Elysium Capital India Commentary 090609

India Commentary June, 2009

Political Stability & Improving Sentiment India Overview

Selected Macro Indicators

India’s surprising General Election outcome resulted in a stable Congress-led UPA coalition (without the Left parties and with 206 seats vs 145 in the last term) to continue much needed reforms over the next 4-5 years. Manmohan Singh, the Oxford-educated economist, continues as Prime Minister and has put together a relatively straightforward cabinet with the addition of Pranab Mukherjee as Finance Minister. Mr Mukherjee was previously Finance Minister under the Indira Gandhi government in 19821984 where the ministry controlled the economy in minute detail. Even with the current more open economy, Mr Mukherjee should be competent in helping India achieve its goal of 9% annual growth as he is a veteran politician, impediments to reaching that goal is mostly political in India.

FY07-08

FY08-09

FY09-10E FY10-11E

Consensus GDP Growth Rate

9.30%

6.70%

6.21%

6.93%

WPI Inflation Rate

5.90%

8.30%

1.00%

4.00%

Centre Fiscal Deficit (% of GDP)

3.30%

6.00%

6.00%

5.00%

Forex Reserves (USD bln)

309.80

252.00

260.00

310.00

Forex USD - INR

43.1

49.0

47.0

44.0

Forex GBP - INR

78.7

75.0

76.0

70.0

8.00%

8.25%

6.20%

5.75%

10-Year Govt Yields

Source: RBI, IMF, Goldman, Merrill Lynch, Cresil, Nomura, JP Morgan, Morgan Stanley & Elysium Estimates

Consensus GDP - Real Growth Rate 10.00%

USD/INR Weekly 2005-2009

GBP/INR Weekly 2005-2009

8.00%

6.00%

4.00%

2.00%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

2011E

Source: RBI, IMF, Goldman Sachs, Merrill Lynch, Crisil & JP Morgan

The government will deliver its Budget in early July and is not expected to present an expansionary one. The Reserve Bank is expected to pursue a soft interest rate regime; India compared to most countries has further scope for rate reductions. The government has expressed its intent to reduce the structural deficit without reducing capital and infrastructure (physical and social) spending through actively pursuing disinvestment of government holdings in public sectors. With the Left absent, this is achievable and especially more so with the technocrat Singh and wily veteran politician Muhkerjee at the reins.

Macro Fundamentals Remains Strong As the global economic crisis continues, we are hopeful that the worst is over but understand that there will be more pain in the near term. It does appear that India remains partially insulated from the ravages of write-downs and mass layoffs. Our argument last year (Nov 08) that India is a domestic consumption economy, with half the export exposure of China, remains the basis for continued optimism. With elections over and the accompanying strong showing of the UPA, estimates for the year ending March 2010 GDP growth has been revised upwards by Morgan Stanley, in th a May 28 note, to 6.2% from 5.8%. The note said "We are now building in higher growth in the services sector - both the financing, insurance, and real estate & business services, and the community, and social & personal services segments - than previously estimated". They kept their forecast for the following year's GDP growth at 6.8%.

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Additionally, the equities market rewarded results the first trading day after elections with an upper circuit shutdown (10% rise) and the market ending with a 17% gain that day. The Sensex is currently trading at a 9 month high and is expected to outperform this year. Recent economic data that end-March 2009 GDP growth was 6.7% year-over-year, beating many analyst estimates, has also buoyed the markets. As Indian corporate confidence improves on both political and economic fronts, we expect to see consumer confidence improving in tandem as well. This bodes well for several sectors of the economy such as real estate, retail and other consumptiondriven industries. Tax cuts across all levels including the surcharge on corporate taxes and the Fringe Benefit Tax (FBT) will also spur consumption. The expected re-rating of the Indian market is underway as investments into India have been historically hobbled by the government’s lack of headroom on the fiscal front. Additionally, the GoI’s intention to privatise airlines and financial services; introduce reforms in the insurance sector to attract long term capital; deregulate oil and fertiliser (50% cut in FY10) prices; and the sales of 3G spectrum licences will boost the markets and the state’s coffers, covering any higher spending. According to an Economic Times Intelligence Group (ETIG) study released in earlyJune, the GoI could reduce its fiscal deficit by a third if it lowers its stakes in 21 public sector firms (PSUs) including NTPC, NMDC, MMTC, Power Grid, Sail and Hindustan Copper to 75%. This is achievable without reducing stakes in sensitive oil and banking PSUs.

Elections 2009 – No More Excuses Over the last five years, Congress has blamed shortcomings in reform and populist measures on coalition politics. That excuse is now implausible. The UPA now has a clear mandate to shore-up reforms in education and agriculture, continue infrastructure/capital spending and adding 25,000 MW of power per year, all without expanding the budget. These were Congress’ election promises, though these also featured in the 2004 [email protected]

elections. If Congress does not perform yet again, Indian voters will move on.

India – Still Best Placed of the BRICs India is largely a domestic economy where hinterland consumption is 58% of the country’s GDP, and with exports, including software, at 17% of GDP. As such, India has shown itself to be relatively insulated from current global weakness, especially in comparison with most other economies. India’s total trade constitutes only 32.5% of GDP (half that of China). Thus India is better protected from fluctuations in global trade than other emerging nations. India’s favourable demographic profile with a median age of 24.4 yrs (2004 estimates) also gives it a distinct advantage. Thus, over the next decade, India will continue to draw on the benefits of a young and rapidly-growing labour force (2/3 of India’s population is under 35) compared to China’s aging population (current median age of 35).

Inflation Benign Inflation is expected to remain benign over the medium term which would allow the RBI to further soften rates and thus help speed up consumption further and availability of cheaper credit. The RBI has allowed the restructuring of commercial real estate debt with about INR90 bln in debt rolled over recently. Banks are increasingly taking a positive viewpoint at new loan disbursements (mostly in the affordable housing space), a 180 degree reversal from just a few months ago. Previous spikes in inflation were mainly a result of price shocks from oil and food prices. Increased risk averseness by commercial banks led to a comfortable liquidity situation in the banking system post November 2008. Banks have continued to park more funds with the RBI through the reverse repo window despite the 50 bps reduction in the reverse repo rate in March 2009. Banks could easily meet their short-term demand for funds, as is evident from the low call rates, which stayed close to reverse repo rate during April as per the latest available data (April 16, 2009). Earlier, towards the end of March 2009, call rates had surged to repo rate levels on account of advance tax outflows and redemption pressures in mutual funds. – Crisil Research Monetary Policy Impact Analysis, April 2009

India imports 72% of its oil needs with total oil consumption forming 10% of GDP. With 2009’s oil price forecast at $68/barrel (IMF Nov 2008), a reduction of $32/barrel over 2008 actual, India will be better positioned to deal with oil imports. Additionally, gas production from the Krishna Godavari basin D-6 gas field would help in reducing the fiscal deficit and provide “some downside protection” to economic growth rate, a Goldman Sachs report said. The report added that gas production would increase the power generation capacity and further expects production to substitute about 7% of oil consumption in 2009-10 and 10-11% over fiscal years 2011-1014.

Affordable Housing Demand Strong and Growing We have long maintained that affordable housing (defined as the ≤INR15-20 lakhs per unit price range) in the residential asset class is where the deeper market is and will continue to show demand as long as India Inc continues to grow. Buoyed by recent sales of affordable housing by various developers and highly markeddown completed properties by the large developers, companies such as Unitech, DLF, HDIL and others have lined up over 60 mln ft2 of residential projects this fiscal year alone (sources: Cushman & Wakefield and other analysts). Private Equity firms are also returning to the real estate space with strong interest in affordable housing, but not in other asset classes. Unitech, DLF, Tata and other real estate firms are reportedly in negotiations with several offshore PE funds that are looking to move into that space. Elysium Capital Ltd

The GoI has made the affordable housing sector a priority since last year and is now increasing its participation through PrivatePublic Partnerships with developers and introducing schemes to provide urban land at affordable costs and reduction of the cost of credit for end-users. Elysium Capital has pipelined and is currently planning several affordable housing projects in South India. These townships range from 50 to 100 acres and are priced from INR4 to 15 lakhs per unit. Our per ft2 prices range from INR1,400 to 1,700. 80% of all mortgages in India are below INR20 lakhs (USD40,000) and avg housing prices in South India are around INR3,000 to 5,000 per ft2.

Conclusion As we continue through the global financial crisis, perhaps more of sliding down a slope than freefall now, we are more than encouraged by India’s effort to stabilise and grow its economy. Its people surprised India watchers with a strong showing at elections and voting back the UPA with a definitive mandate. The technocrats holding the reins have a strong understanding of what needs to be done and, with political discipline, should be able to return India towards a 9% growth rate. Congress fully understands that India has had no better chance than now to effect real reforms. We also feel that the affordable residential segment will have a long life cycle, along with current limited opportunities in industrial/warehousing and selective hospitality and other specialised asset classes. The government is introducing favourable FDI norms (mixed development projects exempt from minimum capitalisation rules and area development norms) to encourage further investments into housing and reforms underway to clear up entitlement issues, transparency and review tax advantages for rental properties are moving in the right direction as India’s real estate market matures. It is also important that the reader takes a micro-market viewpoint to India. Better thought of as a continent, India is a very large and diverse country where driving 200 km could mean speaking a different language and with very different cultural values. India isn’t just Mumbai and Delhi, it is also Chennai, Kochi and a series of highly-educated and industrious Tier 2 and lower cities. Around 60% of India’s wealth is in the Top 30 Tier 2 and 3 cities in India. We reiterate our position that end-users for the residential asset class are still buying at the right price, providing the location makes sense and has proper transportation links. We have seen more than reasonable absorption of affordable projects in and around the metros and other cities. We expect demand to gradually increase as India finds its way back towards the 9% growth territory. Oliver Ontiveros Chief Investment Officer [email protected] The views expressed above are based on information which we believe to be reliable but are not guaranteed as to accuracy or completeness by Elysium Capital Ltd. This document is not, and should not be construed as, an offer or the solicitation of any offer, or general or definitive advice to buy or sell any investments and expressions of opinion are subject to change without notice. Sources of data are available from Elysium on request.

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