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Indian Economy
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Perspectives on the Indian Economy and the Financial Sector
This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.
Renny Thomas, Partner McKinsey & CompanyOctober 2007
1
•Perspectives on Indian Economy
– Context of Indian economy
– Forces likely to propel India ahead
– Challenges for the growth
CONTENTS
Perspectives on Indian Financial Sector
2
* Base year = 2002Source: Global Insight; Economic Survey of India; Team Analysis
Real GDP growth*
US$ billion
60118
279
464
709
1950 1970 1990 2000 2006Population (Million) 365 548 850 1,016 1,112
Average growth rate of 8.6% over the last 4 years
INDIA’s GDP HAS RISEN STEADILY SINCE THE 1950’s. . .
3.4%
4.4%
5.2%
7.3%
3
Source: RBI; EIU
Per cent
0
1
2
3
4
5
6
7
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
AS GROWTH HAS INCREASED VOLATILITY HAS DECREASED
10-year volatility of GDP growth
10-year mean growth
4
37.0
18.0
24.0
27.0
39.055.0
Agriculture
Industry*
Value added to GDP (Per cent)
Services**
29.0
10.0
46.0
50.0
25.040.0
ChinaIndia
AND TRANSFORMED INDIA FROM AN AGRARIAN TO A SERVICES-LED ECONOMY
* Industry includes Mining, Manufacturing, Electricity ,Gas & Water and Construction **Services includes Whole & retail Trade, Restaurants & Hotels, Transportation & Communications, Finance, Insurance, Real Estate & Business Services and Community, Social & Personal Services
Source: Global Insight; Team Analysis
1980 2006 1980 2005
5
High LowSEVERAL MEGA INFRASTRUCTURE PROJECTS ARE SET TO CHANGE THE LANDSCAPE
* Government Flagship ProgrammesSource: Economist; Press-articles; Government Budget Speech 2006-07; Analyst Reports; Team Analysis
Planned spending (timeframe)US$ billion
ProjectLikelihood of completion
2 (2006-07)
4 (2010)
1 (2006-07)
2 (2006-07)
1.1 (2006-07)
1.1 (2006-07)
0.2 (2006-07)
3.2 (2006-07)
0.9 (2006-07)
National Rural Health Mission*
Details
• Providing basic healthcare services to the rural population
• Upgrading Delhi’s infrastructure in preparation for games
• Developing urban infrastructure and providing basic services to the urban poor in ~ 63 cities
• Extending primary education to all children, especially in rural India
• Providing free mid-day meals to all children in government, corporation, panchayat and municipal schools
• Supplying safe drinking water in the rural areas
• Extending sanitary facilities in rural India
• Providing income security to the poor and bridging the rural poverty gap
• Improving the nutritional and health status of children in the age group of 0-6 years and reducing the incidence of infant mortality
National Urban Renewal Mission*
Sarva Shiksha Abhiyan*
National Rural Employment Guarantee Scheme*
Mid-day Meal Scheme*
Rajiv Gandhi Drinking Water Mission*
Total Sanitation Campaign*
Integrated Child Development Services*
Commonwealth Games 2010
6
•Perspectives on Indian Economy
– Context of Indian economy
– Forces likely to propel India ahead
– Challenges for the growth
CONTENTS
Perspectives on Indian Financial Sector
7
Source: Global Insight; Team Analysis
58%
60%
62%
64%
66%
68%
70%
72%
2000 2005 2010 2015 2020 2025 2030 2035 2040
Brazil
Per cent of total population
China
RussiaG6
India
A GROWING WORKING AGE POPULATION WILL PROPEL GROWTH TILL 2035 LATER THAN CHINA
Working age population (age 15-60)
5.5
4.0
3.7
2.8
- Average no. of people per household in 2007
8
HOUSEHOLD INCOMES WILL ACCELERATE ACROSS INDIA
0
100
200
300
400
500
1985 1990 1995 2000 2005 2010 2015 2020 2025
Rural
Urban
5.8%
3.6%
All India
5.3%
4.6%
2.8%
3.6%
Actual Forecast
1985-20052005-2025
Compound annual growth rates
Average household disposable income
Thousand; Indian rupees; 2000
Source: McKinsey Global Institute
9
THE SHAPE OF INDIA’s INCOME PYRAMID WILL CHANGE DRAMATICALLY AS INCOMES GROW
• Middle class to swell from just under 50 million today to about 583 million by 2025
• By 2025, India will produce 2 million globals annually
• Share of incomes of the middle class and globalswill rise from less than 30% today to more than 80% by 2025
Strivers (500–1,000)Seekers (200–500)
Aspirers (90–200)
Deprived (<90)
Globals (>1,000) 1.2
10.9
91.3
101.1
2.4
Number of householdsMillion
Household income bracketsThousand, Indian rupees, 2000
Aggregate consumptionTrillion, Indian rupees, 2000
1.2
2.1
8.5
4.1
1.0
Strivers (500–1,000)Seekers (200–500)
Aspirers (90–200)
Deprived (<90)
Globals (>1,000) 3.3
55.1
106.0
74.1
5.5 4.1
11.8
12.2
3.3
2.7
Strivers (500–1,000)Seekers (200–500)
Aspirers (90–200)
Deprived (<90)
Globals (>1,000) 9.5
94.9
93.1
49.9
33.1 14.1
24.6
11.9
2.4
16.5
2005
2015
2025
Source: MGI India Consumer Demand Model, v1.0
10
CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$585 BILLION DURING 2007-12 (1/2)
AreaExpected spend US$ billion
Key projects
• Six-laning of 6,500 kms and four-laning ~18,000 kms of corridors and highways
• Dedicated Freight Corridors between Mumbai-Delhi and Ludhiana-Kolkatta, ~10,300 kms of new railway lines; modernisation of 21 railway stations
• Additional generation capacity of ~70,000 MW (includes rural areas)
• Capacity addition of 485 million MT in major Ports; 345 million MT in minor Ports
• Modernisation and redevelopment of 4 metro and 35 non-metro airports
• Construction of 7 green-field airports in North East
96
73
177
21
10
Roads
Railways
Power (generation, transmission, and distribution)
Ports
Airports
Source: Planning commission;
11
585Total
CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$585 BILLION DURING 2007-12 (2/2)
• Growing subscriber base to 600 million, including 200 million rural telephone connections
• Providing broadband access to 20 million and 40 million internet connections
• Water supply and sanitation projects
• Developing 16 million hectares through major, medium and minor irrigation works
• Gas distribution infrastructure– LNG terminals, gas transmission lines, city gas
distribution
77
57
62
6
Communi-cation
Water
Irrigation
Gas
Storage • Storage to support agricultural development
6
AreaExpected spend US$ billion
Key projects
Source: Planning commission;
12
* As on 14 Sep 2007 ** As on year end *** Not all deals mentioned disclose deal financials. Deal values are the sum of only those deals where financials were publicly announced (90 deals in 2006 and 87 deals in 2007)
Source: Press articles; CMIE; Dealogic; Prowess; Team Analysis
Number of billion dollar companies
Local corporates expanding overseas
Spurt in number of cross-border deals by Indian companies
2006 2007*Deals # 163 143Value $23 bn $18 bn
A ROBUST AND HIGH-GROWTH PRIVATE SECTOR CONTINUES TO BOOST CONFIDENCE LEVELS
21
446
30
95
US$2-5 bn
US$1-2 bn
1432
1998
88
2007
>US$10 bnUS$5-10 bn
175% increase
Some success stories
• India's largest automobile company, with revenues of US$6.9 billion 2006-07
• World's fifth largest medium and heavy commercial vehicle manufacturer
• Current market cap of US$6.6 billion
• Incorporated in 1995, world's 5th leading & Asia's leading manufacturer of wind turbines
• Current sales of US$1.7 billion and market cap of US$9.8 billion
• Became a bank in 2000; 2nd largest bank in India today
• 30-50% market share across classes• Current market cap* US$24 billion• (US$0.6 billion in 2000**)
The transformation
13
* Number of deals for calendar year 2000, and till Sep 2007** Average deal size is based on deals for which the values has been disclosed
*** As on 13 September, 2007Source: Dealogic; Team Analysis
INDIAN COMPANIES ARE AGGRESSIVELY ESTABLISHING GLOBAL FOOTPRINT
Average Deal Size**
Number of Deals*
The recent spurt in outward FDI is caused by:• Regulatory changes:
Indian companies can now make overseas investments equal to 300% of their net worth on an automatic approval basis
• Easy access to capital
– Decline in interest rates coupled with liberal lending policies adopted by banks
– Active participation by PE firms – Nearly 20% of the deals were backed by private funds in 2006
Cross-border M&A by Indian companies
50
143
0
50
100
150
200
250
2000 2007***0
50
100
150
200
250
300
350
14
^ 2007: As on Sep 2007*Includes all completed deals even where deal value is not available
** Includes Finance, Insurance, Leisure & Recreation, Professional Services, Healthcare, Transportation and Publishing*** Includes Chemicals, Machinery, Auto / Truck, Consumer Products, Textile and Food & Beverage Manufacturing
Source: Dealogic; Press articles; Company website; Team Analysis
No. of Deals*
Acquisitions of Indian companies by MNCs
4
10
13
35
22
16
Manufacturing***
Services**
Cons-truction
Hi-Tech
Telecom
110166 195 301131 250
SIMILARLY, MNCs ARE ACTIVELY SEEKING THE INDIA OPPORTUNITY…
3.030
2002
2.268
2003
2.502
2004
5.748
2005
10.969
2006
27.442
2007^
ValueUS$ billion
Others
Per cent of Total Deal Value, 2007^Break-up by sector
15
THERE ARE 7 MANTRAS FOR SUCCESS IN INDIA…
Source: McKinsey team analysis
Strong India Commitment and local team
Leverage India’s resources for global requirements
Create & Shape the Market Redesign supply chain to profitably deliver value
Acquire if necessary, but re-assess cost of capital
Actively shape and manage perception and regulation
1
2
3
5
6
7
Indianise product and get the price-value equation right4
16
• 11th largest economy today (GDP US$560 billion)• 4th largest by 2025 (GDP US$3,200 billion, six-fold increase)
0123456789
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
* Major world economies considered are the BRIC and G6 countries Source: Goldman Sachs BRIC report 2003
2.15.0
20.1
2000 2020 2050
Per cent
Real GDP growth (Per cent)
IndiaChina
Brazil
Russia
IN SUMMARY, INDIA IS ON COURSE TO BE AN ECONOMIC SUPER POWER OF THE 21ST CENTURY
India – will contribute a giant share of the incremental GDP growth of major world economies*Fastest growing global
economy by 2012
India – most rapid growth potential of the BRICs
17
* Base year: 2002Source: Global Insight; Team Analysis
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
1980 1985 1990 1995 2000 2005 2010
ChinaCAGR = 10.1%(1990-2005)
India 1990-2005 CAGR = 5.98%
“Lead indicators”of inflection
visible in India
“Lead indicators”of inflection
visible in India
1978: China liberalizes
1992: India liberalizes
Inflection in China GDP
Inflection scenario
Conservative growth estimates
• Taxes: Laws simplified resulting in better compliance and ease of tax payment
• Infrastructure: Increased investment in infrastructure e.g., Ultra Mega Power Projects
• Liberalisation: FDI in key sectors like airports, NBFCs, Insurance, electrical equipments, telecommunications, construction etc allowed
US$ billion
AND GROWTH IN INDIA IS AT AN INFLECTION POINT, SIMILAR TO CHINA 15 YEARS AGO
Triggers behind growth inflection in IndiaReal GDP growth PPP adjusted*
18
•Perspectives on Indian Economy
– Context of Indian economy
– Forces likely to propel India ahead
– Challenges for the growth
CONTENTS
Perspectives on Indian Financial Sector
19
THERE ARE CHALLENGES THAT COULD DETER GROWTH
Source: Team Analysis
Risks (in decreasing order of likelihood) Description Mitigating factors
• Large number of parties• Differing ideologies• Regional agendas influence
national policy
• Universal adult suffrage - a correction mechanism
• "Public stance" guarded – but parties realize liberalisation imperatives
1. Internal political complexities(high)
• Highly fragmented country geographically
• Risk of social unrest, resulting from increasing income divide – urban and rural India– rich states and poor states
• Higher inflation
• Few budgetary, fiscal and supply side measures announced by the Govt.
• Numbers below poverty line reducing• Realization (in last election) that only
broad-based economic reform is sustainable
2. Socio -economic factors (moderate)
• Border tensions with Pakistan and China
• Instability in Nepal
• Strong progress in Pakistan relations across two different governments
• China border issue (Sikkim) resolved recently
4. Military conflict(low)
• US economy slows down• Rising oil prices
• Low interest rates • Measures to increase FDI inflows and
competitiveness to capture a larger share of world trade
3. External factors (moderate)
20
INDIA IS A LARGE COUNTRY WITH HUGE GEOGRAPHIC FRAGMENTATION2006; Million Hectare; per cent
Source: Euro Monitor
US
Brazil
Canada
China
Australia
Russia
963171
84660
99846
960148
76846
1,710121
Total land
Arable land
17.8%
7.09%
4.6%
15.4%
6%
7%
Country Land acreage % arable
161
329
Total land
Arableland
Arable land in India is the highest and almost as much as that available in the US in absolute terms
Arable land as a proportion to total land across most countries range between 4 – 10%
However in India land used for agricultural purposes its as high as 48%
48.5%
2. Socio-economic factors
21
1.32.3
0.7 0.3 10.1
5.5
Product market barriers
India (complete reforms)
India (growth rate in 2000-01)
Land market barriers (affects real estate and retail sectors)
• Urban land ceiling act• Unclear land titles• Tenancy laws• Low property taxes
and low user charges• Urban transportation
infra-structure
Government ownership
Others barriers, e.g., labor market
• Lack of nationwide VAT coupled with lower indirect taxes
• Small scale reservations• Poor regulation in power sector• High import duties• FDI restrictions (e.g., retail)• Delicensing key sectors (e.g. coal,
fertiliser, retail, mining, railways)
• Central PSUs• State PSUs
including power• Municipal services
Last 2 years 7% GDP growth
Reforms completedReforms pending Reforms under consideration/ work under way
Overall downside in India is limited. Biggest risk is un-captured potential
THE BIGGEST RISK IS POLITICAL INDECISION WHICH COULD PREVENT INDIA FROM CAPTURING ITS POTENTIAL
* Public sector unit (i.e., government owned enterprises)Source: McKinsey Global Institute Study on Indian Economy (2001); Team Analysis
1. Internal political complexities
22
Australia
LOW CONCENTRATION OF POPULATION IN TOP 5 CITIES
Source: Web search; Census
Population living in the top 5 countries is very fragmented in Asian countries vis-à-vis its global counterparts, but in absolute terms it more than equates the top 5 cities population of the US
USBrazil China Russia
65
25 22 16
35
21
75
189
79
303
84
1427
94
1,1365
95
1,322
Population living in top 5 cities
Rest of population
100% =
India
2006; Million; per cent
2. Socio-economic factors
23
INCREASING INCOME DIVIDE COULD LEAD TO RISK OF SOCIAL UNREST
. . .and income of rich states is 2.2X that of poor states
Rs. ‘000, 2006 prices Rs. ‘000, current prices
21.7
49.8
Urban average* per capita income
Rural average* per capita income
+2.3X
12.9
28.5
Per capita income average* of rich states#
Per capita income average* of poor states#
+2.2X
* Average over 2002-2005 # Rich states are ones having higher per capita income than the All-India average, poor states are all othersSource: Market Skyline 2006 – Indicus Analytics; Global Insight; CSO; Team Analysis
2. Socio-economic factors
Urban income is 2.3X rural. . .
24
•Perspectives on Indian Economy
CONTENTS
Perspectives on Indian Financial Sector
25
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded strong performance on back of continued reforms
•However, financial deepening has to be acclerated, else it could constrain the full potential of the Indian economy going forward
•Pursuing a continued integrated reform agenda for the financial system can help support and enable India’s high GDP growth trajectory
26
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded strong performance on back of continued reforms
•However, financial deepening has to be accelerated, else it could constrain the full potential of the Indian economy going forward
•Pursuing a continued integrated reform agenda for the financial system can help support and enable India’s high GDP growth trajectory
27
3934 31 30 25
41 32 2326
4756 70
89
22
46
106
1994
18
40
1995
2
44
98
1996
217
44
20
9593
1997
220
48
94
1998
222
51
116
1999
124
53
110
2000
127
19
108
2001
130
64
122
2002
133
65
146
2003
2
57 68
160
2004
334
66
172
2005
5
36
64
195
2006
34
INDIA’s FINANCIAL DEPTH HAS GROWN RAPIDLYSINCE 2001
Note: Umbers may not add due to rounding1 Compound annual growth rate
Source: McKinsey Global Institute Global Financial Stock Database; team analysis
EquityCorporate debtGovernment debtBank deposits
CAGR1
1994-2001
2001-2006
-7.5
5.9
5.2
3.2
31.5
33.9
6.5
2.1
Financial stock as a percent of GDPPer cent
No deepening
CAGR14.1%
Financial depth
28
BANKING SECTOR HAS BEEN AT THE CORE OF FINANCIAL SECTOR GROWTH AND HAS CREATED SIGNIFICANT WEALTH FOR INVESTORS
Sources: RBI; national income statistics; Datastream; team analysis
1,700
19,496
1.6
~3.5
3,500
26,237
Contribution to economy of banking sector has improved over the years
1994 2007
1994 2007
16.7
1994 2007
Per cent
Rs billion
Rs billion
1Banking value add to GDP
2 Deposits
3 Advances
20.6
0
200
400
600
800
1000
1200
1400
Jan-
01
Jul-0
1
Jan-
02
Jul-0
2
Jan-
03
Jul-0
3
Jan-
04
Jul-0
4
Jan-
05
Jul-0
5
Jan-
06
Jul-0
6
Jan-
07
Jul-0
7
Indian banks have outperformed share indices in last few yearsTRS CAGR Jan 01 – Oct 07
Indian Market: 29.63%Bank index: 40.54%
Old Private: 38.92%New Private: 44.17%
Public Sector Banks: 42.67%
New Private
Old Private
PSU Banks
Indian Banking
Indian Market
29
15.1Philippines
8.5Malaysia
8.2Thailand
7.1China
6.7Singapore
1.6Korea
1.4India
FINANCIAL PERFORMANCE OF INDIAN BANKING SECTOR IS AMONG THE BEST IN THE REGION
Asset quality Profitability
Per cent, FY 2006
Weak
Strong
* Data for all Scheduled commercial banks in India Source: Central banks of each country; Bankscope; CMIE, McKinsey analysis
NPL/GDP NPL/Net loans Pretax ROEPretax ROA
8.5Malaysia
6.7Singapore
5.9China
5.8Thailand
5.7Philippines
2.1Korea
0.5India
0.1Korea
0.8Thailand
0.8China
1.2Philippines
1.3Malaysia
1.3Singapore
1.3India
9.1Thailand
10.1Philippines
12.4Singapore
14.9Korea
15.1China
16.3Malaysia
17.9India
30
OTHER FINANCIAL MARKETS HAVE BEEN ON AN ACCELERATED GROWTH TRAJECTORY OVER PAST FEW YEARS
* Based on full credit for regular premium + 10% credit for single premiumSource: IRDA; AMFI; SEBI; McKinsey analysis
Life insurance
New business premium (APE)*; $ bn
Equity
Market capitalization; $ bn
Mutual Fund
AUM; $ bn
9.9
1.6
2000-01 2006-07
+519%
816
105
2000-01 2006-07
+677%
75
19
2000-01 2006-07
+295%
Over the past few years the Indian market has witnessed accelerated growth across financial services
31
HOWEVER, JUST 3-4 YEARS OF HIGH ECONOMIC GROWTH SEEMS TO HAVE LED TO A SITUATION OF TIGHT LIQUIDITY AND RISING INTEREST RATES
Source: RBI; Bloomberg; McKinsey analysis
Rapid credit expansion in past few years…
Outstanding advances; US$ billion
448
341
252
196157
Mar ’03
Mar’04
Mar’05
Mar’06
Mar’07
+30%
7572615559
Mar ’03
Mar’04
Mar’05
Mar’06
Mar’07
… resulting in tightening liquidity..
Credit/deposits ratio; Per cent
7.87.56.75.26.2
Mar ’03
Mar’04
Mar’05
Mar’06
Mar’07
… and rising interest rates
10 year G Sec rates; Per cent
32
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded strong performance on back of continued reforms
•However, financial deepening has to be accelerated, else it could constrain the full potential of the Indian economy going forward
•Pursuing a continued integrated reform agenda for the financial system can help support and enable India’s high GDP growth trajectory
33
OVERALL FRAMEWORK FOR ANALYZING FINANCIAL SYSTEM IN INDIA
Source: McKinsey Global Institute analysis
Savers Borrowers
Informal finance
International financial system
Banking system
Equity market
Bond markets
1 23
4
Domestic financial system
Efficiency of each marketRegulatory environment
12
34
Supply of funds from saversAllocation of funds to borrowers
34
Note: Numbers may not add due to rounding*Japan number is for 2005Source: McKinsey Global Institute Global Financial Stock Database; McKinsey analysis
6078
45
51
7089
65 11992
155
104 281
43
Malaysia
145
134
195
Japan*
43
12962439
138
Indonesia
427
536
64
India
2237
85
209
Thailand
1314
150
220
China
1056
58
243
70
Philip-pines
32
254
South Korea
42
94
504
Singapore
369
EquityPrivate debt
Government debtBank deposits
Financial depth, 2006
BUT INDIA’s FINANCIAL DEPTH IS LOW COMPARED TO OTHER ASIAN NATIONS
Financial assets as a percent of GDP
35
THIS IS DESPITE INDIA’S HOUSEHOLDS BEING AMONGST THE HIGHEST SAVERS IN THE WORLD
* MGI estimate based on 2005 GDP and estimates of flow-of-funds information.Source: Country National Accounts; IMF; McKinsey Global Institute
Household savings as a share of gross national savings rates, 2005
162024
3744
55
69
India France China* Mexico Japan South Korea
United States
32.4 18.0 50.4 21.2 26.4 32.8 12.9
Gross national savings rates% of nominal GDP, 2005
Per cent
36
Note: Numbers may not add due to roundingSource: CSO; McKinsey Global Institute analysis
LARGE PROPORTION OF HOUSEHOLD SAVINGS NOT ACCESSIBLE TO FINANCIAL SYSTEM
2832 35
13 19 18
59
66
FY 1995
50
96
FY 2000
47
132
FY 2005
Machinery andequipment
Construction
Financial assets
100% =
Distribution of household savings by asset type$ billion, per cent
37
GOLD CONTINUES TO BE USED AS A SAVINGS VEHICLE DESPITE NEGATIVE RETURNS SINCE 1990
Source: Press Trust of India; Bombay Bullion Association; McKinsey Global Institute analysis
0
50
100
150
200
250
300
350
400
450
1970 1974 1978 1982 1986 1990
Gold
Bank deposits
0
20
40
60
80
100
120
140
160
1985 1988 1991 1994 1997 2000
Gold
Bank deposits
Index, adjusted for inflation
Gold was an attractive investment in the 1970s and 1980s . . .
. . . but has offered negative real returns in recent years
38
ACCESS TO QUALITY BANKING PRODUCTS AND SERVICES IN INDIA IS LIMITEDAccess to banking products is significantly lower in India . . .
ATM penetrationPer million people
Card penetration*Per cent of population
2006; per cent
* Includes both debit and credit cards; ** India Data as on March 2006 ; Mexico only credit cardsSource: Febraban; IBGE; Brazilian Central Bank; FSS; BOK; Bank of Thailand (BOT); NESDB; National Banking and Securities Commission;
Bank of Mexico; China Unionpay; Lit search; RBI; Venture Infotek
Number of bank branches
Deposits Credit
Metro centers
Top 100 centers excluding metro centers
Other centers
100% =
2006; per cent
. . . and is limited to large cities
65.1
25.318.3
17.9
20.6
16.2
17
54.165.4
70,776 20,911 15,138 Rs bn
19
51
81
1,240Australia
755Korea
477Singapore
330Thailand
261Poland
246Mexico
229Malaysia
193Brazil
Philippines
China
India 7
199
362
335
76
63
51
130
142
15
61
39
INDIA’s GOVERNMENT CONSUMES 70 PERCENT OF NETSAVINGS INJECTED INTO THE FINANCIAL SYSTEM
1 Computed as sector specific savings minus investment2 To balance with the current account, we subtract all errors and omissions (E&O) between savings, investments, and capital flows from
household savings (equivalently add it to household investment). Investment in valuables are added to E&O for the years 2000–2005. E&O average 1.4% of GDP over the period implying unadjusted household savings investment balance is 10.4% of GDP.
Source: CSO; McKinsey Global Institute analysis
ESTIMATED
Net contributions to the financial system1
1.2
3.2
9.0Household net contributionsto the financial system2
Foreign capitalinflows
Private sector borrowing
7.0Public sectorborrowing
Per cent of GDP, average FY 1995-2005
40
MORE THAN 80 PERCENT OF GOVERNMENT SECURITIES ARE HELD BY FINANCIAL INSTITUTIONS THAT ARE REQUIRED TO HOLD THEM
1 Latest available data. * Using Rs. 41 as Rupee to dollar rateSource: RBI; McKinsey Global Institute analysis
Ownership of central government securities100% = $ 306 billion, FY 20071
100.0
85.5
45.5Public sector banks
9.0Other banks
25.0Insurance companies
6.0Employee provident fund organization
Total regulatedholdings
8.0RBI own account
6.5Other
Total
Financial institutions required to hold government securities• Statutory liquidity ratio requires banks
to hold 25% of assets in government securities; actual holdings are higher
• Life insurance companies must hold 50% of their assets in government or other approved securities; additional 15% must be invested in infrastructure and social sectors
• Provident regulations cause 90% of assets to be held in government securities
41
INDIAN BANKS HAVE RELATIVELY A HIGH PORTION OF ASSETS IN GOVERNMENT SECURITIES
Fixed/other assetsOther securities and cash
Government securities
Loans 54 54 57
6857
81
2516 15 0.8
12
1618 18 25 18
165 12 10 8 13
2
0
India China Japan SouthKorea
United States(2004)
UnitedKingdom
Source: RBI; bank financial statements; Financial Supervisory Service (South Korea); PBOC; Bank of England; Federal Reserve Bank of the US; McKinsey Global Institute analysis
Asset breakdown of banksPer cent, 2006
42
7
30
13
11
39
211
Private corporatediscretionary
Private corporatepriorityAgricultureHouseholdenterprises and proprietorshipsPublic sectorenterprises
100% =
MORE THAN HALF OF COMMERCIAL CREDIT GOES TO SECTORS WITH LOW INVESTMENT EFFICIENCY
1 Gross bank credit to non-financial companies, corporate bonds and private placements, and loans and investments from the government to public sector enterprises.
2 The incremental capital output ratio is defined as the sum of gross investment divided by the total change in GDP over the period. Source: CSO; RBI; Public Enterprise Survey; McKinsey Global Institute analysis
Amount of investment needed to generate $1 of additional output2
FY 2000-2005
6.8
3.9
2.8Private corporate sector
Household enterprises andproprietorships
Public sector
15.0Agriculture
Distribution of commercial credit1
$ billion, per cent, FY 2005
Priority sectorPublic sectorPrivate corporate sector
43
Priority sector lending
1 Excludes public food procurement credit2 Small businesses determined by either amount of capital, sales, or employees. Now includes small loans to software industry and
investment in venture capital funds registered with SEBI.3 Includes wholesale trade, tourism, and non-bank financial companies.
Source: RBI; CSO; McKinsey Global Institute analysis
PRIORITY SECTOR ACCOUNTS FOR NEARLY A THIRD OF TOTAL LENDING, LIMITING ACCESS TO THE PRIVATE SECTOR
4832
12
8 136
Other priority sectors2
Agriculture
4
Medium and largeenterprises and other privatesector3
100% =
4
912
14
87
FY 2000
16
147
323
FY 2007
OtherMortgagesConsumer credit
Small scale industry
Distribution of gross bank credit outstanding1
$ billion, per cent
44
1 Small businesses determined by either amount of capital, sales or employees. Now includes small loans to software industry and investment in venture capital funds registered with SEBI.
2 Includes non-priority sector commercial credit, mortgages, consumer loans, and other.Source: RBI; CSO; McKinsey Global Institute analysis
PRIORITY SECTOR LOAN DEFAULT RATE IS ~40 PERCENT HIGHER THAN THE NON-PRIORITY SECTOR
2.7
4.9
4.6
8.3
3.5Agriculture
Small scaleindustry
Other prioritysectors1
Prioritysector total
Non-prioritysector total2
Nonperforming assets relative to gross bank credit outstandingPer cent, FY 2007
1.8x
45
SMALL CORPORATE BOND MARKET LIMITS ACCESS TO OTHER FUNDING SOURCES
Corporate bondsPer cent of GDP, 20051
143
10285
7464
48 45 3928 27
15 13 102 138
21
Uni
ted
Stat
es
Ger
man
y
Uni
ted
Kin
gdom
Mal
aysi
a
Kor
ea, R
ep.
Sing
apor
e
Japa
n
Can
ada
Thai
land
Chi
le
Bra
zil
Sout
h A
frica
Chi
na
Phili
ppin
es
Cze
ch R
epub
lic
Indi
a
Pola
nd
Turk
ey
1 India as of March, 2005; If bonds issued by development banks were included, China’s corporate bond market would be 11% of GDPSource: McKinsey Global Institute Global Financial Stock Database
46
INDIAN COMPANIES HAVE VERY LOW LEVELS OF DEBT
Note: Numbers may not add due to rounding1 as of March 2000 and 2005
Source: Central banks of respective countries; EIU; McKinsey Global Institute Global Financial Stock Database; McKinsey Global Institute analysis
Corporate bondsCorporate bank loans
89
119
22
109
83
22
48
0 50 100 150 200
68 157Malaysia
27 146Singapore
117 139United States
10 119China
34 118Hong Kong
56 78South Korea
23 71Chile
13
2
14India1
51
74
31
113
85
40
51
0 50 100 150 200
74 125
50 123
143 174
13 126
50 135
68 108
31 82
16
2
17
Corporate borrowingPer cent of GDP, 1999
Corporate borrowingPer cent of GDP, 2004
47
20 2634 39
35 4047 52
6610
India
2
72
1,916
Japan
3
63
40
Indonesia
3
59
562
South Korea
55
2
Singapore
4
55
91
Malaysia
47
100
United States
42
393
Hong Kong
EquityDebt
Internal funds
100% =
78
204 89
1 Based on sample of 160 companies per country outside of United States. Companies were ranked by gross sales, and 40 companies from each quartile were taken as the sample. US sample includes all listed companies with revenues exceeding $500 million, 1995 to 2004.
Source: Bloomberg; McKinsey Global Institute analysis
INDIAN FIRMS RELY HEAVILY ON RETAINED EARNINGSSources of funds raised
$ billion; percent, 2000–051
48
~ 55% OF EQUITY SHARES ARE HELD BY CORPORATE INSIDERS
1 Includes all those who, in bringing into existence a company or converting their private business into a company, secure control of the management of such company through shareholding and/or otherwise
Source: ISMR; SEBI
14
116
100
54
“Insiders”1 Indianpublic
6
Private corpora-tions
5
NRI’s, foreign corpora-tions
Foreign institu-tionalinvestors
FIs, banks, insurance compa-nies
3
Mutualfunds
Institutional Investors
Shareholding of NSE equity listingsPer cent, December 2006
49
KEY MESSAGES
• Indian financial sector has grown rapidly and recorded strong performance on back of continued reforms
•However, financial deepening has to be acclerated, else it could constrain the full potential of the Indian economy going forward
•Pursuing a continued integrated reform agenda for the financial system can help support and enable India’s high GDP growth trajectory
50
Source: McKinsey Global Institute analysis
Financial system problems
Key outcomes
INCREASING FINANCIAL DEPTH IS A KEY IMPERATIVE FOR THE FINANCIAL SECTOR
Underdeveloped domestic
institutional investors
Underdeveloped consumer
finance market
Suboptimal distribution of capital in the
economy
Very small corporate bond
market
Low lending rates and
conservative approach in
banking
Limited household
participation in capital markets
Root causes:• Lack of
competition in banking and high state ownership
• Statutory liquidity ratio and directed lending policies
Root causes:• Cumbersome
issuance procedures
• Lack of investor demand
• Poor bankruptcy procedures and lack of creditor rights
Root causes:• Restrictions on
asset holdings• Government
ownership of intermediaries
• Above-market deposit accounts
51
DOMESTIC INSTITUTIONAL INVESTORS ARE UNDERDEVELOPED IN INDIATotal assets as percent of GDP, 2005
60.3France
33.1US
22.8Korea
18.7Chile
6.2Thailand
6.3China1
3.8Mexico
4.6Poland
1.2Brazil
13.3India
0 10050
Life insurance
3.5
66.0
3.9
59.4
8.0
1.7
0.2
9.5
20.4
4.2*
0 10050
61.2
69.9
25.3
11.1
10.0
2.5
6.1
4.6
39.6
6.0**
0 10050* Includes only provident funds ** as on March 2006
Source: Financial institution regulators; industry groups; and central banks of respective countries
Registered pensions Mutual funds
52
A PHASED APPROACH HAS TO BE ADOPTED FOR A TRANSFORMATION OF THE INDIAN BANKING SECTOR
Source: McKinsey analysis
• Create 3-4 global sized institutions, 6-8 national champions
• Reduce government participation in the sector
• Allow greater access to foreign banks
• Separate central bank and regulator roles
• Remove directed lending and branch restrictions
• Encourage market driven consolidation
• Move to a coordinated regulator model
• Support creation of industry utilities for processing
• Enrich human capital and support re-skilling of employees
• Ease capital restrictions• Provide more operational
freedom to public sector banks • Develop blue print for sector
• Offer market based incentives for under-penetrated segments
• Remove regulatory arbitrage across different entities
• Effectively implement principles of good corporate governance
• Accelerate credit bureau and payment infrastructure
Industry structure
Social development
Unified regulator
Corporategovernance
Supporting infrastructure
Labour reforms
Build infrastructure and capabilities 1
Apply competitive pressure to local banks 2
Move towards freer structure3
53
Source: RBI; CSO; McKinsey Global Institute Analysis
6.3
5.1
2.321.8
7.8
Improved banking efficiency to best practice
Fully imple-mentelectronic payment system
Migrate informal lendingtoformalbanks
0.3
Reduce corporatebond default rates to bench-mark
Shift infinancing mix from bank loans tobonds
Direct impactof financialsystemreform
0.91.1Percent of GDP 0.7 0.1 3.20.3
18.9
6.6
25.5
Improvedallocationof capitalCapturingmoresavings
3.5
FINANCIAL SYSTEM REFORMS ARE WORTH US$48 BILLION ANNUALLY
US$ billion, FY 2005
Direct impact of financial system reform Indirect impact
54
MORE EFFICIENT INVESTMENT AND FINANCIAL MARKET REFORMS CAN BOOST INDIA’S GROWTH RATE TO 9.4 PERCENT
1 Compound annual growth rate.Source: CSO; RBI; Oxford Economics; McKinsey Global Institute analysis
0
200
400
600
800
1,000
1,200
1,400
1,600
1995 2000 2005 2010 2015
US$ billion 2000, fiscal year 2005–2015
9.4%
6.5%
CAGR1
1995–20055.9%
Baseline
Efficient investment and financial market reform
2015 per capita income: US$ 919
2015 per capita income: US$ 1,203
Real GDP CAGR1