In brief Economic indicators for 2010-11 relevant to Financial Institutional Investors

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State of Indian economy and prospects

The Finance Minister of India presented the Economic Survey for the year 2010-11 in Parliament on 25 February 2011. State of the Indian Economy: An objective Analysis The Indian economy has emerged with remarkable rapidity from the slowdown caused by the global financial crisis of 2007-09. With growth in 2009-10 estimated at 8.0% and 8.6% in 2010-11 as per the Central Statistics Office (CSO), the turnaround has been fast and strong. Growth is strong in 2010-11 with a rebound in agriculture and continued momentum in manufacturing, though there was a deceleration in services caused mainly by the deceleration in community, social and personal services, reflecting the base effect of fiscal stimulus in the previous two years. That there has been a deceleration in industry and manufacturing, in particular, as indicated by index of industrial production (IIP) data is a matter of some concern. However, buoyancy in other indicators of industrial performance and the short-run nature of the IIP slowdown suggest that the deceleration is more in the nature of road bumps than indication of any long-run problem. The medium to long-run prospect of the economy, including the industrial sector, continues to be positive. On the demand side, a rise in savings and investment and pickup in private consumption have resulted in strong growth of the GDP at

constant market prices at 9.7% in 2010-11. A sequenced and gradual withdrawal of the monetary accommodation is helping contain inflationary pressures. Inflation which remained elevated levels for a large part of the current fiscal was largely driven by food items, though the goods that were inflating at the start of the fiscal year were different from the goods for which prices are rising now. Notwithstanding the tightening money markets and moderate growth in deposits, the financial situation remained orderly with a pickup in credit growth, vibrant equity market and stable foreign exchange market. A moderation in the current account of balance-of-payments position is likely with deceleration in imports and acceleration in exports as per latest monthly merchandise trade data. Though

downside risks of global events, particularly movement in prices of commodities like crude oil, remain, the Indian economy is poised to further improve and consolidate in terms of key macroeconomic indicators. Prospects of the Indian Economy: Based on the performance of the economy over the last five years and analysis of the underlying trends of critical variables, Indias real GDP is expected to grow by 9% (+/- 0.25) in 2011-12. The Indian economy had grown at above 9% for three consecutive years starting in 2005-06. So the economy is expected to revert to pre-crisis growth levels next year. The next two decades should see the Indian economy growing faster than it does any time in the past and also faster than the growth in the next two years.

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Key economic indicators for 2010-11 are:

KEY INDICATORS Data categories and components GDP and Related Indicators GDP (current market prices) Growth Rate GDP (factor cost 2004-05 prices) Growth Rate Savings Rate Capital Formation (rate) Per Cap. Net National Income (factor cost at current prices) Production Foodgrains Index of Industrial Productionc (growth) Electricity Generation (growth) Prices Inflation (WPI) (12 month average) Inflation CPI (IW) (average) External Sector Export Growth (US$) Import Growth (US$) Current Account Balance (CAB)/GDP Foreign Exchange Reserves Average Exchange Rate Money and Credit Broad Money (M3) (annual) Scheduled Commercial Bank Credit (growth) Fiscal Indicators (Centre) Gross Fiscal Deficit Revenue Deficit Primary Deficit Population (Year-wise projected population as on 1st Oct) Units Rs crorej % Rs crore % % of GDP % of GDP Rs 2005-06 2006-07 2007-08 2008-09 3692485 13.9 3254216 9.5 33.5 34.7 27123 4293672 16.3 3566011 9.6 34.6 35.7 31198 217.3 11.9 7.2 6.5 6.7 22.6 24.5 -1.0 199.2 45.25 21.7 28.1 3.3 1.9 -0.2 1122 (2006) 4986426 16.1 3898958 9.3 36.9 38.1 35820 230.8 8.7 6.4 4.8 6.2 29.0 35.5 -1.3 309.7 40.26 21.4 22.3 2.5 1.1 -0.9 1138 (2007) 5582623PE 12.0 4162509PE 6.8 32.2 34.5 40605 234.5 3.2 2.8 8.0 9.1 13.6 20.7 -2.3 252.0 45.99 19.3 17.5 6.0 4.5 2.6 1154 (2008) 2009-10 6550271QE 17.3 4493743QE 8.0 33.7 36.5 46492 218.1a 10.5 6.0 3.6 12.4 -3.5 -5.0 -2.8 279.1 47.42 16.8 16.9 6.3i 5.1i 3.1i 1170 (2009) 2010-11 7877947AE 20.3 4879232AE 8.6 na na 54527 232.1b na na 9.4d 11.0d 29.5e 19.0e na 297.3f 45.68g 16.5h 24.4h 4.8 3.5 1.7 1186 (2010)

Mn tonnes 208.6 Per cent 8.0 Per cent 5.2 % change % change % change % change Per cent US$ Bn. Rs / US$ % change % change % of GDP % of GDP % of GDP Million 4.3 4.4 23.4 33.8 -1.2 151.6 44.27 16.9 30.8 4.0 2.5 0.4 1106 (2005)

AE PE QE na a b c

GDP figures for 2010-11 are advance estimates; Provisional Estimates; Quick Estimates not yet available / released for 2009-10 Final estimates Second advance estimates The annual growth rates have been recompiled from 2005-06 onwards since the indices have been recompiled from April 04 onwards using new series of WPI for the IIP items reported in value terms

d e f g h i j

Average Apr-Dec 2010 Apr-Dec 2010 as of December 31, 2010 Average exchange rate for 2010-11 (Apr-Dec 2010) Provisional fiscal indicators for 2009-10 are based on the provisional actuals for 2009-10 Indian Rupee 1 Crore = Indian Rupee 10 million = Approx. USD 218,914 (Conversion 1USD = Rs. 45.68)

We briefly summarize the developments in the financial sector [specifically in the capital market in India relevant to Foreign Institutional Investors (FII)] in the last year which has continued to gain strength in recent years and remained relatively immune to the global financial turbulence through prudent regulations and proactive response to the challenges.

Financial Intermediation and Markets

Broader and deeper financial markets will be crucial for mobilizing higher savings and intermediating them efficiently to finance higher investment and growth. Year-on-year non-food credit growth was up 24 per cent at the end of December 2010, and financed many sectors more broadly (from the agriculture rebound to third generation [3G] spectrum sales and private infrastructure projects), while the overall credit to gross domestic product (GDP) ratio rose to about 55 per cent, continuing its progress (but still structurally well below potential). Domestic capital markets performed well in 2010, primary markets financing reached record levels, including the largest-ever initial public offering (IPO) (for Coal India), while secondary markets reached new highs. Record foreign inflows helped support the market. Pensions and insurance gained, with life insurance premium growing nearly 26 per cent and penetration doubling to 5.4 per cent of GDP in 2009, from 2.3 per cent in 2000 when insurance reforms started. Looking to the future, the twin challenges are to continue this progress on gradual financial reform and to modernize regulations and institutions to ensure its continued safety and stability. Capital Market The capital markets exhibited buoyancy during 2010 as the markets recovered and gained strength against the backdrop of a distinct improvement in the risk appetite of investors leading to a sharp rise in international capital flows to emerging markets including India.
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Domestic capital markets performed well in 2010, primary markets financing record levels, including the largest-ever initial public offering (IPO) (for Coal India), while secondary markets reached new highs.
The year 2010 has been one of strong growth for the Indian capital markets. Bulls tossed off the markets in the year 2010 to a net gain of 18 %, following global recovery and with FIIs pumping money in to the market on account of solid domestic growth coupled with a resurging corporate sector. Indices achieved record highs during the special one-hour muhurut trading on 5 November 2010 with the Sensex touching 21004 and Nifty 6312. As on 31 December 2010, the markets stand just 3 per cent away from this all time peak and closed at 20509 (+ 17.43 % from 31 December 2009 for the Sensex) and 6134 (+ 17.95 % for Nifty). Indian markets have been making gains for eight quarters in a row, their longest winning run in at least 20 years. While 2009 was basically a year of recovery from the crisis year of 2008, 2010 was one of consolidation of gains.

Primary Market The year 2010-11 has seen the Indian capital market put the worst behind and move towards strong growth with the number of companies being listed increasing and also the mean IPO size increasing as compared to 2009. The amount of capital mobilised through private placements in 2010-11 have has reduced as compared to 2009-10. The following table depicts the resource mobilization through the primary market which recorded a decrease of 19.85 per cent in 2010 as against an increase of 32.4% in 2009: (Rs crore) 1. 2. Mode Debt Equity of which IPOs Number of IPOs Mean IPO Size Private Placement Euro Issues (ADR/GDR) Total (1+2+3+4) 2007-08 0 54,511 42,595 85 501 1,18,485 NA 2008-09 1500 2082 2082 21 99 1,73,281 NA 2009-10 2500 46,737 24,696 39 633 2,12,635 NA 2,87,240 2010-11* 2197 46,701 33,068 40 827 1,47,400 NA 2,30,233

3. 4.

2,16,176 1,79,066

Source: SEBI and RBI (for Euro Issues). Notes: NA indicates Not Available. * As on 30 November 2010

Secondary Market As on 31 December 2010, Indian benchmark indices, the BSE Sensex and Nifty, increased by 17.0 % and 17.9 % respectively over the closing value of 2009-10. Nifty Junior and BSE 500 also increased by 17.8 % and 15.1 % respectively over their values in the previous financial year. The free float market capitalization of Nifty,

the Sensex, Nifty Junior, and BSE 500 stood at Rs. 18,27,097 crore, Rs. 16,32,236 crore, Rs. 3,37,573 crore, and Rs. 29,52,135 crore respectively, showing an increase of 19.8 %, 22.8 %, 15.5 % and 20.8 % respectively over their values in financial year 2009-10. The price to earnings (P/E) ratios of Nifty, the Sensex, Nifty Junior, and BSE 500 as on 31 December 2010 were 24.5, 23.6, 17.6 and 21.4 respectively, indicating an increase of 10.1 %, 10.5 %, 11.6 %and 4.5 % respectively over their 2009-10 values.

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International Comparison The following table depicts cumulative change in movement of Global Indices (on year end closing levels) over their 2003 levels from 2004 to 2010. Index BSE Sensex, India Hang Sang Index, Hong Kong Jakarta Composite Index, Indonesia Nikkei 225, Japan Kospi Index, South Korea Kuala Lumpur Comp. Index, Malaysia TSEC weighted Index, Taiwan SSE Composite Index, China 2004 13.1 13.2 44.5 7.6 10.5 14.2 4.2 -15.4 Cumulative Change over end 2003 Level (%) 2005 61 18.3 68.1 50.9 69.7 13.4 11.2 -22.4 2006 136.1 58.8 161 61.3 76.8 38 32.8 78.7 2007 247.4 121.2 296.8 43.4 133.9 82 44.4 251.5 2008 65.2 1.1 35.5 -22.9 25.6 -3.3 -25.2 43.7 2009 199.1 74.2 264.1 -5.3 104.4 58.7 32.3 116.9 2010 251.2 83.2 435.3 -4.2 153 35.3 87.6

Source: Derived from various country sources. Note: * End-year closing.

The P/E ratio of the major stock market indices, which partly discounts future corporate earnings reflecting investors expectations of corporate profit, witnessed a sharp increase in 2010. This trend was also seen in P/E ratios of stock indices across select emerging market economies (EMEs) during 2010. Moreover, the differences in valuation of stocks in terms of P/E ratios amongst EMEs were not very sharp. The following table depicts the P/E/ ratio in the select emerging markets of the world. Country India India Korea Thailand Indonesia Malaysia Taiwan SSE Composite Index, China
Source: BSE, NSE and Bloomberg Notes: * As on 31 December 2010 8

Index BSE Sensex S&P CNX Nifty Kospi SET Jakarta Composite Kuala Lumpur Comp. TSEC weighted -15.4

2008-09 13.7 14.3 25.7 15.7 20.1 15.0 65.7 -22.4

2009-10 21.3 22.3 11.1 12.3 16.6 18.9 19.1 78.7

2010-11 23.6 24.5 14.8 15.0 20.9 17.4 15.7 251.5

Derivative Equity Derivative In the equity derivative segment, the NSE witnessed an increase in the total turnover while the BSE witnessed a fall in the total turnover. The following table shows the Indian equity market turnover trends. Market Turnover (Rs crore) Market 2006-07 BSE Cash 9,56,185 Equity Derivatives 50,007 NSE Cash 19,45,285 Equity Derivatives 73,56,242
Source: BSE and NSE. Notes: * As on 31 December 2010

2007-08 15,78,670 2,42,308 35,51,038 1,30,90,478

2008-09 11,00,074 12,268 27,52,023 1,10,10,482

2009-10 13,78,809 234 41,38,024 1,76,63,665

2010-11* 8,93,839 35 27,87,862 2,05,99,192

Currency Derivative The turnover at the Stock Exchanges in the currency derivative segments increased by 152% during the year 2010-11 as compared to 2009-10 and stood at Rs. 57,31,500 crores. Interest Rate Derivative Trading in interest rates futures started at the NSE on 31 August 2009. During 2010-11 (as on 30 November 2010), the NSE witnessed a total turnover of Rs. 53 crore in this segment as compared to Rs. 2975 crore in 2009-10. Reasons for Market Movements Markets are riding on the strong health of the Indian corporate sector Historically low yields in developed markets due to accommodative monetary policies and weak economic prospects have pushed FII inflows to emerging markets to record highs. The primary market got a new lease of life this calendar year with Indian companies raising Rs. 69,192 crore through IPOs and FPOs. Global recovery also resulted in an upsurge in the markets, boosting sentiments across the globe. Globally, leaders are striving to keep the pace of growth intact.
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Foreign Institutional Investors (FIIs) There has been a marginal growth in the number of FIIs and Sub-accounts registered during the year 2010-11. The FIIs have been net buyers in the Indian equity and debt market activity during 2010-11, however there is a decline of 10.5% in the amount invested in 2010-11. The following table depicts the growth in the FII and their transaction value during the year. (Rs crore) Calendar Year 2008-09 2009-10 2010-11* 1635 1713 1718 5015 5378 5503 5,54,585 7,05,523 6,02,292 5,95,302 -47,706 1,10,221 59,993 58,098 1,895 1,40,914 1,08,477 32,438 6,03,406 4,90,785 1,12,622 1,54,081 1,29,241 24,839 7,57,487 6,20,026 1,37,461

market has languished both in terms of market participation and structure. Non-bank finance companies are the main issuers and very small amounts of finance are raised by companies directly. There are several reasons for this: (i) Pre dominance of banks loans; (ii) FIIs participation is limited; (iii) Pensions and insurance companies and household are limited participants because of lack of investor confidence; (iv) Crowding out by Government bonds. The corporate bond market as a result is only about 14 per cent of the total bond market; and market liquidity and infrastructure remain constrained. With bank finance drying up for long- term infrastructure projects in view of asset liability problems faced by banking system, the need for further development of a deep and vibrant corporate bond market can hardly be over emphasized. The following table shows the status of private placement of corporate bonds listed on NSE and BSE stock markets in India: Year 2007-08 2008-09 2009-10 2010-11 (till Nov-10)
Source: SEBI (includes NBFCs)

Transactions of FIIs Number of FIIs (actual) Number of Sub-accounts (actual) 1. Equity Market Activity (Rs crore) Gross Buy Gross Sell Net 2. Debt Market Activity (Rs crore) Gross Buy Gross Sell Net 3. Total Activity (Rs crore) Gross Buy Gross Sell Net
Source: SEBI Notes: * As on 31 December 2010

6,14,579 8,46,437 6,60,389 7,03,779 -45,811 1,42,658

Debt Market The Government securities market has evolved over the years and expanded given the increasing borrowing requirements of the Government. In contrast, the corporate bond

Number of Issues 744 1041 1278 929

Amount (Rs crore) 118,485 173,281 212,635 147,400

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Initiatives for development of Corporate Bond Market in India Regulatory jurisdiction over corporate bond market has been clearly defined and placed under SEBI. SEBI (Issue and Listing of Debt Securities) Regulations, 2008 simplified disclosures and listing requirements. A minimum market lot criterion has been reduced from Rs.10 lakhs to Rs.1 lakh to encourage retail investors. The limit of FIIs investment in corporate bonds has been increased to USD 20 billion from the existing limit of USD 15 billion and the incremental limit of USD 5 billion has to be invested in corporate bonds with residual maturity of over five years. BSE, NSE and FIMMDA have set up reporting platforms. Aggregate data reported on these platforms is disseminated to the public. Summary data is available on SEBI website. Repos in corporate bonds have been permitted, following RBI guidelines, since March 2010. Draft Credit Default Swap, (CDS) guidelines have been released by RBI in July, 2010. The Finance Act, 2008 (with effect from 01/06/2008) mandated that no TDS (tax deduction at source) would be deducted from any interest payable on any security issued by a company, where such security is issued in dematerialised form and is

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listed on a recognised stock exchange in India. The stamp duty on items in central list (debentures and bonds in the nature of promissory note) have been brought down and made uniform. Clearing and settlement through clearing corporations have been mandated for trades between specified entities namely mutual funds, foresight institutional investors, venture capital funds etc. Clearing and settlement is on DvP I basis. Suggested Initiatives to be taken for further development of Corporate Bond Market Clearing and settlement on DvP (Delivery versus Payment) III basis. Market making with primary dealers. Enabling Credit Default Swap. Allowing banks to do credit enhancement -Guaranteeing of corporate bonds by banks. Relaxing norms on short selling of Government bonds. (RBI). Relaxing norms for use of shelf prospectus -requires amendment to Section 60 of Companies Act (MCA). Empowering bond holder under SARFAESI (Department of Financial Services, RBI). Creating of a comprehensive bond data base (RBI, SEBI, FIMMDA). Amendment to Section 9 of the Stamp Act to lower stamp duties across states and make them uniform (Department of Revenue).

Policy Developments during 2010-11 FII Investments in Government Securities and Corporate Bonds At present, FIIs registered with SEBI are permitted to invest in Government securities and corporate bonds up to US$ 5 billion and US$ 15 billion respectively. After a review in the context of Indias evolving macroeconomic situation, its increasing attractiveness as an investment destination, and need for additional financial resources for Indias infrastructure sector while balancing its monetary policy, it was decided to increase the limit of FII investment both in Government securities and corporate bonds by US $ 5 billion each, raising the cap to US$ 10 billion and US$ 20 billion respectively. The incremental limit of US$ 5 billion has, however, to be invested in securities with residual maturity of over five years and corporate bonds with residual maturity of over five years issued by companies in the infrastructure sector. Report of the Working Group on Foreign Investment in India With a view to rationalizing the present arrangements relating to foreign portfolio investments by FIIs/ non- resident Indians (NRIs) and other foreign investments like foreign venture capital investor (FVCI) and private equity entities, the Government set up a working group to look at various types of foreign flows,

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which are taking advantage of arbitrage across the respective stand-alone regulations, and generate recommendations to the Government. The group submitted its report to the Finance Secretary on 30 July 2010. The focus of the group has been to identify procedures and practices which can help avoid uncertainty, delay, or unequal treatment and to recommend measures which could simplify the portfolio investment environment, at the same time laying a strong emphasis on KYC norms.

Indias Sovereign Rating Presently, India is rated by six international credit rating agencies, namely Standard and Poors (S&P), Moodys Investor Services, FITCH, Dominion Bond Rating Service (DBRS), the Japanese Credit Rating Agency (JCRA), and the Rating and Investment Information Inc., Tokyo(R&I). Information flow to these credit rating agencies has been streamlined. In the calendar year 2010, S&P upgraded Indias foreign currency outlook from negative to stable, FITCH upgraded its local currency outlook from negative to stable, and Moodys upgraded its local currency outlook from Ba2 to Ba1. Credit ratings issued by other agencies maintained status quo. Challenges and Outlook Deepen domestic capital markets Development of Corporate Debt Market The role of non-bank institution, especially in corporate bond and debt markets Regulatory overhaul aimed at updating modern legislation, underlying financial markets and improving macro-prudential safeguards and institutions. With the backdrop of the economic survey, we provide insight to Indias competitiveness as per the Global Competitive Index Report 2010 -2011 issued by the World Economic forum.

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Global competitiveness

Assessing Indias Competitiveness: Insights from the Global Competitiveness Index World Economic Forum came out with The Global Competitiveness Report 2010-2011 as per which Switzerland continues to top the overall ranking in Global Competitive Index (GCI), characterized by an excellent capacity for innovation and a very sophisticated business culture. Sweden has moved ahead of Singapore and United States to claim 2nd position this year. Singapore, United States and Germany round out the top five. European economies continue to prevail in the top 10 with Japan, Finland, Netherlands, Denmark and Canada following suit. After having fallen four positions over the past two years, the United Kingdom moves up one spot to 12th place this year, with a stable performance. India ranks 51st out of 139 economies in the GCI for the year 2010-2011, down two ranks from the previous edition. Indias performance remains quite stable but with a small improvement in score. Indias competitveness is based on its large market size and good results in more complex areas including financial markets, business sophistication and innovation. Up two positions to 27th place, China reinforced its position within the top 30. It is the only BRIC country to improve its rankings this year, thus increasing the gap with the other three. Brazil is at 58th and Russian Federation is at 63rd positions respectively. The ranking of BRIC countries on the twelve pillars of GCI is extracted hereunder:
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No Pillars Basic: 1 2 3 4 5 6 7 8 9 10 11 12 Quality of Institutions Energy and transport infrastructure Macro Economic stability Health and Primary education Efficiency enhancers: Higher Education and training Goods market efficiency Labour market efficiency Technological readiness Market size Innovation-driven: Business Sophistication Innovation Total Overall GCI Rank
Source: World economic forum website

India 58 86 73 104 85 71 92 86 4 44 39 51

Brazil 93 62 111 87 58 114 96 50 54 10 31 42 58

China 49 50 4 37 60 43 38 57 78 2 41 26 27

Russia 118 47 79 53 50 123 57 125 69 8 101 57 63

Financial market sophistication: 17

The Financial Development Report 2010 The Financial Development Report 2010 and the Financial Development Index (FDI) on which it is based provide a score and rank for 57 of the worlds leading financial systems and capital markets. It analyzes the drivers of financial system development that support economic growth in advanced and emerging economies to serve as a tool for countries to benchmark themselves and prioritize areas for reform.

The Report defines financial development as the factors, policies, and institutions that lead to effective financial intermediation and markets, as well as deep and broad access to capital and financial services. In accordance with this definition, measures of financial development are captured across seven pillars. The top-ranked countries within the Index do not change significantly, although the United States does take the top spot from the United Kingdom (2nd); the US score remains essentially unchanged from last year, while the United Kingdoms drops the most of any country Banking financial services 41 38 8 57

within the top 10. It is only very minor score differentials that separate the United Kingdom from the next five countries that score below itHong Kong, Singapore, Australia, Canada, and the Netherlands. All of the BRIC country rankings either improve slightly or stay the same. China shows the biggest advance, moving up four spots to 22nd place. Brazil (34th) moves up two spots, India (37th) one spot, and Russia stays the same at 40th place. The rankings of BRIC countries are extracted hereunder:

Pillars India Brazil China Russia

Institutional environment 51 44 35 53

Business environment 52 49 38 34

Financial stability 46 10 17 42

Non-banking financial services 13 12 4 5

Financial markets 24 34 30 33

Financial access 49 27 26 54

Overall Index 37 32 22 40

Source: World economic forum website

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