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Overview of the Indian Economy

The Indian economy continued to display remarkable resilience and inherent strength, envisioning new dimensions of growth and globalisation, crossing new milestones in 2007. India became the fifth largest economy contributing to 4% of the world GDP (measured in PPP terms). Confronted with issues like rising domestic interest rates, huge quantum of foreign capital inflows, appreciating rupee, rising international oil prices and the risks of a possible spill-over of the US slowdown, while the policy makers endeavoured to adapt to diverse open economy challenges and maintain the growth momentum, corporate India collaborated by taking significant strides towards building ‘Brand India’ internationally. The strength of the business confidence and investment cycle was obvious in the number and nature of inbound, outbound and domestic M&As and private equity deals which were struck in course of the year. Indian companies marched towards new records with regard to total income, net profits and market capitalization, driving India’s GDP growth to 9.4% in FY07. While this publication seeks to provide significant insights into ‘India’s Top 500 Companies’, the performance of these companies cannot be analysed in isolation of the broad macroeconomic developments which form the backdrop for these players – who in turn, have a role in determining the future economic dynamics. An Overview of the Indian Economy providing insights into the growth story is therefore apposite.

Growth trend maintained…

India’s real GDP maintained the high growth trend set since FY04 and recorded a growth of 9.4% in FY07, with an average per annum rate of 8.5% during the last four years. Services sector continued to be a major contributor to GDP.

Source: CSO and RBI

Source: CSO

The buoyancy witnessed in the last few years continued in the first half of FY08 (H1 FY08), and the economy posted a real GDP growth of 9.1%, driven by services (10.4%) and industry (9.8%). Agriculture, which demonstrated a healthy performance backed by favourable monsoons and a 4.6% increase in the area under cultivation, recorded a growth of 3.7% in H1 FY08 (vis-à-vis 2.8% in H1 FY07). The growth in services sector was driven primarily by ‘Trade, Hotels, Transport & Communication’ (11.7%) followed by ‘Financing, Insurance, Real estate & Business Services’ (10.8%). Nonetheless, a moderation in the growth of ‘Trade, Hotels, Transport & Communication’ in H1 FY08 was observed vis-à-vis H1 FY07, which could be attributed to the slow-down in transport sector – owing to rising freight rates.

Industrial growth moderated by a slow down in manufacturing…

A review of the data on industrial production (as measured by the IIP), indicates that high interest rates, higher input costs and an appreciating rupee resulted in moderation in industrial growth in the second quarter of FY08. While ‘Mining & Quarrying’ and ‘Electricity, Gas & Water supply’ posted a growth of 4.9% and 7% respectively during Apr-Nov 07 (vis-à-vis 4.2% and 7.3%, respectively in Apr-Nov 06), ‘Manufacturing’ showed signs of moderation and registered a growth of 9.8% during Apr-Nov 07 as against 11.8% in Apr-Nov 06. The growth of manufacturing sector in Nov 07 was 5.4% (y-o-y), which was lowest during last 12 months.

Source: CSO

The moderation in manufacturing growth can be attributed to the decline in growth of cotton textiles, textile products (including wearing apparel), beverages, transport equipments, non-metallic mineral products, basic metals & alloy industries, machinery & equipment and the negative growth of metal products. However, food products, jute & jute textiles, wood products, leather products and other manufacturing sector witnessed higher growth during Apr-Nov 07 as against Apr-Nov 06.

Interest sensitive consumer goods experience moderation …

In terms of used-based classification, growth, in consumer goods declined substantially to 5.5% during Apr-Nov 07 as against 9.9% in Apr-Nov 06. The consumer durables segment received a major setback and registered a deceleration of 1.7% during Apr-Nov 07 (as against a growth of 12.4% in Apr-Nov 06). This decline can be attributed to the reduction in production of items like telephone instruments, T.V. receivers, motor cycles, tape recorders, utensils, etc. Further, growth rate of the Passenger cars, Refrigerators, Washing/laundry machines, also declined during the current fiscal. Impact of increasing cost of credit manifested itself in lowering the domestic demand for these items. On the other hand, a positive aspect of industrial production during the current fiscal has been the sustained growth of capital goods (20.8% in Apr-Nov 07 as against 17.4% in Apr-Nov 06), indicating a persistent investment demand in the country. Although the growth in Intermediate goods sector declined to 10.1% during April-Nov 2007 as compared to 11.1% during same period last year, it was nonetheless, substantial.

From the perspective of aggregate demand, Government Final Consumption Expenditure increased to 11.1% of GDP in H1 FY08 vis-à-vis 10.9% in H1 FY07. However, high interest rates exerted some downward pressure on Private Final Consumption Expenditure which declined to 57% of GDP during H1 FY08 as against 58.8% during H1 FY07.

Investment cycle continues to be strong…

While National Accounts data on Gross Domestic Capital Formation is available only up to 2005-06, information on some of the components indicates sustained buoyancy in investment. Gross Fixed Capital Formation as a percentage of GDP was 30% during H1 FY08 as compared to 28.3% during H1 FY07. Change in stocks remained stable at 2.9% of GDP in H1 FY08 and valuables marginally increased to 1.7% in H1 FY08 as compared to 1.6% in H1 FY08. This indicates a robust investment cycle and capacity building in the economy.

Growth in credit offtake moderates, capital inflows spur growth in money supply …

In consonance with strong industrial and corporate sector growth, bank credit, in particular, non-food credit grew at around 30% during most of FY06 and FY07. The RBI therefore took certain prudential measures, (including an increase in the general provisioning requirements on standard advances to specific sectors such as retail) to maintain the quality of credit and contain inflationary pressures. The repo rate and the Cash Reserve Ratio were raised at various intervals during 2007, by a total of 75 basis points and 200 basis points, respectively, to contain the increasing money supply which was driven by foreign capital inflows. As a result of these monetary tightening measures, growth in bank credit moderated to 21.4% by the end of 2007. Prime Lending Rates in the domestic market increased from 11.00-11.50% at the end of 2006 to 12.75-13.25% by the end of 2007. With interest rates edging up in the domestic market, coupled with continued strong finance requirements to fund capacity expansions, firms resorted to borrowing at lower interest rates from the international markets. Net External Commercial Borrowings (ECB) stood at US$ 10.6 bn during the Apr-Sep 07 period, an increase of as much as 84% as compared with net ECBs during the year ago period. ECBs accounted for about 30% of net capital flows during this period.

At the same time, FII and FDI inflows continued to spur growth in money supply. M3, the broad measure of money supply, grew at 21-22% during 2007, despite the RBI’s monetary tightening measures. Inward foreign direct investments into the manufacturing, business & computer services sectors grew by 35% to US$ 9.9 bn during H1 FY08, reflecting the prevailing positive investment climate. Robust foreign fund flows into the domestic stock markets, amounting to Rs 709 bn in 2007, (more than twice net FII flows in equity during 2006) further buoyed sentiment in domestic capital markets. The cuts in the US Fed rate during the past year also played a significant role in attracting inflows. Both, the Sensex and the Nifty touched record levels during the past year.

Taking advantage of buoyant stock markets, many firms took route to public issues in the equity market to raise large funds required to finance capacity expansions as well as acquisition activities. During the first half of FY08, i.e. Apr-Sep 07, there were 47 IPO issues amounting to approximately Rs 210 bn, a whopping 73% increase in amount raised as compared with the year ago period. As per certain reports, the BRIC countries accounted for almost 42% of global funds raised through IPO activity during Jan-Nov 07.

Although most Indian firms went public on domestic exchanges, an increasing number of firms listed their shares on foreign exchanges, primarily for higher valuations. Resources mobilised through ADRs/GDRs amounted to US$ 5,674 mn during Apr-Nov 07, an increase of about 50% of that mobilised in the entire FY07.

Monetary tightening measures to control inflation…

With money supply growing at rates far higher than the RBI target rate and with sustained capital inflows, liquidity management was the focal point of the RBI’s monetary policy in 2007. Given that the increasing interest rate differential between the Indian market and global markets has attracted foreign funds, the RBI has had limited options to tackle liquidity. In addition to raising the Cash Reserve Ratio (as mentioned above), interest rate ceilings on NRE deposits were brought down, limit on auctions under the Market Stabilisation Scheme were raised and bond issuances under the LAF increased.

Moderation in credit offtake and import of certain primary articles helped contain inflation. Inflation as measured by the WPI, which had been hovering around the 6% mark at the beginning of 2007 declined to around 3.5% by the end of the year. However, surging global oil prices (which had touched US$ 100 per barrel by the end of 2007) remain a downward risk. Domestic fuel prices have not borne the complete pass through of high international crude oil prices.

Source: RBI and CSO

Appreciating rupee impacts exports of textiles, agricultural products, engineering goods, chemicals and prominent services …

The Annual Supplement to the Foreign Trade Policy (2004-09) released in April 2007set an export target of US$ 160 bn for the year. However, strong growth prospects, high returns on equity and widened interest rate differential between India and the US which resulted in strong FII inflows, led to appreciation of the rupee, in turn deterring exports.

Source: Ministry of Commerce and RBI

While the rupee appreciated by almost 6.4% during Apr-Nov 07, exports (including re-exports) in dollar terms registered a year-on-year growth of 22.08%, as against 26.18% in Apr-Nov 06. Total exports during Apr-Nov07 stood at US$ 98.39 bn. The impact of weak dollar was more perceptible in export realisation in rupee terms. Exports (including re-exports) grew by mere 8.02% during Apr-Nov 07 as compared to around 31.1% in the year-ago period.

Exports of textiles & garments, agricultural products, engineering goods and chemicals witnessed a substantial moderation as the appreciation of the rupee made India’s exports less competitive, especially since most of India’s global competitors witnessed either depreciation or lower rate of appreciation of their respective currencies. The decline in export earnings in turn affected the production and capacity utilisation. In order to soften the impact of the rupee appreciation, Government of India provided a relief package of Rs 14 bn to exporters affected by the appreciation of the rupee. The relief measures also included reduction in the interest rate on pre and post shipment credit by 2 percentage points for the period Apr-Dec 07, raising duty drawback rates by 3 percentage points and quarterly ceilings on deemed exports reimbursements like central sales tax.

Imports registered a y-o-y growth of 26.97% in dollar terms and 12.43% in rupee terms during the Apr-Nov 07. As a result, trade deficit increased to US$ 52.8 bn (Rs 2139.7 bn).

Appreciation in the rupee also led to moderation or decline in the export earnings of some of prominent services.

Source: RBI

However, the increase in current account deficit (CAD) was arrested by invisibles surplus emanating from substantially high NRI remittances and exports revenue from services like travel and transportation. CAD marginally increased to US$ 10.7 bn in H1 FY08 as against US$ 10.3 bn in H1 FY07.

Trade Policy initiatives improve India’s ranking globally…

Policy initiatives undertaken by the Government of India to increase India’s share in international trade by reducing transaction costs in foreign trade, substantially improved India’s ranking in terms of trading across borders. India emerged as the top reformer in the World Bank’s ‘Doing Business’ 2008 survey with regard to trading across borders, improving its ranking to 79 from 142 in the previous year. Also, the Annual Supplement 2007 to the Foreign Trade Policy provided a number of incentives for promotion of SEZs. Units in SEZs were exempted from service tax. Benefits of all duty exemption and remission schemes such as Advance Authorisation Scheme, Duty Entitled Passbook Scheme (DEPB) and Duty Free Import Authorisation (DFIA) Scheme were extended to the supply of goods to developer and co-ordinator of the SEZ.

India attracts substantial capital inflows…

On the Capital Account front, net capital inflows, arising primarily from External Commercial Borrowings and equity inflows from FIIs, remained high. Net Foreign Investment Inflows (including direct investment and portfolio investment) surged to US$ 22.21 bn during H1 FY08 (as against US$ 6.1 bn during H1 FY07), on account of continuing pace of expansion of domestic activities, positive investment climate, and a long-term perception of India as ‘an investment destination’. FDI inflows surged to US$ 9.9 bn during H1 FY08 vis-à-vis US$ 7.3 bn during H1 FY07, with manufacturing, business and computer services attracting maximum amount of FDI inflows. This quantum of inflows led to a bulging of India’s foreign exchange reserves to US$ 276.25 bn (as of 14-Dec-07). In an attempt to moderate foreign capital inflows, the Finance Ministry capped ECBs at US$ 20 mn per corporate per year for funds not spent overseas. The RBI further liberalised cross-border capital flows through increase in the overseas investment limits for Indian companies to 400% of their net worth, while Mutual Fund’s overseas investment limit was raised to US$ 5 bn. The limit for portfolio investment abroad of listed Indian companies in listed overseas companies was also enhanced to 50% of net worth of the Indian company. The limit for prepayment of ECBs without the RBI approval was raised to US$ 500 mn.

Indian companies seek global expansion…

Outward FDI at US$ 6.0 bn during H1 FY08 (as against US$ 2.8 bn in H1 FY07) increased, reflecting the preference of the Indian companies for global expansion in terms of markets and resources. Thus, net FDI inflows stood at US$ 3.9 bn during H1 FY08 vis-à-vis US$ 4.5 bn in H1 FY07.

Strong growth prospects, ease in internal cash generation and the desire to obtain efficiency gains through economies of scale induced Indian corporates to acquire foreign companies. As a result, Mergers and Acquisitions remained buoyant during 2007, witnessing multi-billion dollar M&A deals such as Tata-Corus, Hindalco-Novelis, etc. Indian companies announced deals worth around US$ 70 bn in 2007 as against US$ 28.16 bn in 2006, with metal and telecom accounting for the highest number of M&As in terms of value. The over-riding theme for the Indian economy for 2007 thus seem to have been consolidation of the idea of globalisation, wherein Indian players moved from the notion of just fitting-in to the world economy towards the idea of making strategic in-roads into it.

Future Outlook : D&B Expectations

Against the backdrop of high levels of interest rates, slowing exports (and also the high base effect), which would moderate industrial growth, Dun & Bradstreet expects India’s GDP for FY09 to grow at 8.7-8.8%, following expectations of a GDP growth of 8.7% for FY08. Industry is expected to grow at 9.8% in FY09 and services by close to 10.1%. There would be a continuation in investment buoyancy and D&B expects Investment (as a percentage of GDP) to be close to 37.3% in FY09, financed by Savings of approximately 35.4% of GDP.

On the inflation front, although the monetary tightening policy seems to have succeeded in achieving its goal of containing inflation, given that international prices of crude oil are high and much of this rise has not been passed through, we expect inflationary pressures on fuel group to continue in the near future. In the wake of a possible revision in retail fuel prices during subsequent months, inflation (as measured by WPI) is expected to touch 4% by March 2008 and rise further to average at 5% during FY09. With money supply growing at rates far higher than the RBI target rate and with sustained capital inflows, liquidity management would continue to remain the focal point of the RBI’s monetary policy.

On the exports front, certain export-oriented sectors have felt the heat of the appreciating rupee in the last few months. Given that the rupee remains overvalued on a REER basis, (i.e. the rupee will have to depreciate to make the domestic industry globally competitive), D&B does not expect the rupee to appreciate substantially. The exchange rate per US$ is expected to be in the range of 39.2-39.4 during FY09. Given this, we expect that most sectors would have factored in the stronger Rupee, and exports will grow by close to 19.1% (in dollar terms) in FY09, while imports will be marginally higher at around 25.9%.

2008 marks the entry of the Indian economy into the eighteenth year since the new economic policy and reforms were initiated. This may be symbolic in terms of the coming of age of the Indian economy, and will place on it the responsibility of consolidating its place in the world economy.

The Challenges Ahead…

The diverse reforms initiated by the Government to facilitate overall growth led to an improvement in India’s overall ranking in the World Bank’s ‘Doing Business’ report, to 120th in 2008 (as against 138 in 2006). However, India still ranks lower than China (50), which is reforming at a faster pace. The report reveals that it is still very difficult to start a business in India, with the country being ranked 111th for the parameter on starting a business. Cumbersome entry procedures; dearth of governance norms; inadequacy and inconsistency of information relating to polices, rules and procedures are some of the institutional challenges – in addition to the challenges posed by inadequacy of physical infrastructure – that pull down India’s potential for doing business. These need to be effectively addressed. Expediting implementation of e-governance and measures like single window clearances would play a significant role in easing the procedural hassles. On the infrastructure front, the Government has emphasised upon Public-Private-Partnership and increased allocation for ‘Bharat Nirman’ and NHAI to accelerate the pace of project execution.

Further, as the economy matures, its concerns towards the realization of its growth potential must mature as well. We expect that the dominant theme for 2008 will therefore be resource management, with particular focus on human resource. As the war for talent intensifies, well trained and capable human resource will become the defining component to achieving strategic successes, exploiting opportunities, and thus enabling growth. The unavailability of such resources could possibly become the bottleneck to growth, and could well be the differentiating factor between companies and nations alike. As a related concept, productivity and efficiency gains through innovative management techniques coupled with the use of technology will emerge as key growth drivers. We expect the Government to articulate specific initiatives for the education sector which is also the accent of the 11th Five Year Plan. The forthcoming year could well emerge as the year of investing in the human resource development of India.