INDIA / INDONOMICS

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February 9, 2007

Will Indias high economic growth lead to overheating? Vasudeo Joshi Head, Institutional Equity Research, Strategy/Economics (vasudeo.joshi@manfinancial.in) +91 22 6667 9754 Anjali Verma - Economist (anjali.verma@manfinancial.in) +91 22 6667 9969 The Central Statistical Organization (CSO) has estimated that the Indian economy will grow at 9.2% in FY07; higher than our estimates of 8.6%. The average GDP growth between 1971 and 1981 was at 3.2%, which rose to 5.6% between 1981 and 2001. This figure has now reached 7% in the past five years. Although higher economic growth brings confidence, it is also generally followed by economic overheating in the form of higher bank credit, money supply and inflationary expectations. Highlights The GDP growth of 9.2% in FY07 is over and above the higher base of 9% last yearThe highest in 17 years Agriculture is expected to grow at 2.7% as against 6% last year, in line with our expectations Industry and services are expected to grow at 10% and 11.2%, respectively. Growth in the service sector is

higher than our expectations Manufacturing, Trade, hotel, transport and communication and Financing, real estate, insurance and

business services are the frontrunners We upgrade our FY08E GDP estimates to 8.2% from 7.7% previously

Economic growth indicators FY02 FY03 FY04 FY05 FY06 FY07 AE* FY08 E Agriculture 6.3 -7.2 10.0 0.0 6.00 2.7 2.5 Industry 2.4 6.8 6.0 8.4 8.00 10.2 9.3 Mining and quarrying 1.8 8.8 3.1 7.5 3.6 4.5 5.5 Manufacturing 2.5 6.8 6.6 8.7 9.1 11.3 10.0 Electricity 1.7 4.7 4.8 7.5 5.3 7.7 7.5 Services 6.8 7.4 8.9 10.0 10.3 10.9 9.8 Construction 4.0 7.9 12.0 14.1 14.2 9.4 9.0 Trade, hotels, transport and communication 9.1 9.2 12.1 10.9 10.4 13.0 11.5 Financing, insurance, real estate and business services 7.3 8.0 5.6 8.7 10.9 11.1 10.0 Community, social and personal services 4.1 3.9 5.4 7.9 7.7 7.8 7.0 GDP at factor cost 5.8 3.8 8.5 7.5 9.00 9.2 8.2 * FY07 estimates are CSO advance estimates

Source: RBI, CSO, Man Financial Research.

RBIs stanceOverheating is a possibility The Reserve Bank of India (RBI), in its credit policy review on 31 January 2007, raised the GDP expectation to 8.5-9%. Hence, it will be right to say that the growth is in line with RBIs expectations. Also, the pre-emptive measures taken by RBI in the form of hiking the repo rate and keeping the reverse repo rate unchanged should be looked at in the context of its expectations of higher economic growth. At the same time, RBI has been worried about rising bank credit, money supply and inflation resulting in an asset bubble and the heating up of the economy.

February 9, 2007 Man Financial z INDONOMICS z 2

What we believe Inflation is currently around 6% due to the lower base effect as well as the gap between demand and supply. Domestic demand is rising due to rising income and the rising workforce. Although the demand is being met by capacity expansion, it is falling short due to infrastructural bottlenecks, limited funds, policy constraints, etc. Investments in FY06 rose to 33.8% of GDP as compared to 28% in FY04. Also, the concern about rising money supply can be mitigated as the money supply growth is below the trend line implying the need of higher money supply on account of rising economic growth. Since GDP is backed by a higher investments and savings rate, it makes us believe that the Indian economy is not overheating. Also, the rising interest rate is expected to moderate the economic growth in FY08. On the grounds of buoyant GDP growth in FY06 and FY07 and robust manufacturing, electricity and service sector reforms, we upgrade our GDP estimates for FY08 from 7.7% to 8.2%. Most of the public as well as private sector banks have hiked their PLRs, which are expected to put brakes on ongoing credit boom as well as real estate prices. At the same time, it may slowdown the credit off take by the corporate sector and they may have to look at global markets to finance further expansions, as long as the demand continues. Indian economyIn control Investments are on the rise Money supply below the trend line

20

22

24

26

28

30

32

34

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

2000

-01

2002

-03

2004

-05

Sav ings/GDP (%) Inv estment/GDP (%)

40

45

50

55

60

65

70

75

80

8519

90-9

119

91-9

219

92-9

319

93-9

419

94-9

519

95-9

619

96-9

719

97-9

819

98-9

919

99-0

020

00-0

120

01-0

220

02-0

320

03-0

420

04-0

520

05-0

620

06-0

7E20

07-0

8E

M3/GDP (%) Poly . (M3/GDP (%))

(%)

Source: RBI, CSO, Man Financial Research.

February 9, 2007 Man Financial z INDONOMICS z 3

Other indicators imply Overheating However, if credit growth does not moderate and continues to grow at such a robust pace resulting in higher demand, demand-supply gap and higher inflation. Also, the following graph depicts that Indian economy is experiencing above trend cyclical growth and a positive output gap mainly due to lower interest rates, rising investments and productivity gains. Positive output gap implies that actual output is higher than the potential output, thus overheating. Growth - Up trending Economic growth above the trend line Positive output gap as a % of GDP

0

500000

1000000

1500000

2000000

2500000

3000000

1970

-71

1974

-75

1978

-79

1982

-83

1986

-87

1990

-91

1994

-95

1998

-99

2002

-03

2006

-07

INR

Cr

Real gdp reconstructed on 99-00 basePoly . (Real gdp reconstructed on 99-00 base)

-6%

-4%

-2%

0%

2%

4%

6%

1970

-71

1974

-75

1978

-79

1982

-83

1986

-87

1990

-91

1994

-95

1998

-99

2002

-03

2006

-07

Source: RBI, CSO, Man Financial Research

Risks/Constraints Credit growth remains robust Abrupt slowdown in the US Infrastructure bottlenecks to continue due to poor investment by the public as well as the private sector Constraints in capacity expansion due to the rising interest rate Poor farm sector reforms Rising economic divide and inequality Currently, the Indian economy is growing at a manageable pace, but, if it is not supported by adequate infrastructure, social reforms and a more inclusive growth, the growth may taper off in the future. Investments and savings are expected to grow at a robust pace, supporting the stable economic growth. While a partial impact of the measures employed by the finance ministry and the RBI to pull down inflationary expectations is expected to become visible in about six months, the full impact will take longer to manifest. Another interest rate hike is a possibility if the credit growth and inflation continues to grow at the same pace. We believe that the ongoing economic scenario is a mix of cyclical upturn and structural changes. While India has benefited from global economic growth and global liquidity inflows, structural changes in form of changing GDP composition, sectoral reforms etc. have also been significant.

February 9, 2007 Man Financial z INDONOMICS z 4

Gangadhara Kini Head Institutional Equities 91-22-6667 9752 gangadhara.kini@manfinancial.in Vasudeo Joshi Head Institutional Equity Research 91-22-6667 9754 vasudeo.joshi@manfinancial.in Jignesh Shah Head Equity Derivatives 91-22-6667 9735 jignesh.shah@manfinancial.in Equity Research Abhijeet Dakshikar Engineering, Construction & Power 91-22-6667 9963 abhijeet.dakshikar@manfinancial.in Anjali Verma Economist 91-22-6667 9969 anjali.verma@manfinancial.in Mandar Pawar Oil & Gas 91-22-6667 9987 mandar.pawar@manfinancial.in Nimesh Mistry IT Services 91-22-6667 9768 nimesh.mistry@manfinancial.in Parthapratim Gupta Financial Services 91-22-6667 9962 parthapratim.gupta@manfinancial.in Rahul Jain Metals 91-22-6667 9758 rahul.jain@manfinancial.in Shishir Manuj FMCG & Retail 91-22-6667 9759 shishir.manuj@manfinancial.in Shobhit Khare Telecom & Cement 91-22-6667 9974 shobhit.khare@manfinancial.in Vinod Nair Midcap & Media 91-22-6667 9766 vinod.nair@manfinancial.in Aravind Manickam Research Associate 91-22-6667 9992 aravind.manickam@manfinancial.in Chaturya Tipnis Research Associate 91-22-6667 9764 chaturya.tipnis@manfinancial.in Manik Taneja Research Associate 91-22-6667 9986 manik.taneja@manfinancial.in Prachi Kulkarni Research Associate 91-22-6667 9966 prachi.kulkarni@manfinancial.in Rupesh Sonawale Research Associate 91-22-6667 9769 rupesh.sonawale@manfinancial.in Shridatta Bhandwaldar Research Associate 91-22-6667 9965 shridatta.bhandwaldar@manfinancial.in Vaibhav Agarwal Research Associate 91-22-6667 9967 vaibhav.agarwal@manfinancial.in Pankaj Kadu Database Analyst 91-22-6667 9972 pankaj.kadu@manfinancial.in Ganesh Deorukhkar Production 91-22-6667 9756 ganesh.deorukhkar@manfinancial.in Roshni Kalloor Editor 91-22-6667 9762 roshni.kalloor@manfinancial.in Institutional Cash Equity Sales Vijay Baoney Senior Vice President 91-22-6667 9753 vijay.baoney@manfinancial.in Sweta Ganguly Asst. Vice President 91-22-6667 9973 sweta.ganguly@manfinancial.in Smitesh Sheth Asst. Vice President 91-22-6667 9991 smitesh.sheth@manfinancial.in Roshan Sony Asst. Vice President 91-22-6667 9964 roshan.sony@manfinancial.in Sajid Khalid (UK) Equity Sales 44-20-7144 5246 skhalid@mansecurities.com Institutional Cash Equity Sales Trading Suketu Parekh Sales Trader 91-22-6667 9746 suketu.parekh@manfinancial.in Chetan Savla Sales Trader 91-22-6667 9749 chetan.savla@manfinancial.in Institutional Cash Equity Dealing Chetan Babaria Dealer 91-22-6667 9749 chetan.babaria@manfinancial.in Rajesh Ashar Dealer 91-22-6667 9748 rajesh.ashar@manfinancial.in Bhavin Shah Dealer 91-22-6667 9749 bhavin.shah@manfinancial.in

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