consider that such an outcome ―would be a major surprise running contrary to the long-term trend.‖ The still unfolding election outcome has, therefore, to be seen as a tectonic paradigm shift in Indian electoral politics, ie: 

This is India‘s most decisive election outcome for three decades.



It also bucks the long-term trend of the two major parties, ie the BJP and the Indian National Congress (INC), seeing their joint share of the total vote declining – indeed, of late falling below 50%.



The geographical spread of the BJP‘s share of the vote marks its establishment as a genuinely national force in India‘s politics, breaking out of its traditional ‗heartland‘ of the north and west of the country and



It marks, in our view, not only the end of 10 years rule by the INC but also, possibly, the end of the Nehru-Gandhi dynasty, which defined Indian politics for almost 100 years and dominated post-independence India, as the party goes into a period of opposition and, we believe, deep introspection over its future.

Enter ‘Modi-nomics’ The key to this remarkable outcome has, by general consensus, been one man, ie the BJP‘s prime ministerial candidate Narendra Modi. As we commented on our 8 April report, Mr Modi wrought a fundamental change in electoral strategy, basing his campaign on personalities in a quasi-presidential manner. We therefore see the outcome not only as a powerful mandate for the NDA/BJP, but also as a major vote of confidence in Mr Modi personally, with three important consequences, as follows: 

With 339 seats, the NDA will not have to bring in additional coalition partners to enjoy a stable majority in the Lok Sabha – indeed, can even afford to have some dissenters within its ranks and still secure majority votes.



Furthermore, with 284 seats the BJP itself is in a strong position to exercise a good degree of control over its fellow NDA-members; and,



The scale of a victory for which he can personally claim much of the credit should give Mr Modi authority over dissenters within the ranks of the BJP itself.



Add to these the fact that the election saw a record turn-out of 66.38% (totalling around 551 million votes) and it is clear that India has voted for ‗change‘ based principally on Mr Modi‘s record of economic reform over the past 12 years as chief minister of Gujarat, which now accounts for 16% of India‘s industrial output and 22% of its exports despite having just five percent of its population.

In short, India has voted decisively for Modi-nomics. Reality check All this being said, we think it important to keep firmly in mind the challenges which Prime Minister Modi will face as he looks to meet what Sanjeev Miglani of Thomson Reuters rightly described in an article published earlier today as ―soaring expectations‖.1 Without wishing for one moment to detract from the positive implications for reform and growth of the election outcome, we also believe that: 

Voting for the principle of ‗change‘ is one thing, whereas accommodating the reality of it where there will inevitably be ‗losers‘, including among strong-vested interests, as well as winners is quite another.



Among those strong-vested interests is, in our view, India‘s bureaucracy, whose ‗buy-in‘ is essential for policy implementation, but which Mr Miglani describes as ―more wedded to socialist controls than reform.‖



Regional governments will likely remain a powerhouse in India and even those controlled by the BJP will not necessarily automatically toe the Delhi line; and

1 ‗Modi faces mammoth task to meet India‘s soaring expectations‘ by Sanjeev Miglani, Thomson Reuters, 16 May 2014. 3

Nomura | Asia Insights



17 May 2014

History suggests that, despite the scale of Mr Modi‘s victory, keeping the NDA coalition united in pushing through reforms will not necessarily be straightforward, especially after the incoming government‘s ‗honeymoon‘ period is over.

The next steps and reforms Once the dust settles on the election outcome we see the market focus shifting to the next steps. By end-May, cabinet portfolio allocations are likely to be completed. According to the Economic Times2, a Modi-led government will have the smallest cabinet with some wellknown technocrats as junior ministers. The portfolios of Finance, Home, Defence, External Affairs and Railways will be in focus. The BJP‘s outright majority will give it complete flexibility in allocating important portfolios to the candidate of its choice. Markets will particularly focus on who becomes the Finance Minister with Arun Jaitley3 and Arun Shourie the possible frontrunners. After the portfolio allocations, the focus will shift to budget preparations and we expect the budget to be presented by end-June/early-July. The budget will be the first official platform for the new government to present its larger economic vision and fiscal consolidation plans. Reforms and policy priorities We expect the pace of economic reforms to pick up in momentum. Figure 5 lists the immediate, short-term and medium-term reform prospects. 

Immediate and short-term: Reviving the investment cycle and presenting the budget are the immediate priority. The government could announce a singlewindow clearance mechanism for investment projects and a time-bound environmental clearance (with online tracking mechanism). The NDA is expected to restructure the existing ministries into smaller and more compact cabinets. In the upcoming budget, the government may undertake an independent fiscal audit to ascertain the extent of due payments, but at the same time commit to mediumterm fiscal consolidation without compromising on the quality of consolidation (rejig spending towards asset creation and away from consumption). Finally, we expect centre-state relations to get a boost with the NDA likely to allow more independence to states in decision-making (more fungibility in spending under centrally-sponsored schemes) and greater co-ordination between centre and states.



Medium-term priority: Infrastructure development is likely to see a renewed thrust. In particular, the focus is likely to be on investment in railways, ports, continued investment in the dedicated freight corridor, roads and national fibre optic grid. We expect the agriculture sector to also be an increased focus because of worries about high food price inflation. Moving towards a national agriculture market, the incentive to the private sector to build cold storage, use of technology and better quality seeds to boost productivity are possible. The BJP‘s manifesto also indicated that it will increasingly rely on e-auctions to ensure transparent transfer of the nation‘s natural resources, which should substantially reduce the risk of deallocation, as seen in the case of 2G spectrum and coal blocks recently. The other policy priorities will likely include: urbanisation (creating new cities and upgrading existing urban infrastructure), better and more effective implementation of the existing entitlement programmes, recapitalising/reorganising public sector banks and building consensus around the Goods and Services tax.

2

Lok Sabha elections 2014: Technocrats may serve as junior ministers in Narendra Modi‘s government, 14 May 2014, Economic Times. 3

Senior BJP member Arun Jaitley had been widely tipped for the role of Finance Minister, but bucking the national trend, he was defeated by the INC candidate in a seat in Punjab which the BJP had won in 2009.

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Nomura | Asia Insights

17 May 2014

Fig. 5: Potential policy reforms: Immediate, short-term and medium-term Area Central government restructuring Fiscal

Centre-state relationship

Manufacturing/investment

Objective

Horizon

Reorganize and consolidate the existing ministers

Immediate

Get an independent fiscal audit to ascertain the extent of payments due Strict fiscal discipline; rejig the expenditure mix away from consumption towards asset creation; simplify tax regime More autonomy to states on expenditure (on centrally sponsored schemes), land laws, labour laws, in attracting foreign investments and in mobilising own resources for industry Revive Inter-state council and national development council to increase state participation in national governance Setup global manufacturing hub Empanel state chief ministers in Cabinet Committee on Investments to speed up approval process Focus on improving the 'ease of doing business' by introducing single window clearance, time bound environmental clearance; procedural simplification Investment in railways; diamond quadrilateral project (high speed trains); port development; build coastal and border highways; national fibre optic grid

Immediate

Expedite the work on freight corridors and industrial corridors

Short-term Short term Medium-term Medium-term Immediate Short-term Medium term Short term

Infrastructure River linkage and development to improve irrigation and flood/drought management

Disinvestment

Agriculture

Urbanisation Entitlement Tax reforms Jobs Banking sector Foreign Direct Investment

Medium term

Use e-auction route to transfer natural resources

Short term

To try and turn around PSUs (more efficiency) without going down the privatisation route

Short term

Reform agriculture produce and marketing Act (APMC) Act; restructure Food Corporation of India and the Public Distribution System, Move towards a national agri market; use of technology, better quality seeds to boost productivity Create 100 smart cities focusing on concept of twin cities and satellite towns; upgrade existing urban infra Ensure effective implementation of the 'right' schemes; massive low-cost housing program Bring states on board in GST adoption; strengthen the IT network to implement Push to bring in the Direct Tax Code Focus on housing, tourism and other labour-intensive industries to generate jobs Recapitalise and reorganize (merge, dilute government stake in) public sector banks Barring multi-brand retail, encourage FDI across other sectors

Medium term Medium term Medium term Medium term Medium-term Medium-term Medium term Short term Medium-term

Source: BJP, Media sources and Nomura Global Economics.

5

Nomura | Asia Insights

17 May 2014

An economic inflection point We see the election outcome as further strengthening our view that India today is at an inflection point. The election results give a clear and strong mandate for the BJP, which should ensure faster decision-making and enable accelerated implementation of the economic reforms noted above. With political clarity emerging, business and household confidence is likely to rise. Increased capital inflows and rising asset prices will likely enable firms to raise more equity capital and reduce their debt burdens. Faster execution will enable debottlenecking of investment projects and drive the capex cycle, albeit with a lag. Enhancing the supply side of the economy, coupled with continued prudent monetary policy, should encourage a steady improvement in India‘s macroeconomic fundamentals – namely gradual disinflation and smaller and more stable twin current account and fiscal deficits. Improving economic fundamentals should lead to an upgrade in India's sovereign credit rating outlook. Economic fundamentals always change slowly, but a combination of factors – growth bottoming out, increased inflation-fighting credibility of the Reserve Bank of India (RBI) and now a strong mandate for the NDA government – suggest that economic fundamentals are likely to gradually improve in the coming years. Importantly, these reforms will take time, but as they progress they should feed off each other and unleash other positive indirect effects on the economy. Hence, we see India at an inflection point from a medium-term perspective (India Outlook 2014: Inflection Point, 25 April 2014). Growth outlook to gradually improve over 2015-17 India‘s real GDP growth has fallen from a peak of 9.3% in FY11 (year-ending March 2011) to under 5% in FY14. Nomura‘s composite leading indicators suggest that nonagriculture growth is consolidating and that the worst in behind us (Figure 6). Overall, we expect real GDP growth of around 5% y-o-y in FY15 versus 4.7% in FY14, as a fall in agriculture growth is likely to be offset by higher non-agriculture GDP growth. Agriculture GDP growth will likely be hit in FY15 owing to poor rains, hence, we are revising down our agriculture GDP growth projection from 2.8% y-o-y earlier to 0.9% now. However, with political stability in place and rising confidence likely to lead to pent-up demand, we believe that India‘s non-agriculture GDP growth should see a gradual revival towards end-2014 and into 2015. Hence, we are revising up our FY15 non-agriculture GDP growth forecast from 5.3% earlier to 5.7%. Further out, we are revising up our FY16 real GDP growth forecast from 5.7% y-o-y earlier to 6.5%. We expect a visible improvement in the growth outlook from FY16 onwards supported by three factors. First, stronger global GDP growth should have a positive impact on India. Nomura expects global GDP growth to rise from 2.9% y-o-y in 2013 to 3.4% in 2014 and to 3.6% in 2015 which should further support India‘s recovery as India's exports, industrial production and investment cycles are closely correlated with global growth cycles (Figure 7). Second, debottlenecking of existing investment projects should also boost the capex cycle by increasing capital productivity. The Cabinet Committee on Investments has approved around 300 projects worth more than USD100bn. As demand and corporate balance sheets improve, a time-bound approval process will likely expedite investments. Third, a gradual moderation in inflation is likely to boost household real disposable incomes. Hence, we see India at the trough of a multi-year growth cycle.

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Nomura | Asia Insights

17 May 2014

Fig. 6: Nomura's composite leading index for India Index

Non-agriculture GDP (2qma), rhs

104

Nomura's composite leading index, lhs

Fig. 7: India versus global growth cycle % y-o-y 12

% y-o-y 6

World GDP, lhs

% y-o-y

India real GDP (ex-agri), rhs

5

10

10 4

8

102

8

12

3

6 6

100

2 4

1

4

2

0

98 2 Sep-96 Sep-99 Sep-02 Sep-05 Sep-08 Sep-11 Sep-14

-1

1984 1988 1992 1996 2000 2004 2008 2012 2016

0

Source: IMF, CEIC and Nomura Global Economics. Source: CEIC and Nomura Global Economics.

Imbalances to gradually correct Very loose fiscal and monetary policies worsened India‘s macroeconomic imbalances during 2007-12. However, we expect these imbalances to correct over the coming years, supported by three factors (Figure 8): 1) tight monetary policy, which will gradually disinflate the economy4 and encourage financial savings; 2) fiscal consolidation, which should crowd-in private investment and boost public savings; and 3) better governance and faster execution, which should boost productivity, encourage investment and ease supply-side constraints. As the macroeconomic imbalances correct, some of these tight policies may initially prevent growth from rising very sharply (hence we expect a gradual growth rise), but stability, in our view, should encourage investment and support higher trend growth in the medium term. As inflation eases, this should allow lower rates in the medium term. Fig. 8: India’s macroeconomic imbalances should correct over time

Source: Nomura Global Economics.

Large balance of payments surplus India‘s current account deficit has narrowed from close to 5% of GDP in FY13 to less than 2% of GDP in FY14. We believe this is a sustainable current account deficit level. The bulk of the moderation in the current account deficit in FY14 was owing to restrictions on gold imports. We expect these restrictions to be eased in Q3 2014. However, even then, we expect the current account deficit to remain at sustainable levels in FY15 aided by stronger demand from advanced economies for Indian exports. On the capital account, a turnaround in investor sentiment will likely lead to sharp increase in portfolio flows, while a business-friendly government focused on building infrastructure and promoting manufacturing should support FDI flows. Overall, we expect India‘s balance of payments to record a surplus of around USD25bn in FY15.

4

A gradual disinflation is already underway due to tighter monetary policy, the past slowdown in domestic demand and falling rural wages (lower input costs). We expect CPI inflation to moderate to around 8% y-o-y by Q1 2015, in line with the RBI‘s target, and to 6.5-7.0% by Q1 2016, slightly above the RBI‘s stated target of 6.0%.

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Nomura | Asia Insights

17 May 2014

Fig. 9: India’s balance of payments projections USD bn A Current Account 1 Merchandise Exports Imports Oil Gold Non-oil/non-gold 2 Invisibles Services Transfers Income B Capital Account 3 Foreign Direct Investment (net) 4 Portfolio Investment 5 Loans External Assistance Commercial Borrowings Short Term Credit to India 6 Banking Capital 7 Rupee Debt Service 8 Other Capital C Overall Balance Current account (% of GDP)

FY09 (27.9) (119.5) 189.0 308.5 93.7 21.3 193.5 91.6 53.9 44.8 (7.1) 7.4 22.4 (14.0) 8.3 2.4 7.9 (2.0) (3.2) (0.1) (5.9) (20.1) (2.3)

FY10 (38.2) (118.2) 182.4 300.6 87.1 28.8 184.7 80.0 36.0 52.0 (8.0) 51.6 18.0 32.4 12.4 2.9 2.0 7.6 2.1 (0.1) (13.2) 13.4 (2.8)

FY11 (45.9) (130.6) 250.5 381.1 106.0 40.7 234.4 84.6 48.8 53.1 (17.3) 62.0 9.4 30.3 28.4 4.9 12.5 11.0 5.0 (0.1) (11.0) 13.1 (2.7)

FY12 (78.2) (189.8) 309.8 499.5 155.0 56.5 288.1 111.6 64.1 63.5 (16.0) 67.8 22.1 17.2 19.3 2.3 10.3 6.7 16.2 (0.1) (6.9) (12.8) (4.2)

FY13 (88.2) (195.7) 306.6 502.2 169.4 53.8 279.1 107.5 64.9 64.0 (21.5) 89.3 19.8 26.9 31.1 1.0 8.5 21.7 16.6 (0.1) (5.0) 3.8 (4.7)

FY14F (33.1) (147.6) 318.6 466.2 167.8 28.9 269.5 114.5 73.0 64.5 (23.0) 49.3 25.0 8.9 10.5 0.6 8.0 1.9 18.0 (0.1) (13.0) 16.2 (1.8)

FY15F (36.9) (155.9) 332.0 487.9 170.0 37.6 280.3 119.0 80.0 64.0 (25.0) 63.9 25.0 25.0 17.0 1.0 9.0 5.0 5.0 (0.1) (8.0) 27.0 (1.7)

Source: CEIC and Nomura Global Economics.

Near-term fiscal outlook uncertain; expect consolidation thereafter One key issue concerning the FY15 budget is whether the new government will account for outstanding payments (~0.5-1.0% of GDP) in the first year or stick to the 4.1% of GDP fiscal deficit target set by the outgoing government and thus continue to rollover outstanding payments. If the NDA government announces a fiscal audit, then it may undertake to disclose the ‗true‘ fiscal deficit in year one and then commit to fiscal consolidation over the medium term, aided by better growth, expenditure and tax reforms. India’s outlook at a glance Overall, with growth bottoming out, the central bank‘s increased credibility and greater macroeconomic stability, we believe the Indian economy is at an inflection point. We believe that the strong political mandate for the NDA government will result in prudent macroeconomic policies and a business-friendly reformist agenda, which will prove to be the catalyst for revival of multi-year growth cycle from 2015 onwards. Fig. 10: India outlook at a glance % y-o-y growth unless otherwise stated 4Q13 Real GDP 4.7 Agriculture 3.6 Industry -1.2 Services (incld Construction) 6.7 Wholesale price index Consumer price index

7.1 10.4

1Q14 4.8 4.8 -0.4 6.3

2Q14 4.6 3.5 0.8 5.9

5.2 8.3

6.9 8.7

3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 4.6 5.0 5.7 6.3 6.7 6.5 -1.0 0.0 1.0 3.8 5.8 5.0 0.6 2.3 3.7 4.9 4.7 5.0 6.6 7.0 7.2 7.2 7.3 7.3 5.2 8.5

5.1 7.5

5.7 8.0

5.6 7.7

5.8 6.7

5.8 6.5

Current account balance (% GDP) Fiscal balance (% GDP) Repo rate (%) Reverse repo rate (%) Cash reserve ratio (%) 10-year bond yield (%) Exchange rate (INR/USD)

7.75 6.75 4.00 8.82 62.0

8.00 7.00 4.00 8.80 60.1

8.00 7.00 4.00 8.80 58.0

8.25 7.25 4.00 8.80 57.6

8.25 7.25 4.00 8.70 57.0

8.25 7.25 4.00 8.70 56.6

8.25 7.25 4.00 8.70 56.3

8.25 7.25 4.00 8.70 55.9

8.25 7.25 4.00 8.70 55.5

FY13 FY14 4.5 4.7 1.4 3.9 0.9 -0.3 6.3 6.3

FY15 5.0 0.9 1.9 6.7

FY16 6.5 5.0 5.0 7.3

7.3 10.2

5.9 9.5

5.7 8.2

5.8 6.8

-4.8 -4.9

-1.8 -4.6

-1.7 -4.1

-1.9 -3.6

7.50 6.50 4.00 8.01 54.4

8.00 7.00 4.00 8.80 60.1

8.25 7.25 4.00 8.70 56.6

8.25 7.25 4.00 8.70 55.5

Source: Note: Interest rates and currency are end-of-period; other measures are period averages. Consumer price index is the series with base year as 2010. FY14 refers to year ending March 2014. Figures in bold are actual.

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Nomura | Asia Insights

17 May 2014

Equity strategy: The right medicine An historic mandate The overwhelming mandate received by Modi-led NDA (National Democratic Alliance) is historic – this is the first time since 1984 that a single party has won a clear majority in central Lok Sabha elections. As we write this note, the NDA is leading in 339 of the 543 seats, having increased their tally by an unprecedented 184 seats from 2009. BJP (Bharatiya Janata Party) is on course to cross the half-way 272 mark with ~33.7% vote share. The bears on the Indian market argue that India is in a structural downturn and its ossified bureaucracy and balance sheet-challenged corporates mean that any investment revival will likely be a distant dream. We, on the other hand, believe that a strong government can solve a number of impediments plaguing the Indian economy through a mix of policy, execution and quick and decisive decision making. In this regard, the track record of the NDA government has been quite good. Please refer to figures 14-16 below for a detailed list of policy actions and reforms undertaken by the NDA (National Democratic Alliance) government when it was last in power from 1999 to 2004. Much of why we think that an NDA-led government, led by Narendra Modi, is the right medicine for the currently sluggish economy is based on the significant push in infrastructure and development that was undertaken by the NDA during 1999-2004. Key among them were the unbundling of SEBs (state electricity boards) and opening up the power sector to private participation, unprecedented building of roads and highways, legislating a ceiling for central fiscal deficits with the FRBM act (Fiscal Responsibility and Budget Management Act), throwing open oil & gas exploration to the private sector, delicensing coal and petroleum and opening up a host of sectors, including insurance, to foreign direct investment. We believe that an NDA-led government will move India‘s economic policy to right of centre and focus of development-led growth in contrast to a model of wealth redistribution that was the guiding principle of the incumbent UPA (United Progressive Alliance). Easing macro pressures The historic mandate received by the BJP-led NDA translates to a stable government at the center. The timing of this majority government could not have been more opportune as India has moved past key macro hurdles it has faced in the last three years. India‘s current account deficit has fallen to very manageable levels, growth seems to have bottomed out, inflation is peaking and the currency has started to look stronger. Additionally, the RBI, through a slew of proactive measures, has built up a sizeable war chest of forex reserves that will repose confidence in Indian currency. The job of the new government becomes that much easier as it will not have to firefight pressures on currency and external account, not to mention that increasing downgrade pressure by rating agencies faced by the UPA government towards the end of its tenure. Firm focus on governance and investments will be the key agenda for the new government, in our view. Positives of a Modi-led majority government We believe that a Modi-led government‘s key comparative advantage, relative to that of the incumbent government, lies in its superior managerial and execution ability, which will help considerably in mitigating heightened bureaucratic risk aversion, reversing a debilitating policy paralysis and improving coordination between government departments, in addition to resolving issues plaguing key factors of production markets and jumpstarting the weak investment cycle. The key positive of having Mr. Modi at the helm of affairs will, in our view, be a government that delivers and implements the policies which it formulates. UPA‘s key failing in several sectors was not poor policy but poor implementation and execution. This is especially evident in infrastructure and manufacturing where slow decision making by bureaucracy along with delays in key approvals (land, environment and forests) have led to a significant risk aversion among risk takers. A reversal of tardy decision-making, on its own, can likely cause a revival in India‘s investment cycle, albeit over a period of time – the investment cycle is a slow-moving beast, after all. Mr. Modi has strongly emphasized strong governance throughout his election campaign. One of his key messages has been an ―algorithmic-style‖ policy framework with an aim 9

Nomura | Asia Insights

17 May 2014

to reduce procedural delays and other systemic inefficiencies and to stick to well laid down timelines, thereby limiting discretionary decision-making. Our feedback from companies operating in Gujarat—Mr. Modi‘s home state where he has been the chief minister since 2001—provides ample evidence in this regard. In our view, the short-term manifestation of these election results will be the arrest of the downward slide in policy and a marked improvement in the executive ability of the government, thereby enabling speedier decision-making at the government level. Meanwhile, unencumbered legislative ability, a consequence of a clear majority in Parliament, is a key positive in the medium term. The BJP manifesto (see figure 13), along with actual achievements by the NDA government during 1999-2004 (see figures 14-16), is a good indicator of possible thrust areas for the new government in so far as they relate to areas which impinge on the market. If BJP‘s manifesto is anything to go by, then we expect infrastructure to be the big priority area for the new government. Market and sector strategy As such, we expect markets to be underpinned by an inherent positive bias and to give an initial benefit of doubt to a potential Modi-led government. In our view, this calls for a mild multiple expansion of the market on the back of a likely fiscally prudent government which will bring down the cost of capital in the economy, on the one hand, and higher growth expectations, on the other. Given this strong election verdict, we formally raise our December-end Sensex target to 27,200 from 24,700, offering a potential ~10% from current levels. We note that shortterm catalysts for the market will be: 1) cabinet formation over the coming weeks; 2) the budget in about a month and half‘s time and 3) potential policy announcements and ―feel good‖ initiatives by the new Prime Minister. Meanwhile, the chart below shows the market‘s 12-month forward, consensus-based earnings multiple. We note that currently the Sensex is trading at 14.6x one-year forward earnings, up from 13.7x at the beginning of this year and 12.8x in Sep-13, which was when the rally in capital goods and banking stocks began. In comparison, the average multiple in the high water mark year of 2010 was 15.9x; the 5-year average multiple is 14.8x and the three-year average multiple is 14.2x. Our Dec-end Sensex target is based on a one-year forward earnings multiple of 16.4x which translates to a 15% premium to its three-year average, which refers to a period of largely ~5% GDP growth. We believe that this premium is justified on better macro and a stable and majority government at the centre. Fig. 11: Sensex 12-month forward consensus-based earnings multiple (x) 34

Sensex 12-m fwd P/E

29 24

12.8x on 2 Sep'13 13.7x on 1 Jan'14

5-year average = 14.8x 3-year average = 14.2x 2010 average = 15.9x

19 14

Apr-14

Apr-13

Apr-12

Apr-10

Apr-09

Apr-08

Apr-07

Apr-06

Apr-05

Apr-04

Apr-03

Apr-02

Apr-01

Apr-00

Apr-99

Apr-98

Apr-97

4

Apr-11

14.6x as on 16May'14

9

Source: Bloomberg, Nomura research

Sector-wise, we reiterate our preference for rate cyclicals, which we expect to benefit from higher growth expectations, a compression of credit risk premiums and potential fiscal consolidation. Valuations for PSU banks are quite supportive, in our view. However, our conviction on domestic growth cyclicals is not as high. We think that there is a reasonable likelihood that the market‘s high hopes of a quick turnaround in the fortunes of capex-exposed companies might well come in for reassessment in the coming months, especially after the stupendous outperformance by stocks in the sector. 10

Nomura | Asia Insights

17 May 2014

We feel more comfortable getting exposure to a potential Modi-led government‘s superior coordination and execution skills and policy focus through companies in the power/coal space, downstream oil marketing companies and selective asset owners in the infrastructure space. We believe that valuations of these sectors are still comparatively supportive and that opportunity for growth is very large and realizable in a positive policy environment. We continue to like IT services stocks for the following reasons: 1) the sector offers a good hedge against the risk that the government‘s actions to resolve domestic growth issues fall short of market expectations; 2) normalising growth conditions in US and Europe are supportive of demand for the sector‘s service; and 3) the rupee might well find support from potential capital inflows, but with the Fed-taper underway and bond purchases expected to end later this year, we think that the RBI might well continue to add to forex reserves in the coming months. We would be buyers on potential near-term weakness. We maintain our UW on consumer and pharma sectors. Changes to our recommended strategy long-only bask can be seen in the table below. Also Nomura‘s Asia-Pacific ex-Japan and Global Equity Strategist Michael Kurtz maintains an Overweight allocation recommendation to India in both the regional and Global contexts. Michael upgraded India to Overweight last October (see Delayed stratification, Oct. 29, 2013) while downgrading China, specifically citing India‘s improving political prospects among other factors. Since then the SENSEX has outperformed the China H-share Index by fully 23%.‖ Fig. 12: Strategy long-only basket Sector

Previous sector Current sector Changes in stock picks vs. stance (13 May'14) stance previous stance

Currently recommended stocks

Automobiles

Underweight

Underweight

Banks

Overweight

Overweight

Mahindra & Mahindra (*) Bharat Forge (*) HDFC ICICI Bank (*) IDFC (*) Axis Bank (*) Yes Bank (*) State Bank of India (*)

Cement Consumer

Underweight Underweight

Underweight Underweight

Infra & construction

Underweight

Underweight

Electrical Equipment Media

Underweight Overweight

Underweight Overweight

Metals & Mining

Underweight

Underweight

Oil and gas

Overweight

Overweight

Pharmaceuticals Technology

Overweight Overweight

Underweight Overweight

Telecoms Utilities

Underweight Overweight

Underweight Overweight

OUT: DRRD IN:LPC

Rating

Current Price

Target Price

MM IN BHFC IN HDFC IN ICICIBC IN IDFC IN AXSB IN YES IN SBIN IN

BUY BUY NEUTRAL BUY NEUTRAL BUY BUY BUY

1174.1 451.9 946.6 1533.6 126.4 1805.0 565.0 2480.7

1261 410 860 1425 105 1720 550 2300

Titan Industries (*)

TTAN IN

Emami IRB Infrastructure Container Corporation (*)

HMN IN IRB IN CCRI IN

321.0 440.1 161.5 1105.1 230.2

305 530 212 1053 237

Bloomberg Ticker

Adani Port (*)

ADSEZ IN

BUY BUY BUY BUY BUY

Zee Entertainment Dish TV Tata Steel Coal India (*) Reliance Industries (*) HPCL (*) BPCL (*) GAIL India (*) Lupin HCL Technologies Infosys Technologies Tata Consultancy Services Tech Mahindra

Z IN DITV IN TATA IN COAL IN RIL IN HPCL IN BPCL IN GAIL IN LPC IN HCLT IN INFO IN TCS IN TECHM IN

BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY

277.7 47.6 471.2 364.1 1119.1 399.3 552.2 426.4 962.0 1373.7 3062.2 2120.0 1801.0

325 104 518 315 1175 330 580 450 1119.807 1730 3770 2570 2100

NTPC (*) Power Grid Corp (*) JSW Energy (*)

NTPC IN PWGR IN JSW IN

BUY BUY BUY

135.3 119.4 61.1

145 125 54

Source: Bloomberg, Nomura research Note: Pricing as of 16 May 2014; (*) TP under review

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Nomura | Asia Insights

17 May 2014

BJP 2014 manifesto Fig. 13: BJP 2014 manifesto Measures in BJP's manifesto Growth

No specific GDP growth target but emphasis on accelerating growth

Fiscal policy

Strict implementation of fiscal discipline Fiscal autonomy for states

Industry and manufacturing

Simplification of procedures Focus on infra, Stable power supply Single-window clearance; environmental clearances - transparent and time bound Industrial regions with global hubs of manufacturing Interest rate rationalisation, R&D focus Software and hardware manufacturing hubs Focus on PPP; higher autonomy to regulators

Taxation

GST Implementation Simplification of tax structure

Energy

Gas grids National energy policy for power; Focus on fuel supply Steps to increase domestic coal exploration and production, to bridge the demand and supply gap. Oil and gas explorations would also be expedited in the country Give a thrust to renewable sources of energy as an important component of India's energy mix Expand and strengthen the national solar mission Implement auction of precious resources through efficient mechanisms including e-auction Value addition will be encouraged in all resources, instead of just marketing Use technology to reduce transmission and distribution losses

Transportation

Hinterland TO be connected to ports through strategic new Rail networks Agri Rail network will be established - with Train Wagons designed to cater to the specific needs of perishable agricultural products like milk and vegetables as well as light weight wagons for salt movement Diamond Quadrilateral project - of High Speed Train network (bullet trains) Work on the Freight Corridors and attendant Industrial Corridors to be expedited National highway construction projects to be expedited, especially border and coastal highways Modernisation of existing ports on one hand, and develop new ones on the other - stringing together of Sagar Mala (Sea necklace) project

Urban Infrastructure

Major steps to be undertaken in transport and housing for 'Urban upliftment' in India. 100 new cities, enabled with the latest in technology and infrastructure - adhering to concepts like sustainability, walk to work etc, and focused on specialized domains The approach to urban development will be based on integrated habitat development - building on concepts like Twin cities and Satellite towns Upgradation of existing urban centres, transitioning focus from basic infrastructure to public utility services like waste and water management Cleanliness and sanitation to be given priority - efficient waste and water management systems to be set up. Model towns to be identified for rolling out integrated waste management infrastructure Wi-Fi facilities to be made available in public places and commercial centres Urban poverty alleviation scheme to be a key thrust area Use of technology for scientific, strategic and long term town planning - including GIS based mapping. Build quality integrated public transport systems, discouraging usage of private vehicles

Education

Hike in public spend on education at 6% of GDP; Focus on skill building, right to education

Inflation

Agri rail network for agri produce Unbundling of FCI (Food Corporation of India) National agricultural fund Price stabilisation fund Reforming of APMC (Agricultural Produce Marketing Committee) Act Strengthening of agri infra Evolve a single National Agricultural Market

Governance

Technology enabled e-Governance - minimizing the discretion in the citizen-government interface System-based, policy-driven governance - making it transparent Rationalization and simplification of the tax regime Simplification of the processes and procedures at all levels - bestowing faith in the citizens, institutions and establishments Place Centre-State relations on an even keel through the process of consultation and strive for harmonious Centre-State relations Digitization of government records to be taken up on top priority so that they are easily accessible Performance review, social and environment audit to be mandated for all government schemes and programmes Open up government to draw expertise from the industry, academia and society into the services Government to be redefined by elimination of whatever is obsolete in laws, regulations, administrative structures, practices and would be purposive

Entitlements/ subsidies

BJP's focus seems to be not on increasing entitlement schemes but to better administer already existing schemes. The manifesto specifically talks about a revamp of PDS (Public Distribution System; effective implementation of Right to Food; Low-cost housing

Overall Reforms

Labour reforms; 33% reservation for women in Parliament/ state assemblies; FDI in all sectors except multi-brand retail; National land use authority; Judicial reforms; Banking reforms

Source: BJP website, Nomura research

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17 May 2014

Time-line of NDA government reforms Fig. 14: Time-line of NDA government reforms FY1999

Comments

Delicensing of coal, lignite, petroleum, bulk drugs and sugar

Major

Coal, lignite and mineral oils removed from sole purview of public sector

Major

Announcment of disinvestment of IOC, GAIL, CONCOR, VNSL

Major

Buybacks by corporates permitted

Minor

Automatic route FDI limits enhanced

Minor

100 per cent foreign equity permitted in electricity generation, transmission and distribution

Major

100 per cent foreign equity permitted in construction & maintenance of roads, highways, bridges, ports and harbours

Major

No prior approval of RBI for FDI/NRI/OCB after FIPB/Govt approval

Minor

Electricity Act of 1948 amended for private investment in power transmission

Minor

Setting up of central electricity regulatory commission, provisions for state ERCs

Major

Additional tax at the rate of one rupee per litre on petrol imposed. To generate Rs.790 crore in a year and the proceeds to be utilised to augment the corpus of the National Highways Authority of India (NHAI) A National Integrated Highway Project merging the golden quadrilateral connecting Delhi, Mumbai, Chennai and Calcutta with the East-West (Silchar to Saurashtra) and North-South (Kashmir to Kanya Kumari) corridors launched The Government announces that five cities will be identified for developing world class international airports

Minor

IDFC on par with other All India Public Financial Institutions regarding fiscal incentives and the fund raising benefits extended to these institutions The repeal of the Urban Land (ceiling and regulation) Act, 1976

Minor

Major Major

Major

FY2000 RBI introduceS an Interim Liquidity Adjustment Facility (ILAF) in place of the General Refinance Facility with effect from April 21,1999

Minor

Relaxation of listing requirement in respect of securities in the IT sector by reducing the stipulated minimum offering of securities from 25 per cent to 10 per cent The passing by Parliament of the Securities Laws (Amendment) Bill, 1999, incorporating derivative instruments in the definition of securities in the Securities (Regulation) Act, 1956scrips with effect from January 10, 2000 Introduction of Contract rolling settlement for 10 select

Minor

Insurance Regulatory and Development Authority (IRDA) Bill passed by the Parliament in December, 1999 which, inter alia, gives statutory status to the interim Insurance Regulatory Authority, opens up the insurance sector to private providers, allows foreign equity in domestic insurance companies subject to a maximum of 26 per cent of the total paid-up capital Reduction of long-term capital gains tax from 20 per cent to 10 per cent for resident Indians

Major

Reduction in the existing 7 major ad valorem rates of customs to 5 basic rates and rationalisation of both import duty and excise duty structures

Minor

Free Trade Zones (FTZ) to replace export processing zones and to be treated as outside the country‘s customs territory

Minor

Far-reaching rationalisation of the excise duty structure by reducing the existing eleven rates to only three

Minor

Tax incentives for facilitating industrial restructuring through mergers and amalgamations

Minor

Extension of infrastructure sector tax holiday to power transmission

Major

The scope of the automatic approval scheme of the RBI significantly expanded

Minor

FDI up to 74 per cent, under the automatic route, in bulk drugs and pharmaceuticals

Minor

Restructuring the US 64 scheme of UTI (Unit Trust of India), a favourable tax treatment of incomes earned through mutual funds

Minor

A new Department of Disinvestment created for expediting disinvestments in PSEs

Major

Uniform tax holiday of 15 years for all infrastructure sector projects

Major

Mega Power Project policy announced

Major

Accelerated Power Development and Reforms Programme (APDRP) introduced

Major

Restructuring of SEBs to be encouraged; new transmission and distribution systems to get fiscal benefits given to infrastructure sector

Major

Domestic long distance calls to be opened up

Major

Department of Telecom Services (DTS) to be corporatised by 2001

Major

DTS/MTNL to enter as third cellular operators

Minor

TRAI (Telecom Regulatory Authority of India) reconstituted through an ordinance

Major

Existing licence holders of basic and value added services allowed to switch over to a revenue sharing agreement

Major

A new cess of Re.1 per litre on HSD (High Speed Diesel) imposed to generate funds to be transferred to Central Road Fund. Most of it to be used for development and maintenance of State Roads and National Highways Model Concession Agreement for BOT (Build Operate Transfer) for road project of more than Rs. 100 crore and less than Rs. 100 crore finalized Indian Railway Catering & Tourism Corporation (IRTC) Ltd. incorporated as a government company with the objective of upgrading and managing rail catering and hospitality Ministry of Petroleum and Natural Gas crafts the New Exploration License Policy (NELP) in 2000, which permits foreign companies to hold 100% equity possession in oil and natural gas projects. To date, only a handful of oil fields controlled by foreign firms

Major

Major Minor

Minor

Major Minor Major

Source: Budget documents, Nomura research Note: 10 lakh = 1 million; 1 crore = 10 million

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Nomura | Asia Insights

17 May 2014

Fig. 15: Time-line of NDA government reforms (contd.) FY2001 A new programme called ―Sarva Siksha Abhiyan‖ announced to enable all children to enroll by 2003 and expand the coverage of District Primary Education Programme To fulfill critical needs of the rural people, a new scheme, ―Pradhan Mantri Gramodya Yojna‖ launched with an outlay of Rs.5000 crore

Major

The system of central excise drastically overhauled with the introduction of a single Central Value Added Tax (CENVAT) of 16 per cent ad valorem on all manufactured goods with a few exceptions States/Union Territories encouraged to implement their agreed programme for converting their sales taxes into VAT by 1.4.2002

Major

The peak rate of import duty scaled down further from 40 per cent to 35 per cent

Minor

The Budget proposed to bring out an institutional mechanism embodied in the ―Fiscal Resposibility Act‖. Accordingly, the Fiscal Responsibility and Budget Management Bill (FRBM), 2000 introduced in Lok Sabha in December, 2000. The Bill provides for elimination of revenue deficit and reduction of the fiscal deficit to not more than 2 per cent of gross domestic product within a period of five financial years

Major

Transition to a full-fledged Liquidity Adjustment Facility (LAF) involving injection and absorption of liquidity via variable rate reverse Repo auctions and variable rate Repo auctions respectively Legislative initiative to reduce the proportion of Government holding in the equity of nationalised banks

Minor

Permission to raise FII equity limit to 40 per cent through a special resolution by shareholders

Minor

Removal of cap on investment in the power sector

Major

100 per cent FDI permitted in oil refining

Major

100 per cent FDI allowed in Special Economic Zones (SEZs) for all manufacturing activities

Major

100 per cent FDI allowed in Telecom Sector for certain activities with some conditions

Minor

The States of Orissa, Harayana, Andhra Pradesh, Uttar Pradesh, Karnataka, Delhi and Rajasthan enact their Electricity Reforms Acts. Madhya Pradesh Legislative Assembly passes Electricity Reforms Bill. Gujarat also drafts Reforms Bill A fourth cellular operator in all the circles permitted

Follow up

Limited mobility to fixed service providers in the form of Wireless In local loop (WILL)

Follow up

20 BOT road projects awarded

Major

Major

Major

Major

Follow up

FY2002 The coverage of service tax at the rate of 5 per cent on the value of taxable service expanded to include fifteen new services

Follow up

Decision taken that all States and Union Territories will implement VAT from April, 2003

Follow up

Level playing field to private insurers accorded by allowing similar benefits to them and their clients as are available to LIC, GIC and their clients

Follow up

Government of India draws up a scheme called the States' Fiscal Reforms Facility (2000-01 to 2004-05). Incentive Fund of Rs.10,607 crore earmarked over a period of five years to encourage States to implement monitorable fiscal reforms. Three areas emphasized - Fiscal consolidation, PSE Reforms and Power sector reforms Income tax at source made deductible at the rate of 10 per cent

Follow up

Freedom for banks to lend at interest rates below their respective PLRs (Prime Lending Rates) to exporters and other creditworthy borrowers (including public enterprises)

Minor

VRS (Voluntary Retirement Scheme) implemented by 26 out of 27 public sector banks in 2000-2001

Follow up

Clearing Corporation of India Limited (CCIL) set up

Minor

Negotiated Dealing System (NDS) introduced in phases to supplement or replace the current telephone mode used in trading on the fixed income market Rolling settlement extended to all stocks and all exchanges. Cycle shortened to T+3

Minor

Peak level of customs duties to decline marginally from 38.5 per cent to 35 per cent

Follow up

Extension of the concessions available for infrastructure by way of 10-year tax holiday to the developers of Special Economic Zones (SEZs) on the same lines as developers of industrial parks Futher impetus on SEZ

Minor

Quantitative restrictions on exports of agricultural items like wheat, wheat products, coarse grains, butter and non-basmati rice and packaging restrictions on exports of pulses were in February, 2002 Ten-Year tax holiday for the core sector of infrastructure, namely, roads, highways, water-ways, water supply, sanitation and solid waste management systems, which may be availed of during the initial twenty years In the case of airports, ports, inland ports, industrial parks and generation and distribution of power, which also become commercially viable only in the long run, a tax holiday of ten years allowed to be availed of during the initial fifteen years Tax incentives have been provided for the investors providing long-term finance or investing in the equity capital of the enterprises engaged in infrastructure facility. Any income by way of interest, dividends or long-term capital gains from such investments fully exempt

Follow up

Electricity Bill 2001 introduced in Parliament

Major

Central Government to accelerate the program of reforms for State Electricity Boards (SEBs) anchored in Centre-State partnership on the following: 1) A time bound program for installation of 100 percent metering; 2) Energy audit at all levels; 3) Commercialization of distribution; 4) SEB restructuring

Major

Competition introduced in all service segments of telecoms

Major

The total outlay for the road sector enhanced

Follow up

Rs 2,500 crore assistance out of Pradhan Mantri Gram Sadak Yojana (PMGSY) to provide connectivity of every village with a population of over 1000 persons through good all weather roads by year 2003 and those with a population of upto 500 persons by 2007 Pradhan Mantri Gramin Yojna (PMGY) extended to cover rural electrification

Major

Continued dereservation for small scale industry

Follow up

Major

Follow up

Follow up

Follow up Minor Minor

Major

Source: Budget documents, Nomura research Note: 10 lakh = 1 million; 1 crore = 10 million

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17 May 2014

Fig. 16: Time-line of NDA government reforms (contd.) FY2003 To reduce the interest burden of States, a debt swap scheme enabling States to swap their high cost Central Government loans bearing a coupon rate of 13 per cent and above with relatively low cost market borrowings and loans from NSSF, put in place Enactment of "Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002. Act enabled setting up of ARCs (Asset Restructuring Companies). Enabled debt recovery by taking possession of assets. Paved the way for enhanced power of banks in default situations Further enhancement of SEBI's power

Major

Corporate disclures made widely available through Electronic Data Information Filing and Retrieval

Follow up

Further concession given to SEZs in terms of procurement of duty free equipment, raw materials and components

Follow up

Continued dereservation from small scale industry

Follow up

Reduction in peak import duty from 35 per cent to 30 per cent

Follow up

Significant reduction in ECB usage restrictions

Follow up

100 per cent FDI premitted in advertising, film, tea, township development including housing, commercial premises, hotels, resorts and regional urban infrastructure, in manufcturing of SEZs 26 per cent FDI alllowed in print media

Follow up

Disinvestment od Hindustan Zinc, Maruti, IPCL, Modern Foods and eleven government-owned hotels

Major

Infrastructure Equity Fund set up for providing equity investment in infra projects

Major

IDFC to act as coordinating agency for coordinated debt syndication for infrastructure

Minor

20 state government sign MOUs (Memorandum of Understanding) with center for timebound reforms

Follow up

State level electricity regulatory commissions start to function

Follow up

SEB (State Electricity Board) debundling starts

Follow up

APDRP (Accelerated Power Development and Reform Programme) given further thrust

Follow up

Airport modernisation started

Major

Mass rapid transport thrust introduced. Urban Delhi Metro project slated for completion in 2005

Minor

Monitoring of government project strengthened to reduce delay. Starts to show results

Minor

Electricity distribution privatised in Delhi in July 2002

Follow up

The Ministry of Agriculture circulates a model Agriculture Produce Marketing Committee (APMC) Act, 2003, and suggests amendments to the State APMC Acts so as to promote investment in marketing infrastructure, motivating corporate sector to undertake direct marketing and to facilitate a national integrated market

Major (not completed)

Major

Follow up

Follow up

FY2004 - change of the government takes place to UPA late in FY2004 Fiscal Responsibity and Budget Management (FRBM) bill 2003 introduced and made into an Act in August 2003. Specified revenue and fiscal deficit targets. Borrowing from RBI not allowed for bridging deficit. RBI not to subscribe to primary issuances of government paper from FY07. Review of fiscal policy every year. Quarterly review of fiscal situation. Shift from contribution pension system to defined pension benefit for central government employees

Major

Introduction of risk based supervision in the banking sector

Minor

Issuance of guidelines for "Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act

Follow up

FDI in banking increased to 74% from 49%. Foreign banks allowed to operate in India through 1) branches, 2) wholly owned subsidiary, and 3) a subsidiary with aggregate foreign investment upto a maximum of 74 per cent in a private bank Commodity futures trading allowed. Recognition granted to various commodity exchanges including MCX, NCDEX etc

Follow up

New regulator for pension sector - PFRDA (Pension Fund Regulatory and Development Authority) created with intent to efficiently manage pension funds and expected to develop a new class of institutional investors ECB policy liberalised further. All sectors except banks and financial institutions allowed in the ECB market

Major

5 states enact fiscal responsibility legislations

Follow up

Disinvetmtnment in Maruti, Jessop, HZL, ICIL, IBP, IPCL, CMC, DCIL, GAIL, ONGC

Follow up

Electricity act notified in June 2003

Follow up

28 States sign the tripartite agreement for onetime settlement of the dues of State Electricity Boards (SEBs) to Central Public Sector Undertakings (CPSUs), and, after securitizing the dues, 27 states issued bonds amounting to Rs. 28,983.85 crore, August 2003 onwards.

Major

Unified Access Service License regime introduced in October 2003

Follow up

Pradhan Mantri Bharat Jodo Project for development of 10,000 kms of roads connecting state capitals with National Highways launched in January 2004. Rail Vikas Nigam set up in January 2003

Follow up

Major

Major

Follow up

Major

Source: Budget documents, Nomura research Note: 10 lakh = 1 million; 1 crore = 10 million

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Nomura | Asia Insights

17 May 2014

INR – Medium-term appreciation prospects improve With the NDA looking set to garner a huge majority according to the latest vote count which suggests it should win 339 seats out of 543 (source: NDTV), the initial INR reaction was positive as expected. Spot INR appreciated (against USD) by just over 100bp from yesterday‘s close by 12pm SGT before suspected USD buying by the RBI and some profit-taking emerged, which took spot to 58.96 (56bp appreciation from previous close) as of 17:44 SGT. We maintain our long INR (vs. USD) position through options5, which expires on 20 May (see First Insights - Asia FX portfolio update: Add to long INR position through options, 16 April 2014) and believe the market could sustain the positivity around the election result in the very near term. Although, we see some risk of profit-taking in the coming sessions as INR has been the best performing FX in Asia over the past three months with around 5% appreciation vs. USD and our view that this has been one of the favourite long trades in the region, our medium-term optimism on India‘s outlook has strengthened. We revise our end-2014 USD/INR forecast6 to 57.0 (59.5 previous) and end-2015 to 55.5 (57.5 previous) as, beyond the strong mandate for the new government, the domestic growth momentum will continue with support from improved global growth and the revival of the investment cycle. Accordingly, we scaled into a 6M USD put / INR call spread7 with the confirmation of the NDA gaining a simple majority (see Asia FX Portfolio Update: Initiating medium-term long INR position, 16 May 2014). We will look to add to our long INR position, dependent on: 1) the NDA‘s selection of key cabinet minister positions (likely before 31 May 2014), 2) the end-June budget from the new government (looking for a continued fiscal consolidation drive), and 3) a push in policies towards greater economic reforms (infrastructure, urbanisation, agriculture, etc). The positive sentiment surrounding the new government‘s efforts to revitalize the economy should also help attract further foreign portfolio inflows that will fund the narrowed current account deficit (at 0.9% GDP in Q4 2013 or USD4.1bn, Figure 17). Indeed, since the start of 2014, local equity and bond markets have seen inflows worth USD6.6bn and USD5.1bn (as of 13 March) respectively, but we expect these to continue given positive political expectations, increased monetary policy credibility, cooling inflation and improved growth outlook. Our economists expect growth to improve steadily beyond Q2 2014 from 4.5% y-o-y to 5.1% in Q4 2014, which could be further boosted over the medium term if the new government pursues the much-needed structural reforms (see Asia Special Report - India‘s defining moment, 8 April 2014). However, there are some risks to our medium-term positive INR view including some risk of the current account deficit widening in 2H as a result of the relaxation of gold import restrictions. This is likely to be announced around end-Q2, and we note that the precious metal trade deficit accounted for USD45.7bn or 49.2% of the current deficit in the 12 months to June 2013 (ahead of the quantitative restriction on gold imports imposed on 22 July). The metal trade deficit has narrowed sharply in 2H 13, totalling USD0.8bn or only 9% of the current account deficit (Figure 18). Other risks include below-normal rains due to likely El-Nino this year which could result lower food-grain output growth, zero to negative agriculture GDP growth and higher food price inflation (see Asia Insights - India: Implications of below-normal rains, 25 April 2014). In addition, although we believe the improved structural story will support INR appreciation over the medium term, INR FX valuations are unfavourable at around 5.4% overvalued (as of 16 May 2014).

5 Long 59.7/58.3 USD put / INR call spread against short 63.50 USD call / INR put, Notional: USD15mn, Expiry: 20 May 6 We forecast spot USD/INR trajectory as: Q2 14(58.0), Q3 14(57.6), Q4 14 (57.0), Q1 15 (56.6), Q2 15(56.3), Q3 15(55.9) and Q4 15 (55.5). 7 6M USD put / INR call spread (Strikes: 58.5/56.5, Notional: USD15mn, NDF reference: 60.75, Premium: 70bp, Expiry: 18 November) 16

Nomura | Asia Insights

Fig. 17: India – improved flow picture

40

Net CA and Capital inflows (USD bn) Current Account (USD bn) PI+FDI+ECB+NRD (USD bn)

17 May 2014

Fig. 18: Gold import curbs aided trade deficit narrowing 20 18

30

16

20

14

10

Oil Deficit ($bn, 3mma) Precious Metals Deficit ($bn, 3mma) Trade Deficit ($bn, 3mma)

12

10 0

8

-10

6

-20

4

2 -30

-40 Mar-05 Jun-06 Sep-07 Dec-08 Mar-10 Jun-11 Sep-12 Dec-13 Source: CEIC, Nomura

0 -2 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Source: CEIC, Nomura

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Nomura | Asia Insights

17 May 2014

India rates: Stay bullish As noted in our special report (see Asia Special Report - India‘s defining moment, 8 April 2014), we believe that a positive election result should encourage a medium-term rally. We believe that, a positive election result could affect the rates market indirectly via two channels: 1.

Market‘s perception on fiscal consolidation.

2.

Improved liquidity in the banking system.

We believe the RBI‘s reserve accumulation (i.e., USD buying), which ceased during the current account jitters last year, will become a critical source of domestic liquidity creation. This will result in improvement in deposit growth in the banking system. An improvement in liquidity will lower funding costs for the banking system and increase demand for bonds. Also, we believe if an improvement in liquidity occurs, along with fiscal consolidation, it will be very positive for India rates. Overall, we maintain our receive and flattening view in India swaps and we remain bullish on bonds. We continue to like the 3yr to 5yr part of (ND)OIS curve and 3yr-9yr (see Figure 19) as the most preferred tenors on India sovereign bonds(see Asia Insights - India rates: Assessing the factors affecting the rates market, 16 April 2014). We continue to expect any bullish pressure on rates to result in bull flattening of the curve, because the hurdle for monetary policy action (to change) in either direction remains high. On specific recommendations, we suggest investors stick with our recommendations (see Figure 20) of: (1) receive 3mfwd3yr (ND) OIS (entry 8.37% on 21 April, current 8.16%); and, (2) receive 3mfwd1s5s flatteners (entry 3.3bp on 28 Feb 2014, current -21.6bp) (see INR (ND) OIS: Initiate outright receive along with flatteners, 21 April 2014). We also continue to hold IGB 8.12 2020 as a medium-term position in our strategy portfolio. Fig. 19: Bond, swap rates movement

(bp) 40 Forward implied

9.0

20 0

8.5

9.5

-20

8.0

9.0

-40 7.5

8.5

-60

7.0

Source: Nomura, Bloomberg

Jan-14

Apr-14

Jul-14

Nov-14

Oct-13

Sep-14

Jul-13

May-14

Apr-13

-120

Mar-14

7.0

-100

6.0

Jan-14

7.5

-80

6.5 Nov-13

8.0

6.5 Jan-13

INR 3yr (ND) OIS INR 1s5s (RHS)

(%) 9.5

Sep-13

10.0

MSF Rate Repo Rate 5yr swap 5yr Bond

Jul-13

10.5

Liquidity tightening measures in summer

May-13

11.0

Fig. 20: 1s5s (ND) OIS and 3yr ND (OIS)

Source: Nomura, Bloomberg

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Nomura | Asia Insights

17 May 2014

Appendix A-1 Analyst Certification I, Sonal Varma, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

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