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The Indian Economy 20 20 Mc Kinsey
 

The Indian Economy 20 20 Mc Kinsey

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    The Indian Economy 20 20 Mc Kinsey The Indian Economy 20 20 Mc Kinsey Presentation Transcript

    • Perspectives on the Indian Economy and the Financial Sector Renny Thomas, Partner McKinsey & Company October 2007 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.
    • CONTENTS • Perspectives on Indian Economy – Context of Indian economy – Forces likely to propel India ahead – Challenges for the growth Perspectives on Indian Financial Sector 1
    • INDIA’s GDP HAS RISEN STEADILY SINCE THE 1950’s. . . Real GDP growth* US$ billion 7.3% Average growth 709 rate of 8.6% over the last 4 years 5.2% 464 4.4% 279 3.4% 118 60 1950 1970 1990 2000 2006 Population 365 548 850 1,016 1,112 (Million) * Base year = 2002 Source: Global Insight; Economic Survey of India; Team Analysis 2
    • AS GROWTH HAS INCREASED VOLATILITY HAS DECREASED Per cent 7 10-year 6 mean growth 5 4 3 2 10-year volatility of 1 GDP growth 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: RBI; EIU 3
    • AND TRANSFORMED INDIA FROM AN AGRARIAN TO A SERVICES-LED ECONOMY Value added to GDP (Per cent) India China 25.0 Services** 39.0 40.0 55.0 46.0 Industry* 24.0 50.0 27.0 Agriculture 37.0 29.0 18.0 10.0 1980 2006 1980 2005 * 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 4
    • SEVERAL MEGA INFRASTRUCTURE PROJECTS High Low ARE SET TO CHANGE THE LANDSCAPE Likelihood of Planned spending Project completion (timeframe) Details US$ billion 2 (2006-07) • Providing basic healthcare services to the rural National Rural Health Mission* population National Urban Renewal 1 (2006-07) • Developing urban infrastructure and providing Mission* basic services to the urban poor in ~ 63 cities 2 (2006-07) • Extending primary education to all children, Sarva Shiksha Abhiyan* especially in rural India National Rural Employment 3.2 (2006-07) • Providing income security to the poor and Guarantee Scheme* bridging the rural poverty gap 1.1 (2006-07) • Providing free mid-day meals to all children in Mid-day Meal Scheme* government, corporation, panchayat and municipal schools Rajiv Gandhi Drinking Water 1.1 (2006-07) • Supplying safe drinking water in the rural areas Mission* 0.2 (2006-07) • Extending sanitary facilities in rural India Total Sanitation Campaign* Integrated Child Development 0.9 (2006-07) • Improving the nutritional and health status of Services* children in the age group of 0-6 years and reducing the incidence of infant mortality 4 (2010) • Upgrading Delhi’s infrastructure in preparation Commonwealth Games 2010 for games * Government Flagship Programmes Source: Economist; Press-articles; Government Budget Speech 2006-07; Analyst Reports; Team Analysis 5
    • CONTENTS • Perspectives on Indian Economy – Context of Indian economy – Forces likely to propel India ahead – Challenges for the growth Perspectives on Indian Financial Sector 6
    • A GROWING WORKING AGE POPULATION WILL PROPEL GROWTH TILL 2035 LATER THAN CHINA Working age population (age 15-60) Per cent of total population - Average no. of people per 72% household in 2007 70% 68% India 5.5 66% Brazil 4.0 64% 62% China 3.7 60% Russia 2.8 58% G6 2000 2005 2010 2015 2020 2025 2030 2035 2040 Source: Global Insight; Team Analysis 7
    • HOUSEHOLD INCOMES WILL ACCELERATE ACROSS INDIA Average household disposable income Compound annual Thousand; Indian rupees; 2000 growth rates 1985-2005 2005-2025 Actual Forecast Urban 500 400 All India 300 5.8% 200 5.3% Rural 4.6% 3.6% 100 3.6% 2.8% 0 1985 1990 1995 2000 2005 2010 2015 2020 2025 Source: McKinsey Global Institute 8
    • THE SHAPE OF INDIA’s INCOME PYRAMID WILL CHANGE DRAMATICALLY AS INCOMES GROW Household income Number of Aggregate brackets households consumption Thousand, Indian Million Trillion, Indian rupees, rupees, 2000 2000 • Middle class to Globals (>1,000) 1.2 1.2 swell from just Strivers (500–1,000) 2.4 1.0 under 50 million 2005 Seekers (200–500) 10.9 2.1 today to about Aspirers (90–200) 91.3 8.5 583 million by 2025 Deprived (<90) 101.1 4.1 • By 2025, India will Globals (>1,000) 3.3 4.1 produce 2 million Strivers (500–1,000) 5.5 2.7 globals annually 2015 Seekers (200–500) 55.1 11.8 • Share of incomes Aspirers (90–200) 106.0 12.2 of the middle Deprived (<90) 74.1 3.3 class and globals will rise from less Globals (>1,000) 9.5 14.1 than 30% today to Strivers (500–1,000) 33.1 16.5 more than 80% by 2025 2025 Seekers (200–500) 94.9 24.6 Aspirers (90–200) 93.1 11.9 Deprived (<90) 49.9 2.4 Source: MGI India Consumer Demand Model, v1.0 9
    • CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$585 BILLION DURING 2007-12 (1/2) Expected Area spend Key projects US$ billion • Six-laning of 6,500 kms and four-laning ~18,000 Roads 96 kms of corridors and highways • Dedicated Freight Corridors between Mumbai- 73 Delhi and Ludhiana-Kolkatta, ~10,300 kms of new Railways railway lines; modernisation of 21 railway stations Power (generation, • Additional generation capacity of ~70,000 MW transmission, 177 (includes rural areas) and distribution) 21 • Capacity addition of 485 million MT in major Ports Ports; 345 million MT in minor Ports • Modernisation and redevelopment of 4 metro and Airports 10 35 non-metro airports • Construction of 7 green-field airports in North East Source: Planning commission; 10
    • CURRENT PLANS REVEAL ASPIRATIONS TO SPEND OVER ~US$585 BILLION DURING 2007-12 (2/2) Expected Area spend Key projects US$ billion • Growing subscriber base to 600 million, including Communi- 200 million rural telephone connections cation 77 • Providing broadband access to 20 million and 40 million internet connections Water 57 • Water supply and sanitation projects • Developing 16 million hectares through major, Irrigation 62 medium and minor irrigation works • Gas distribution infrastructure Gas 6 – LNG terminals, gas transmission lines, city gas distribution • Storage to support agricultural development Storage 6 Total 585 Source: Planning commission; 11
    • A ROBUST AND HIGH-GROWTH PRIVATE SECTOR CONTINUES TO BOOST CONFIDENCE LEVELS The transformation Local corporates expanding overseas Number of billion dollar companies Spurt in number of cross-border deals by Indian companies 2006 2007* 175% 88 Deals # 163 143 increase 5 Value $23 bn $18 bn 9 Some success stories • Incorporated in 1995, world's 5th 30 leading & Asia's leading manufacturer of wind turbines • Current sales of US$1.7 billion and market cap of US$9.8 billion >US$10 bn 32 • Became a bank in 2000; 2nd largest bank 1 in India today US$5-10 bn 4 • 30-50% market share across classes 6 44 US$2-5 bn • Current market cap* US$24 billion • (US$0.6 billion in 2000**) US$1-2 bn 21 • India's largest automobile company, with revenues of US$6.9 billion 2006-07 • World's fifth largest medium and heavy 1998 2007 commercial vehicle manufacturer • Current market cap of US$6.6 billion * As on 14 Sep 2007 ** As on year end *** Not all deals mentioned disclose deal financials. Deal values are the sum of only those deals where financials were publicly announced (90 deals in 2006 and 87 deals in 2007) Source: Press articles; CMIE; Dealogic; Prowess; Team Analysis 12
    • INDIAN COMPANIES ARE AGGRESSIVELY ESTABLISHING GLOBAL FOOTPRINT Cross-border M&A by Indian companies The recent spurt in Number of Average outward FDI is caused Deals* Deal Size** by: 250 350 • Regulatory changes: Indian companies can now make overseas 300 200 investments equal to 300% of their net worth on an 250 automatic approval basis 143 150 200 • Easy access to capital – Decline in interest rates 100 150 coupled with liberal lending policies adopted by banks 50 100 – Active participation by PE 50 firms – Nearly 20% of the 50 deals were backed by private funds in 2006 0 0 2000 2007*** * Number of deals for calendar year 2000, and till Sep 2007 ** Average deal size is based on deals for which the values has been disclosed *** As on 13 September, 2007 Source: Dealogic; Team Analysis 13
    • SIMILARLY, MNCs ARE ACTIVELY SEEKING THE INDIA OPPORTUNITY… Acquisitions of Indian companies by MNCs No. of 166 131 110 195 301 250 Break-up by sector Deals* 27.442 Per cent of Total Deal Value, 2007^ Others Services** 16 Telecom 35 4 Cons- 10 truction 10.969 13 Hi-Tech 22 5.748 3.030 2.268 2.502 Manufacturing*** Value US$ billion 2002 2003 2004 2005 2006 2007^ ^ 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 14
    • THERE ARE 7 MANTRAS FOR SUCCESS IN INDIA… Strong India Commitment Leverage India’s resources 1 and local team for global requirements 5 Redesign supply chain to 2 Create & Shape the Market profitably deliver value 6 Acquire if necessary, but re- Actively shape and manage 3 assess cost of capital perception and regulation 7 Indianise product and get 4 the price-value equation right Source: McKinsey team analysis 15
    • IN SUMMARY, INDIA IS ON COURSE TO BE AN ECONOMIC SUPER POWER OF THE 21ST CENTURY India – most rapid growth potential of the BRICs India – will contribute Real GDP growth (Per cent) a giant share of the incremental GDP growth 9 Fastest growing global of major world economies* 8 economy by 2012 7 Per cent 20.1 6 India 5 China 4 Brazil 3 2 5.0 Russia 2.1 1 0 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2000 2020 2050 • 11th largest economy today (GDP US$560 billion) • 4th largest by 2025 (GDP US$3,200 billion, six-fold increase) * Major world economies considered are the BRIC and G6 countries Source: Goldman Sachs BRIC report 2003 16
    • AND GROWTH IN INDIA IS AT AN INFLECTION POINT, SIMILAR TO CHINA 15 YEARS AGO Triggers behind growth Real GDP growth PPP adjusted* inflection in India US$ billion Inflection • Taxes: Laws simplified 8,000 scenario resulting in better compliance and ease of 7,000 China tax payment CAGR = 10.1% • Infrastructure: Increased 6,000 (1990-2005) investment in 5,000 infrastructure e.g., Ultra Inflection in Conservative Mega Power Projects 4,000 China GDP growth • Liberalisation: FDI in key estimates sectors like airports, 3,000 India NBFCs, Insurance, 1990-2005 electrical equipments, 2,000 CAGR = 5.98% telecommunications, 1992: India construction etc allowed 1,000 1978: China liberalizes liberalizes 0 “Lead indicators” 1980 1985 1990 1995 2000 2005 2010 of inflection visible in India * Base year: 2002 Source: Global Insight; Team Analysis 17
    • CONTENTS • Perspectives on Indian Economy – Context of Indian economy – Forces likely to propel India ahead – Challenges for the growth Perspectives on Indian Financial Sector 18
    • THERE ARE CHALLENGES THAT COULD DETER GROWTH Risks (in decreasing order of likelihood) Description Mitigating factors 1. Internal political • Large number of parties • Universal adult suffrage - a correction complexities • Differing ideologies mechanism (high) • Regional agendas influence • "Public stance" guarded – but parties national policy realize liberalisation imperatives 2. Socio - • Highly fragmented country • Few budgetary, fiscal and supply side economic factors geographically measures announced by the Govt. (moderate) • Risk of social unrest, resulting • Numbers below poverty line reducing from increasing income divide – urban and rural India • Realization (in last election) that only broad-based economic reform is – rich states and poor states sustainable • Higher inflation 3. External • US economy slows down • Low interest rates factors • Rising oil prices • Measures to increase FDI inflows and (moderate) competitiveness to capture a larger share of world trade • Border tensions with Pakistan • Strong progress in Pakistan relations 4. Military conflict and China across two different governments (low) • Instability in Nepal • China border issue (Sikkim) resolved recently Source: Team Analysis 19
    • 2. Socio-economic factors INDIA IS A LARGE COUNTRY WITH HUGE Total land GEOGRAPHIC FRAGMENTATION Arable land 2006; Million Hectare; per cent Arable land as a proportion to total land across most However in India land used countries range between 4 – 10% for agricultural purposes its Country Land acreage % arable as high as 48% 963 17.8% US 171 329 48.5% 846 7.09% Brazil 60 161 998 Canada 4.6% 46 960 China 15.4% 148 Total Arable land land 768 Australia 6% 46 Arable land in India is the highest and almost as 1,710 much as that available in Russia 7% 121 the US in absolute terms Source: Euro Monitor 20
    • 1. Internal political complexities THE BIGGEST RISK IS POLITICAL INDECISION WHICH COULD PREVENT INDIA FROM CAPTURING ITS POTENTIAL Reforms completed • Lack of nationwide VAT coupled with Reforms pending lower indirect taxes • Urban land ceiling act Reforms under • Small scale reservations • Unclear land titles consideration/ • Poor regulation in power sector • Tenancy laws work under way • High import duties • Low property taxes • Central PSUs • FDI restrictions (e.g., retail) and low user charges • State PSUs • Delicensing key sectors (e.g. coal, • Urban transportation including power fertiliser, retail, mining, railways) infra-structure • Municipal services 0.7 0.3 10.1 Last 2 years 1.3 7% GDP growth 2.3 5.5 Overall downside in India is limited. Biggest risk is un-captured potential India (growth Product Land market Government Others India rate in 2000- market barriers ownership barriers, e.g., (complete 01) barriers (affects real labor market reforms) estate and retail sectors) * Public sector unit (i.e., government owned enterprises) Source: McKinsey Global Institute Study on Indian Economy (2001); Team Analysis 21
    • 2. Socio-economic factors LOW CONCENTRATION OF POPULATION IN TOP 5 CITIES 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 2006; Million; per cent 100% = 21 189 303 142 1,136 1,322 7 5 25 22 16 Population living in top 65 5 cities 94 95 75 79 84 Rest of 35 population Australia Brazil US Russia India China Source: Web search; Census 22
    • 2. Socio-economic factors INCREASING INCOME DIVIDE COULD LEAD TO RISK OF SOCIAL UNREST Urban income is 2.3X rural. . . . . .and income of rich states is 2.2X that of poor states Rs. ‘000, 2006 prices Rs. ‘000, current prices 49.8 +2.3X 21.7 28.5 +2.2X 12.9 Urban average* Rural average* Per capita income Per capita income per capita income per capita income average* of rich average* of poor states# states# * Average over 2002-2005 # Rich states are ones having higher per capita income than the All-India average, poor states are all others Source: Market Skyline 2006 – Indicus Analytics; Global Insight; CSO; Team Analysis 23
    • CONTENTS • Perspectives on Indian Economy Perspectives on Indian Financial Sector 24
    • 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 25
    • 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 26
    • INDIA’s FINANCIAL DEPTH HAS GROWN RAPIDLY Equity Corporate debt SINCE 2001 Government debt Bank deposits Financial depth Financial stock as a percent of GDP CAGR1 Per cent 1994- 2001- CAGR 2001 2006 14.1% 195 No 172 deepening 160 146 -7.5 31.5 89 56 70 122 5.9 33.9 98 116 110 47 106 95 108 2 2 26 2 5.2 6.5 93 94 1 3 5 41 32 23 1 39 31 25 1 30 33 34 34 36 34 30 2 1 2 2 24 27 2 20 22 19 20 17 18 3.2 2.1 57 64 65 68 66 64 46 44 44 48 51 53 40 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Note: Umbers may not add due to rounding 1 Compound annual growth rate Source: McKinsey Global Institute Global Financial Stock Database; team analysis 27
    • BANKING SECTOR HAS BEEN AT THE CORE OF FINANCIAL SECTOR GROWTH AND HAS CREATED SIGNIFICANT WEALTH FOR INVESTORS Contribution to economy of banking sector has improved over the years Indian banks have outperformed share indices in last few years Per cent New Private TRS CAGR Jan 01 – Oct 07 ~3.5 PSU Banks Banking Indian 1 value add Indian Market: 29.63% 1.6 Banking to GDP 1400 Bank index: 40.54% Old Private Old Private: 38.92% Indian 1994 2007 1200 Market New Private: 44.17% Rs billion 1000 Public Sector Banks: 42.67% 16.7 26,237 2 Deposits 800 3,500 600 1994 2007 400 Rs billion 20.6 19,496 200 3 Advances 0 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 1,700 1994 2007 Sources: RBI; national income statistics; Datastream; team analysis 28
    • FINANCIAL PERFORMANCE OF INDIAN BANKING SECTOR IS AMONG THE BEST IN THE REGION Per cent, FY 2006 Asset quality Profitability NPL/GDP NPL/Net loans Pretax ROA Pretax ROE Weak Malaysia 8.5 Philippines 15.1 Korea 0.1 Thailand 9.1 Singapore 6.7 Malaysia 8.5 Thailand 0.8 Philippines 10.1 China 5.9 Thailand 8.2 China 0.8 Singapore 12.4 Thailand 5.8 China 7.1 Philippines 1.2 Korea 14.9 Philippines 5.7 Singapore 6.7 Malaysia 1.3 China 15.1 Korea 2.1 Korea 1.6 Singapore 1.3 Malaysia 16.3 India 0.5 India 1.4 India 1.3 India 17.9 Strong * Data for all Scheduled commercial banks in India Source: Central banks of each country; Bankscope; CMIE, McKinsey analysis 29
    • OTHER FINANCIAL MARKETS HAVE BEEN ON AN ACCELERATED GROWTH TRAJECTORY OVER PAST FEW YEARS Life insurance Equity Mutual Fund New business premium Market capitalization; $ bn AUM; $ bn (APE)*; $ bn 9.9 816 75 +295% +519% +677% 19 1.6 105 2000-01 2006-07 2000-01 2006-07 2000-01 2006-07 Over the past few years the Indian market has witnessed accelerated growth across financial services * Based on full credit for regular premium + 10% credit for single premium Source: IRDA; AMFI; SEBI; McKinsey analysis 30
    • HOWEVER, JUST 3-4 YEARS OF HIGH ECONOMIC GROWTH SEEMS TO HAVE LED TO A SITUATION OF TIGHT LIQUIDITY AND RISING INTEREST RATES Rapid credit expansion in past few years… … resulting in tightening liquidity.. Outstanding advances; US$ billion Credit/deposits ratio; Per cent 72 75 448 59 55 61 +30% 341 Mar Mar Mar Mar Mar ’03 ’04 ’05 ’06 ’07 252 … and rising interest rates 196 10 year G Sec rates; Per cent 157 6.7 7.5 7.8 6.2 5.2 Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar ’03 ’04 ’05 ’06 ’07 ’03 ’04 ’05 ’06 ’07 Source: RBI; Bloomberg; McKinsey analysis 31
    • 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 32
    • OVERALL FRAMEWORK FOR ANALYZING FINANCIAL SYSTEM IN INDIA International financial system Savers Domestic financial system Borrowers Banking Bond Equity system markets market 1 3 2 Informal finance 4 1 Supply of funds from savers 3 Efficiency of each market 2 Allocation of funds to borrowers 4 Regulatory environment Source: McKinsey Global Institute analysis 33
    • BUT INDIA’s FINANCIAL DEPTH IS LOW Government debt Bank deposits COMPARED TO OTHER ASIAN NATIONS Equity Private debt Financial depth, 2006 Financial assets as a percent of GDP 504 427 369 104 281 155 45 243 254 209 220 195 92 145 43 51 65 119 78 138 89 14 13 43 22 10 60 70 5 37 42 36 150 56 32 6 134 129 24 85 94 64 58 70 39 Indonesia India Thailand China Philip- South Malaysia Japan* Singapore pines Korea Note: Numbers may not add due to rounding*Japan number is for 2005 Source: McKinsey Global Institute Global Financial Stock Database; McKinsey analysis 34
    • THIS IS DESPITE INDIA’S HOUSEHOLDS BEING AMONGST THE HIGHEST SAVERS IN THE WORLD Household savings as a share of gross national savings rates, 2005 Per cent 69 55 44 37 24 20 16 India France China* Mexico Japan South United Korea States Gross national savings rates 32.4 18.0 50.4 21.2 26.4 32.8 12.9 % of nominal GDP, 2005 * MGI estimate based on 2005 GDP and estimates of flow-of-funds information. Source: Country National Accounts; IMF; McKinsey Global Institute 35
    • LARGE PROPORTION OF HOUSEHOLD SAVINGS NOT ACCESSIBLE TO FINANCIAL SYSTEM Distribution of household savings by asset type $ billion, per cent 100% = 66 96 132 Machinery and 13 equipment 19 18 Construction 28 32 35 Financial assets 59 50 47 FY 1995 FY 2000 FY 2005 Note: Numbers may not add due to rounding Source: CSO; McKinsey Global Institute analysis 36
    • GOLD CONTINUES TO BE USED AS A SAVINGS VEHICLE DESPITE NEGATIVE RETURNS SINCE 1990 Index, adjusted for inflation Gold was an attractive investment in the . . . but has offered negative real returns 1970s and 1980s . . . in recent years 450 160 400 140 Bank Gold 350 deposits 120 300 100 250 80 200 60 Gold 150 Bank 100 deposits 40 50 20 0 0 1970 1974 1978 1982 1986 1990 1985 1988 1991 1994 1997 2000 Source: Press Trust of India; Bombay Bullion Association; McKinsey Global Institute analysis 37
    • ACCESS TO QUALITY BANKING PRODUCTS AND SERVICES IN INDIA IS LIMITED Access to banking products is significantly lower in India . . . . . . and is limited to large cities 2006; per cent 2006; per cent Card ATM penetration penetration* Per million people Per cent of 100% = 70,776 20,911 15,138 Rs bn population Metro centers 17 Australia 1,240 199 Top 100 Korea 755 362 17.9 centers 54.1 Singapore 477 335 excluding 65.4 metro centers Thailand 330 76 Poland 261 63 Mexico 246 51 Other 20.6 65.1 centers 16.2 Malaysia 229 130 Brazil 193 142 25.3 18.3 Philippines 81 15 China 51 61 Number Deposits Credit of bank India 19 7 branches * Includes both debit and credit cards; ** India Data as on March 2006 ; Mexico only credit cards Source: 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 38
    • INDIA’s GOVERNMENT CONSUMES 70 PERCENT OF NET SAVINGS INJECTED INTO THE FINANCIAL SYSTEM Net contributions to the financial system1 Per cent of GDP, average FY 1995-2005 ESTIMATED Household net contributions 9.0 to the financial system2 Foreign capital 1.2 inflows Private sector 3.2 borrowing Public sector 7.0 borrowing 1 Computed as sector specific savings minus investment 2 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 39
    • MORE THAN 80 PERCENT OF GOVERNMENT SECURITIES ARE HELD BY FINANCIAL INSTITUTIONS THAT ARE REQUIRED TO HOLD THEM Ownership of central government securities 100% = $ 306 billion, FY 20071 Financial institutions required to hold Public sector banks 45.5 government securities • Statutory liquidity ratio requires banks to hold 25% of assets in government Other banks 9.0 securities; actual holdings are higher • Life insurance companies must hold Insurance companies 25.0 50% of their assets in government or other approved securities; additional Employee provident 15% must be invested in infrastructure 6.0 and social sectors fund organization • Provident regulations cause 90% of Total regulated 85.5 assets to be held in government holdings securities RBI own account 8.0 Other 6.5 Total 100.0 1 Latest available data. * Using Rs. 41 as Rupee to dollar rate Source: RBI; McKinsey Global Institute analysis 40
    • INDIAN BANKS HAVE RELATIVELY A HIGH PORTION OF ASSETS IN GOVERNMENT SECURITIES Asset breakdown of banks Per cent, 2006 Fixed/other assets 5 8 2 12 10 13 Other securities 16 16 and cash 18 18 25 0 18 Government 25 0.8 16 15 12 securities 81 68 54 54 57 57 Loans India China Japan South United United Korea States Kingdom (2004) Source: RBI; bank financial statements; Financial Supervisory Service (South Korea); PBOC; Bank of England; Federal Reserve Bank of the US; McKinsey Global Institute analysis 41
    • MORE THAN HALF OF COMMERCIAL CREDIT GOES Priority sector Public sector TO SECTORS WITH LOW INVESTMENT EFFICIENCY Private corporate sector Amount of investment needed to Distribution of commercial credit1 generate $1 of additional output2 $ billion, per cent, FY 2005 FY 2000-2005 100% = 211 Private corporate Private corporate 30 2.8 discretionary sector Private corporate Household priority 13 enterprises and 3.9 Agriculture proprietorships 11 Household 7 enterprises and Public sector 6.8 proprietorships Public sector 39 enterprises Agriculture 15.0 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 42
    • PRIORITY SECTOR ACCOUNTS FOR NEARLY A THIRD OF TOTAL LENDING, LIMITING ACCESS TO THE PRIVATE SECTOR Distribution of gross bank credit outstanding1 $ billion, per cent Priority sector lending 100% = 87 323 Other 4 6 4 Mortgages 8 13 Consumer credit 9 12 Other priority sectors2 12 Agriculture 16 14 Small scale industry 14 Medium and large 7 enterprises 48 and other private sector3 32 FY 2000 FY 2007 1 Excludes public food procurement credit 2 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 43
    • PRIORITY SECTOR LOAN DEFAULT RATE IS ~40 PERCENT HIGHER THAN THE NON-PRIORITY SECTOR Nonperforming assets relative to gross bank credit outstanding Per cent, FY 2007 Agriculture 3.5 Small scale 8.3 industry Other priority 4.6 sectors1 Priority 4.9 sector total Non-priority 1.8x 2.7 sector total2 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 44
    • SMALL CORPORATE BOND MARKET LIMITS ACCESS TO OTHER FUNDING SOURCES Corporate bonds Per cent of GDP, 20051 143 102 85 74 64 48 45 39 28 27 21 15 13 10 8 3 2 1 United Kingdom United States Czech Republic Korea, Rep. Japan Poland Philippines Canada Chile South Africa China India Brazil Singapore Thailand Germany Malaysia Turkey 1 India as of March, 2005; If bonds issued by development banks were included, China’s corporate bond market would be 11% of GDP Source: McKinsey Global Institute Global Financial Stock Database 45
    • INDIAN COMPANIES HAVE VERY LOW LEVELS Corporate bonds Corporate bank loans OF DEBT Corporate borrowing Corporate borrowing Per cent of GDP, 1999 Per cent of GDP, 2004 Malaysia 89 68 157 51 74 125 Singapore 119 27 146 74 50 123 United 22 117 139 31 143 174 States China 109 10 119 113 13 126 Hong Kong 83 34 118 85 50 135 South Korea 22 56 78 40 68 108 Chile 48 23 71 51 31 82 2 2 India1 13 14 16 17 0 50 100 150 200 0 50 100 150 200 Note: Numbers may not add due to rounding 1 as of March 2000 and 2005 Source: Central banks of respective countries; EIU; McKinsey Global Institute Global Financial Stock Database; McKinsey Global Institute analysis 46
    • INDIAN FIRMS RELY HEAVILY ON RETAINED EARNINGS Sources of funds raised $ billion; percent, 2000–051 100% = 204 1,916 40 562 89 91 100 393 Equity 2 2 3 3 4 6 6 10 Debt 20 26 34 39 35 40 47 52 Internal 78 72 funds 63 59 55 55 47 42 India Japan Indonesia South Singapore Malaysia United Hong Korea States Kong 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 47
    • ~ 55% OF EQUITY SHARES ARE HELD BY CORPORATE INSIDERS Shareholding of NSE equity listings Per cent, December 2006 Institutional Investors 100 3 6 11 5 6 54 14 “Insiders”1 Indian Private NRI’s, Foreign FIs, banks, Mutual public corpora- foreign institu- insurance funds tions corpora- tional compa-nies tions investors 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 48
    • 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 49
    • INCREASING FINANCIAL DEPTH IS A KEY Financial system problems IMPERATIVE FOR THE FINANCIAL SECTOR Key outcomes Suboptimal distribution of capital in the Root causes: economy • Cumbersome Root causes: issuance Low lending procedures • Lack of rates and Very small • Lack of investor competition in conservative corporate bond demand banking and approach in market high state banking • Poor bankruptcy ownership procedures and • Statutory lack of creditor liquidity ratio and rights directed lending Underdeveloped Underdeveloped Root causes: policies domestic consumer finance market institutional • Restrictions on investors asset holdings • Government Limited ownership of household intermediaries participation in • Above-market capital markets deposit accounts Source: McKinsey Global Institute analysis 50
    • DOMESTIC INSTITUTIONAL INVESTORS ARE UNDERDEVELOPED IN INDIA Total assets as percent of GDP, 2005 Registered Life insurance pensions Mutual funds France 60.3 3.5 61.2 US 33.1 66.0 69.9 Korea 22.8 3.9 25.3 Chile 18.7 59.4 11.1 Thailand 6.2 8.0 10.0 China1 6.3 1.7 2.5 Mexico 3.8 0.2 6.1 Poland 4.6 9.5 4.6 Brazil 1.2 20.4 39.6 India 13.3 4.2* 6.0** 0 50 100 0 50 100 0 50 100 * Includes only provident funds ** as on March 2006 Source: Financial institution regulators; industry groups; and central banks of respective countries 51
    • A PHASED APPROACH HAS TO BE ADOPTED FOR A TRANSFORMATION OF THE INDIAN BANKING SECTOR Move towards freer Apply competitive pressure 3 Build infrastructure and 2 to local banks structure 1 capabilities • Ease capital restrictions • Encourage market driven • Create 3-4 global sized Industry • Provide more operational consolidation institutions, 6-8 national structure freedom to public sector banks champions • Develop blue print for sector • Reduce government participation in the sector • Allow greater access to foreign banks • Offer market based incentives • Remove directed lending and Social for under-penetrated segments branch restrictions development • Remove regulatory arbitrage • Move to a coordinated regulator • Separate central bank and Unified regulator across different entities model regulator roles • Effectively implement Corporate principles of good corporate governance governance • Accelerate credit bureau and • Support creation of industry Supporting payment infrastructure utilities for processing infrastructure • Enrich human capital and Labour reforms support re-skilling of employees Source: McKinsey analysis 52
    • FINANCIAL SYSTEM REFORMS ARE WORTH US$48 BILLION ANNUALLY Direct impact of financial system reform Indirect impact US$ billion, FY 2005 21.8 25.5 2.3 0.3 5.1 Improved allocation 18.9 6.3 of capital 7.8 Capturing more savings 6.6 Improved Fully Migrate Reduce Shift in Direct banking imple- informal corporate financing impact efficiency ment lending bond mix from of financial to best electronic to default bank system practice payment formal rates to loans to reform system banks bench- bonds mark Percent 1.1 0.9 0.7 0.1 0.3 3.2 3.5 of GDP Source: RBI; CSO; McKinsey Global Institute Analysis 53
    • MORE EFFICIENT INVESTMENT AND FINANCIAL MARKET REFORMS CAN BOOST INDIA’S GROWTH RATE TO 9.4 PERCENT Real GDP CAGR1 US$ billion 2000, fiscal year 2005–2015 1,600 Baseline 2015 per capita 1,400 Efficient investment and 9.4% income: US$ financial market reform 1,203 1,200 2015 per capita 6.5% income: US$ 1,000 919 800 600 400 CAGR1 200 1995–2005 5.9% 0 1995 2000 2005 2010 2015 1 Compound annual growth rate. Source: CSO; RBI; Oxford Economics; McKinsey Global Institute analysis 54