February 9, 2007

INDIA / INDONOMICS

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.

Disclaimer & disclosures

This report must be read with the disclaimer and disclosures on the last page that form part of it
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
34 85
(%
32 80 )
75
30
70
28 65

26 60
55
24
50
22 45

20 40
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07E
2007-08E
1990-91

1992-93

1994-95

1996-97

1998-99

2000-01

2002-03

2004-05

Sav ings/GDP (%) Inv estment/GDP (%) M3/GDP (%) Poly . (M3/GDP (%))

Source: RBI, CSO, Man Financial Research.

February 9, 2007 Man Financial z INDONOMICS z 2

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
3000000 6%

2500000 4%
2000000
2%
INR Cr

1500000
0%
1000000
-2%
500000

0 -4%
1970-71

1974-75

1978-79

1982-83

1986-87

1990-91

1994-95

1998-99

2002-03

2006-07

-6%
1970-71

1974-75

1978-79

1982-83

1986-87

1990-91

1994-95

1998-99

2002-03

2006-07
Real gdp reconstructed on 99-00 base
Poly . (Real gdp reconstructed on 99-00 base)
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 3

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

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Roshan Sony Asst. Vice President 91-22-6667 9964 roshan.sony@manfinancial.in
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February 9, 2007 Man Financial z INDONOMICS z 4