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A Five Year Roadmap for Markets: A Policy perspective - Outside View by PersonalFN
 
 
A Five Year Roadmap for Markets: A Policy perspective

First 2 months of 2012 have been extremely rewarding for investors as markets have rallied quite a bit. Foreign Institutional Investors (FIIs) have been pumping in money into Indian equity markets like there's no tomorrow. Against the net monthly average outflow of Rs226.2 crorein 2011; FII's have invested Rs10,357 and Rs 25,212crore in January and February respectively this year. In contrast, Indian Mutual Fund industry has sold stocks worth Rs 4,029.5crore since the beginning of this year. This rally was partially driven by liquidity and it may be difficult to predict whether the FII money would stay in for the relatively longer term. However, the most painful aspect of any rally in Indian market is; the domestic investors, by and large, miss the major part of rally and retail investors are left out always. At this juncture; many of you would find it difficult to decide upon whether to invest at these levels when markets have already rallied or wait for a meaningful correction to kick in which seems to be already underway at the time of writing. Well, we believe that more than the market levels; one should look at the direction of economic growth in the country and importantly should invest in equities only with a long term view. While developed economies are struggling to keep the growth in the fast lane despite the numerous incentives given in terms of fiscal stimulus packages; emerging economies are growing vibrantly. India is most likely to register 7% GDP growth in the current fiscal. We may witness even more rapid growth in coming years. Here's why...

The government plays a major role in the economic development of the nation by providing a policy framework to encourage growth. This framework acts as a guide not only to business houses but also to the various stakeholders. Successful implementation of policies would bring about desired positive changes. In India, five year plans are considered extremely important since they; in general, give us the guidance as to where the country wants to see itself in next five years. Various policies are framed or altered to achieve the planned objectives. Union budgets and Reserve Bank Of India (RBI) monetary policies work around the broader objectives set under a 5 year plan.

The chart below summarises the performance of five year plans against the growth targets of each plan.

Five Year Plans - Targeted Growth Vs. Actual Growth
Source: Business Standard
* adjusted for calorific value
(Source: Planning Commission Reports; PersonalFN Research)
It is clear from the chart that; performance has been mixed as the actual growth has been in excess of the targeted growth only on 5 occasions.Nonetheless, India has been growing at 6% plus rate for last 10 years. India managed to grow at 8.2% during the eleventh five year plan despite the global financial crisis which hit the economies hard in the year 2008.

Next few months are going to be hectic on the policy front. The 12th five year plan will come into effect from 1st April 2012. Moreover, the revamped manufacturing policy, which has already been notified, will see some real development from August onwards this year. It is imperative for every investor to know the direction of the economy and these two documents are the powerful tools in this context.

What the Twelfth Five Year Plan says?

The motto of 12th five year plan is "Faster, Sustainable and More Inclusive Growth". The Planning Commission has set two alternative targets for economic growth in the 12thPlan. The first is to achieve the 9% growth, targeted for 11th plan which has yet to be achieved (aswe are most likely to record 8.2% growth for the 11th plan).The second target is to work towards achieving an even higher growth of 9.5%on an average over next five years.

The plan envisages attaining faster growth by investing heavily in infrastructure development, accelerating the growth in the manufacturing sector and stimulating investment and providing budgetary assistance to Research and Development in many sectors of the economy. Massive investment would be done in roads, ports, railways and electricity. Urban transportation and mobilization of goods should be given special attention. This aims at optimum utilisation of resources. Furthermore, enhanced access to various modes of Funding/Financing will ensure rapid growth in business activities which otherwise would not be possible in absence of it.

The plan aims to achieve inclusive growth by creating more durable rural non-farm jobs, ensuring more focused and effective implementation of centrally sponsored flagship programmes.It spells out a need to provide incremental budgetary support to health and education programmes, improving the quality of primary education and emphasizing on secondary education.

However, the plan has identified some areas where the special impetusis needed in order to make the growth more sustainable. We have been witnessing the inflationary pressure, mainly in food articles, in last couple of years. Low inventory levels in the early years of 11th plan and relatively poor performance of agriculture sector in 9th and 10th plan are some of the main reasons for stubbornly high inflation. 12th plan aimsto bring down inflation and to maintain itin the range of 4.5% to 5.5%. Moreover, average target for the fiscal deficit has been set as 3.25%. To make the growth sustainable, efficient use of energy and rational pricing regime would be envisaged.

Key to make this plan work....

Growth rate of 9% would be achieved when all underlying sectors of the economy would perform in line with the set targets. Agriculture, Mining, Manufacturing and infrastructure should grow at a brisk pace in order to make 9%-9.5% growth feasible.

Individual targets for Key Sectors to achieve the targetedGDP growth
Sector Targeted GDP growth
9% Target 9.5% Target
Manufacturing 9.80% 11.50%
<>Construction 10% 11%
<>Mining & quarrying 8% 8.50%
Agriculture 4% 4.20%
(Source: Planning Commission approach draft of 12th plan; PersonalFN Research)


Sectoral Growth Rates (in %) Previous Plans and Target for Twelfth Plan
Source: Source: Business Standard
* adjusted for calorific value
(Source: Planning Commission approach draft of 12th plan; PersonalFN Research)

Share of manufacturing sector in India has been very low compared to that of some emerging world nations. Manufacturing sector contributes about 15% of GDP in India as against 34% In China and 40% in Thailand. Agriculture sector has constraints on creating jobs rapidly.Hence to make India's growth inclusive; the manufacturing sector has to create more jobs. More jobs will put more money in the hands of people which will create organic demand in the country which will then accelerate the overall growth.

To achieve the targeted growth of 9% and 9.5%; investments in the economy should be done at the rate of 38.5% and 41.4% of GDP respectively. Average investments, during the 11th plan stood at 36.4% (up from 31.8% during 10th plan.). The pace of investment in some sectors such as roads, electricity, railway and ports has been poor and must improve during 12th plans. Moreover, Public Private Partnerships (PPP) needs to be further encouraged. The rate of fixed capital formation is likely to average around 31% of GDP in the 11thPlan, which is 2.5% higher than that in the Tenth Plan. To keep the inflation under check and record higher growth; productive use of capital must improve and therefore capital formation over next five years should average out around 33.5% of GDP for the 9% growth.Growth target of 9.5% would be achievable if the fixed capital formation comes at about 35.5%.The savings rate has to improve from the current estimated of 34.0% to 36.2% during 12th plan.

To fuel the growth of 9%; commercial energy supplies will have to grow at about 6.5% to 7% every year. Since India depends majorly on imports for fulfilling its energy requirements and given that the petroleum prices are at elevated levels for the extended period; it would be critical to manage the energy pricing. Moreover; massive capacity additions in the power generation sector would need an uninterrupted supply of coal since India has more thermal power projects. Any shortage there would throw the power plants out of gear. Right fuel pricing would be critical.

Synchronisation of Policies

To make the 12th plan successful; supplementary polices have been designed and some work has already started. The New Manufacturing Policy is a landmark document which has the potential to completely transfigure the manufacturing sector. This policy aims at growing the share of manufacturing sector from 15% of GDP to 25% of GDP by 2022. This in turn would mean creation of 220 million jobs by 2025 which would help reap rich demographic dividends.

Goals of National Manufacturing Policy
  • Increase manufacturing sector growth to 12-14% over the medium term to make it the engine of growth for the economy. The 2% to 4 % differential over the medium term growth rate of the overall economy will enable manufacturing to contribute at least 25% of the National GDP by 2022.

  • Increase the rate of job creation in manufacturing to create 100 million additional jobs by 2022.

  • Creation of appropriate skill sets among the rural migrant and urban poor to make growth inclusive.

  • Increase domestic value addition and technological depth in manufacturing.

  • Enhance global competitiveness of Indian manufacturing through appropriate policy support.

  • Ensure sustainability of growth, particularly with regard to the environment including energy efficiency, optimal utilization of natural resources and restoration of damaged/ degraded eco-systems.
Industries that will be given special attention
  • Employment intensive industries (sectors such as Textiles, Food Processing Industries etc.)

  • Capital Goods (Electrical equipment, Transport Mining and Earth moving equipment etc.)

  • Industries with strategic significance (Aerospace, Shipping, Equipment)

  • Industries where India enjoys a competitive advantage (Such as Pharmaceuticals, Auto)

  • Small and Medium Enterprises

  • Manufacturing-Technology sectors for Energy Security (Solar Energy for example)
It is projected that if the infrastructure deficit is leveraged to the extent of the required equipment, the manufacturing sector growth could be enhanced by close to 3% per annum.Further, bringing some subsectors of manufacturing under priority lending would help businesses to grow more rapidly.

On the other note, Government has recently directed the state miner, Coal India to sign 20 year Fuel Supply Agreements with private power producers. This move is said to be aimed at curtailing the chronic electricity shortages. This has come on the eve of 12thfive year plan.

Key Takeaways for Investors

Next 5 years we may see rapid growth in some sectors of the economy while others will play a supportive role. India has the second largest population and is one of the nations with the youngest population. Improved quality of education and industry oriented training programmers would ensure availability of large talent pool. Revamped manufacturing policy, constant thrust on infrastructure development, rationalization of energy pricing would facilitate the growth at a much faster rate. The much awaited changes in the tax structure andspecial emphasis on agriculture should help India resolve the problem of inflation and would help strengthen the fiscal position.

Having said this, the economy remains vulnerable to external shocks and high oil and other commodity prices for an extended period pose a threat. We are entering the 12th financial plan with a first year projection of 7% and thereabouts; which would not be a good start considering ambitious growth target set for the plan. India's exports to western economies would always face a threat of slowdown in those economies. Furthermore, back home, government would find it difficult to announce big bang budgets considering the ever-changing political equations. Any populous decision that plays a party pooper in maintaining fiscal discipline would make the growth targets unattainable. Consolidation of Central Flagship Schemes and proper allocation of resources would help in making the growth inclusive and sustainable.

Our View

We believe that investors shouldn'tlay their eyes on the daily market movement. If one looks at the direction of Indian economy; it is northwards. Basic arguments that flocked FIIs to India still remain in India's favour.
Composition of Global GDP (in %)
  2000 2011 2016 (EST) 2020 (EST) 2025 (EST)
Developed Economies 79.7 64.6 58.9 55.3 51.1
Emerging Economies 20.3 35.4 41.1 44.7 48.9
India 1.5 2.8 4.0 5.2 7.1
EST: Estimates
(Source: Planning Commission approach draft of 12th plan; IMF Estimates PersonalFN Research)


India has grown faster than the other emerging world nations in last decade. The International Monetary Fund (IMF) estimates the trend to continue. India's national debt is much lower than that of the developed countries. Given that the growth is still anemic in the western economies and despite all the potential threats India looks well poised for growing above 6%; it will remain a favourite market for global investors. One should take a long term view and invest sip by sip to reap the long term dividends.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

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