0

20

40

60

80

100

120

0

5

10

15

20

25

30

35

40

Feb-64 Mar-73 Mar-83 Mar-93 Mar-03 Mar-13

US Monetary Indicators

M2 [YoY %Growth]

Base Money[YoY Growth%]

India Economic Outlook

The steep jump in YoY growth of Base Money between 2008 and March 2009 was due to the Federal Reserve’s QE1 where

it started buying Mortgage backed securities and ended up with $1.75 trillion of bank debt, mortgage-backed securities,

and Treasury notes in March 2009 from around $700 billion in 2008. It also resulted in a growth in M2.

Since late 2013, M2 has decelerated due to the Fed’s tapering where it has cut back on its monthly bond purchase

program. This is leading to a contraction of money supply in the economy. The Fed may have to ease off a bit on its

tapering to prevent a total slump of M2. Also the Fed is keeping a close watch on the target 2% inflation rate and 6.5%

unemployment rate in order to hike the interest rate.

Abenomics pillared upon fiscal stimulus, monetary easing and structural reforms which includes a 2% annual inflation

target by boosting monetary growth which has weakened the Yen to counter excessive Yen appreciation. This in turn will

lead to a reduction in fiscal deficit and push asset prices up also increasing real and nominal GDP. But an increase in

consumption tax to 8% in 2014 and an expected 10% in 2015 will have to be met by an increase in the degree of

quantitative easing. Only those expecting a pay rise would be able to spend contributing to the demand. But most will cut

back on spending due to the high consumption tax.

-3

-2

-1

0

1

2

3

4

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13Japan PrimaryBalance (% ofGDP) [LHS]

Japan CPI YoY% [RHS]

Japan CPI coreYoY % [RHS]

QE3 tapering leading

to deceleration of

Base Money and M2

over 2014

QE, monetary growth

weakens Yen;

Higher the inflation,

lower the primary

deficit

With a near zero Fed funds rate, the unemployment rate has fallen below the threshold 6.5% which has

been because of moderate growth in employment. The Fed believes that it needs to run a 2% target inflation

to see a healthy economic revival. Before this the Fed was using the threshold 6.5% unemployment rate to

hold the Funds rate near zero but has switched to inflation as a metric to hold funds rate.

Tax hikes and spending cuts by the Obama led government has reduced the fiscal deficit considerably but

hasn’t eliminated it. Heavy military spending over the last couple of years towards operations in the

unsettled Middle-East region has added to the deficit woes.

On a year by year basis budget deficit isn’t a concern, but if debt as a % of GDP (debt/GDP ratio) reaches a

100% then creditors might fear a rising risk of default. The US has already raised the debt ceiling to $16.7

trillion and debt has risen steeply since the crisis.

0

5

10

15

20

Jan-78 Jan-83 Jan-88 Jan-93 Jan-98 Jan-03 Jan-08 Jan-13

US Federal FundsRate %

Core PCE DeflatorYoY %

Core CPI YoY %

-800

-600

-400

-200

0

200

400

600

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Monthly Change in US Non-Farm

Monthly Changein US Non-Farm

Near zero Fed funds

rate, 2% target

inflation not reached

As the monopoly supplier of monetary base, the ECB , is targeting a 2% inflation rate concerns over

disinflation is rising over the Eurozone. There is a possibility that such low inflation rates might lead to a fall

in asset prices, prices of goods and services and wages. People start spending reluctantly and demand falls.

Repayment of loans becomes more costly because a low inflation rate means a high real interest rate

(borrowers lose out). This may become a deflationary cycle which starts feeding off itself. Here, the ECB

might be cornered into using negative interest rates as a tool to stir up inflation.

The YoY growth of the Harmonized Index of Consumer Prices (HICP) as measured by the ECB, harmonized for

the entire Eurozone stood at 0.8% in Jan 2014.

M3 growth has been well below ECB’s 4.5% YoY target. So we might as well see a cut in interest rates which

will follow on from an asset purchasing program (quantitative easing) of the ECB just like the US Federal

Reserve’s.

-40

-30

-20

-10

0

10

20

30

40

50

60

70

80

Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

MoneySupply M3YoY%

Base MoneyEU YoY %

-1

0

1

2

3

4

Dec-01 Dec-05 Dec-09 Dec-13

Euro Interbank Rate(overnight)

EU Harmonized CPI YoY %

M3 still below ECB

target (4.5% YoY);

QE likely to start, may

cut down interest

rates

ECB target 2%

inflation incomplete;

Fear of deflationary

cycle looms

Clearly China’s M2 money supply has risen more than sharply from 2008 all the way into 2014 which is

almost 1.6 times the M2 of the US. Due to heavy social financing prevalent in China, hence more money

supply resulting from the money creation process. Countries with mature financial markets like the US have

lower M2/GDP ratio due to direct financing.

This excess liquidity (money supply) might have gone towards inflating an asset bubble in China. China’s M2

must grow less that nominal GDP in order to prevent the asset bubble from bursting and cut back property

price.

With Social financing expected to slow down in 2014, it is a positive sign to reduce the risk and pressure on

the banking system. Also M2 has grown at a much faster pace than GDP which indicates oversupply of

money.

0

2000000

4000000

6000000

8000000

10000000

12000000

14000000

16000000

18000000

20000000

Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12

EU

China

Japan

US

Money Supply M2 (US$ mn)

0.75

1.00

1.25

1.50

1.75

2.00

2.25

0

20000

40000

60000

80000

100000

120000

Dec

-96

Dec

-98

Dec

-00

Dec

-02

Dec

-04

Dec

-06

Dec

-08

Dec

-10

Dec

-12

Money SupplyM2

SMAVG (4) ofNominal GDP

M2/GDP Ratio

Steep rise in M2:

China;

Rising US M2, result

of QE 1,2,3

High M2/GDP ratio,

excess liquidity;

Concern over inflated

asset bubble bursting

US imports from Asia grew negatively YoY at -29% in 2009 during the helm of the Global financial crisis after

growing positively YoY for a span of 7 years from 2002.

Though Asia exports to the US have rebounded from 2010 onwards, we can notice a slight slump in Asian

exports after 2H FY2012. This can be rightly attributed to the gradual revival of the US manufacturing and its

on-shoring. But Asia’s exports are set to strengthen over the second half of 2014 though new orders haven’t

shown any steady growth as reported by the ISM.

-45%

-30%

-15%

0%

15%

30%

45%

Nov-95 Nov-99 Nov-03 Nov-07 Nov-11

US Imports from Asia-10 (YoY % 3mma)

US Imports fromAsia-10 (YoY %3mma)

0

10

20

30

40

50

60

70

80

Dec-94 Dec-98 Dec-02 Dec-06 Dec-10

US ISM new orders

US ISM new orders

Rebound in US

imports;

Sluggish growth in

Asian Exports due to

US onshoring

We must note that Asia has had consistent current-account surpluses since 1998 (after the Asian Financial

Crisis) and China since 1994.

Along with this Asia has received consistent net positive FDI though FPI and other investments have not

been consistently positive over the years. But the high Current Account surplus has been able to negate the

net FPI and other investments and has kept overall BoP positive.

On observation, China’s Current Account surpluses have been larger, averaging around 8-8.5% and overall

BoP surpluses rose to their all-time high in the period 2008-09.

These surpluses may have aggravated the excess liquidity situation that then went into pushing up asset

prices, especially in a situation where the Chinese Yuan was fixed and not allowed to appreciate against the

dollar.

China’s Forex reserves have risen somewhat steadily over the past 12 years from 1999 until 2011.But over

the period between 2011 and 2013 forex reserves have grown rather sheepishly in anticipation of broader

tightening of policy.

China’s Reserve import cover has risen consistently from around 9 months in Dec 2000 to almost 29 months

in Dec 2009. But fell sharply between Dec-09 and Dec-11 to 19 months.

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

4000000

4500000

Forex Reserves China

Forex ReservesChina

0

5

10

15

20

25

30

35

Jan-99 Jan-02 Jan-05 Jan-08 Jan-11

China Reserve Import Cover (months)

China Reserve ImportCover

In India, a reversal of capital inflows resulting from QE tapering could destabilize the rupee and the country's

equity market. Net capital inflows into the Indian economy totalled $88 billion in 2012, accelerated by global

quantitative easing.

In Indonesia a reversal of the FPI due to tapering could lead to heavy pressure on the BoP in turn weakening

the Indonesian Rupiah.

Also any sudden move by the US Fed could leave a devastating impact on emerging markets assets like the

sell-off and capital flight that was witnessed in May 2013.

Property deflation is a medium-term threat to China. China has seen land-price appreciation since 2002 due

to the excess liquidity that went into pushing up asset prices. Japan has seen its fair share of land price

inflation between 1986 and 1990.

China’s demographic dividend ended in 2013, and its dependency ratio is now rising and working-age

population declining where the numbers of dependents are on the rise which might lead to depletion of

savings. Supply of cheap labour is also reducing pushing the govt. to raise wage rates to compensate for slow

labour growth.

-10

-5

0

5

10

15

20

25

Japan Land PriceInflation YoY %

China Land PriceInflation YoY %

30

40

50

60

70

80

90

100

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

(%)

ChinaJapan

Demographic

dividend

Demographic debt

Gross Fixed Capital Formation refers to the outlays on additions to fixed assets and net changes in

inventories. It includes land, infrastructure and machinery of all kind, investments made by public, private

corporate and household sectors.

Indonesia, China, India, Taiwan and Philippines are the only countries that have had a net positive change in

GFCF over the 7 years from 2004 to 2011. Among these Indonesia and India have had substantial addition to

Fixed capital formation as indicated by the chart. This seems to be a positive sign as domestic investment

from the all three sectors have helped the economy to expand. China’s increase in GFCF can be attributed to

the excess liquidity which has gone not only toward fixed asset creation but also contributed to the

escalation of asset prices.

China’s low cost of capital (and under-valued Renminbi) has resulted in an investment boom, and an

excessively capital-intensive pattern of economic growth. To avoid any imbalances China is expected to

allow the Renminbi to appreciate slightly.

17.83

37.82

-14.60

92.77

13.53

-3.59

-21.02

-4.53

16.67

-3.52

-7.37

-12.92

-9.66

-50 0 50 100

China

India

Singapore

Indonesia

Philippines

European Union

United States

South Korea

Taiwan

Hong Kong

Malaysia

Japan

Thailand

Gross Fixed Capital Formation: 2004 vs. 2011 (% change)

Gross Fixed CapitalFormation: 2004 vs. 2011 (%change)

(8)

(4)

0

4

8

12

Dec-97 Dec-00 Dec-03 Dec-06 Dec-09 Dec-12

Asia-10's current account surplus moderating (as % of GDP, 4Q rolling sum)

Asia-10 US ASEAN-4+Korea

The 10-year moving average of real GDP growth has risen close to 8% – but the 5-year moving average

slumped to 6.2% in Dec 2013, having peaked at 8.9% in FY2006/07, just before the Global Financial Crisis.

Though the pace of 10yr moving average GDP growth rate has slowed down since Dec 2011, the Modi

government’s investment led approach to growth may improve business sentiment which might provide an

incentive for revival in private investment. With inflation hovering around 6%, real GDP is expected to grow

from a low of 4.3% in Dec 2013 to 6.4% by Dec 2015.

The near term challenges for the Indian economy in the next 12 months include El Nino and the recovery of

exports while the US Fed’s QE tapering and consequent change in capital inflows along with global economic

environment are medium term challenges.

Clearly we can notice that a high level of investment since 2001 has been responsible for spurring GDP

growth since 2004. GFCF has also been a major contributor to the increase in real GDP coupled with heavy

government spending.

0

2

4

6

8

10

12

Jan

-80

Jan

-83

Jan

-86

Jan

-89

Jan

-92

Jan

-95

Jan

-98

Jan

-01

Jan

-04

Jan

-07

Jan

-10

Jan

-13

Jan

-16

Jan

-19

Real GDP YoY %

Real GDP (5yr SMAVG)

Real GDP (10yr SMAVG)

0

5

10

15

20

25

30

35

40

0

1

2

3

4

5

6

7

8

9

10

GDP: YoY %(5yr SMAVG)(LHS)

GDI: % of GDP(RHS)

India Real GDP growth:

five and ten year moving

averages

Investment/GDP ratio as

a measure of rate of GDP

growth

India’s GFCF has witnessed a growth from FY 04 due to heavy government as well as private spending. A

good portion of the govt. spending can be attributed towards infrastructure development (roadways, ports

etc.) and employment programs of the Govt. of India such as the MGNREGA among others. The fall in GFCF

from 2011 to 2014 has been due to the Govt cutting back on its spending program especially Capital

Expenditure and Subsidies.

0

5

10

15

20

25

30

35

4019

95-9

6

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

% o

f G

DP

Gross Capital Formation (% of GDP)

GrossCapitalFormation(% of GDP)

0

5

10

15

20

25

30

35

40

% o

f G

DP

Bank Credit Growth [India]

Bank CreditGrowth

Growth in Manufacturing has not been consistent and has stagnated between 2010 and 2014 causing a

slump in Real GDP. NREGA has successfully boosted rural consumption despite a slowdown in urban

consumption. This implies that any improvement in overall consumption will be driven by rural

consumption.

There are concerns over growth in Agriculture due to the impending fears over El-nino posing a widespread

threat to production. But the new DMIC which is under development and 3 newly commissioned NMIZ’s (1

in AP & 2 in Karnataka) should be instrumental in spurring GDP growth under Modi.

To add to the woes heavy oil and gold imports have also mounted pressure on India’s CAD. The rise in gold

import duty and lower oil imports over the last year and a half should allow the CAD to moderate by the end

of FY 14.

-10

-5

0

5

10

15

20

25

30

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Real GDPYoY %

Agriculture

Industry

0

5

10

15

20

25

30

35

40

45

50

-12000

-10000

-8000

-6000

-4000

-2000

0

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

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

Ru

pee

s B

illio

n

Trade balance[Export - Import]

MerchandiseExports YoY %

MerchandiseImports YoY %

-6

-5

-4

-3

-2

-1

0

1

2

3

1970

-71

1972

-73

1974

-75

1976

-77

1978

-79

1980

-81

1982

-83

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

2000

-01

2002

-03

2004

-05

2006

-07

2008

-09

2010

-11

2012

-13

India CAD as a % of GDP

CAD as a% ofGDP

-5

0

5

10

15

20

25

30

35India Inflation [WPI YoY %]

Inflation - AllCommodities

Inflation - FoodArticles

Inflation - Fuel& Power

Inflation -ManufacturedProducts

Current Account Balance

(CAD) = Trade Balance +

Net Invisibles