What We Are Reading - Volume 2.097

28th Jan 2022
What We Are Reading - Volume 2.097
The enclosed 2.097 version includes interesting set of reports by HSBC Global Research ‘India: The odds of an investment upswing – What
the budget can do right’ Credit Suisse’s ‘India Market Strategy’, Jefferies ‘India Equity Strategy’ report, Macquarie’s report on ‘India:
Financialization of savings & credit’, UBS report ‘Global risk radar’, GMO’s ‘Let the wild rumpus begin’, LPL Research’s ‘Weekly Market
Commentary’ and Economist’s article on ‘Why Microsoft is splashing $69bn on video games’
• India: The odds of an investment upswing HSBC Global Research

• India Market Strategy Credit Suisse
• India Equity Strategy Jefferies
• India - Financialization of savings & credit Macquarie Research
• Global Risk Radar UBS
• Let the wild rumpus begin GMO
• Weekly Market Commentary LPL Research
• Why Microsoft is splashing $69bn on video games The Economist
19 January 2022
India: The odds of an Economics

India
investment upswing
What the budget can do right
 There is hope that investment will revive, led by buoyant Pranjul Bhandari
world growth and lower corporate debt Chief Economist, India
HSBC Securities and Capital Markets (India) Private Limited
pranjul.bhandari@hsbc.co.in
 But we find that elevated policy uncertainty and unsure future +91 22 2268 1841
growth expectations can come in the way Aayushi Chaudhary
Economist
 The budget can step in here by being a much-needed source HSBC Securities and Capital Markets (India) Private Limited
aayushi.chaudhary@hsbc.co.in
of predictability and stability in volatile times +91 22 2268 5543
Priya Mehrishi
As pent-up services demand runs its course, growth could begin to slow in 2HFY23. Associate
Bangalore
That’s when it is hoped investment will step in. After a decade-long decline, many believe
the time is ripe for a revival. Corporations have deleveraged, liquidity is ample, rates are
low. But there have been false starts in the past. How likely is a revival this time?
Our trusted investment model has four explanatory variables – world growth, a
corporate indebtedness metric, a policy uncertainty index, and excess growth returns
(i.e. future growth over and above real interest rates). Each of these has pushed
investment lower in the last decade. Now, two of the four – world growth and corporate
balance sheets – have become supportive of a revival. But, alas, the other two –
policy uncertainty and excess growth returns – which tend to be tightly interlinked in
periods of high volatility, have not.
Moreover, an exercise on rolling coefficients shows that, in the most recent period when
corporate debt has fallen, its importance in driving the investment cycle has fallen, too,
suggesting that strong balance sheets may not be enough for an investment revival.
Something more is needed. Indeed, around the same time, the importance of growth
returns has risen sharply. Against this backdrop, unless policy uncertainty falls and the
prospects of economic growth rise, the investment cycle uptick may not be strong footed.
What’s keeping excess growth returns from rising? One, the economic cost of rising
firm- and individual-level inequality during the pandemic period. Note here that the fall
in investment over the last decade was led largely by a weak household sector,
implying that it was hurting even before the pandemic. Two, weak capacity utilisation.
Recent trends in domestic goods demand show that, after reaching pre-pandemic
levels, it has stagnated. The PLI scheme was meant to enable firms to cater to global
demand, but rising import tariffs are coming in the way. Three, sticky inflation is likely
to elicit an RBI response; tighter liquidity could impact capital market excesses.
Yet, all is not bleak. At a time of heightened exogenous shocks, government policy can
be a source of stability and predictability, prerequisites for investment revival. And it
could start with the budget on 1 February. Last year’s budget had a lot of positives –
transparent accounts, credible estimates, high-quality spending, gradual consolidation,
and tax policy stability. Sticking to these can go a long way. Alongside, effective
implementation of some already announced reforms (fiscal, financial, and
manufacturing) could help set the stage for strong growth once pent-up demand fades.
Economics ● India
19 January 2022
Hopes for an investment revival
Many are predicting a rapid rise in India’s investment cycle.
For one, it is urgently needed in order to sustain growth. Let us explain.
Pent-up goods demand was a key driver of growth for much of 2021 before it eased towards the
end of the year (see chart 1). After an Omicron-led growth hiccup in the March 2022 quarter,
pent-up services demand is likely to become a key driver of growth over the June and
September 2022 quarters (see chart 2)1.
But after pent-up demand has run its course, growth may begin to slow around the December
As pent-up demand fades,
growth may begin to slow in 2022 and March 2023 quarters. The rising inequality-led scars that the pandemic is likely to
2HFY23 leave behind may also begin to show up around then (see India: Informally, yours: The
prospects of the omnipresent unorganised sector, 15 July 2021). India will be in search of a new
growth driver to sustain a healthy growth momentum.
Chart 1: Pent-up goods demand was a key Chart 2: Services demand is below normal;
driver of growth for much of 2021 and could drive growth for a few quarters
Index Recovery trends in goods Index Recovery trends in services
140 Feb'20 SA =100 140 Feb'20 SA = 100
120 120
100 100
80 80 83
60 60
40 2nd wave 40 2nd wave
20 20 1st wave
1st wave
0 0
Feb-20 Sep-20 Apr-21 Nov-21 Feb-20 Sep-20 Apr-21 Nov-21
PV sales 2W sales Railway freight Railway passengers
Cons: Durables Cons: Non-durables Air passengers Air cargo
Cap goods Infra& Cons goods Port volume MV registration
Tractor sales Average Average
Source: CEIC, HSBC Source: CEIC, HSBC
Chart 3: India’s investment rate has been Chart 4: Corporations have been able to
sluggish bring down their debt levels
% GDP Investment: % y-o-y % GDP Credit to non-financial corporations
35 Gross fixed capital formation 18 75.0
33 13 70.0
8 65.0
31
3
60.0
29
-2
55.0
27 -7
50.0
25 -12
FY08 FY10 FY12 FY14 FY16 FY18 FY20 FY22 45.0
Share Growth, RHS Jun-09 Jun-11 Jun-13 Jun-15 Jun-17 Jun-19 Jun-21
Source: CEIC, HSBC Source: BIS, HSBC
______________________________________
1 There is also likely to be support from pent-up housing demand. As people try to improve their houses after being stuck
indoors for a long time, real estate construction could rise, raising demand for labour and material.
2
Economics ● India
19 January 2022
And that’s where investment comes in. After peaking in FY12 (at 34.4% of GDP), India’s
investment rate has fallen by 5.5ppt over a decade (see chart 3). Several factors have led to
this, and we discuss them later in the report.
In good news, some of these factors have improved over the pandemic period. Corporations
Many believe that investment
will rise and fill the growth
have been able to shed some of the elevated debt in their books (see chart 4). World growth
gap has risen. Interest rates have fallen and liquidity is in surplus, both globally and domestically. All
of this, many believe, will usher in a new investment cycle. And investment will be the new
growth driver for the country, once pent-up demand has run its course.
From the lens of our model
But will the hopes of an investment revival come to bear?
To answer this more systematically, we update our investment model and look closely at the
Four variables drive much of
India’s investment
drivers of investment. Our model has a good fit and has provided the right intuitions in the past
(see India’s investment challenges: What can go right?, 16 May 2017). It uses a combination of
four explanatory variables:
 World growth (W): Investment in the past decade had moved closely with the global
business cycle2.
 Indebtedness (ICR): India’s decade-long banks and corporate balance sheet indebtedness
problem is well-known and has played a key role in slowing investment3. We proxy the twin
balance sheet problem with the interest coverage ratio (EBIT/interest payments) of c2,800
listed non-government, non-financial companies aggregated by the Reserve Bank of India
(RBI) on a quarterly basis. Falling (rising) values of this ratio suggests that the profit cover
of interest payments is worsening (improving).
 Economic policy uncertainty (EPU): We use the Economic Policy Uncertainty Index
which captures inflation and fiscal deficit-led uncertainty, as well as negative news flow on
economic policies4. The idea is that this index will pick up on policy-induced macro-
economic uncertainty, which could make businesses more cautious about investing.
 Excess future growth returns (G-R): G stands for one-year-ahead real GDP growth forecast.
R is the repo rate minus 12-month forward WPI forecast. As long as domestic growth
expectations remain relatively high, real interest rates may not be a deterrent for investment.
We find that the four regressors – domestic future returns, policy uncertainty, corporate
indebtedness, and world growth – do well in explaining India’s investment patterns over the last
decade (see Table 1 and Chart 5). The explanatory power of the regression is 82%, the highest
we have seen across various investment models for India.
In the FY12-FY16 period, each of these four drivers pushed India’s investment rate lower (see
chart 6). Thereafter some stabilisation followed in the FY17-FY20 period, as each of the four
drivers steadied.
But will there be a rise going forward?
______________________________________
2 We use world growth to capture the global business cycle.
3 India’s banks were sitting on a formidable stock of bad loans and, relatedly, India’s corporate houses were sitting on
overleveraged balance sheets. All of this was hurting investment growth.
4 This index is a weighted average of: a) the dispersion of consensus inflation and fiscal deficit forecasts, and b) negative
news coverage about economic policies. For more details, see www.policyuncertainty.com and see Baker, S.R., N. Bloom,
and S.J. Davis, 2013, “Measuring Economic Policy Uncertainty”, Chicago Booth, Research Paper No. 13-02.
3
Economics ● India
19 January 2022
Table 1: Our investment model … Chart 5: … has a good fit

Method: Ordinary Least Square % y-o-y Actual vs fitted
Time period: Sep-2004 to Sep-2021 60
Frequency: Quarterly 40
Dependent variable: Investment growth % y-o-y
20
Regressors Coefficients
World growth (W) 2.21*** 0
Excess future returns (G-R) 0.49*** -20
Policy uncertainty (EPU) -0.03**
-40
Indebtedness (ICR) 0.83*
Constant -0.87 -60
R-Squared 82% Sep-05 Sep-09 Sep-13 Sep-17 Sep-21
Actual Fitted
Source: HSBC estimates. Level of significance: ***1%, **5%, *10%. The model Source: CEIC, HSBC estimates
includes appropriate lags for the regressors
Chart 6: In the FY12-FY16 period, India’s investment rate fell, led by all four explanatory
variables
ppt Drivers of India's investment rate
0.1 FY12 - FY16
0.0
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
Gross fixed capital Excess returns Economic policy World growth Indebtedness
formation uncertainty
Source: CEIC, Refinitiv Datastream, www.policyuncertainty.com , HSBC
Investment prospects – Will it? Won’t it?
Looking through the lens of the model suggests that two of the drivers are doing better than
Strong world growth and
lower corporate debt are
before. World growth has rebounded smartly from pandemic lows, and the interest coverage
supportive of an investment ratio of (listed) corporations has risen in the pandemic period as they managed to write down
upswing significant chunks of their debt (see chart 7).
But two other drivers are not as robust. Policy uncertainty levels have risen in the pandemic
period, and the index is running c40% higher than during India’s golden period of investment
(2003-07). This is not surprising given back-to-back uncertainties triggered by the pandemic
waves, chip shortages, container shortages, commodity price volatility, rising global inflation and
changing central bank stance.
True, expectations of excess future growth returns have shot up from their pandemic lows.
But they are likely to moderate as pent-up demand runs its course (i.e. the base normalises), the
inequality-led economic scars of the pandemic begin to show up, and the repo rate is gradually
raised5 (see chart 8). We believe that India’s potential growth will fall from 6% on the eve of the
pandemic to 5.5% post pandemic (see India: Four burning questions, 22 November 2021).
______________________________________
5 We expect GDP growth to normalise gradually from 9.2% y-o-y in FY22 to 6.8% in FY23 and 6% in FY24. We expect two
repo rate hikes in 2022 (2Q and 3Q), followed by two more in 2023 (1Q and 2Q), taking the repo rate to 5% by end 2023.
4
Economics ● India
19 January 2022
Chart 7: World growth has rebounded and Chart 8: … but policy uncertainty has
the interest coverage ratio has gone up risen, and expectations of future growth
lately … returns have moderated
% y-o-y World growth and corporate interest ratio % Excess future growth returns and policy Index
6.0 5.0 20 uncertainty 120
coverage ratio
4.5 10
3.0 100
4.0 0
0.0 80
3.5 -10
-3.0 3.0 -20 60

Mar-15 Mar-17 Mar-19 Mar-21 Mar-14 Mar-16 Mar-18 Mar-20 Mar-22
World growth Interest coverage ratio, RHS Excess return Policy uncertainty, RHS
Note: Dotted lines indicate HSBC forecasts
Source: CEIC, Refinitiv Datastream, HSBC Source: CEIC, www.policyuncertainty.com, HSBC
Which of the drivers will dominate? Will the improvement in world growth and corporate
balance sheets outpace the rise in policy uncertainty and moderating growth returns?
To answer this, we undertake another exercise to ascertain the changing importance of the four
But policy uncertainty and
moderating excess growth
investment drivers. We calculate their rolling coefficients, which tells us how the importance of
returns are not the drivers in explaining investment trends is changing over time.
Two messages come out clearly. One, the recent period of improving interest coverage ratio is
also the period when the importance of it in driving the investment cycle has fallen (see chart 9).
This, we believe, shows that strong balance sheets may be a necessary condition for
investment revival, but are not sufficient. Something more is needed.
And indeed, around the same time, the importance of the excess growth returns variable (i.e. G-
R) has risen sharply (see chart 10). The future expectations of growth (over and above interest
rates) are gaining importance as an investment driver.
We also find that excess growth return is strongly interlinked with policy uncertainty (see chart
11). Particularly at a time of big global changes triggered by the pandemic, domestic policy
certainty becomes an important driver of sustainable activity and growth.
As such unless policy uncertainty falls and the prospects of excess growth returns rises, the
investment cycle uptick may not be strong footed.
Chart 9: The health of corporate balance Chart 10: The importance of expected GDP
sheets has improved, but its importance in growth in driving investment has risen
driving capex has fallen sharply
Indebtedness Excess future return
Rolling coefficients and actual values 1.2 Rolling coefficients
6.0 6.0
1.0
5.0
4.0 0.8
4.0
2.0 0.6
3.0 0.4
0.0
2.0 0.2
1.0 -2.0 0.0

Jun-15 Jun-16 Jun-17 Jun-18 Jun-19 Jun-20 Jun-21 -0.2
Interest coverage ratio ICR: Rolling coeff, RHS Jun-09 Jun-12 Jun-15 Jun-18 Jun-21
Source: CEIC, HSBC estimates Source: CEIC, HSBC estimates
5
Economics ● India
19 January 2022
Chart 11: At a time of global changes, Chart 12: Demand moved from small firms
domestic policy certainty becomes to the bigger ones during the pandemic
important for growth
% Correlation: Excess return & EPU Ppt Change in share of sales
12qtr moving correlation, axis reversed 0.20 Dec20 to Sep21 vs Dec18 to Sep19
-100%
0.15
0.10
-50% 0.05
0.00
-0.05
0%
-0.10
-0.15
50% -0.20
Small firms Large firms
(paid-up capital (paid-up capital
100% <INR150m) >INR150m)
Dec-06 Dec-09 Dec-12 Dec-15 Dec-18 Dec-21 Corporates as per paid-up capital
Note: Economic Policy Uncertainty (EPU) leads excess returns by four quarters Source: RBI's database of the performance of the private corporate business sector,
Source: CEIC, www.policyuncertainty.com, HSBC CEIC, HSBC
Chart 13: Breakdown of India’s labour force (% share of total)
Source: PLFS, NSS and census data, HSBC calculations
What’s holding back future growth prospects?
In this section we look closer at our outlook for excess future returns, i.e. G-R. Why do we have
it falling gradually?
 Rising inequality. Inequality has risen at both the firm and individual level. Large firms
The cost of rising inequality
is weighing on the growth have become larger at the cost of smaller firms. Informal sector firms have been disrupted
outlook (see chart 12). Those earning their livelihoods from small and informal firms have suffered.
This is a problem because 80% of India’s labour force is employed in the informal sector,
and the roughly half of them who are in the non-agricultural sector have borne the
economic brunt of the pandemic (see chart 13, and see India: Informally, yours: The
prospects of the omnipresent unorganised sector, 15 July 2023). The disruption they have
faced may show up over time in the form of lower demand and growth in the economy.
6
Economics ● India
19 January 2022
Chart 14: The fall in India’s investment rate Chart 15: Credit to industry has been weak
was led by private household investment
Ppt Change in investment/GDP Ppt Bank credit to industry
contribution
FY13 - FY20 0.8 25
1.0
0.5 20
0.0
15
-0.5 -0.2
-0.4 10
-1.0
-1.5 5
-2.0 -1.8 -1.7 0
Household
General Gov
Overall
Corporates
Corporates
Private:
Private:
Public:
-5
Public:
3/2010 3/2012 3/2014 3/2016 3/2018 3/2020 YTD
Ind: Micro & small Ind: Medium
Ind: Large Credit: Industry
Source: CEIC, HSBC Source: CEIC, HSBC
Chart 16: The reliance of large firms on Chart 17: Small firms rely excessively on
capital markets has risen bank credit, and hurt when it is not
forthcoming
Share Resource mobilisation by the % y-o-y MSME and corporate loan growth
70% commercial sector
38
60% 58% 28
50% 18
50% 49%
40%
-2
FY09 FY11 FY13 FY15 FY17 FY19 FY21
Nov-08 Nov-10 Nov-12 Nov-14 Nov-16 Nov-18 Nov-20
Share of non-bank credit Average MSME Corporates
Note: Corporate debt includes loans to industries and services but excludes loans to micro
and small industry, transport operators and trade finance. The later constitutes as MSME
Source: RBI, HSBC Source: CEIC, HSBC
The rise in inequality also holds significance for the investment cycle. In the period when India’s
Even in the past, weak
household capex had pulled investment rate was falling (FY13-FY20), a closer look reveals that it wasn’t the public sector or
down the investment cycle the private corporations leading the fall. Rather, it was private household investment that was
falling sharply (see chart 14). This category includes a bulk of the small businesses in the
economy. It was already a hurting and underperforming sector even before the pandemic.
There may also be a funding angle to the large fall in household investment in the FY13-
FY20 period. With NPLs on the rise, risk averse banks slowed credit outgo, particularly to
industry (see chart 15)6. Large firms had access to capital markets and overall reliance on
banking sector credit fell (see chart 16). Small firms, which don’t have as much access to
capital markets, are likely to have suffered.
While many banks are keen on increasing credit to small firms this time around, whether or
not it rises significantly is an area to track (see chart 17).
______________________________________
6 The fact that public sector banks’ credit growth where NPLs had risen much more was weaker than private banks’ credit
growth, suggests to us that supply side issues were at play, and its wasn’t just weak demand for credit.
7
Economics ● India
19 January 2022
Chart 18: Capacity utilisation is at low levels Chart 19: India has been raising import
tariffs over the last few years
% RBI OBICUS: Capacity Utilisation % Tariff rate, applied
80 40.0 Simple mean, all products
75 30.0
70 20.0
10.2
65 10.0
5.2
60 0.0
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
Jun-12 Dec-13 Jun-15 Dec-16 Jun-18 Dec-19 Jun-21
OBICUS capacity utilisaiton (SA)
HP of SA India World
Source: CEIC, HSBC Source: World bank, HSBC
Table 2: The Production Linked Incentive (PLI) scheme is likely to generate about 1.2% of
annual investments per year
Sectors Outlay (INR, bn) Expected investment (In one year)
Semiconductor 760 340
Mobile manufacturing 410 22
Auto and components 261 85
Pharmaceuticals 254 19
Chemicals 181 90
Telecom 122 6
Food products 109 56
Textiles 106 38
IT hardware 73 6
Specialty Steel 63 80
White goods 62 16
Renewable energy 45 34
Aviation 1 17
Total 2,447 809
% of GFCF 1.2%
Source: PIB, Media reports, HSBC
 Sluggish capacity utilisation (CAPU). As per the RBI’s OBICUS survey, the CAPU index
Capacity utilisation is weak;
goods production is sluggish been on the decline since 2012, and fell further in the pandemic period. It used to be above
the 75-mark in the golden period of investment (i.e. 2003-07), and is now c15% lower than
those levels (see chart 18). A rise back-up is becoming increasingly important for ushering
in new investment. But some recent developments make us a bit worried.
2021 was the year of the rising goods demand. The jury was out on whether it is pent-up
demand or will it rise further. If it is just pent-up demand, it can only go so far and perhaps
not be enough to raise capacity utilisation to levels that incentivise new investment.
After rising rapidly, goods production has indeed plateaued at about pre-pandemic levels
(see chart 1)7. There is hope that services demand does better, but both goods and
services demand are driven by the same underlying drivers (e.g. incomes).
There is a sense that the government’s Production Linked Incentive (PLI) scheme will
provide a push to manufacturing and investment by enabling Indian firms to not just cater to
domestic demand, but also to global demand. And while the scheme has been successful
in encouraging the mobile handsets industry, continued success for the 10-odd new sectors
it has been extended to, may need more work.
______________________________________
7 Worth noting here that in as late as November 2021 the production of consumer durables was 12% below pre-pandemic
levels, and that of consumer non-durables was 3% below pre-pandemic levels
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Economics ● India
19 January 2022
For one, the scheme is small-sized. The yearly investment it is likely to generate is about
1.2% of annual investments (see table 2). Two, there seems to be some confusion on
whether the scheme is for export promotion or import substitution. India has been raising
import tariffs over the last few years (see chart 19), and even some sectors under the PLI
scheme are complaining about high cost of inputs making them uncompetitive8.
There is also an expectation that higher central government capex will crowd in private
The PLI scheme may work if
import tariffs are not raised in
capex. While the rise in central government capex in FY21 is worth complementing, our
parallel sense is that it will have to rise further and for longer, and be complemented by state capex
in order to truly crowd in private investment. Because even though central capex is rising, it
is still below budget estimates (13% y-o-y y-t-d versus 30% BE). And moreover, public
capex tends to be only a quarter of the overall investment pie of the economy.
 Sticky inflation. During the demonetisation episode, strong wealth effects from buoyant
The RBI is expected to raise
rates and tighten liquidity in
capital markets hid the disruption in the informal sector. It only showed up in terms of
2022 weaker growth down the line.
Inflation is above the RBI’s target and remains sticky9. It is likely that the RBI will gradually
normalise monetary policy by draining liquidity and raising rates in 2022. If some of the
boom in capital markets over the pandemic period has been driven by excess liquidity, an
adjustment there could impact growth.
What can the budget do right?
Is all bleak? We think not.
At a time of heightened exogenous shocks, government policy can be a huge source of stability
and predictability, which is needed to sustain growth once pent-up demand has run its course.
And it can start with the budget to be announced on 1 February.

Last year’s budget had many
positives Last year’s budget had a lot of positives. Sticking to those and delivering on the promises made
can go a long way –
 Transparent accounts: The budget over the last two years has made big strides on fiscal
transparency. First year was about quantifying off-budget items. The next year was about
repaying dues owed to the Food Corporation of India (see India budget 2021: Much cheer,
some challenges, 1 February 2021). Maintaining this transparency will go a long way.
 Credible budget estimates: The tax revenue estimates made in last year’s budget were on the
conservative side, and surprised on the upside. This was very different from some previous
years when very ambitious tax revenue estimates eroded the credibility of the budget instantly
as it was announced. It may be a good idea to sticking to conservative tax revenue estimates
this year as well, especially because there are huge uncertainties on the growth front.
 High quality spending: The capex drive in FY22 has been impressive and should
continue. But there are vulnerabilities at the bottom of the pyramid. It may be a good idea to
keep social welfare spending elevated for longer. Given limited resources and fiscal
consolidation pressures, it may be a good idea to keep pre-existing schemes like NREGA
well-funded, rather than exploring new schemes.
______________________________________
8 For instance, there are issues faced by mobile charger producers because of higher tariff led input cost increases. See
Economic Times: Handset makers seek import duty hike rollback (29 December 2021)
9 Inflation expectations have risen through the pandemic. Core inflation has averaged above 5% in the pandemic period.
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Economics ● India
19 January 2022
 Gradual fiscal consolidation: The budget last year outlined a target of 4.5% of GDP fiscal
deficit by FY26 (from 9.2% in FY21 and a BE of 6.8% in FY22). This would entail a fiscal
consolidation of 0.5% of GDP per year. Sticking to that path would help keep borrowing
costs contained.
 Tax stability. Like last year, a stable tax regime may do more for policy stability and the
revival of investment than unexpected tax changes could do.
But is it possible to pursue each of these simultaneously? We believe yes. Table 3

Continuing with those
principles can be a source of
outlines one such scenario where all of the above can work together.
stability and growth For FY22, the scenario shows that an upside surprise in tax revenues is likely to more than
offset weak disinvestment receipts and higher-than-budgeted current expenditure, while
maintaining strong capex. In fact, the fiscal deficit is likely to be a tad lower than budgeted.
For FY23, tax buoyancy may not be as strong – and may even decline in the case of excise
duties (where taxes have been cut). The hope is that privatisation receipts rise and cover that
slack. As some crisis level subsidies fall, that space can be split between higher capex, a well-
funded NREGA programme, and fiscal consolidation. We expect the government to lower the
fiscal deficit by 0.5% of GDP in FY23.
Table 3: India's fiscal math (a scenario based on the principles outlined in Budget-2021)
FY21 FY22f FY23f FY21 FY22f FY23f Comments
(GoI) HSBC HSBC (GoI) HSBC HSBC
INR, bn INR, bn INR, bn % GDP % GDP % GDP
Gross tax revenue 20224 25800 28416 10.2% 11.1% 10.9%
Direct tax 9264 12995 14914 4.7% 5.6% 5.7% FY22: Strong income and corporate tax
Corporate 4572 7113 8111 2.3% 3.1% 3.1% inflows, helped offset the disappointment in
Income 4692 5882 6803 2.4% 2.5% 2.6% disinvestment receipts
Indirect tax 10960 12805 13502 5.6% 5.5% 5.2%
GST 5488 7536 8373 2.8% 3.2% 3.2% FY23: The excise duty cut of INR5-10 per
Customs 1348 1771 1989 0.7% 0.8% 0.8% litre will likely lower excise duty collections
Excise 3897 3417 3140 2.0% 1.5% 1.2%
Net tax receipts 14240 18060 19891 7.2% 7.8% 7.6%
Non-tax revenue receipts 2081 2747 2826 1.1% 1.2% 1.1%

Capital receipts 576 500 1400 0.3% 0.2% 0.5% FY23: Disinvestment receipts could rise
Privatisation receipts 379 370 1300 0.2% 0.2% 0.5%
A. Total Receipts 16897 21307 24117 8.6% 9.1% 9.2%
Current Expenditure 30864 31002 33231 15.6% 13.3% 12.7% FY23: Fiscal consolidation to be led by lower
Interest expenses 6821 8388 9469 3.5% 3.6% 3.6% current expenditure
Subsidies 7230 4771 3961 3.7% 2.0% 1.5%
Others 16813 17843 19801 8.5% 7.7% 7.6%
Capital expenditure 4248 5542 6698 2.2% 2.4% 2.6%
B. Total Expenditure 35112 36544 39929 17.8% 15.7% 15.3%

Fiscal deficit 18215 15237 15812 9.2% 6.5% 6.0%
Fiscal Financing FY21 FY22 FY23

(INR billion) (GoI) HSBC HSBC
Gross market borrowing 13703 12055 12696 FY23: Gross market borrowing could remain
% of GDP 6.9% 5.2% 4.9% elevated despite fiscal consolidation
Net market borrowing 11431 9247 9596
% of GDP 4.9% 3.5% 3.3%
Nominal GDP growth (% y-o-y) -3.0 18.0 12.3
Source: CEIC, HSBC estimates
10
Economics ● India
19 January 2022
How about reforms?
The continuity and predictability theme can be extended to policy reforms as well. The
government is already pursuing some important reforms related to fiscal policy (e.g. the asset
monetisation scheme), tax policy (e.g. improving the GST regime), the financial sector (e.g.
improving the Insolvency and Bankruptcy Code and the creation of a bad bank), and
manufacturing (e.g. the Production-Linked Incentive scheme). Implementing them properly is a
better strategy than announcing new reforms.
Some sectors (like power, telecom and retail) have faced policy shocks over the last few years.
Some good reforms have
been announced; now need
Efforts to improve policy certainty can have a positive spill-over effect.
to be implemented And the central bank faces an urgent task, too – namely, inflation control. Core inflation in
India was elevated even before global inflation started to tick up. Inflation expectations have
risen sharply over the pandemic. Monetary policy needs to be normalised quickly as any delay
risks even bigger rate hikes down the road and more policy uncertainty, which could be painful.
Growth will be strong in the next few quarters. It will be fuelled by pent-up demand. The
challenge will be to use this period efficiently and take some important policy steps, which bring
in a sense of certainty and predictability, while setting the stage for continued growth once pent-
up demand fades. The good news is that the steps needed have already been laid out by
policymakers. The challenge now is to walk the talk.
Key forecasts
Table 4: India's key macroeconomic forecasts

In fiscal year terms, unless otherwise stated Unit FY21 FY22 FY23
(Apr'20-Mar'21) (Apr'21-Mar'22) (Apr'22-Mar'23)
Real gross domestic product (GDP) %y-o-y -7.3 9.2 6.8
Consumer price index (CPI) %y-o-y 6.2 5.5 5.0
Central government fiscal balance % GDP -9.2 -6.5 -6.0
Current account balance (C/A balance) % GDP 0.9 -1.7 -1.7
Repo rate %, end-period 4.00 4.00 4.75
Source: CEIC, RBI, HSBC estimates
11
11 January 2022
Equity Research
Asia Pacific | India
India Market Strategy

Export boost to manufacturing
Please select Sector | Strategy
Figure 1: Manufacturing exports could add 2.4% to GDP in five years Research Analysts
120 Estimated increase in Indian exports (US$ Bn) 3.0% Neelkanth Mishra
91 22 6777 3716
100 2.5%
Apparel Chemicals PLI As % of GDP (RHS) neelkanth.mishra@credit-suisse.com
80 2.0%
Abhay Khaitan
60 1.5% 91 22 6777 3747
abhay.khaitan@credit-suisse.com
40 1.0%
Prateek Singh
20 0.5% 91 22 6777 3894
prateek.singh@credit-suisse.com
0 0.0%
FY23 FY24 FY25 FY26 FY27
Source: Credit Suisse estimates
India gaining share in manufacturing exports. India’s share of global merchandise

exports is now at an all-time high. Gains in commodities may not last, but momentum
should persist in electronics (large market size, opportunities for share gains, policy
support) and specialty chemicals (a decade of steady growth has brought scale to firms:
important for global reach). In textiles, exports are growing after a decade-long stagnation,
currently mostly in upstream yarn/fabric, but order-books for apparel are strengthening too.
The opportunity in autos is as much local (strong demand growth gives scale), as potential
share gains as global industry disrupts (new OEMs, business models and supply chains).
PLI schemes: A year’s delay, but contours now clearer. We take stock of PLI
schemes a year after we flagged them as a significant turn in India’s industrial policy. The
impact on GDP five years out remains largely the same vs estimated in Dec-2020, though
this means a one-year lag. Schemes in electronics are in the execution phase, and while
supply-chain challenges/lockdowns slowed progress in 2021, trends are encouraging. The
food-processing scheme has seen 60 firms selected across categories, including FMCG
majors. Of major schemes, autos and apparel went through iterations, the former due to a
rapid global shift to EVs: the new scheme is smaller, but can hasten EV transition in India.
The redesigned apparel scheme was published in Dec-2021 after feedback from industry.
Exports can add meaningfully to growth. Other than autos and apparel, most large
schemes are now in the execution stage, reducing the risk of further delays. India’s
manufacturing share of GDP has been declining steadily since 2012, partly due to a
stagnation in exports of manufactured goods. As exports pick up again, either due to the
impact of PLI schemes or otherwise, they could boost GDP by 2.4% in five years. The
boost to jobs would be concentrated in electronics and apparel. We continue to expect
economic momentum to surprise positively, and are overweight domestic cyclicals (SBI,
L&T, ABB), and beneficiaries of the growth in manufacturing (Aarti, PI).
11 January 2022
Focus charts
Figure 2: Export share gain in autos, chemicals, electronics Figure 3: Excl. metals, electronics, chemicals fastest growing
8.0%
India's exports as % of world Steel
6.0%
Electronics
4.0% Non-Ferrous
2.0% Other Machinery 5Y CAGR 2Y CAGR
0.0% Chemicals
Others
Autos
Jewellery
Others
Chemicals
Engg. Goods
Textiles
Leather
Electronic Goods
Autos
Textiles
Gems
2001 2010 2019
-5% 0% 5% 10% 15% 20% 25% 30% 35%
Source: Trademap, Credit Suisse estimates Source: Ministry of Commerce, Credit Suisse estimates
Figure 4: Textile and Apparel exports starting to grow again Figure 5: Significant import substitution in A-Cs
40 Yarn Fabric Cotton Apparel Synthetic Apparel Carpets Others
8.0 Consumption Imports Imports/Consumption 100%
30 80%
US$bn 6.0
20 60%
4.0
40%
10 2.0
20%
0 0.0 0%
Jan-00 Jul-02 Jan-05 Jul-07 Jan-10 Jul-12 Jan-15 Jul-17 Jan-20 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21
Source: Ministry of Commerce, Credit Suisse estimates Source: Statista, Ministry of Commerce, Credit Suisse estimates
Figure 6: Higher and growing global share in specialty chem. Figure 7: India 21% of incremental global PV demand 2020-30
4% 100
India's exports as % of world India to account for 21% of 5.7 99.7
Specialty Chemicals Bulk Chemicals 95 growth in sales till 2030 vs
3% <4% of sales today 4.0
90 2.1
2%
85 3.3
4.0
1% 80
PV Industry- Incremental growth from
80.7 CY21 - CY30 (mn Units)
75
0%
CY21 India China NA EU Rest of CY30
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
World
Source: Trademap, Credit Suisse estimates Source: Credit Suisse estimates
Figure 8: PLI impact on GDP to be 1.5% in FY27E Figure 9: Apparel and electronics PLI most important for jobs
80US$ Bn Domestic Value Addition Investment As % of GDP 2.0% Others Mobile Autos
Electronics 10% 15% 2%
Estimated GDP 10%
60 1.5% Battery
impact from PLI
2%
schemes
Telecom Pharma
40 1.0%
1% 4%
Food
20 0.5% 6%
0 0.0% Split of US$10bn of

Textile
FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 incremental wage bill
50%
Source: Credit Suisse estimates Source: Credit Suisse estimates
India Market Strategy 2

11 January 2022
Investment summary
India gaining share in electronics, chemicals
India’s share of global merchandise exports is now at an all-time high, with the upward trend
seen till 2015 resuming since 2020. Gains in commodities may not last, but strong momentum
in electronics and chemicals should persist; opportunities are also emerging in textiles and autos.
Electronics hold much promise, not only on the large size (~30% of global goods exports), but
also opportunities for share gains, given geopolitical shifts and China’s shrinking industrial labour
force. Helped by policy support, a critical mass appears to be building, with local and global
firms investing in capacities in India (even those not gaining from PLI schemes). In chemicals,
while India lacks sustainable advantage in bulks, its share of global exports of specialty
chemicals has risen steadily (these are now 10%-plus of India’s exports). Through steady
growth, and in some cases China ceding share, the industry has now gained critical mass.
In textiles and apparel, after nearly a decade-long stagnation, Indian exports have picked up
over the past year. Growth is concentrated in (upstream) yarn and fabric thus far, and
(downstream) apparel exports are yet to reach new highs, but order books are filling up. The
manufacturing opportunity in autos is as much local (India to be 21% of incremental global
demand this decade) as global. Disruption in the latter due to the shift to EVs also opens up
opportunities to enter, given: (1) new business models (EMS firms announcing car assembly
plants); (2) new OEMs (Sony, Apple, Xiaomi); and (3) more vertically integrated manufacturing.
PLI schemes: A year’s delay

A year after we flagged the Production-Linked Incentive (PLI) schemes as a significant turn in
India’s industrial policy, we take stock of the progress. Schemes in electronics (handsets and IT
hardware) are in the execution phase, and while semiconductor shortages/pandemic lockdowns
slowed progress, the momentum is encouraging. The scheme for food processing has seen 60
applicants selected across categories, including FMCG majors, and early signals are positive.
In autos, which had the largest fiscal allocation in the first iteration, the rapid global shift to EVs
meant a redesign of the scheme after industry consultation. The revamped scheme, launched in
Sep-2021, mainly for EVs and components, has a smaller budget, but CS analysts believe it
should accelerate the EV transition in India, which should help gain scale as supply-chains reset.
The apparel scheme has also seen some iterations, with the most recent guidelines published in
Dec-2021, with incentives for FY25-29. The focus remains on building scale in India’s value-
chain for man-made fibres (MMF) to attract business exiting China due to labour shortages.
The scheme for semiconductors is an addition to the schemes announced in 2020, and is a
significant improvement over previous attempts. However, given the evolving landscape, it could
go through a few more iterations before it builds traction.
Exports can add meaningfully to growth

Manufacturing share of GDP has been declining steadily since 2012, partly due to a stagnation
in exports of manufactured goods. As exports pick up again, either due to the effect of PLI
schemes or gains in chemicals and (non-PLI) apparel, GDP boost could be 2.4% in five years.
Progress in PLI schemes has been slower than expected, possibly due to global supply-chain
disruptions and the multiple Covid-19 waves. However, the broad architecture remains the
same. We estimate that the impact on GDP and exports five years out remains largely the same,
though this means a one-year lag. The sectors with meaningful impact remain electronics,
apparel, autos, food and telecom equipment. Other than autos and apparel, these schemes are
now in the execution stage, reducing the risk of further delays. The boost to jobs would be
concentrated in electronics and apparel: of this, only the latter has higher uncertainty.
We continue to expect economic momentum to surprise positively, and are overweight domestic
cyclicals (SBI, L&T, ABB), and beneficiaries of the manufacturing renaissance (Aarti, PI).

11 January 2022
India gaining share in electronics, chemicals

India’s share of global goods exports at a record-high
The post-Covid-19 rebound in India’s merchandise exports is not just due to the recovery in
global trade. Its share of global exports has also climbed to an all-time high 1.9% (in the first
ten months of CY21: Figure 12), resuming the upward trend seen till 2015, but which had
flattened thereafter. Manufactured goods have been a key driver of these gains (Figure 13).
Figure 12: India’s share of global goods exports rising again Figure 13: Large growth contribution from manufactured goods
450 2.0% 450 2021: Extrapolated from 11 months data
2021: Extrapolated from 10 months data
400
1.8% 400 India's Exports (CY, US$ Bn)
350 350
1.6%
300 300
250 1.4%
250
200 1.2% 200
150 150
1.0%
100 100
0.8%
50 50
0 0.6% 0
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2004 2006 2008 2010 2012 2014 2016 2018 2020
India Exports (US$ Bn) As % of World (RHS) Agri Petroleum Ores Manufactured Goods Others
Source: Trademap, Ministry of Commerce, Credit Suisse estimates Source: Ministry of Commerce, Credit Suisse estimates
Gains in electronics, chemicals, autos, apparel

India runs a structural deficit in sectors dependent on resource availability, like oil, gas, coal and
gold (together around a fifth of global exports); the share in agriculture is higher than average
given structural advantages, but its share of manufactured goods exports is lower (Figure 14).
Figure 14: Share gains in agri, oil and manufactured goods Figure 15: Mainly in autos, chemicals, apparel, electronics
4.0% 7.0%
India's exports as % of world India's exports as % of world
3.5% 6.0%
3.0% 5.0%
2.5% 4.0%
3.0%
2.0%
2.0%
1.5%
1.0%
1.0%
0.0%
Autos
Jewellery
Chemicals
Others
Engg. Goods
Textiles
Leather
Electronic Goods
0.5%
0.0%
Manufactured Oil Products Ores Agri
Goods
2001 2010 2019 2001 2010 2019
Source: Trademap, Ministry of Commerce, Credit Suisse estimates Source: Trademap, Ministry of Commerce, Credit Suisse estimates

11 January 2022
Within manufactured goods, pre-Covid-19 India’s share was above average in jewellery (though
it has low value-add) and textiles, and below average in electronics (Figure 15). Since 2015,
metals have grown the fastest, but these may not sustain (global commodity cycles). Growth in
electronics and machinery has been well above average (Figure 16), though chemicals and
textiles (incl. apparel) have contributed the most in absolute terms given their size (Figure 17).
Figure 16: Excl. metals, electronics, chemicals fastest growing Figure 17: Chemicals and textiles are larger in size
300 2021: Extrapolated from 11 months data

Steel
India's Exports (CY, US$ Bn)
Electronics 250
Non-Ferrous
200
Other Machinery
Chemicals 150
Others
100
Autos
50
Textiles
Gems 0
2004 2006 2008 2010 2012 2014 2016 2018 2020
-5% 0% 5% 10% 15% 20% 25% 30% 35%
Steel Non-Ferrous Autos
5Y CAGR 2Y CAGR Other Machinery Chemicals Electronics
Textiles Gems Others
Source: Ministry of Commerce, Credit Suisse estimates Source: Ministry of Commerce, Credit Suisse estimates
Electronics: Large opportunity, a steady ramp up

ahead?
Electrical (HS Code 85) and equipment (HS Code 84) account for ~30% of global goods trade
(Figure 18). Electrical consists of integrated circuits (ICs, or semis in common parlance) and
phones, followed by components like monitors, printed circuit boards, batteries, switches, etc.
Equipment includes computers and computer parts, semiconductor capital equipment, robots,
air-conditioners, and heavy-equipment, like turbines. China dominates these sectors, and is half
of the global exports in sub-categories like handsets, computers and computer parts (Figure 19).

11 January 2022
Figure 18: Electronics (HS Code 84 & 85) ~30% of global trade Figure 19: Several sub-categories are dominated by China
6,000 30% 1,400 30%
29%
5,000 1,200 25%
28%
1,000
4,000 20%
27%
800
3,000 26% 15%
600
25%
2,000 10%
24% 400
1,000 5%
23% 200
0 22% 0 0%
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Global Exports of HS Code 84+85 (US$ Bn) As % of Total (RHS) China Exports of HS Code 84+85 (US$ Bn) As % of World (RHS)
The shrinkage in China’s industrial workforce that started in 2015 has accelerated since then
(Figure 20). In labour-intensive sectors like apparel/footwear, numbers have been falling
steadily (Figure 21). In equipment, now the largest segment (29% of total), they held steady in
2020-21, but likely only because of lockdowns elsewhere, and should be the next to fall.
Figure 20: Chinese industrial workforce shrinking meaningfully Figure 21: Equipment jobs held steady in 2020-21, to fall now
105 China industrial employment Agri/Food
100
100 98 98 Transport Equip.
95
95 Other Materials
Dec-18
90
90 Metals & Mining
Furniture Dec-19
85
79 79 Toys
80
Nov-21
Footwear
73 74
75
Apparel/Textiles
70
Equipment
65 Total
60 Others
Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Nov-21 Growth
mn YoY -25% -15% -5% 5%
peop
Source: CEIC, Credit Suisse estimates Source: CEIC, Credit Suisse estimates
As these jobs are hard to automate, business is likely to shift out of China to labour-surplus
economies like India (see Half-a-Trillion dollar shift, Oct-2019). While electrical and equipment
together account for ~US$600 bn of global exports annually, India’s opportunity would be
primarily in labour-intensive segments initially; scale could eventually drive upstream integration.

11 January 2022
Figure 22: India can only participate in a few categories now Figure 23: India’s share of phone manufacturing
Global Exports of HS Integrated
Circuits 1,800 Smartphone production (Mn) Govt target of 50%
Code 84+85 (CY20) 1bn by FY25
16%
1,600 Forecast 45%
Handsets 1,400 40%

11%
35%
1,200
30%
1,000
Computers 25%
Others 800
49% 8%
20%
600
15%
Other
Components 400 10%
3%
200 5%
Wires/Switches/
Diodes - 0%
Turbojets 9% FY17 FY18 FY19 FY20 FY21e FY22e FY23e FY24e FY25e
Monitors 2%
2% Global India India as % of Total (RHS)
Source: Trademap, Credit Suisse estimates Source: Ministry of Electronics and IT, Credit Suisse estimates
Aided by a series of phased manufacturing programs (PMP), India’s global share of last-mile
assembly of handsets has been rising (Figure 23). It is expected to grow further, helped by
government’s Production-Linked Incentive (PLI) schemes (see “PLI Schemes: a new pro-
growth template for India’s industrial policy?”, Dec-2020 for details; updates in the next section),
given that now non-PLI firms are also expanding in India (Figure 24).
Figure 24: Several non-PLI firms expanding capacity too

Manufacturers Location Year Brands
Foreign Manufacturers selected for the PLI Scheme
Foxconn X 2 TN and AP 2015 Apple, Xiaomi
Pegatron TN 2021 Apple
Wistron KA 2017 Apple
Samsung UP 2007 Samsung
Domestic Manufacturers selected for the PLI Scheme
Micromax UP and TE 2014 Micromax
Lava X 2 UP 2014 Lava, Nokia, Motorola
Dixon X 2 UP 2016 Nokia, Motorola, LG. Gionee
Smartphone manufacturers outside PLI scheme
Flex TN 2015 Xiaomi, Huawei
BYD TN 2021 Xiaomi
DBG HA 2019 Xiaomi, Nokia, Samsung
Oppo UP 2016 Oppo, Vivo, Realme, Oneplus
HiPad UP 2018 Xiaomi, Oppo
Karbonn UP 2015 Karbonn
Celkon TE 2015 Celkon
Intex UP 2014 Intex, Reliance Jio Lyf
Source: Govt. of India, News Reports, Credit Suisse
To broaden these share gains and to consolidate them, we need to see evidence of Indian
groups investing in the value chain (like Tata Electronics, which has already invested US$1 bn in
its Hosur facility and plans to hire 40,000 workers), as well as foreign technology companies
setting up operations in India. Elsewhere, in consumer electronics like air-conditioners, import
substitution has driven significant growth in manufacturing (Figure 25).

11 January 2022
Figure 25: Significant import substitution in A-Cs Figure 26: India’s global share of textiles peaked in CY13
8.0 90% 45 5.0%
7.0 80% 40
70% 35 4.5%
6.0
60% 30
5.0
50% 4.0%
25
4.0
40% 20
3.0 3.5%
30% 15
2.0
20% 10 3.0%
1.0 10% 5
0.0 0% 0 2.5%
FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Consumption Imports Imports/Consumption India Exports of Textiles (US$ Bn) As % of World (RHS)
Apparel/textiles: Can India step out of the stasis?

Textile and apparel exports from India have picked up over the past year, as after a period when
lockdowns hurt demand for new clothes, global apparel markets have rebounded. However,
while rolling 12M exports have broken through the US$35 bn level they were stuck at for much
of the last decade (Figure 27), growth, at least until Nov-2021, was in upstream yarn and fabric,
and downstream apparel exports were lower than the prior peak in May-2019 (Figure 28).
This could just be a time lag in demand flowing through a value-chain, and preliminary data for
Dec-2021 shows a meaningful pick-up in apparel exports. However, there can be another
factor as well: India lacks the treaty advantages that Bangladesh and Vietnam possess. Further,
the US ban on Xinjiang cotton effective Dec-2021 could help upstream businesses in India
going forward.
Figure 27: Textile and apparel exports starting to grow again Figure 28: Gains in CY21 were mainly in yarn and fabric
40
US$bn US$bn
35 Others 1.1
30 Carpets 0.3
25
Synthetic Apparel -0.8
20
15 Cotton Apparel -0.6
10 Fabric 1.0
5
Yarn 1.3
0
Jan-00 Jul-02 Jan-05 Jul-07 Jan-10 Jul-12 Jan-15 Jul-17 Jan-20 -1.0 -0.5 0.0 0.5 1.0 1.5
Yarn Fabric Cotton Apparel Synthetic Apparel Carpets Others Change in 12M Rolling Exports, May-19 to Nov-21

11 January 2022
It is unlikely that China will cede its entire market share in apparel (read-made garments, or
RMG), but trends of the past decade are likely to persist (Figure 29). While nearly all of China’s
share in cotton apparel was taken by Bangladesh and Cambodia and that in man-made fibres
by Vietnam, current industry feedback suggests that volumes are also beginning to shift to India.
Figure 29: Significant opportunity in apparel as China cedes Figure 30: Some opportunity for gains in yarn and fabric too
share
50% Synthetic apparel 30%
Cotton apparel India exports as % of global exports
45%
CN 25%
40%
35% 20%
30%
15%
25%
Global export market share
20%
BD 10%
15%
10% 5%
IN
5%
0%
0% 2001 2005 2009 2013 2017
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Cotton Fiber C. Yarn C. Fabric Synth Yarn S. Fabric
Source: Trademap, Credit Suisse estimates Source: Trademap, Credit Suisse estimates
Similarly, in yarns and fabric as well, there are opportunities for India to expand share (Figure
30), particularly with geopolitical changes.
Projections
Chemicals gaining from share shifts, local demand
While specialty chemicals are ~20% of global as well as Indian chemicals demand, they are
more than half of India’s chemicals exports (Figure 31). India lacks raw material (like crude oil or
natural gas) and low cost-of-capital and hence lags in bulk chemicals, but in specialty chemicals,
abundant labour skilled in process chemistry provides advantages, helped by a globally dominant
position in pharmaceuticals manufacturing, explaining the higher and growing share (Figure 32).

11 January 2022
Figure 31: Specialty chem. dominate India’s chemicals exports Figure 32: Higher and growing global share in specialty chem.
120 55% 3.5%
Indian exports (US$ Bn) India's exports as % of world
100 50% 3.0%
45% 2.5%
80
40% 2.0%
60
35% 1.5%
40
30% 1.0%
20 25% 0.5%
0 20% 0.0%
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Specialty Chemicals Bulk Chemicals Specialty as % of toal Specialty Chemicals Bulk Chemicals
Gains have been relatively steady (Figure 33), and one of the reasons the sector is now
gathering attention that it has now gained scale. While the re-rating of multiples has helped, and
in some cases may have been excessive, the sector’s market capitalisation has now reached
~US$80 bn, with 18 firms having market capitalisation above US$1 bn (Figure 34). Scale is
important not only for the sector to have macroeconomic impact (specialty chemicals are now
10%-plus of exports), but also for firms to invest in developing and serving export markets.
Figure 33: Balance sheet and profits have seen steady gains Figure 34: 18 firms with >US$1 bn market cap (vs 4 in 2015)
60% 1,400 20
50% 18
Growth YoY 1,200
16
40% 1,000 14
Index: Jan-10=100
30% 12
800
10
20% 600
8
10% 400 6
4
0% 200
2
-10% 0 0
2014 2015 2016 2017 2018 2019 2020 2021 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jan-22
Profits NAV Market cap Index Firms with M.cap >US$1bn (RHS)
Source: RAVE, Credit Suisse estimates Source: RAVE, Credit Suisse estimates
Opportunity in autos as much local as global

India’s share of the global auto industry has been rising steadily, primarily driven by growth in
the domestic market (Figure 35), which is protected by high import duties. This should continue:
more than a fifth of incremental car demand globally over the next decade is forecast to come
from India (Figure 36). This should provide a boost to the domestic industry: scale should help
them expand into global markets: this holds true whether the OEM is Indian or global.

11 January 2022
Figure 35: India’s share of global auto market rising but slowly Figure 36: India 21% of incremental global demand 2020-30E
160 7% 100
99.7
140 6% 5.7
95
120 India to account for
5%
21% of growth in 4.0
100
4%
sales till 2030 vs <4%
90
80 2.1
3%
60 3.3
85
2%
40
4.0
20 1%
80
80.7
0 0% PV Industry- Incremental
FY20 FY26 growth from CY21 - CY30
India Domestic Value Add As % of World (FY20, RHS) 75
CY21 India China NA EU Rest of World CY30
Source: SIAM, Credit Suisse estimates Source: Credit Suisse estimates
The US$2.3 tn global automotive industry is predominantly in personal vehicles (Figure 37),
which also shows up in the mix of global exports (Figure 38).
Figure 37: Global auto market is dominated by PVs Figure 38: ~80% of global trade in autos also PV/components
2W
CY19 Sales: US$2.3tn Others
4%
2W 8%
MHCV Components
17% 3%
Two-wheelers
4%
CVs
7%
Cars
LCV 48%
8%
PV Industry
71% Car/CV
Components
30%
Split of Asian Auto Exports (2017): $389bn
Asian countries currently dominate only the 2W space when it comes to global exports (Figure
39), and three-fourths of all auto exports are from Japan and Korea (Figure 40).

11 January 2022
Figure 39: Asian countries dominate the 2W space Figure 40: Japan & Korea are three-fourths of Asian exports
JP
Cars 13%
TR
2%
Car/CV Components KR
5% TH
1%
CVs
AE
1%
Two-wheelers
CN
2W Components 1%
IN
1%
Others
Oth Asia
Total Autos ROW 1%
75%
-20% 0% 20% 40% 60% 80%
Car Exports (2017):
2001 2001-10 2010-17 Global : $750bn
Asia : $185bn
This structure limits the near-term potential for India’s exports of vehicles or automotive
components, even though expanding domestic demand should keep manufacturing activity
growing strongly (Figure 41).
However, the transition to electric vehicles over the next decade is likely to disrupt global supply
chains and can open up opportunities: (1) new OEMs like Apple, Sony and Xiaomi; (2) new
business models, with EMS firms announcing car assembly plants; and (3) more vertically
integrated manufacturing so as to shorten product cycles and manage supply chains better.
China currently has a significant lead in EVs, with a much higher share of global EV production
than of ICE vehicles (Figure 42). India’s share of global EV production is near-zero, though
several component suppliers are making inroads into EV OEMs.
Figure 41: Shift to EVs is likely to disrupt auto value chains Figure 42: China has a high share of global EV production
80,000 80% 40%
Forecast Forecast
China's share of
70,000 70% 35% global production
60,000 60% 30%
50,000 50% 25%
40,000 40% 20%
30,000 30% 15%
20,000 20% 10%
10,000 10% 5%
0 0% 0%
2012 2014 2016 2018 2020 2022E 2024E 2026E 2028E 2030E 2012 2014 2016 2018 2020 2022E 2024E 2026E 2028E 2030E
Mild HEV Full HEV PHEV
EV FCEV xEV Penetration ICE EV
Source: Credit Suisse estimates Source: Credit Suisse estimates

11 January 2022
PLI schemes: A one-year delay

A year after we flagged a significant turn in India’s industrial policy through the PLI schemes
(see report), we take stock of the progress so far. Somewhat as expected, progress in some
sectors has been better than in others, and several have not started yet: we had built in a
“success ratio” to account for iterations to calibrate better, execution delays and poor scheme
design.
Figure 43: Process flow within the government for PLI schemes
Source: Government data, News Reports, Credit Suisse estimates
Autos: A shift to EVs necessitated by market changes

The largest fiscal allocation in the first iteration was for autos: Rs570 bn, with the government
targeting a doubling of India’s global share of value-add in the auto sector by getting OEMs to
do assembly in India, leveraging India’s expertise in component manufacturing. However, the
scheme did not cross the industry-consultation phase, perhaps as, with the shift to EVs
accelerating, global OEMs were unwilling to commit to ICE capacity.
The government then changed tack, and in Sep-2021 launched a smaller (Rs259 bn over five
years, starting FY23) and refocused (on EVs, this time) scheme for auto OEMs and auto parts
suppliers. 1-Jan-2022 is the start date for applications.
Figure 44: Incentive design for auto OEMs and auto parts suppliers
OEMs Auto Components
Determined Sales Value (Rs Bn) Incentive Rate Determined Sales Value (Rs Bn) Incentive Rate
<=20 13% <=2.5 8%
>20 to 30 14% >2.5 to 5 9%
>30 to 40 15% >5 to 7.5 10%
>40 16% >7.5 11%
Cumulative Sales of 100bn over 5 years Additional 2% Cumulative Sales of 12.5bn over 5 years Additional 2%
Battery EVs & Hydrogen Fuel cell components Additional 5%
Source: Ministry of Heavy Industries, Credit Suisse estimates
There are two separate categories for EV OEMs and component suppliers (Figure 44). For
OEMs, incentives worth 13-16% of ASP exist only for OEMs making battery electric vehicles
(BEVs) or hydrogen fuel cell (FC) vehicles. For auto parts suppliers, the scheme has notified a
list of auto parts, which largely includes key components for electric vehicles as well as
components with high import content currently, to encourage electrification and localisation
respectively. Incentives are 8-11% for non-EV components and 13-16% for EV parts.

11 January 2022
Only firms crossing a minimum capex threshold (starting 1-Apr-2022) will be eligible for
incentives. The hurdle rate for incentives is annual production growth exceeding 10%. Unlike in
other PLI schemes though, incentives apply on total sales value for the year (as against
incremental sales), and are thus back-end loaded (Figure 45); an additional 2% incentive also
applies on a cumulative sales threshold. Incentives are capped at Rs65 bn for each firm,
implying a minimum of four companies. If the scheme finds the maximum takers, total sales can
be boosted by Rs640 bn (US$9 bn) by FY27 (Figure 46), with domestic value addition of US$5
bn.
Figure 45: Bulk of Incentives are loaded towards the end Figure 46: Expected sales by FY27 can be Rs650 bn
100 700
90
600
80
70 500
60
400
50
40 300
30
200
20
10 100
0 0
FY24 FY25 FY26 FY27 FY28 FY23 FY24 FY25 FY26 FY27
Max PLI incentive (Rs Bn) Expected Incremental Sales (Rs Bn)
Source: Ministry of Heavy Industries, Credit Suisse estimates Source: Ministry of Heavy Industries, Credit Suisse estimates
Battery: Strong interest

The PLI scheme for ACC (advanced chemistry cell) battery storage got approval in May-2021
and RFP was issued Oct-2021. The scheme starts from FY23, with two years allocated for
setting up of manufacturing plants, and incentives start rolling out from FY25 (Figure 47). The
scheme envisages 50 GWh of manufacturing capacity, with minimum investment of Rs2.25
bn/GWh.

11 January 2022
Figure 47: Incentive layout for ACC PLI scheme Figure 48: Minimum domestic value to be 60% to be eligible
50 70%
45
40 60%
Minimum DVA to be eligible
35 for incentive
50%
30
25 40%
20
30%
15
10
20%
5
0 10%
Incentive layout (Rs Bn) 0%

FY25 FY29
Further, domestic value-add should be a minimum of 25% in FY25E, rising to at least 60% in
FY29E (Figure 48). Incentives are calculated as the product of applicable subsidy amount per
kWh, domestic value addition and actual sales in kWh. As per media reports, response from the
industry has been better than expected (applicants include Ola Electric, Tata Chemicals, Exide,
Amara Raja and Lucas TVS), and capacity commitments exceed 50 GWh.
Semiconductors: Priority is the ecosystem/geopolitics

The PLI scheme for semiconductors was not part of the first 13, and was launched in Dec-
2021, with planned incentives of Rs760 bn (US$10 bn) over three to six years which defray
30-50% of project cost for four categories: (1) silicon semiconductor fab; (2) compound
semiconductors/ATMP (assembly, testing, marking & packaging); (3) IC design; and (4) display
fab (Figure 49).
Figure 49: Details of various schemes under PLI for semiconductors

Fab Compound Semiconductor/ATMP DLI Display Fab
Compound
Silicon Product Design Deployment Linked
Semiconductors/Sen ATMP/OSAT Display Fab
Semiconductor Fab Linked Incentive Incentive
sors Fab
Compound Semiconductor
Semiconductor
Semiconductors/Silic Semiconductor design for Integrated
Silicon CMOS based design for Integrated
on Photonics (SiPh) / Assembly,Testing, Circuits (Ics),
Semiconductor Fab Circuits (Ics), Display Fabrication
Sensors (including Marking, and Chipsets, System on
in India for Chipsets, System on Unit (Fab) in India for
MEMS) Fab in India Packaging (ATMP) / Chips (SoCs),
Description manufacturing Logic / Chips (SoCs), manufacturing TFT
for manufacturing Outsourced Systems and IP
Memory / Digital ICs / Systems and IP LCD or AMOLED
High Frequency / Semiconductor and cores and
Analog ICs / Mixed cores and based display panels
High Power / Test (OSAT) Facility semiconductor linked
Signal ICs / SoCs semiconductor linked
Optoelectronics in IndiaAssembly design deployed in
design
devices electronic products
50% of total cost 6% to 4% of net
50% of total cost
Incentive 30-50% of total cost 30% of total cost 30% of total cost (max Rs sales turnover (max
(max Rs 120bn)
150mn/applicant) Rs 300mn/applicant)
Min Capital Investment
200 1 0.5 100
(Rs Bn)
Min Revenue (Rs Bn) 75 75
No. of Beneficiaries >=2 ~100 ~100 <=2
Scheme Tenure 6 years 3 years 3 years 3 years 5 years 6 years
Source: Ministry of Electronics and Information Technology, Credit Suisse estimates

11 January 2022
Figure 50: Split of semiconductor value chain Figure 51: Estimated split of US$10 bn in various schemes
ATMP
10%
Display Fab
32%
Chip Design
Silicon
30%
Semiconductor
Deployment Fab
Linked 56%
Incentive
4%
Fabs Product Design

40% Linked
Silicon wafers
5% Incentive
2%
Compound Estimated split of

Chip fabrication ATMP/OSAT Semiconductors
Split of tool 2% US$10bn PLI
/Sensors Fab
Semiconductor 15% 4% package
Value chain
Source: BusinessLine, Credit Suisse estimates Source: Ministry of Electronics and IT, Credit Suisse estimates
This is India’s third attempt to seed semiconductor manufacturing in India: (1) the 2007 policy
gave tax breaks, interest free loans and a subsidy of 20% of capex for the first ten years. (2) In
2013, the government approved setting up of two fab units and provided incentives like zero
custom duty on plants and machinery. This scheme is far more attractive, but it is unclear if this
will work too for fabs, and may need active work with global firms to attract them. Design,
ATMP and display fabs have a greater chance of succeeding (Figure 50, Figure 51).
IT hardware: Strong demand, promising prospects

The guidelines for PLI scheme for IT hardware were published in Mar-2021, which included
incentives for four major product categories: (1) laptops, (2) tablets, (3) all-in-one PCs, and (4)
servers. In Jul-2021, the list of firms eligible for incentives was announced (Figure 52): there
were four global companies selected as against the maximum five notified in the guidelines; ten
domestic firms filled the maximum quota for domestic category.

11 January 2022
Figure 52: Selected companies for IT hardware Figure 53: Expected incremental sales by FY25
Global Domestic 1,600
Dell Lava 1,400
ICT (Wistron) Dixon 1,200
Flextronics Infopower 1,000
Rising Stars (Foxconn) Bhagwati 800
Neolyne 600
Opteimus 400
Netweb 200
Smile Electronics 0
VVDN FY22 FY23 FY24 FY25
Panache Digilife Incremental Sales (Rs Bn)- Total
The scheme was to run from FY22 to FY25, though given the pandemic, as well as the global
shortage of semiconductors, production delays meant FY22 targets are likely to be missed (see
media reports). Companies have requested for an extension of the scheme by at least one year.
We estimate the scheme can drive incremental sales in FY25 of Rs1.4 tn (US$19 bn, Figure
53).
Apparel: An attempt to build scale man-made fabrics

Apparel provide a large opportunity for job creation, but India has been unable to attract
manufacturers exiting China. The problem is particularly acute in artificial fibres (man-made
Fibre or MMF), where India lacks scale in the whole value-chain from yarns to fabrics to apparel
(ready-made garments, or RMG). A PLI scheme can help build scale and thus holds promise.
There was slow progress on the scheme over the past year, and guidelines got notified only in
Dec-2021, with incentives available FY25-29. The products included in the scheme include
MMF apparel (50 8-digit HS code items where India’s share is low: these are ~7% of India’s
MMF exports, Figure 54), MMF fabric (woven fabrics including nylon and polyester), technical
textiles (defense, sports, medical, etc.) and smart textiles (textiles embedded with electronics).
The scheme is designed separately for companies that will invest at least Rs3 bn in plant,
machinery, equipment and civil work; these companies are to receive incentives once they
achieve a turnover of at least Rs6 bn (Figure 55) starting from FY25 (after a gestation period of
two years, starting FY23). The second scheme is for producers who are investing Rs1 bn and
generating revenue of at least Rs2 bn, but will be incentivised 4 pp lower than the first scheme.

11 January 2022
Figure 54: Selected MMF Apparels just ~7% of total exports Figure 55: Sales to grow by at least 25% to be eligible
1.2 6.80% 16 16%
6.75%
1.0 14
15%
6.70%
12
0.8 6.65% 14%
10
6.60%
0.6 8 13%
6.55%
0.4 6.50% 6
12%
6.45% 4
0.2 11%
6.40% 2
0.0 6.35% 0 10%

FY20 FY21 FY25 FY26 FY27 FY28 FY29
Exports of selected items (US$ Bn) As % of Total MMF Apparel Exports Minimum Sales/Company (Rs Bn) Incentive Rate (RHS)
Source: Ministry of Commerce, Credit Suisse estimates Source: Ministry of Textiles, Credit Suisse estimates
Incentives are, however, contingent on achieving at least 25% growth YoY and achieving
minimum domestic value addition of 60%. Companies that are willing to set up factories in
aspirational districts/Tier-2 cities will be preferred.
Figure 56: Bulk of the incentive to be paid in first year Figure 57: Expected incremental sales of ~Rs900 bn by FY29
45 1,000
40 900
35 800
30 700
25 600
500
20
400
15
300
10
200
5
100
0 0
FY25 FY26 FY27 FY28 FY29 FY25 FY26 FY27 FY28 FY29
Incentives/year (Rs Bn) Total Incremental Sales (Rs Bn) DVA (Rs Bn)
Source: Ministry of Textiles, Credit Suisse estimates Source: Ministry of Textiles, Credit Suisse estimates
While incentive for the first year of the scheme (FY25) will be decided on total sales, incentive
for subsequent years will be calculated on YoY incremental sales (unlike incremental sales from
base year in other schemes). Thus, bulk of the incentives (~40%) are to be paid out in the first
year itself (Figure 56). The total incremental sales by the end of FY29 is expected to be Rs880
bn (US$12 bn), with domestic value addition of US$ 7bn (Figure 57).
Food
The details of the PLI scheme for processed foods were released in May-2021: it allocates
Rs109 bn over six years (FY22-27) and covers four segments: (1) ready-to-cook/ready-to-eat
(RTC/RTE) foods, (2) processed fruits and vegetables, (3) marine products, and (4) mozzarella

11 January 2022
cheese. Innovative and organic products in these segments, including poultry, meat, and egg
products, are also covered (Figure 58).
Figure 58: Scheme details of PLI for food processing

Min Sales in Min Investment Min Applicable Incentives
Category FY20 (Rs Bn) (Rs Bn) CAGR FY22 FY23 FY24 FY25 FY26 FY27
Ready to Eat/Ready to Cook 5.0 1.00 10% 10% 10% 10% 10% 9% 8%
Processed Fruits & Vegetables 2.5 0.50 10% 10% 10% 10% 10% 9% 8%
Marine 6.0 0.75 5% 6% 6% 6% 6% 5% 4%
Mozzarella cheese 1.5 0.23 15% 10% 10% 10% 8% 6% 4%
Source: Ministry of Food Processing Industries, Credit Suisse estimates
The scheme offers incentives of 6-10% on incremental turnover for projects approved. The
incremental turnover for the first four years (FY22, FY23, FY24, FY25) will be calculated on
the base of FY20, while for the last two years (FY26 and FY27) the base year for calculation of
incremental turnover will shift to FY22 and FY23, respectively. The threshold growth rate to be
eligible for incentives is 10% CAGR for RTC/RTE products and processed fruits and vegetables.
Among major food categories, the main inclusions in the PLI scheme are biscuits, Indian savory
snacks, fruit-based beverages, spices, and ice creams. Smaller categories like ketchups, soups,
and jams are also included. On the other hand, large categories like noodles, chocolates, and
packaged commodities (branded flour, edible oils, etc.) are not part of the scheme.
Figure 59: Selected companies for PLI

RTE/RTC Fruits and Vegetables Fruits and Vegetables (cont.) Marine Mozzarella Cheese
Britannia Industries Parle Agro Keventer Agro Falcon Marine Parag Milk
Haldiram Snacks Synthite Industries Capital Foods Asvini Fisheries Gujarat Co-Operative Milk
Gujarat Co-Operative Milk Asandas And Sons Nestle India Devi Sea Foods Sunfresh Agro
Parle Biscuits Plant Lipids Vidya Herbs Nekkanti Sea Foods Indapur Dairy
Bikaji Foods Kancor Ingredients DS Spiceco Sandhya Aqua
ITC Everest Food Dabur India Devi Fisheries
Haldiram Foods Mtr Foods Tata Consumer Sandhya Marines
Bikanervala Foods Mccain Foods Om Oil & Flour Mills Avanti Frozen Foods
Balaji Wafers Tasty Bite Eatables Fieldfresh Foods Gadre Marine Export
Anmol Industries ITC Nilons Enterprises Choice Trading
Hindustan Unilever Hindustan Unilever Suruchi Spices ITC
Prataap Snacks Exotic Fruits Gujarat Co-Operative Milk
Foods And Inns Sahyadri Farmers
Iscon Balaji Foods Moon Beverages
Aachi Masala Foods Emami Agrotech
Pravin Masalewale Ghodawat Consumer
Varun Beverages
Source: Ministry of Food Processing Industries, Credit Suisse estimates
60 applicants have been selected across the four categories (Figure 59). If the scheme is
utilised to its capacity, incremental sales by the end of FY27 can be Rs800 bn (US$11 bn).

11 January 2022
Exports can add meaningfully to growth

Contribution to GDP should start improving again
Since the new GDP series started in 2011-12, the share of manufacturing has been declining
(Figure 60), partly due to a stagnation in exports of manufactured goods (Figure 61).
Figure 60: Manufacturing GVA as % of GDP Figure 61: Manufacturing exports as % of GDP
Manufacturing GVA (Trailing 12M) as % of GDP 300 Manufacturing Goods Exports (US$Bn) As % of GDP (RHS) 11%
17%
16% 250 10%
15% 200 9%
14% 150 8%
13% 100 7%
12%
50 6%
11%
Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Jun-18 Jun-19 Jun-20 Jun-21 0 5%
1994 1998 2002 2006 2010 2014 2018 2022(A)
Source: MOSPI, Credit Suisse estimates Source: Ministry of Commerce, Credit Suisse estimates
As exports pick up again, particularly sectors discussed earlier in this report, electronics,
chemicals, textiles and apparel, they would boost GDP. To avoid double counting, we add
exports of non-PLI apparel and chemicals to the PLI effect on net exports (through import
substitution or exports). The impact is a substantial ~2.4% of GDP (Figure 62).
Figure 62: Exports could add 2.4% to GDP over the next five years
120 Estimated increase in Indian exports (US$ Bn) 2.5%
100
Apparel Chemicals PLI As % of GDP (RHS) 2.0%
80
1.5%
60
1.0%
40
0.5%
20
0 0.0%
Source: Company data, Credit Suisse estimates
PLI impact still meaningful, pushed out by a year

Progress on PLI schemes has been slower than expected, possibly due to global supply-chain
disruptions and the multiple Covid-19 waves. However, the broad architecture remains the
same.

11 January 2022
The sectors with meaningful impact remain electronics (including handsets), apparel, autos,
food and telecom equipment (beneficiaries announced Oct-2021). Other than autos and
apparel, these schemes are now in the execution stage, reducing the risk of further delays.
Altogether, the incremental sales generated could be US$134 bn by FY27E (Figure 63) vs
US$144 bn we estimated in Dec-2020. Similarly, the domestic value-add, or the accretion to
GDP, should still be US$61 bn (Figure 64) in the fifth year, except that it gets pushed out.
Figure 63: PLI schemes could add US$134 bn to FY27E sales Figure 64: Domestic value-added shifted by one year
180 80
Incremental Sales due to PLI Scheme ($ Bn) Incremental DVA due to PLI Scheme ($ Bn)
160
70
140
60
120
50
100
40
80
60 30
40 20
20 10
0 0
FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29
Mobile Autos Battery Pharma Food Textile Telecom Electronics Others Mobile Autos Battery Pharma Food Textile Telecom Electronics Others
Including the boost to capex by the selected firms, this means an increase of 1.5% of GDP by
FY28; our estimate last year was 1.7% by FY27 (Figure 65): the numbers shifting out by one
year means that the GDP base is higher. This also means that the fiscal payouts occur later: the
design of the schemes has also changed, with a front-loaded scheme for apparel and a back-
end loaded one for autos (Figure 66).
Figure 65: Impact on GDP to be 1.5% in FY27 Figure 66: Fiscal costs for the government from PLI schemes
US$ Bn Domestic Value Addition Investment As % of GDP
80 1.6% Fiscal outlay of incentives (Rs Bn) As % of GDP (RHS)
450 0.16%
70 Estimated GDP 1.4% 400 0.14%

impact from PLI
60 schemes 1.2% 350
0.12%
50 1.0% 300
0.10%
250
40 0.8% 0.08%
200
30 0.6% 0.06%
150
20 0.4% 0.04%
100
10 0.2% 0.02%
50
0 0.0% 0 0.00%
FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY30

11 January 2022
Boost to job creation mainly in apparel, electronics

While the government has estimates for job creation in every scheme launched, the major
segments from a labour perspective are electronics and apparel (Figure 67). In electronics, the
ball is in motion, and firms are already hiring. Uncertainty remains high only in apparel, where
the uptake of the scheme and its execution are still unclear.
Figure 67: Apparel and electronics most important for jobs Figure 68: Net export impact of PLIs: electronics dominate
Others
Mobile 35 0.7%
10%
15%
Electronics Autos 30 0.6%
10% 2%
Battery 25 0.5%
2%
Telecom Pharma 20 0.4%
1% 4%
15 0.3%
Food
6% 10 0.2%
5 0.1%
0 0.0%
Split of US$10bn of
incremental wage bill
Textile
Change in Trade Balance As % of GDP
50%

EQUITY RESEARCH
India | Equity Strategy
Strategy
State Fiscal Improves but not as Good as Central Exhibit 1 - % YoY growth in SOTR and its
sub-components
24 January 2022 *all nos. Nov FYTD % YoY
70 (%)
Key Takeaway
59
60
50
40
Cumulative state govt expenditure is 20% more than the central govt expenditure. 40
38 38 37
30
YTD data from 17 states shows that a rebound in tax growth at states (up 38% YoY)
22
20
is slower than the central govt (link) (up 50% YoY). State's capex has grown 8%
10
0
over FY20-22, same pace as centre. Surge in stamp duty collections across states,
SOTR
State Excise
Stamps duty
Sales Tax
GST
Other taxes
indicates a broad based housing recovery. Rising state bond yields, however, now
. Growth in States own tax revenue (SOTR) and its components
indicate a need for fiscal consolidation in FY23.
Source: CAG, Jefferies
State revenues seeing weaker bounce than centre. Our analysis of fiscal data for Apr- Exhibit 2 - State vs Center capex spends
Nov'21 for 17 states accounting for 90% of India's GDP shows that while State's own *FY21 (RE); # FY22 (BE)
tax revenues (SoTR) have rebounded sharply YoY at 38%; the 2-Y cagr at 7% is slower 3.5 (%)
3.0
than the 15% jump seen for the centre. The SoTR jump is primarily driven by GST 2.5
(16ppt), though taxes are up across board on higher sales of auto fuels & alcohol
2.0
1.5
(reopening) and rising property transactions. The YoY difference in tax performance 1.0
0.5
is largely explained by strong direct tax collections (66% YTD) which are collected 0.0
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
by the central govt.
Center's Capex (as % of GDP) State's Capex (as % of GDP)
.
Stamp duties surge on housing revival. The stamp duty collections are up 59%
Source: RBI, CAG, Jefferies
YTD/8% on 2-yr cagr. Our analysis shows that stamp duty collections have aligned
Exhibit 3 - State-wise comparison of
with the property cycle well, with growth slowing substantially post FY13 housing Stamp dut collections
cycle peak. The surge in stamp duties on a country-wide level is a strong indicator *all nos. Nov FYTD % YoY
of the improvement in the broader housing/property cycle. (%)
100.0
296 100
90.0
80.0
States stepping up on capex too. State govt. total expenditure is up 16% YTD, rising 70.0
60.0
50.0
2ppt faster than the centre's pace. Capex is up 60% YoY YTD (2 yr up 7.6% cagr), 40.0
30.0
20.0
though on a much lower base, and led by the election bound states of UP and Punjab. 10.0
0.0 Uttarakhand
W. Bengal
Punjab
M.P.
Rajasthan
Telangana
Maharashtra
Gujarat
Total
U.P.
Chhattisgarh
Andhra
Tamil Nadu
Kerala
Haryana
Jharkhand
Karnataka
Interestingly, the data from RBI's state budget analysis shows that state capex as
% GDP has increased by 0.8ppt over FY20-FY22E; inline with the centre's increase
in capex. States are historically the bigger spenders on capex (FY22BE at 2.9% of . State-wise comparison of Stamp duty collections

GDP vs. centre at 2.4%).
Relevant notes
Some long term trends. a) SoTR's share in their total revenues has stayed stable
~46% since FY16 i.e. same pre and post GST; b) Centre's tax devolution to state's FY23 Budget: Amid the threat of Twin
as % revenue declined by 8ppt over last 3 years, partly a function of centre growing deficit
its revenue via 'cesses' which are non-shareable; c) State's reliance on 'grants' from Strong Tax Growth Drives Social Spending
centre has gone up, which is partly GST compensation and partly due to objective
based funding; d) total expenditure by states as % GDP at 18.8% in FY22 is 3ppt India Strategy 2022: Enter Economic
higher than pre-COVID levels. Supercycle
Fiscal pressure persisting, yields rise. State fiscal deficit (absolute levels) is higher
by 22% vs. Apr-Nov19 levels. The state govt. gross borrowing for FY22 is projected
at Rs7.9Trn, -1% YoY, inline with RBI's budgeted estimates. As such, the state fiscal
deficit is likely to be near the budgeted 3.7% level for FY22, -1.0ppt YoY. Nonetheless, Mahesh Nandurkar *
Equity Analyst
state's borrowings are relatively back-ended in FY22 (34% yet to happen) which has
+91 224224 6120
put pressure on yields, driving 10-yr state govt bond (SDL) yields to 7.27%, up 90bps mnandurkar@jefferies.com
from 2020 lows. State govt. bond spreads vs. centre have also increased by 20bps
Abhinav Sinha *
from Dec'21 lows, though at 65bps, are at last 3-year average levels.
Equity Analyst
+91 22 4224 6121
abhinav.sinha@jefferies.com
^Prior trading day closing price unless
otherwise noted.
* Jefferies India Private Limited

EQUITY RESEARCH
Exhibit 4 - State fiscal summary as of FTYD Nov'21

Data for 17 states (Rs bn) FY20 FY21 FY22 % YoY 2yr cagr
Revenue receipts 13,730 11,929 15,077 26.4 4.8
Tax-revenue 10,361 8,531 11,318 32.7 4.5
Own tax revenue 7,400 6,174 8,519 38.0 7.3
State's share of Union Taxes 2,961 2,357 2,799 18.8 (2.8)
Non-tax revenue 896 734 1,139 55.2 12.7
Grants 2,473 2,664 2,619 (1.7) 2.9
Total Expenditure 16,455 15,846 18,474 16.6 6.0

RevEx 14,546 14,465 16,262 12.4 5.7
CapEx 1,909 1,381 2,212 60.2 7.6
Fiscal balance (2,725) (3,917) (3,398) (13.3) 11.7

*as of Nov'21 FYTD
.
Exhibit 5 - Break-up of States own tax revenues GST and sales tax account for almost
FY20 (A) Stamp duty 2/3rd of State's own tax revenues
11%
Other Taxes
11%
SGST
41%
State Excise
13%
Sales Tax
. 24%
Source: RBI, Jefferies
Exhibit 6 - Contribution to States own tax revenue growth GST and and sales tax largest
as of Nov'21 FYTD contributors to SOTR growth
40.0 (%) 38.0
35.0 3.2
3.2
30.0 5.5
25.0
20.0 9.7
15.0
10.0
16.4
5.0
0.0
Sales Tax
SOTR
GST
Stamp duty
State Excise
Other taxes
. Contribution to States own tax revenue (SOTR) growth

2
EQUITY RESEARCH
Exhibit 7 - States own tax revenue growth State's own tax revenue up 38% YoY in
*FY21 (RE); # Nov FY22 YTD Nov'21 FYTD; up 7% on 2yr cagr
40.0 (%)
35.0
30.0
25.0
20.0
15.0
2yr Cagr
10.0 = 7%
5.0
0.0
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. State's own tax revenue growth (% YoY)
Exhibit 8 - States share in central taxes Growth of state's share in central taxes
*FY21 (RE); # Nov FY22 YTD has been dwindling since FY16
60.0 (%)
50.0
40.0
30.0
20.0
10.0
0.0
(10.0)
2yr Cagr = -3%
(20.0)
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. State's share in central taxes growth (% YoY)

Exhibit 9 - Stamp duty collections The stamp duty collections are up 59%
YTD/8% on 2-yr cagr
70.0 (%)
60.0
50.0
40.0
30.0
20.0
10.0
0.0
(10.0)
(20.0)
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
Stamp Duty Collections (% YoY)

.
3
EQUITY RESEARCH
Exhibit 10 - State's revenue expenditure Revenue expenditure up 12% YTD; +5.6%

*FY21 (RE); # Nov FY22 YTD on 2yr cagr
20.0 (%)
18.0
16.0
14.0
12.0
10.0
8.0
6.0
2yr Cagr
4.0
= 5.6%
2.0
0.0
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. State's Revenue Expenditure (% YoY)
Exhibit 11 - States capital expenditure Capital expenditure up 60% YTD; +8% on
*FY21 (RE); # Nov FY22 YTD 2yr cagr
70.0 (%)
60.0
50.0
40.0
30.0
20.0 2yr Cagr
10.0 = 8%
0.0
(10.0)
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. State's Capital Expenditure (% YoY)

Exhibit 12 - State vs Center capex spends Capex by states and center both rising;
*FY21 (RE); # FY22 (BE) albeit states rising marginally faster than
3.5 (%) center
3.0
2.5
2.0
1.5
1.0
0.5
0.0
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
Center's Capex (as % of GDP) State's Capex (as % of GDP)

.
4
EQUITY RESEARCH
Exhibit 13 - State-wise comparison of own tax revenue collections growth Own-tax revenue collections strong at
*all nos. Nov FYTD % YoY 38% YoY, bolstered by 45-50% growth
60.0 (%) seen in large states like Maha, Gujarat,
Telangana
50.0
40.0
30.0
20.0
10.0
0.0
W.Bengal
Punjab
Odisha
M.P.
Telangana
U.P.
Rajasthan
Total
Tamil Nadu
Chhattisgarh
Andhra
Jharkhand
Gujarat
Uttarakhand
Kerala
Haryana
Maharashtra
Karnataka
State-wise comparison of own tax revenue collections
.
Exhibit 14 - State-wise comparison of SGST collections SGST collections up 38% YoY for 17 large
*all nos. Nov FYTD % YoY states accounting for 90% of GDP
60.0 (%)
50.0
40.0
30.0
20.0
10.0
0.0
M.P.
Telangana
Gujarat
Tamil Nadu
Odisha
U.P.
Punjab
W. Bengal
Uttarakhand
Jharkhand
Karnataka
Maharashtra
Total
Andhra
Haryana
Chhattisgarh
Rajasthan
Kerala
State-wise comparison of SGST collections

.
Exhibit 15 - State-wise comparison of Stamp duty collections Stamp duty collections up 59% YoY; the
*all nos. Nov FYTD % YoY surge in stamp duties on a country-
(%) 296 100
wide level is a strong indicator of the
100.0 improvement in the broader housing/
90.0
80.0 property cycle.
70.0
60.0
50.0
40.0
30.0
20.0
10.0
0.0
Uttarakhand
M.P.
Punjab
W. Bengal
Rajasthan
Maharashtra
Gujarat
U.P.
Telangana
Total
Chhattisgarh
Andhra
Tamil Nadu
Kerala
Haryana
Jharkhand
Karnataka
State-wise comparison of Stamp duty collections

.
5
EQUITY RESEARCH
Exhibit 16 - State-wise comparison of capital expenditure Capex spends much higher in election
*all nos. Nov FYTD % YoY bound states of UP and Punjab
350.0 (%)
300.0
250.0
200.0
150.0
100.0
50.0
0.0
(50.0)
(100.0)
Telangana
M.P.
U.P.
Uttarakhand
Odisha
Punjab
W. Bengal
Gujarat
Maharashtra
Andhra
Rajasthan
Haryana
Chhattisgarh
Karnataka
Total
Tamil Nadu
Kerala
Jharkhand
State-wise comparison of Capital expenditure
.
Exhibit 17 - Share of State's own tax revenue in total revenue collections
*FY21 (RE); # FY22 (BE)
54.0 (%)
52.0
50.0
48.0
46.0
44.0
42.0
40.0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. State's own tax revenue (as % of total revenues)

Exhibit 18 - Share of non-tax revenue in total revenue collections The non-tax revenue expansion is partly
*FY21 (RE); # FY22 (BE) to fill up the gap for the lowered tax
36.0 (%) transfers from centre
34.0
32.0
30.0
28.0
26.0
24.0
22.0
20.0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. State's non-tax revenue (as % of total revenues)

6
EQUITY RESEARCH
Exhibit 19 - Share of central grants to states total revenue collections The sharp jump in grants from centre as
*FY21 (RE); # FY22 (BE) % revenues is partly on account of higher
28.0 (%) GST compensation transfers
26.0
24.0
22.0
20.0
18.0
16.0
14.0
12.0
10.0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21*
FY22#
. Grants from Center (as % of total revenues)
Exhibit 20 - Combined fiscal deficit trend We expect 50bps reduction in fiscal
16 (%) deficit for both the centre and states in
FY23, though deficit would still be high in
14
absolute terms
12
4.7
10
3.7
8
3.1
3.2
2.5
2.0
6
2.1
2.0
2.6
2.3
3.3
2.7
3.1
2.4
3.5
2.9
2.4
9.2
4
1.7
6.9
2.6 1.6
6.6
6.4
6.1
5.9
4.9
4.9
4.6
2
4.5
4.1
4.0
4.0
3.9
3.5
3.5
3.4
3.4
0
FY22E
FY23E
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21
Center Fiscal Deficit (as % of GDP) State FD (as % of GDP)

.
Source: RBI, Budget documents, Jefferies
Exhibit 21 - Central govt. 10Y yield - State govt. 10Y yield The spreads of state govt. bonds vs.
9.0 (%) (bps) 160 centre have started rising from Nov'21
8.5 140 lows
8.0 120
7.5 100
7.0 80
6.5 60
6.0 40
5.5 20
5.0 0
Jan-19
Jan-20
Jan-21
Jul-19
Jul-20
May-21
Jan-22
Jul-21
May-19
Sep-19
May-20
Sep-20
Sep-21
Nov-21
Mar-19
Nov-19
Mar-20
Nov-20
Mar-21
State govt. 10-yr yield at auction (%) Central govt. 10yr benchmark yield (%) Spread (bps), RHS
.
Source: RBI, Bloomberg, Jefferies
7
EQUITY RESEARCH
Exhibit 22 - State government bond issuance trend Bond issuance for state govt. projected
(Rs bn)
to be flat YoY based on RBI's latest
9,000
borrowing calendar, implying fiscal
8,000
7,000
consolidation is broadly on track
6,000
5,000
4,000
3,000
2,000
1,000
0
Gross issuance Net issuance

.
8
21 January 2022 India
EQUITIES India: Macq’s Big Book of Trends (8 of 10)

Inside Financialization of Savings & Credit
Financialization of Savings & Credit 2
Financialization of Savings 3 Key points
Financialization of Credit 14  The Big Book of Trends is our cross-sector annual insight book providing
perspective on the megatrends we see shaping the future of India.
Appendix 21
 In this eighth chapter we focus on financialization of savings and credit.
 Digitization is driving a diversification of India’s financial system. Newer
avenues are seeing rapid growth yet remain under-penetrated.
Macquarie India Research Products
Best Ideas: India Opportunities

What caught our eye?
Portfolio
• Financialization of savings. India’s gross savings rate (relative to GDP) of
Top-Down Cross-Sector: MacroBeats. ~30%, while down from a peak of 38% (pre-GFC), is still comparable with
Monthly, multiple alternative data sources. Asian EMs. Within this, household savings as a % of GDP has slowly inched
Thematic work on Formalization. back toward 20%, with physical assets still accounting for ~60% of the savings
Quarterly based on MCA data. mix. By far the biggest story in savings mobilisation in recent years has been
the rise of alternative channels to the banking system via growing allocation to
Private markets: Show Me The Money. Insurance, Mutual Funds, and Direct Investments.
Macquarie proprietary ESG scorecards. • (a) Insurance. Assets under management (AUM) is up nearly five-fold since
2010 and now equivalent to 30% of bank deposits. Yet India’s insurance
density is less than 20% of the world average and lower than several EMs.
We have leveraged analytics from
IndiaDataHub in this report. • (b) Mutual Funds. AUM here is also up 5x and now ~20% of bank deposits,
as the household savings allocation has improved from 4% to a still-low 8%.
The overall number of MF folios have increased from 40 million in 2014 to
nearly 100 million today, largely supported by the ongoing focussed
Systematic Investment Plan campaign. Yet India’s ratio of mutual fund
accounts to banking accounts is 5% and MF AUM-to-GDP is 15% versus a
world average of 75%.
• (c) Direct Investments. The number of people investing directly into capital
markets has doubled over the past two years to, now, 80 million. Fintechs
have been instrumental in increasing penetration, with the top-5 players
accounting for 56% of overall market share here.
• Financialization of Credit. Origination of credit continues to get diversified.

At one end we have the NBFCs competing with banks to originate smaller
ticket credit and the new-age digital players competing with both existing
NBFCs as well as banks. At the high-grade corporate end, the growth in AUM
of the domestic mutual funds and insurance companies has enabled the
growth of the bond market (albeit still nascent).
• The other aspect of increasing financialisaton is the growing usage of digital

modes of payment which has increased by 5x-10x in value-volume terms
Analysts since 2015, with UPI the key catalyst.
Macquarie Capital Limited
• Fintechs in India have driven the ‘sachetization’ of credit. They now
Aditya Suresh, CFA +852 3922 1265
aditya.suresh@macquarie.com contribute a significant chunk in terms of incremental loan volumes but are still
a small part in value terms. In payments, the customer base for fintechs is
Macquarie Capital Securities (India) Pvt. Ltd.
bigger than that of the large private banks. Fintechs have also on-boarded
Suresh Ganapathy, CFA +91 22 6720 4078
suresh.ganapathy@macquarie.com merchants at scale. However, monetization remains unclear, see India
Fintech – Enablers, not disruptors.
Param Subramanian +91 22 6720 4099
param.subramanian2@macquarie.com
Macquarie Research India: Macq’s Big Book of Trends (8 of 10)
Financialization of Savings
Over the years, the Indian economy has become increasingly financialised. That is to say the
financial sector has grown, both in value and volume terms. In the last decade, the financial
sector’s gross value added has increased.
India’s financial system • On one hand, the banking sector, which is the biggest component of the financial sector, is
is growing, getting growing by reaching out to the people left out of the formal financial system. But equally on the
diversified, and seeing other hand, banks are being challenged and disrupted by non-bank entities. The financial
higher level of system is thus growing, getting diversified, and seeing a higher level of complexity in terms of
complexity products.
• One of the ways this has manifested itself is the increase in the share of the financial sector in
equity market indices. Not only has the weight of the financial sector increased but the sector
now offers several different types of businesses for investors to invest – apart from banks, there
are the non-bank financials (NBFCs), insurance companies, asset managers, payment
companies, etc.
• This is critical because mobilising savings, providing credit, and facilitating payments are the
most important functions of a financial system. Innovation and competition here, reduces
friction, increases access which ultimately boosts productivity.
Mobilising Savings
India’s gross savings • Gross Domestic Savings. Through the 1990s and the early 2000s, India’s savings rate had
rate comparable to averaged in the mid-20% (relative to GDP). In 2004, India’s savings rate touched 30% of GDP
Asian EMs and it has never fallen below that. India’s savings rate reached a peak of 38% of GDP just pre-
GFC. The savings rate has since declined and has averaged just over 30% in the last few
years. As things stand, India’s overall gross savings rate is now comparable to most Asian
emerging economies (with China being a big outlier) and higher than most key emerging
economies outside Asia.
Fig 2 India Gross Domestic Savings (relative to GDP)
Source: RBI, World Bank, IndiaDataHub, Macquarie Research, January 2022
• Household Savings. Within this, India’s household savings rate has been ~20-25% (relative to
GDP) between 2000-15, but has since dipped below 20%. A fundamental feature of India’s
household savings is the emphasis on ‘physical’ assets – real estate, gold – which today
account for ~60% of the savings mix.
21 January 2022 3
Fig 3 India Household savings (relative to GDP)
Source: RBI, IndiaDataHub, Macquarie Research, January 2022
• Mobilising savings is the principal job of the financial sector in any economy. Banks are
the easiest and widely available avenue for savings for households in any economy. And the
banking system in India has generally been efficient in this. In the last decade, almost half of
incremental household savings in any given year have been through bank deposits. And while
overall growth in bank deposits has not been very strong in the last decade, banks have
deepened savings mobilisation by increasing presence in hitherto underbanked areas. Thus,
the number of bank accounts in the lesser banked states like Bihar or Uttar Pradesh have
grown faster than in states like Maharashtra or Delhi. There has been deepening of access to
banks – something that received significant impetus through the current Government’s Jan
Dhan scheme. For details see Big Book of Trends – Financial Inclusion and Ungumming Credit
Bypassing the banking
system via Insurance, • By far the biggest story in savings mobilisation in recent years has been the rise of alternative
Mutual Funds, Direct channels to the banking system, via growing allocation to Insurance, Mutual Funds, and Direct
Investment Investments. We discuss trends in these categories in the following pages.
21 January 2022 4
Insurance
Insurance sector in • The insurance sector in India has always been large – in terms of mobilising saving – thanks to
India has always been the Life Insurance Corporation of India (LIC). Even as early as 2001, the assets under
large and now ≈30% of management (AUM) of life insurance companies were 20% of bank deposits. The decade of the
bank deposits 2000s saw strong growth in insurance driven by the popularity of Unit Linked schemes. Thus, as
of 2010, insurance AUM had increased to 27% of bank deposits.
• However, after the GFC and the concerns over the high-cost structure of the product, its
popularity waned and so did the growth in insurance sector. Thus between 2010 to 2016, AUM
of life insurance companies remained steady around 26-27% of bank deposits.
• The last few years have once again seen growth rates improve with a better suite of products
offered by the private sector entrants. As of March-2021, the AUM of life insurance companies
had risen to 30% of the deposits of all scheduled commercial banks.
Fig 4 Life Insurance – Assets Under Management
Source: IRDA, RBI, IndiaDataHub, Macquarie Research, January 2022
India is less than 20% of • Under-penetration. Given that insurance density in India is less than 20% of the world average
the world average and and lower than several emerging markets, the quantum of savings being intermediated by life
lower than several insurance companies can continue to increase. In terms of sum-assured as a % of GDP, India
emerging markets ranks one of the lowest in the world. Similarly, the protection gap, or the level of under-
insurance, for India is estimated at 83%, one of the highest in the world, against 70%-76% for
ASEAN peers and 55%-60% for South Korea-Japan. Even if we assume a 20% CAGR in
protection premiums, penetration levels will still be lower for India compared to other relevant
markets indicating ample scope for growth in life insurance industry AUM.
21 January 2022 5
Fig 5 Life Insurance Penetration – Significant under-penetration
Source: Swiss Re via IRDA, IndiaDataHub, Macquarie Research, January 2022. Note: Insurance penetration is measured as ratio of premium to GDP
and insurance density is measured as ratio of premium (US$) to total population
• Over the past few years, as interest rates on bank deposits declined, the demand for traditional
savings products like par and non-par increased. Further, many private sector insurance
companies came out with guaranteed return products and protection products, with both seeing
good traction.
LIC dominance • At the turn of the last century, the sector was dominated by the LIC with almost 100% market
declining share. In FY20, LIC’s share has dropped to 66%. And even as the life insurance sector has
grown, the incumbent player has been challenged by new entrants. The loss of share has
principally been at an individual level, where the private sector offers a better and more
diversified product suite.
Fig 6 LIC losing market share
Source: IRDA, RBI, IndiaDataHub, Macquarie Research, January 2022
21 January 2022 6
14%-17% 20Y CAGR • In general, if you look at the longer-term evolution of life insurance industry in India,
premiums have seen a CAGR of 14%, sum assured at a CAGR of 16%, and AUM at a CAGR of
17%. The period between FY2010 to FY2015 saw heavy regulatory intervention and growth
suffered. We believe, with much of the regulatory actions already done, the next decade can
witness higher growth levels than that witnessed in earlier period.
Fig 7 Evolution of life insurance industry in India

FY02-21
FY2002 FY2010 FY2015 FY2021
CAGR
New Business Premium (Rs bn) 116 550 408 757 10%
Total Premium (Rs bn) 501 2,654 3,281 6,284 14%
Penetration (as a % to GDP) 2.1% 4.1% 2.6% 3.2%
Assets under management (Rs bn) 2,304 12,899 23,361 46,563 17%
In-force sum assured (Rs bn) 11,812 37,505 78,091 188,615 16%
In-force sum assured (as % to GDP) 50% 58% 63% 96%

Source: IRDA, Macquarie Research, January 2022
21 January 2022 7
Mutual Funds
Investment in capital • But by far the biggest trend in the last few years has been the increased investments by
markets traditionally households in capital markets – primarily mutual funds and direct equities. Historically,
very low at 4% of investments by households in capital markets has been modest. In the last 10 years (FY11-20),
savings... the average investments by households in capital markets has been just 4% of their gross
annual savings in financial assets.
…this is now 8% • Indeed, in only five of the last 20 years have households invested more than 5% of their
annual savings in these risk assets – FY06, FY07, FY08, FY17 and FY18. But today,
households are estimated to have invested 8% of their savings in capital markets.
Fig 8 Composition of Household Financial Savings
Source: NSE, NSDL, CDSL, SEBI, IndiaDataHub, Macquarie Research, January 2022
Mutual fund AUM up 5x • In the last decade the AUM of domestic mutual funds (MF) has increased by more than
in ten years five times. This is almost twice the growth in bank deposits. The disintermediation has
been especially strong in the last five years. Thus, between 2011 to 2016 the quantum of
savings disintermediated by MFs increased from 11% of Bank deposits to 13%. And between
2016 to 2021, the quantum of domestic savings disintermediated by MFs has increased
from 13% of bank deposits to 20%. Together with the Insurance sector thus, the quantum of
savings being managed by non-bank entities has increased to ~50% of bank deposits as of
March-2021.
70% of mutual fund • There has been broad-based growth in AUM – reflecting a general acceptance of mutual
AUM was contributed by funds as an important part of individual investor’s portfolio and not just as a vehicle to punt in
non-equity funds the equity market. And it is not just equity funds (driven by buoyant equity markets) which have
driven this increase. As of March-2021, almost 70% of the AUM was contributed by non-equity
funds. And two-thirds of this non-equity AUM was contributed by debt funds. However, over the
last three years, debt and liquid mutual funds have seen some consolidation led by a tight
liquidity environment and risk-aversion post the IL&FS crisis (Aug-18). That said, with the
enhanced liquidity environment and a pick-up in corporate savings post-COVID, growth has
rebounded here as well (as can be seen in the chart below on MF AUM relative to bank
deposits).
21 January 2022 8
Fig 9 India Mutual Funds AUM
Source: AMFI, RBI, SEBI, IndiaDataHub, Macquarie Research, January 2022
Fig 10 Composition of India Mutual Fund AUM
Source: AMFI, RBI, IndiaDataHub, Macquarie Research, January 2022
Systematic Investment • The primary reason for this is the concerted industry campaign to promote mutual funds as a
Plans long-term and safer investment option. The Systematic Investment Plan (SIP) through which
individuals invest a small sum every month has been a key feature of this campaign. SIPs into
mutual funds have seen secular monthly flows over the last five years, driven by increased retail
participation. As of December-2021 there are almost 50 million such SIP accounts and the
AUM of these accounts constituted 15% of total AUM of the MF industry. In just the last
two years, the number of such SIP accounts have increased 65% and the AUM through these
accounts by almost 80%.
21 January 2022 9
Fig 11 Systematic Investment Plan accounts
Source: AMFI, RBI, IndiaDataHub, Macquarie Research, January 2022
Mutual fund folios ~5% • Under-penetration. While it seems like the mutual fund industry has already become large, it
number of bank still has a large runway for growth. As of March-2021 the MF industry had approximately 100
accounts million folios. This has more than doubled in the preceding five years. For perspective, the
banking system had more than two billion deposit accounts, implying that the mutual fund
industry is just 5% of the banking system. And despite having two billion deposit accounts, bank
deposits continue to grow in double digits. Thus, the mutual fund industry can quite comfortably
continue to grow at 20% for the foreseeable future.
Fig 12 Mutual Funds # of investor folios and scale relative to bank deposits
Source: NSE, NSDL, CDSL, RBI, SEBI, IndiaDataHub, Macquarie Research, January 2022
21 January 2022 10
Mutual Fund AUM-to- • Furthermore, under-penetration of India’s mutual fund industry versus the rest of the world is
GDP: India 15% vs highlighted by the chart below. Mutual Fund AUM-to-GDP in India is at 15% versus a global
World 75% average of 75% – this industry can continue to be a key beneficiary from the mega-trend of
financialization of savings.
Fig 13 India’s mutual fund AUM to GDP is much lower than global average
Source: IMF, IIFA, Macquarie Research, January 2022. CY2020 shown.
21 January 2022 11
Direct Equity
2x increase in retail • Households are also becoming more risk-taking, with investments directly into capital markets,
trading accounts to ~80 largely equities, rising sharply through the pandemic. Number of depository accounts, a proxy
million for number of people investing directly into capital markets, have doubled over the past two
years to now 80 million. Albeit with penetration at slightly under 6%, far lower than developed
markets, retail participation in India capital market still has a long runway for growth.
• Digital players/fintechs have played the largest part in the increasing penetration of retail stock
trading accounts in India. The top-5 fintech players have more than doubled their overall broking
market share versus pre-pandemic levels and now boast of 56% market share.
Fig 14 India direct equity participation rising, incrementally enabled by fintechs
Source: AMFI, NSE, SEBI, RBI, IndiaDataHub, Macquarie Research, January 2022
• The ownership of direct equities which had been on a long-term declining trend has
reversed during the pandemic. Retail investors own 9% of Indian equities as of September-
2021, up 100bps since December-2019. A large part of this increase is attributable to the large
number of new primary listings. CY2021 was a record year for IPOs in India with almost US$15
billion being raised. Some of these IPOs like Zomato, Nykaa, exemplify the success of Indian
entrepreneurship and have caught popular imagination of retail investors drawing new investors
into the fold of capital markets. Further, what has helped draw new investors to capital markets,
is the proliferation of personal finance websites and apps that aim to make investing easy by
providing relevant tools to investors. Some of these also make relatively sophisticated strategies
available to individual investors.
• Barring a scenario where stock prices see a prolonged and sharp decline, it is quite likely that
the current higher allocation of households to capital markets will sustain. Indeed, the newer
entrants into India’s workforce are probably more comfortable with investing in capital markets
than their prior generation.
• Consider this, assuming India’s overall household financial savings rate remains unchanged
from pre-pandemic levels, just a 10% allocation to capital markets will mean an annual inflow of
about US$35-40 billion in capital markets from Indian households as against an actual inflow of
US$10 billion in FY20.
21 January 2022 12
Fig 15 Direct retail participation in equity markets inching up
Source: NSE, RBI, IndiaDataHub, Macquarie Research, January 2022
• This higher direct retail inflow should achieve two important things. Firstly, it should reduce the
dependence of India’s capital markets on foreign portfolio flows. To some extent this has
already happened – in December-2019, FPIs owned 22% of listed Indian stocks versus 20%
today. And despite this lack of a large net buying from the FPIs, equity markets remained
buoyant and are close to their all-time highs. Secondly, increased domestic flows into the capital
markets support increased capital raising from secondary markets through IPOs. The
government has a large disinvestment agenda in the next few years and there is a large IPO
pipeline. Already, Indian equity markets is among the more diversified amongst emerging
markets. Higher free float and a wider choice of business models will go a long way towards
making Indian capital markets more attractive for both domestic and foreign investors.
21 January 2022 13
Financialization of Credit
India has a large banking sector, and it dominates credit in the economy. And while, historically,
bank credit has grown significantly faster than nominal GDP growth, post the GFC, credit growth
has been relatively weak (1.1x multiplier). Thus, bank credit to GDP has stabilised at ~50% for
over a decade. Relative to other emerging markets though, this is not unusually low. India’s bank
credit to GDP ratio is comparable to EMs like Russia or the Philippines and higher than Mexico
and Indonesia. China is as expected an outlier with Bank credit over 150% of GDP. For details
see Big Book of Trends – Financial Inclusion and Ungumming Credit
Credit Origination
• Like with deposits as is with bank credit. It too is getting deepened. In absolute terms, bank
credit growth has been anaemic in the last few years. Between March-2015 and March-2021
bank credit had a modest 8% CAGR. However, the number of borrower accounts has more
than doubled during this period – an almost 13% CAGR. Indeed, in the preceding 10-year
period when bank credit growth was much higher (a 20% CAGR between March-2005 and
March-2015), the number of borrower accounts had not even doubled.
Fig 16 India bank sector credit
• This increase in borrower accounts is across the board. The number of individual borrower
accounts has almost doubled in these six years. The number of borrower accounts of informal
firms (proprietorships, partnership firms etc) has increased 2.4x in the same period. And the
number of corporate borrower accounts has increased 55%. In the case of corporates, this
increase in borrower accounts most likely reflects the growth of formal enterprises, see our
thematic work around Formalization in India. But in the case of individuals and informal firms,
this reflects a combination of new borrowers and existing borrowers switching from informal
sources of credit to formal banking channels for credit. The bottom line is that while bank credit
has not expanded in value terms in the last few years, it has expanded significantly in terms of
the number of entities accessing credit. Credit has thus deepened.
• Not surprisingly, the share of bank credit in rural and semi-urban areas has increased in the last
few years. In September-2015, the share of bank credit in rural and semi-urban areas was 19%
and this has increased to 23% in 2021.
• This deepening of credit has happened outside the banking sector too through the growth of
NBFCs and increasingly in the last few years through the new-age digital lenders.
21 January 2022 14
Fintechs • Fintechs in India have driven the ‘sachetization’ of credit. They now contribute a significant
chunk in terms of incremental loan volumes but are still a small part of incremental
disbursements in value terms (3% of personal disbursements in FY20). Digital players have
some advantages in terms of distribution, but what remains lacking for many of these players is
the loan collection infrastructure – which very much still requires an on-ground presence.
• Digital lenders/fintechs have also seen higher adoption from ‘new-to-credit’ and millennial
customers. However, the key concern here remains that their lending so-far has been largely
sub-prime in nature. Nevertheless, these players are playing a key role in expanding the credit
net in India. For details see India Fintech – Enablers, not disruptors
Fig 17 Fintechs in India – Enablers, not disruptors
Source: Experian, RBI, IndiaDataHub, Macquarie Research, January 2022
21 January 2022 15
India bond market still • But there is also disintermediation of credit that is underway through the growth in the
at an early stage, albeit bond market. Policymakers in India have long tried to develop the bond market with only
scale has increased 4x limited success. But in the last decade, the bond market has seen strong growth, both in
in 10Y absolute terms as well as relative to bank credit. In the last 10 years (September-2011 to
September-2021), the size of the bond market (value of outstanding bonds) has increased
almost 4x. In contrast, outstanding bank credit has expanded 2.6x. Consequently, the value of
outstanding corporate bonds which was just over 20% of bank credit in 2011 is now 33%
of bank credit. Thus, for every $1 of outstanding bank loans, there are now 33 cents of
outstanding corporate bonds. If we add outstanding commercial papers also, then the total
amount of credit provided by the debt market is now approaching 40% of the size of bank credit.
• That said, to put scale in perspective, the size of India’s bond market today is ~US$530
billion or 17% of GDP against equity market cap of US$3.5 trillion or ~120% of GDP.
Fig 18 India Debt Market evolution
Source: NSE, NSDL, CDSL, SEBI, IndiaDataHub, Macquarie Research, January 2022
21 January 2022 16
• India’s bond market is currently largely dominated by high-grade issuers. So, the large
high-grade corporate borrowers have started to bypass the bank loan market and access credit
directly from the debt market. Thus, while banks have gained customers as discussed above,
they have also lost customers at the other end. The last decade has thus seen both an increase
in the intermediation of credit by banks and at the same time disintermediation of credit through
the debt market.
Growth in AUM of the • A key driver of this disintermediation of credit is the disintermediation of savings. The
domestic mutual funds growth in AUM of the domestic mutual funds and the domestic insurance companies has
and the domestic enabled the growth of the bond market. Unlike banks that can give loans, mutual funds (non-
insurance companies equity funds) and insurance companies must necessarily invest in corporate bonds. The
has enabled the growth growing size of these two entities has created the demand for bond issuances and supply has
of the bond market thus followed. Thus, the domestic bond market has grown, despite not a lot of reliance on
overseas portfolio flows.
• What has happened is that origination of credit has effectively got diversified away from
banks. From banks dominating credit, the whole credit origination has become diversified with
several disparate players coming into the picture.
 On one end we have the NBFCs competing with banks to originate smaller ticket
credit and the new-age digital NBFCs are competing with both existing NBFCs as well as
banks. NBFCs enjoy leaner cost structures, strong retail distribution, and lower regulatory
compliance requirements. NBFCs are more exposed to self-employed/informal sectors of
the economy. There has been some risk aversion in the recent past (driven by IL&FS crisis
and the economic slowdown that ensued), which has kept NBFC credit muted. NBFCs are
also more dependent on the interest-rate environment (as they are dependent on banks
and bond markets for their funding), and hence a benign liquidity/interest rate environment
will also aid their growth going forward.
 At the high-grade corporate end, the mutual fund and insurance companies are
competing with banks to originate credit. There have also been accidents along the way
with some mutual funds burning their hands in relatively lower grade credit. But despite
this, the broader trend has remained intact.
21 January 2022 17
Payments
• The other aspect of increasing financialisaton of the economy is the growing usage of
digital modes of payment. This was one of the objectives of demonetisation carried out in
Retail digital payments
2016. And while the quantum of currency in circulation in the economy has gone back to the
have increased by 5x-
level before the demonetisation (even higher during the pandemic), the usage of digital modes
10x in value-volume
for payments has expanded significantly. And conversely, the usage of cash reduced.
terms since 2015
• In just the last six years (FY15-21), the total value of retail digital payments has increased by 5x,
and the number of retail digital transactions has increased over 10x.
Fig 19 Digital Payments in India – exponential growth
• Since 2015, the number of debit cards in the country has expanded by almost 300m to over
900m currently. The number of credit cards issued has more than tripled to 66m today. And
there are over two billion payment wallets in the country – that is two payment wallets per adult,
on average.
Fig 20 Card Payments
21 January 2022 18
UPI has revolutionised • But it is the Unified Payments Interface (UPI) that has truly revolutionised the payments
payments in India space in the country. In a short span of five years, UPI has risen from zero to accounting for
over 10% of retail non-cash payments in value terms. Payments through UPI are now thrice as
much as those through credit cards, debit cards and payment wallets combined. And despite
this size, UPI is still growing almost 100% YoY.
• And like with savings and credit, even in payments, banks are facing intense competition
from non-bank entities. Fintech platforms in India have built sizable customer franchises in
India, with customer bases for payments companies being larger than those of large private
banks. They have also on-boarded merchants at scale.
• Thus, while in UPI, the transaction is ultimately settled between two bank accounts, banks do
not own the customer facing interface. PhonePe and Google Pay apps dominate this
processing over 80% of UPI payments. PayTM comes third with ~10% of UPI payments. All the
banks put together thus originate less than 10% of UPI payments.
• However, what makes UPI successful is also a key pain point for fintech business models – UPI
is completely free (zero merchant discount rate), as mandated by the government of India.
Hence, fintechs have struggled to monetise the merchant and customer bases on their
platforms. This has driven them towards cross-sell of other products (BNPL, financial product
distribution, super-app approach etc), but most of them struggle to find their feet in this still.
Fig 21 Digital Payments & UPI
Growth in QR Codes • Similarly, payments acceptance infrastructure (POS terminals) was a revenue source for Banks.
Not just the actual POS terminal but the Merchant Discount Rate (MDR) was a source of fee
income. With UPI this too has got disrupted because UPI bypasses the traditional card payment
networks like MasterCard and Visa. In addition, the growth in QR Codes means that merchants
do not need expensive POS terminals to accept digital payments. There are now more QR
Codes in the country than POS Terminals. The rise of QR Codes has been a game changer
for the reduction in usage of cash for smaller ticket transactions.
• Like with the other aspects discussed above, the rise of digital payments too is a long-term
structural trend. Non-cash payments will continue to grow, usage of cash for transactions will
continue to fall. Banks will face growing competition from newer businesses in what traditionally
used to be their monopoly.
21 January 2022 19
Fig 22 India Fintech: Digital Payment Penetration
21 January 2022 20
Global risk radar
What do geopolitical tensions in Eastern Europe mean for global markets?
25 January 2022
Chief Investment Office, WM
Tilmann Kolb, Analyst, tilmann.kolb@ubs.com; Tatiana Boroditskaya, PhD, Analyst, tatiana.boroditskaya@ubs.com; Michael Bolliger,
Chief Investment Officer Global EM, michael.bolliger@ubs.com; Xingchen Yu, Emerging Markets Strategist Americas; Dirk Effenberger,
Head Investment Risk, Chief Investment Office GWM, dirk.effenberger@ubs.com; Wayne Gordon, Strategist, wayne.gordon@ubs.com;
Rudolf Leemann, Analyst, rudolf.leemann@ubs.com; Frederick Mellors, Strategist, frederick.mellors@ubs.com; Claudia Panseri, Strategist,
claudia.panseri@ubs.com; Giovanni Staunovo, Strategist, giovanni.staunovo@ubs.com
This publication series helps investors identify and assess global financial
market risks and their investment implications.
At a glance
• Tensions around Ukraine have escalated in recent weeks. Our

base case is for a continuation of diplomatic efforts leading to a
stabilization and an eventual easing of these tensions. This may
take several months, during which flare-ups remain possible, for
example as a result of actions taken by the separatists in Ukraine,
Russian special forces, or cyberattacks. All of these could trigger
countermeasures by Western countries. In this scenario, we see
any aggression staying below the threshold at which it would
trigger the full range of threatened sanctions, with a thin margin
of overstepping thresholds from either side.
• A full-scale invasion of Ukraine by Russian forces is a tail risk Source: iStock
event, in our view. Should it occur, it would trigger risk-off sen-
timent among investors and tough sanctions against Russia.
Energy flows, commodity prices, and the ability to execute cross-
border transactions would be in focus. Energy supply disruption,
whether as a result of sanctions, a Russian decision, or accidents,
could have a longer-lasting impact. However, both parties seem
keen to avoid such an outcome, in our view.
• We believe the current global rout in risk asset prices is not
related to the tensions around Ukraine. In case of an esca-
lation, investors therefore need to brace for more downside. Past
market drawdowns driven by similar events have been short-
lived, however.
• Investors with diversified portfolios and a long-term investment
plan are best prepared for an eventual relaxation of tensions,
as in our base case, but also to withstand setbacks caused by
geopolitical events, as in our downside case. Exposure to com-
modities, especially energy, and cybersecurity should benefit in
both the base and negative risk case, in our view.
This report focuses on the market implications of escalating tensions Additional contributing authors: Sundeep
around Ukraine. Our thinking is structured around four scenarios Gantori, Dominique Huber, Dean Turner
and, where possible, insights from previous geopolitical events. The
scenarios we look at are:
Global risk radar
1. A base case scenario where diplomatic and political efforts

ultimately lead to a dialing down of tensions. This may take several
months during which the possibility of flare-ups remains elevated.
Risk sentiment is likely to be negative, albeit likely only for some
weeks, whenever these occur.
2. An upside risk case where a diplomatic solution is found quickly.
Global assets show little reaction, as the risk premium priced in for
an escalation currently is relatively low, in our view. Russian assets
recover rapidly.
3. A risk case scenario where we see a military escalation of the
conflict and the imposition of new sanctions against Russia, stopping
short though of disrupting energy flows. We assume a quick
cessation of fighting once it occurs. Experience suggests that market
drawdowns driven by geopolitical stress events are typically short-
lived. Russian assets would sell off further, and later recover only
partially.
4. A severe risk case where we see prolonged fighting and a
prolonged interruption of Russian energy exports. Broad equity
markets would suffer, as would most other cyclical assets, and no
quick recovery would ensue.
What is driving the geopolitical tensions around Ukraine? Fig. 1: Europe depends on Russian energy supplies…
Tensions in Eastern Europe have escalated in recent weeks. Russian EU imports from Russia (in % of total, as of 2019)
troop movements near its border with Ukraine and statements by
various Western leaders that a Russian invasion of Ukraine is both likely
and imminent have led to fears of a military conflict.
In an attempt to redraw the European security architecture, Russia has

signaled to the West that it sees the eastward expansion of NATO over
the past years, as well as the potential future accession of further states
in the region, as a red line for its own national security. The West
has underlined its commitment to the self-determination of sovereign
states and the security of Ukraine, and has threatened a wide range
of sanctions on Russia. Given that the positions of two parties are far Source: Eurostat, UBS, 24 January 2022
apart, diplomatic efforts have so far not led to a relaxation of tensions.
The recent publication of intelligence information in Western media has

been criticized by Russian authorities as a campaign against the country
by the West and NATO. Russian Deputy Foreign Minister Alexander
Fig. 2: … and Russia depends on Europe as a customer
Grushko has described it as “demonizing” Moscow and an attempt to Russian exports by destination (in %, as of 2020)
justify NATO’s eastern expansion.
The situation remains fluid and is complicated by the involvement and

interests of various countries. Much attention has been given to US
President Biden’s statement “My guess is he [Putin] will move in” at
his 19 January press conference, which underlines the urgency behind
the White House’s thinking. At the same press conference, Biden
emphasized the importance of a unified Western position and the
significant response Russian aggression would entail. Currently, the US
Congress is considering two packages of substantial sanctions against
Russia. On the EU side, shaping a unified position means balancing the
Source: EIA, UBS, 24 January 2022
interests of its 27 member states first. Decisions on sanctions require
unanimity in the European Council.
Notwithstanding the difficulties, diplomatic and political efforts are

continuing, as US Secretary of State Antony Blinken’s meeting with
Russia’s Foreign Minister Sergey Lavrov on 21 January shows.
Chief Investment Office GWM 25 January 2022 2

Global risk radar
Key risks for global markets

Should the crisis worsen, Europe’s energy security would represent a
key risk to markets in our view. The threat or reality of supply disruption
of hydrocarbon flows could lead to their prices to rocket. Global energy
markets are already tight, making near- to medium-term substitution
near impossible. That said, energy continued flowing from Russia to
Europe even at the height of the Cold War.
The West’s threat to disrupt financial transactions with specific Russian

counterparts or even the Russian economy as a whole would lead to
significant disruption in cross-border business and difficulties settling
Russian external debt. Such sanctions could also interrupt energy flows,
as they may de-facto prevent payment flows for received fuel deliveries.
For Russia, a tightening of the sanctions regime would likely reduce its
long-term growth potential further, with negative consequences for the
living standards of the population and the return outlook for Russian
assets.

Global risk radar
Fig. 3: Russian incomes left behind

Scenario 1: Base case Adjusted net national income per capita (GNI minus
consumption of fixed capital and natural resources
Our base case is for a continuation of diplomatic and political efforts
depletion; in current USD)
leading to a stabilization and an eventual relaxation of tensions.
However, this may take several months during which the possibility of
flare-ups of local conflicts remains elevated. Action by separatists in
Ukraine or Russian special forces to further the division of the separatist
regions from Ukraine, additional large-scale troop movements and
military exercises, or cyberspace attacks could all trigger Western
countermeasures. Yet any aggression in this scenario would not
trigger the full range of threatened sanctions. We acknowledge the
considerable risk of miscalculation, but believe that eventually the best
interest of all parties involved is served by finding a diplomatic offramp.
We base our assessment on the following considerations: Source: World Bank, UBS, 24 January 2022
• A military escalation would impose human and economic costs

on all parties involved. The integration of Russia and Ukraine
in world energy and agricultural markets, as well as their
cross-border business dealings, mean that significant sanctions
against Russia would also lead to repercussions for Western
companies, sectors, and even economic growth and inflation
dynamics. According to Eurostat, 41% of the EU’s natural gas
imports, 27% of crude oil imports, and 47% of solid fuel imports
originated from Russia in 2019. The EU conducted close to 5%
of its goods trade with Russia in 2020, while that share stood
at 37% for Russia, according to the European Commission.
Gazprom, Russia’s top gas producer, sold roughly 40% of its
output to Europe (including Turkey) in 2020. The Russian energy
sector comprised close to 20% of Russian GDP and 40% of
fiscal revenues in 2019. Russia is also an important metals
producer; for example, the country provides close to 40% of
global palladium production and non-negligible amounts of
metals needed for a successful energy transition. In sum, all
parties have much to lose from a further deterioration in their
relationship.
• A tightening of the sanctions regime would likely reduce Russia’s

long-term growth potential further, with negative consequences
for the living standards of the population. Two years ahead of
the next presidential elections in Russia, and against a backdrop
of protests in Belarus in 2020, in Russia in early 2021, and in
Kazakhstan this year, we think that further economic pressure
on the local population, together with potential casualties,
risks domestic resentment. The Russian government is likely to
considers this scenario in its calculations, in our view. That said,
previous sanctions against Russia have led not to a change in
behavior, but rather a shift from West to East (China), and focus
on reducing dependency on foreign funding and building up
buffers.
• US President Joe Biden is facing midterm elections later this year.

The president’s disapproval ratings are currently high, and in our
view he will want to signal a tough stance on Russia to voters
and Congress. Similarly, European politicians may find it easier
to talk tough publicly on Russia to the average voter than to
justify higher energy costs and less employment opportunities.
The same may apply to UK Prime Minister Boris Johnson. Not
every statement needs to signal true intent—grandstanding
Global risk radar
is part of politics. But public messaging is also important for

Russian politicians as a sign of control and strength to the local
population.
• Maximalist demands and unwavering positions are unlikely to

be dropped early on in the negotiations, as both sides are
waiting for concessions from the other side. In addition, the
public display of positions may not fully reflect more nuanced
discussions held behind closed doors. In this context, however,
the unusual amount of intelligence information appearing
currently in Western media might make it increasingly difficult
to find a diplomatic solution to the conflict. History suggests a
diplomatic offramp needs to reduce the political costs for it to
work. We highlight that local media in Russia, the West, and
even Ukraine portray the conflict very differently. The transition
to a diplomatic resolution might therefore be easier to be
achieved.
• By moving to a scenario of military escalation, the involved actors

risk a loss of control by upending the value of the optionality
inherent in the respective threats of a military escalation and
harsh sanctions.
One potential resolution could involve an understanding of the chances

of Ukraine’s NATO membership in the foreseeable future that can
be accepted by all involved parties. Here, official communication and
behind-the-scenes dialogue may differ. Security guarantees, even if not
in an ironclad, binding format, can be exchanged at the highest political
levels. Signposts for an improvement in the tensions could stem from
a stronger focus on what is possible, rather than impossible, engaging
more strongly on areas of shared interest in parallel to the areas of
opposing views, and the emergence of a framework of conducting
talks than the ad-hoc meetings currently being called. Similarly, a
bigger Restraint in official statements and media announcements could
indicate that the focus is shifting toward an easing of tensions.
Scenario 2: Upside risk case

Diplomatic and political efforts are ongoing, and an off-ramp to the
tensions may be in the making behind the scenes. This scenario is
unlikely to materialize in the near term, in our view. A more stable
relationship between the West and Russia could have benefits in the
medium to longer-term for arms control, conflict resolution, and the
energy transition.

Global risk radar
Scenario 3: Downside risk case

A military escalation is a tail risk, in our view. While the likelihood of
such escalation has risen in recent weeks, we think that the worst-
case outcome of a large-scale conflict, pitting Russia openly against
Western states and NATO, will be avoided in light of the above-outlined
costs (see scenario 4 for more on this). We believe that Russia is
not willing to be involved in an ongoing military conflict involving a
possible occupation of large parts of Ukrainian territory. The invasion of
a small part of Ukraine, long-range warfare, or targeted strikes against
military installations appear much more feasible for Russia than a larger
invasion. We think a military escalation would likely focus minds on
ceasing fighting rapidly, moving back to the diplomatic sphere, and
limiting the conflict to a regional one. That said, the escalation will likely
have created new circumstances for negotiations, with new facts on
the ground and new sanctions.

Global risk radar
What effect could such an escalation have on global financial

markets?
At this point, we think that global markets are not pricing in a large
risk premium linked to the crisis. While Russian assets have accelerated
their sell-off since last week, global markets only seem to be starting
to take note of the crisis recently, as the greatest focus remains on
global yield moves. Oil prices are not trading out of line with market
fundamentals at this point, in our view – despite potential large spikes
should a military escalation take place (see also scenario 4 below).
An escalation of the situation could trigger risk-off sentiment among

investors. However, experience suggests that market drawdowns driven
by geopolitical stress events are typically short-lived and often provide
opportunities for investors to increase market exposure. Please see also
the figures further below, illustrating the market impact of the Crimea
crisis in 2014 and of Iraq’s invasion in Kuwait in 1990.
During a risk-off period, we would expect global equities to move

down, but only slightly. As Europe is the region most dependent on
Russian gas imports, we would expect EMU equities to suffer more
than global equities. In fixed income, emerging market credit would be
impacted the most, led by Russia, which makes up 3.2% of the EMBI
Global Diversified and 4.4% of the CEMBI Diversified.
The main beneficiaries from a market sell-off would likely be traditional

safe-haven assets such as the CHF, the JPY and US Treasury bonds. The
gold price typically rises during geopolitical events, and it would likely
additionally benefit from potentially higher inflation expectations on
the back of rising energy costs in Europe. Inflationary pressure may stem
as well from rising food prices should grain supplies from Russia and
Ukraine, two large exporters, be disrupted. Food prices are already at
their highest levels since 2011. The effect would be greater on lower-
income countries.
How should investors position themselves?

While the geopolitical tensions around Ukraine could weigh on
markets, we highlight that investors with diversified portfolios and a
long-term investment plan are best prepared for an eventual relaxation,
as in our base case, and also to withstand setbacks, as in our risk case.
While some of our tactical recommendations, like our preference for

Eurozone stocks, may suffer when negative headlines surface, our
preference for energy stocks should soften the blow. Allocations to
Global risk radar
commodities and energy stocks can be an option for investors to

position for a benign fundamental outlook independent of the situation
around Ukraine, with the extra benefit of adding some safety to their
portfolio in case of an escalation.
We also recommend considering investments in cybersecurity. The

threat from cybercrime is rising, along with the need for investment to
defend against it. Frequent reports about breaches in the cyberspace
of corporates and individuals underscore the urgency of this risk.
Cyberattacks have also been a prominent topic between state actors
over recent years. This is why cybersecurity is part of the “ABCs of tech”
theme, which also includes artificial intelligence and big data.
Russian assets in the spotlight Fig. 4: Russian equities under pressure…

When it comes to Russian assets, investors who are concerned about a Performance of MSCI Russia and MSCI Emerging Markets
(indexed, 100 = 1 January 2021)
further escalation can consider establishing hedges via short positions
in the Russian ruble. The currency would likely see sharp downside in
case of a meaningful escalation, with USDRUB levels between 80–90
within reach. However, we note the risk premium incorporated in the
ruble has risen to a significant extent already, and it is trading at cheap
levels compared to its fundamentals. Together with the elevated carry,
such a hedge would come at potentially high costs. In our base case
of a relaxation of tensions—even if this takes a considerable amount
of time—we expect the ruble to appreciate again as the geopolitical
risk premium is priced out and investors focus more on the benefits of
high hydrocarbon prices for Russia’s external balance and its hawkish
monetary policy. USDRUB traded below the 70 mark as recently as late Source: Bloomberg, UBS, 25 January 2022
October, and we forecast the ruble to trade in the lower 70s over the
course of the year. For investors not shying away from the geopolitical
risks and those aware of potentially significant losses, we retain a long
RUB, short USD recommendation in our EM FX strategy.
Fig. 5: … and losing touch with oil prices
Performance of MSCI Russia (indexed, 100 = 1 January
We maintain a neutral tactical allocation to Russian equities and hard 2021), Brent crude oil (in USD/bbl)
currency credit, given the ongoing geopolitical uncertainty. Russian
sovereign and corporate credit spreads have widened by 110bps
and 66bps, respectively, year-to-date, underperforming similarly rated
peers. While we can’t rule out further volatility in the Russian credit
space, we remain comfortable with Eurobonds of Russian issuers under
CIO coverage. The fundamentals of Russian sovereign and corporates
under CIO coverage remain sound, in our view, supported by sizable
gains in energy prices over the past year as well as the global and
domestic economic recovery. The technical backdrop is less supportive,
however, given the sizable share of foreign investors across key Russian
assets. For example, 52.3% of Russian sovereign Eurobonds (or USD
Source: Bloomberg, UBS, 25 January 2022
20.5bn) were held by foreign investors as of end-3Q21, according to
the Central Bank of Russia. This compares to a low of 29.4% in 1Q17.
Still, under our base case, and especially our positive risk case, Russian
credit should recover some of the relative underperformance. But given
the opacity of the situation and the potential for further aggressive
steps, we think that at this point the risk-reward of Russian credit is not
favorable compared to other emerging market (EM) issuers.
Russian equities have been under pressure since November, after

significantly outperforming EM peers in the previous quarters. Russian
equities’ sell-off is especially pronounced against the rise in oil prices
since mid-December. Overweight positioning in Russian equity markets
likely contributed to the sharp sell-off trigged by the geopolitical
tensions. The 12-month-forward dividend yield for MSCI Russia now
exceeds 10%, the highest level in recent years, and its 12-month
Global risk radar
forward P/E has dropped to below 5x, which is closer to the crisis
levels when oil prices were at a trough in March/April 2020. Once
the geopolitical tensions abate, as per our base case, we think
Russian stocks will rebound to trade more in line with their supportive
fundamentals. In light of current elevated uncertainties, however, we
abstain from recommending investors to gain exposure or add to
existing positions in Russian equities for now.
Scenario 4: Severe downside risk case

An escalation of the conflict that disrupts the flow of energy supply
would carry negative consequences for the global economic outlook.
This may occur due to unintentional outage, a political decision by
Moscow, or US and international sanctions targeting the Russian
energy sector. The latter two options would likely occur only after a
large-scale invasion of Ukraine by Russia or persistent fighting. In such
a scenario, broad equity markets would suffer, as would most other
cyclical assets.
Explainer: How energy markets could be impacted

• Russia is the world’s third-largest producer of oil and second-
largest producer of natural gas, with a global market share
of 12% and nearly 17% in 2020, respectively, according to
the BP Statistical Review of World Energy. Europe is Russia’s
main overseas market for both commodities; in 2020, European
OECD nations took in 48% of Russia’s crude and condensate
shipments and 72% of its natural gas exports. Around 70%
of Russian crude is transported out of four ports (Primorsk,
Nakhodka, Kozmino Bay, and Ust-Luga). The majority of its
natural gas exports travel by pipeline. Russia also has a few
terminals for deliveries of liquified natural gas (LNG).
• Our base case is that oil demand will reach a record high
this year. We forecast Brent crude to trade at USD 80–90/
bbl, with the risks biased to the upside. With OPEC and its
allies (OPEC+) unwinding their production cuts and benefiting
from higher demand, spare capacity should fall to multiyear
lows this summer. OECD commercial oil inventories are also at
their lowest levels since late 2014. Given this backdrop, the oil
market will be sensitive to news of supply disruptions. While
our base case expects no disruption to Russian energy exports,
we see three ways Russian production and exports could fall:
by unintentional outage (e.g., damage to pipelines), a political
decision by Moscow, or US and international sanctions targeting
the Russian energy sector. That said, with the exception of
the Nord Stream 2 pipeline, Washington has indicated that it
may exempt energy from the punitive measures it is currently
considering, given the potential impact such measures could
have on energy prices. Energy has been flowing from Russia to
Europe even at the heights of the Cold War.
• Nonetheless, in a severe scenario, we assume that 10–20%

of Russian oil production and exports are disrupted, lifting
Brent prices to USD/bbl 125 or higher. Elevated prices temper
oil demand, keeping the market from overtightening. The
magnitude of the price reaction would depend on when the
disruption occurs. OPEC+ still has some spare capacity, so
the group could increase production and compensate for the
disruption at this time. This buffer, however, is likely to diminish
Global risk radar
this summer, with only Saudi Arabia and the UAE having spare
capacity. A post-summer disruption would result in a greater
price reaction, which would then trigger a fall in demand and
support production in short-cycle supply such as US shale oil.
The exact level at which demand falls off is difficult to calculate.
It also depends on the US dollar exchange rate (since most oil
is consumed by countries with other currencies) and the energy
subsidies and economic growth in emerging Asia, which has
been the engine of oil demand growth in recent years. A simple
way to estimate at which point oil prices will start to pinch is to
use global oil spending as a percentage of global GDP. In 2011–
13, it was around 4.5%; currently, it is around 3%. A price level
of USD 125/bbl would raise global oil spending to around 5%
of GDP—a level at which we expect demand growth to correct
and trigger a vigorous supply response from US shale.
Economic impact: A sharp rise in the oil price could have two material
consequences at the macro level. The first would be a hit to global
GDP growth due to lower consumption as households and businesses
allocate a greater share of their wallets to energy and fuel. The second
would be inflation, with consumer price indexes rising even further in
the short term, but falling even faster thereafter.
In a scenario of oil prices rising to USD 150/bbl in the first half of this
year, we would expect world GDP to undershoot our current estimate
by around 40–50 basis points. Of course, not all countries will be hit
evenly: Given its greater dependence on oil, for example, the US will
likely feel a slightly larger impact than Europe, China, or Japan. Our
GDP impairment estimate might not seem large, but we believe it is
reasonable as we expect a surge in oil prices would be met with a
few mitigating factors. The first is policy response. We think central
banks will dial down their recently hawkish tone and slow the pace at
which they are planning to tighten monetary policy. On the fiscal side,
governments may ease the burden on businesses and households either
by reducing taxes or through direct support payments. The second is
an adjustment in market behavior; we could see an effect similar to
that experienced in the aftermath of Japan’s Fukushima disaster, where
a shock provokes a stronger demand reaction than a gradual increase
in prices. Third, higher oil prices will hurt the spending power of US
lower-income households, who also have the lowest levels of savings.
Middle- and higher-income groups will likely be less affected given their
remaining savings accrued during the pandemic. European consumers
also have a savings cushion that is more or less intact.

Global risk radar
Financial markets’ historical performance… Fig. 6: Global stocks and energy price reaction during
Supply-driven energy price shocks based on geopolitical tensions Kuwait invasion in 1990: Global equities hurt
Performance of MSCI ACWI (lhs) and Energy prices (rhs)
are not an uncommon phenomenon to global financial markets. In
past episodes*, global equities have fallen 15–18% on average, but
recovered within six months. Countries more reliant on imported oil
tended to suffer more, as is the case for Europe, which imports around
90% of the crude oil it consumes. High grade bonds have offered some
protection in the past, but less so than during other periods of market
stress without energy-induced inflation worries. In credit, high yield
and emerging market bonds suffered the most, but recovered within
three months. The US dollar was initially seen to appreciate as investors
sought a safe haven; however, this move reversed later due to higher oil
prices. Safe-haven currencies such as the Swiss franc and the Japanese
yen appreciated due to increased geopolitical risk premium.
Source: Bloomberg, UBS, 24 January 2022
*For the historical performance around supply driven energy price
shocks, we look at the following episodes: Iran-Iraq war (1979), Gulf
War (1990-1991), Venezuelan general strike (2002-2003), Libyan civil
war (2011).
…and expected performance under the outlined severe risk case

We would expect global equities to fall 13–15%, mainly driven by a
multiple contraction on higher inflation and falling leading indicators. Fig. 7: Global stocks and energy price reaction during
Global earnings would be less impacted than European ones as margins the Crimea crisis in 2014: Quick recovery of global
are less sensitive to rising energy costs. Consumer staples, utilities, equities
healthcare, and energy would be the less impacted, while cyclicals and Performance of MSCI ACWI (lhs) and Energy prices (rhs)
small-caps would be particularly under pressure.
In fixed income, we would expect long-term government bonds to

rally as yields decline and markets readjust their expectations on when
central banks will hike rates. The breakeven inflation curve would
most likely invert as higher energy prices feed into near-term inflation,
while the long end would reprice lower due to higher risk premiums.
This would then entail lower real yields. On the credit side, high-beta
names and segments would suffer the most due to lower growth and
hence earnings prospects. Emerging market credit spreads would be
most vulnerable, particularly for issuers that are dependent on energy
Source: Bloomberg, UBS, as of 24 January 2022
imports or have links to Russia and Western economic sanctions.
A severe downside scenario as outlined above would add to existing

stagflation fears. As laid out in the Global Risk Radar “Stagflation:
How would markets react?” (2 December 2021), we think only a few
traditional asset classes would deliver positive returns. Investors would
have to turn to hedge funds, commodities, volatility-linked products,
and more granular asset class strategies to protect their portfolios.
In the severe risk case, Russian assets would come under severe
additional pressure. The ruble, as the main shock absorber for the
Russian economy, could breach 100 per USD, as a large part of Russia’s
external trade would be impeded, and amid further portfolio outflows
from Russia. The Russian central bank would likely not defend the ruble
at a specific level, but let it find a new equilibrium and possibly only
try to attenuate the largest swings. An escalation scenario that curtails
the free flow of energy will likely also involve sanctions on specific
Russian banks, companies, and (parts of) the sovereign complex—
Russian credit, local bonds, and equities would likely face the additional
headwind of Western investors selling the securities of the entities in
scope, and further reducing their overall exposure to Russia.

LET THE WILD
RUMPUS BEGIN
JEREMY GRANTHAM *
VIEWPOINTS
(Approaching the End of) The First U.S. Bubble Extravaganza:

Housing, Equities, Bonds, and Commodities
EXECUTIVE SUMMARY
All 2-sigma equity bubbles in developed Jeremy Grantham | January 20, 2022
countries have broken back to trend.
But before they did, a handful went on
to become superbubbles of 3-sigma or
greater: in the U.S. in 1929 and 2000 Introduction
and in Japan in 1989. There were also In a bubble, no one wants to hear the bear case. It is the worst kind of party-pooping.
superbubbles in housing in the U.S. For bubbles, especially superbubbles where we are now, are often the most exhilarating
in 2006 and Japan in 1989. All five of financial experiences of a lifetime. I participated in a wonderful micro-cap fireworks
these superbubbles corrected all the display from 1968 to 1969, in which I made a small fortune (7 times the then full
way back to trend with much greater cost of a year at business school). My main stock, American Raceways, tripled while I
and longer pain than average. was on vacation – $7 to $21 – then went to $100 by Christmas, only to lose it all even
quicker by the following June, as almost all the fireworks exploded and crashed. This
Today in the U.S. we are in the fourth taught me a lesson, and it helped make me cautious. The experience also makes it easy
superbubble of the last hundred years. for me to sympathize with the view that bearish advice in bubbles always comes from
Previous equity superbubbles had old fogeys who “just don’t get it,” because I received that old fogey advice back then and
a series of distinct features that just didn’t listen. I doubt speculators in the current bubble will listen to me now; but
individually are rare and collectively giving this advice is my job and possibly the right thing to do. So, once more unto the
are unique to these events. In each breach, dear friends.
case, these shared characteristics
This time last year it looked like we might have a standard bubble with resulting
have already occurred in this cycle. The
standard pain for the economy. But during the year, the bubble advanced to the
checklist for a superbubble running
category of superbubble, one of only three in modern times in U.S. equities, and the
through its phases is now complete and
potential pain has increased accordingly. Even more dangerously for all of us, the
the wild rumpus can begin at any time.
equity bubble, which last year was already accompanied by extreme low interest rates
and high bond prices, has now been joined by a bubble in housing and an incipient
bubble in commodities.
One of the main reasons I deplore superbubbles – and resent the Fed and other
financial authorities for allowing and facilitating them – is the underrecognized
damage that bubbles cause as they deflate and mark down our wealth. As bubbles
form, they give us a ludicrously overstated view of our real wealth, which encourages
us to spend accordingly. Then, as bubbles break, they crush most of those dreams and
accelerate the negative economic forces on the way down. To allow bubbles, let alone
help them along, is simply bad economic policy.
What nobody seems to discuss is that higher-priced assets are simply worse than
lower-priced ones. When farms or commercial forests, for example, double in price so
that yields fall from 6% to 3% (as they actually have) you feel richer. But your wealth
compounds much more slowly at bubble pricing, and your income also falls behind.
Some deal! And if you’re young, waiting to buy your first house or your first portfolio,
* it is too expensive to get even started. You can only envy your parents and feel badly
With reference to Maurice Sendak’s “Where the Wild treated, which you have been.
Things Are."
GMO | JEREMY GRANTHAM VIEWPOINTS
Let The Wild Rumpus Begin | p2
And then there is the terrible increase in inequality that goes with higher prices
of assets, which many simply do not own, and “many” applies these days up to the
“
median family or beyond. They have been let down, know it, and increasingly (and
understandably) resent it. And it absolutely hurts our economy. Looking back in a
decade or two, if bad things have happened to our democracy, the huge surge in
The bottom line is that income and wealth inequality of the last 50 years (as CEO income moved from about
in general the bubbles in 25x the average worker’s to about 250x) will have carried the largest share of the
multiple assets, not just blame. So, a pox on asset bubbles!
equities, have continued Today – nerd alert – I will cover more of the definitions, the statistics, the history, and
to inflate and therefore the technical details of superbubbles. The bottom line is that in general the bubbles in
multiple assets, not just equities, have continued to inflate and therefore the potential
the potential pain from a
pain from a break has increased. As usually happens, the equity bubble begins to
break has increased. deflate from the riskiest end of the market first – as it has been doing since last
February. So, good luck! We’ll all need it.
Summary
All 2-sigma equity bubbles in developed countries have broken back to trend. But
before they did, a handful went on to become superbubbles of 3-sigma or greater:
in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in
housing in the U.S. in 2006 and Japan in 1989. All five of these superbubbles corrected
all the way back to trend with much greater and longer pain than average.
Today in the U.S. we are in the fourth superbubble of the last hundred years.
Previous equity superbubbles had a series of distinct features that individually are rare
and collectively are unique to these events. In each case, these shared characteristics
have already occurred in this cycle.
The penultimate feature of these superbubbles was an acceleration in the rate of price
advance to two or three times the average speed of the full bull market. In this cycle,
the acceleration occurred in 2020 and ended in February 2021, during which time the
NASDAQ rose 58% measured from the end of 2019 (and an astonishing 105% from the
Covid-19 low!).
The final feature of the great superbubbles has been a sustained narrowing of the
market and unique underperformance of speculative stocks, many of which fall as
the blue chip market rises. This occurred in 1929, in 2000, and it is occurring now. A
plausible reason for this effect would be that experienced professionals who know that
the market is dangerously overpriced yet feel for commercial reasons they must keep
dancing prefer at least to dance off the cliff with safer stocks. This is why at the end of
the great bubbles it seems as if the confidence termites attack the most speculative and
vulnerable first and work their way up, sometimes quite slowly, to the blue chips.
The most important and hardest to define quality of a late-stage bubble is in the touchy-
feely characteristic of crazy investor behavior. But in the last two and a half years there
can surely be no doubt that we have seen crazy investor behavior in spades – more even
than in 2000 – especially in meme stocks and in EV-related stocks, in cryptocurrencies,
and in NFTs.
This checklist for a superbubble running through its phases is now complete and the
wild rumpus can begin at any time.
What is new this time, and only comparable to Japan in the 1980s, is the
extraordinary danger of adding several bubbles together, as we see today with three
and a half major asset classes bubbling simultaneously for the first time in history.
When pessimism returns to markets, we face the largest potential markdown of
perceived wealth in U.S. history.
The Definition of a Bubble and a Superbubble

We have defined investment bubbles at GMO for over 20 years now by a statistical
measure of extremes – a 2-sigma deviation from trend. For a random, normally
distributed series, like the sum of tosses of a fair coin, a 2-sigma event should occur once
“
every 44 trials in each direction. This measure is arbitrary but seems quite reasonable.
In real life, though, humans are not efficient (in the economic sense) but are often quite
irrational and can get carried away so that 2-sigma outliers occur more often than
In developed equity
random – not every 44 years, but every 35 years. We studied the available data across
markets, every single all asset classes over financial history and found a total of more than 300 2-sigma
example of a 2-sigma moves.1 In developed equity markets, every single example of a 2-sigma equity bubble
equity bubble in the last in the last 100 years has eventually fully deflated with the price moving all the way
back to the trend that existed prior to the bubble forming.
100 years has eventually
fully deflated with the But market extremes do not stop at 2-sigma. I define a superbubble as a 3-sigma event.
price moving all the That would occur in a world of tossing fair coins about once in every 100 events, but in
real life appears to occur two or three times more frequently than that. We humans do
way back to the trend crazy very well indeed! Yet whether the bubble hits 2-sigma, 3-sigma, or even higher, it
that existed prior to the still falls all the way back to trend, incurring enormous asset value losses. The key here
bubble forming. is that two things are true: 1) the higher you go, the lower the expected future return;
you can gorge on your cake now or enjoy it piece by piece into the distant future, but
you can’t do both; and 2) the higher you go, the longer and greater the pain you will
have to endure to get back to trend – in the current case to a trend value of about 2500
on the S&P 500, adjusted for the passage of time, from whatever high point the market
might reach (currently at nearly 4700).
And so it was in the three great bubbles in U.S. assets – equities in 1929 and 2000, and
housing in 2006. And so it was, in spades, in the Japanese stock and real estate markets
in the late 1980s. All five of these greatest of all bubbles fell all the way back to trend.
The Dangers of Multiple Asset Bubbles at the Same Time

The Japanese case, in particular, made one thing pretty clear: while it is dangerous to
have a bubble in equities – for the loss of value can cause a shock through the wealth
effect that can get out of control, which was a part of the problem in 1929 and the
ensuing slump – it is much more dangerous to have a bubble in housing, and it is very
much more dangerous to have both together. The economic consequences of the double
bubble in Japan are arguably still playing out. Exhibit 1 shows that neither the equity
1 market nor land have yet recovered their 1989 peaks!
Of these, over 90% reverted to the old mean; almost
10% appeared to be paradigm shifts that persisted for
decades. These 10%, however, were all in commodities,
whose finite nature might suggest the possibility of
permanent shortages and resulting price shifts – as has
occurred in oil (whose old trend line for 70 years was about
$23 in today’s currency); or in real estate where zoning
restrictions have caused increasing shortages; or in a
very few cases in equity markets in developing economies
where prior to economic and financial development
valuations had been extremely low.
EXHIBIT 1: NIKKEI INDEX AND JAPANESE CITY

COMMERCIAL REAL ESTATE, 1980-TODAY
50000 800
40000
Commercial Real
600
Estate index
30000
Nikkei 225
400
20000
10000 200
0 0
1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
Nikkei 225 (left axis)
“
Japan Real Estate Institute 6-City Commercial Real Estate index (right axis)
As of 1/7/2022 | Source: Bloomberg

…for the first time
in the U.S. we have
But now, for the first time in the U.S. we have simultaneous bubbles across all major
simultaneous bubbles asset classes. To detail:
across all major asset
First, we are indeed participating in the broadest and most extreme global real
classes. estate bubble in history. Today houses in the U.S. are at the highest multiple of family
income ever, after a record 20% gain last year, ahead even of the disastrous housing
bubble of 2006. But although the U.S. housing market is selling at a high multiple of
family income, it is less, sometimes far less, than many other countries, e.g., Canada,
Australia, the U.K., and especially China. (In China, real estate has played an unusually
important and unique role in the extended boom and thereby poses an equally unique
risk to the economy and hence the rest of the world if its real estate market loses air
exactly as it appears to be doing as we sit.)
Second, we have the most exuberant, ecstatic, even crazy investor behavior in the
history of the U.S. stock market. The U.S. market today has, in my opinion, the greatest
buy-in ever to the idea that stocks only go up, which is surely the real essence of a
bubble. (Interestingly, where other developed countries lead in housing prices, they lag
the U.S. in equity prices. Some, such as Japan, by so much that they are merely slightly
overpriced today.)
Third, as if this were not enough, we also have the highest-priced bond markets in the
U.S. and most other countries around the world, and the lowest rates, of course, that go
with them, that human history has ever seen.
And fourth, as gravy (as if we needed any) we have broadly overpriced, or above trend,
commodities including oil and most of the important metals. In addition, the UN’s
index of global food prices is around its all-time high (see Exhibit 2). These high prices
are important as they push inflation and stress real incomes. The combination, which
we saw in 2008, of still-rising commodity prices with a deflating asset price bubble is
the ultimate pincer attack on the economy and is all but guaranteed to lead to major
economic pain.
EXHIBIT 2: UN FAO FOOD PRICE INDEX

160
140
120
100
80
60
“
40
20
What our financial 0
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020
leadership should know
is that multiplying these As of 12/31/2021 | Source: UN Food and Agriculture Organization
risks – these three and
a half bubbles – will What our financial leadership should know is that multiplying these risks – these three
multiply the total shock and a half bubbles – will multiply the total shock if the damage occurs simultaneously.
if the damage occurs And this package presents more potential for writing down perceived wealth than
simultaneously. And this at any previous time in history. We wrote in 2007 that deflating U.S. housing prices
could directly lose $10 trillion or well over half a year’s GDP if house prices declined to
package presents more moderately below trend – which they did. But at that time the bond market was merely
potential for writing overpriced at the risky corporate end and the stock market merely normally overvalued.
down perceived wealth (The stock market still halved in price in sympathy, if you will, with the main event –
than at any previous housing and housing-related debt.)2 Yet despite that recent pain, all of the economic and
financial dangers that are now building up from multiple major bubbles do not appear
time in history. to be considered especially dangerous by the Fed or most of its equivalents around the
world. In fact, the warning signs appear to be barely noticed at all.
How Did This Happen: Will the Fed Never Learn?

As of today, the U.S. has seen three great asset bubbles in 25 years, far more than
normal. I believe this is far from being a run of bad luck, rather this is a direct outcome
of the post-Volcker regime of dovish Fed bosses. It is a good time to ask why on Earth
the Fed would not only have allowed these events but should have actually encouraged
and facilitated them.
The fact is they did not “get” asset bubbles, nor do they appear to today. This avoidance
2 of the issue seemed to us remarkable as long ago as the late 1990s. Alan Greenspan,
It is worth noting, though, that in 2007 the U.S. house who I considered then and now to be dangerously incompetent, famously acted as
building industry had expanded to build an extra million
cheerleader in the formation of the then greatest equity bubble by far in U.S. history in
houses, with all the stimulus to realtors et al., and
retrenched by 2010 and 2011 to a half million fewer the late 1990s and we all paid the price as it deflated.3
houses than normal. This drop packed a powerful punch
and accounted for much of the depth of the recession Bernanke should have been wiser from the experience of this bubble bursting and
and its resistance to stimulus. For a glimmer of good the ensuing pain, and he might have moved against the developing housing bubble
news, although our house prices in the U.S. are even more
– potentially more dangerous than an equity bubble as discussed. No such luck! It is
unaffordable and even more vulnerable than in 2006, at
least the house building industry is only jogging along pretty clear that Bernanke (and Yellen) were such believers in market efficiency that in
more or less normally now. their world bubbles could never occur.
3
Note that the 2000 tech bubble was accompanied by This is old territory for me, but I have to admit to enjoying it. Back then, when confronted
unusually cheap bond markets (TIPS at 4.3%!); cheap real
with a clear 3-sigma event in the U.S. housing market, Bernanke insisted that “the
estate (REITs yielding over 9%); even cheap value stocks
– it was focused solely on U.S. growth stocks and still we U.S. housing market merely reflects a strong U.S. economy,” and that “the U.S. housing
suffered from the negative wealth effect when it burst. market has never declined.” The information he meant to deliver was unsaid but clear:
“and it never will decline because there is no bubble and never can be.” On a purely
statistical basis, the history of U.S. house prices had indeed never bubbled before, being
so diversified collectively – booming in Florida while coasting in Chicago and falling
in California. Until, that is, the sustained excess stimulation of the Greenspan and
Bernanke era created a perfect opportunity to finally boom in every region together.
And what of the Fed’s statisticians? Picked for either their thick academic blinders
or intimidated by the usual career risk we all know and love so well – don’t deliver
information your boss doesn’t want to hear – they were totally silent or ineffective.
Whereupon the unprecedented and apparently non-existent housing bubble retreated

all the way back to its trend that had existed prior to the bubble, and then quite
typically for a bubble, went well below. So, the 3-sigma event came and went, the
best looking, most well-behaved bubble of all time (see Exhibit 3), causing profound
economic damage to the U.S. and global economies, particularly because of the lack
of regulation around the new mortgage-related instruments. Thus, the Fed had for
the second time aided and abetted a great bubble forming. And this time the pain
was augmented by the housing bust, associated mortgage mayhem, and the ensuing
decline in the U.S. stock market – merely badly overpriced but not a bubble – with
the combined loss of “perceived wealth” threatening a depression and necessitating
an unprecedented bailout and massive, but rather inept, stimulus. Yet, when society
looked around to assign blame and process lessons learned, it was as if it tried very
hard to miss the point.
EXHIBIT 3: THE U.S. HOUSING BUBBLE

5.0
4.5
Median House Price to
Median Income Ratio
4.0
3.5
3.0
2.5
1998 2000 2002 2004 2006 2008 2010
As of 12/31/2021 | Source: National Association of Realtors, U.S. Census Bureau, GMO
Yes, Bernanke and Paulson did a perfectly fine job of lobbying Congress for help,
etc., after the fact. But overall it was as if the Fed, at the wheel of a titanically-sized
economy, had imprudently raced the economy through dangerous waters, ignoring the
risks of icebergs so profoundly that the captain deserved a court martial but instead,
after the boat sank, was rewarded for doing a serviceable job of helping women and
children (and bankrupt bankers at Citi for that matter) into lifeboats. Previously,
Greenspan had even fought to help the boat speed up, by trying to bully Brooksley Born
at the CFTC to not regulate the growing wave of dangerous subprime instruments.
When she refused to back off from a job that was clearly hers, he then resorted to
lobbying Congress to change the law to leave these new “demons of our own design”4
4 altogether unregulated. In this infamous side job, he was joined by Arthur Levitt of
From the title of the excellent book by Richard Bookstaber.
the SEC (who apparently on this occasion saw “security” as a dirty word) and one of
my favorite Teflon men, Larry Summers. What were they thinking with this reckless
behavior? That bankers could regulate themselves? The episode was remarkable in
many ways as was our willingness to forget it. But what a good job it did in revealing
where Greenspan’s heart really lay – in deregulation.
With the clear dangers of an equity bubble revealed in 2000 to 2002, the even greater
dangers of a housing bubble in 2006 to 2010, and the extra risk of doing two asset
bubbles together in Japan in the late 1980s and in the U.S. in 2007, what has the Fed
learned? Absolutely nothing, or so it would appear. In fact the only “lesson” that the
economic establishment appears to have learned from the rubble of 2009 is that we
didn’t address it with enough stimulus. That we should actually have taken precautions
to avoid the crisis in the first place seems to be a lesson not learned, in fact not even
“
taught. So we settle for more lifeboats rather than iceberg avoidance. And we forgive
and forget incompetence and fail to punish even outright malfeasance. (Iceland, pop
At some future date, 300,000, sent 26 bankers to prison; the U.S., pop 300,000,000, sent zero. Zero!)
when pessimism rules
Bubbles, Growth, and Inequality
again as it does from Perhaps the most important longer-term negative of these three bubbles, compressed
time to time, asset prices into 25 years, has been a sustained pressure increasing inequality: to participate in
will decline. the upside of an asset bubble you need to own some assets and the poorer quarter of
the public owns almost nothing. The top 1%, in contrast, own more than one-third of
all assets. And we can measure the rapid increase in inequality since 1997, which has
left the U.S. as the least equal of all rich countries and, even more shockingly, with
the lowest level of economic mobility, even worse than that of the U.K., at whom we
used to laugh a few decades back for its social and economic rigidity. This increase in
inequality directly subtracts from broad-based consumption because, on the margin,
rich people getting richer will spend little to nothing of the increment where the
poorest quartile would spend almost all of it.
5
So, here we are again. This time with world record stimulus from the housing bust
The back-of-the-envelope calculation goes like this: days, followed up by ineffably massive stimulus for Covid. (Some of it of course
1. Currently, the U.S. nonfinancial corporate sector is necessary – just how much to be revealed at a later date.) But everything has
worth $48 trillion. If cyclically-adjusted P/Es fall from
consequences and the consequences this time may or may not include some intractable
their current level of nearly 40 to 25 – which would
still be among the highest valuations ever recorded inflation. But it has already definitely included the most dangerous breadth of asset
prior to 1997 – this would be a 37% loss of value, over overpricing in financial history. At some future date, when pessimism rules again as it
$17 trillion. does from time to time, asset prices will decline. And if valuations across all of these
2. U.S. households own real estate worth $41 trillion. asset classes return even two-thirds of the way back to historical norms, total wealth
Current Census data on median household incomes
losses will be on the order of $35 trillion in the U.S. alone.5 If this negative wealth and
and median home sale prices suggest a price to
income ratio of about 5.5 after accounting for a income effect is compounded by inflationary pressures from energy, food, and other
considerable estimated increase in incomes in 2021 shortages, we will have serious economic problems.
(last datapoint was 2020). If this ratio returns to 4.0 –
which is well above any levels prior to the mid-2000s
housing bubble – this would be a 27% loss of value,
Some Last-Minute Color on Market Frenzy and Breadth
over $11 trillion. The penultimate phase of major bubbles has been characterized by a “blow-off” –
3. U.S. Treasury, agency/GSE, and corporate debt an accelerating rate of stock price growth to two or three times the average of the
securities outstanding come to about $24 trillion, $11 preceding bull market. This pattern was shown as clearly as any of history’s other great
trillion, and $15 trillion, respectively. We can quite superbubbles in 2020 (see Exhibit 4).
conservatively estimate the duration of these three
sectors at 5 years, 4 years, and 7 years, respectively. If
rates rise a mere 2% – from current levels of -0.7% for
10-year TIPS, this would take us to only 1.3% real at
the long end, still significantly below historic norms –
and if corporate spreads rise only 0.5% on top of that,
losses on debt securities would total about $6 trillion.
EXHIBIT 4: STOCK MARKET SUPERBUBBLES HAVE

BLOW-OFF TOPS
U.S. 1929: Shiller S&P 500 Proxy Tech 2000: NASDAQ Composite
4000
16 2000
BLOW-OFF
1000 BLOW-OFF
4 500
1921 1924 1927 1930 1992 1994 1996 1998 2000
Japan 1989: Nikkei 225 U.S. 2022: S&P 500

40000 4000
20000
10000 2000
BLOW-OFF BLOW-OFF
5000
2500 1000
1975 1980 1985 1990 2012 2015 2018 2021
As of 1/14/2022 | Source: Robert Shiller, DataStream
As for speculative madness, there were already many fantastic bubble anecdotes from
2020, which I wrote about last year.6 Since then, the anecdotes have been even better.
We’ve had:
■ The meme stock madness of GME and AMC – two companies in declining
industries further decimated by Covid-19 – that managed to rally 120x and 38x,
respectively, from their post-pandemic lows to their 2021 highs, driven by message
board sentiment, taking GME briefly to 20% of the entire Russell 2000;
■ The dogecoin phase, in which a cryptocurrency conceived as a parody of the

crypto craze went up nearly 300x, to a market cap of $90 billion because Elon
Musk kept joking about it; and
■ La pièce de résistance: after Hertz (one of 2020’s meme stock stars) saw a quick
stock surge from announcing it would purchase a fleet of Teslas, Avis rather
plaintively said something like, “Hey dudes, we might buy electric cars too,” and
tripled in a day!
But – as fits the final “narrowing market” phase of a great bubble – most of these events
are now well in the past, and the last six months have seen a growing numbness to
the euphoria (see Exhibit 5). GME, AMC, dogecoin, and more than one-third of all
NASDAQ stocks are now all down more than 50% from their highs. Bitcoin is down
over 40%, and my own unfortunate Quantumscape, which 13 months ago was worth
more than GM (1929 had many extreme speculations but nothing on this scale), is
down from its December 2020 peak by 83%. Ouch!
6
Jeremy Grantham, “Waiting for the Last Dance: The
Hazards of Asset Allocation in a Late-stage Major Bubble,”
January 5, 2021.
Jeremy Grantham EXHIBIT 5: BIGGEST AND HIGHEST QUALITY STOCKS

Mr. Grantham co-
founded GMO in 1977 CARRIED THE MARKET IN 2021
10 Largest
and is a member of
Names in S&P 500
GMO’s Asset Allocation 1.4 Cap-Weighted
team, serving as the 1.3 S&P 500
firm’s long-term investment strategist. He 1.2
is a member of the GMO Board of Directors Russell 2000
Total Return
1.1
and has also served on the investment
1.0
boards of several non-profit organizations. Goldman Sachs
0.9 Non-Profitable
Prior to GMO’s founding, Mr. Grantham
0.8 Tech index
was co-founder of Batterymarch Financial
Management in 1969 where he recommended 0.7
commercial indexing in 1971, one of several 0.6
Dec-20 Mar-21 Jun-21 Sep-21 Dec-21
claims to being first. He began his investment
career as an economist with Royal Dutch As of 12/31/2021 | Source: Bloomberg, Goldman Sachs, GMO
Shell. Mr. Grantham earned his undergraduate
degree from the University of Sheffield
(U.K.) and an M.B.A. from Harvard Business The Death of the Vampire
School. He is a member of the Academy of In the meantime, we are in what I think of as the vampire phase of the bull market,
Arts and Sciences, holds a CBE from the UK where you throw everything you have at it: you stab it with Covid, you shoot it with
and is a recipient of the Carnegie Medal for the end of QE and the promise of higher rates, and you poison it with unexpected
Philanthropy.
inflation – which has always killed P/E ratios before, but quite uniquely, not this time
yet7 – and still the creature flies. (Just as it staggered through the second half of 2007
as its mortgage and other financial wounds increased one by one.) Until, just as you’re
Disclaimer
beginning to think the thing is completely immortal, it finally, and perhaps a little
The views expressed are the views of
anticlimactically, keels over and dies. The sooner the better for everyone.
Jeremy Grantham through the period ending
January 20, 2022, and are subject to change What to Do as an Investor?
at any time based on market and other GMO has a detailed set of recommendations available that I agree with. A summary
conditions. This is not an offer or solicitation might be to avoid U.S. equities and emphasize the value stocks of emerging markets
for the purchase or sale of any security and several cheaper developed countries, most notably Japan. Speaking personally,
and should not be construed as such. I also like some cash for flexibility, some resources for inflation protection, as well as
References to specific securities and issuers a little gold and silver. (Cryptocurrencies leave me increasingly feeling like the boy
are for illustrative purposes only and are not watching the naked emperor passing in procession. So many significant people and
intended to be, and should not be interpreted institutions are admiring his incredible coat, which is so technically complicated and
as, recommendations to purchase or sell superior that normal people simply can’t comprehend it and must take it on trust. I
such securities. would not. In such situations I have learned to prefer avoidance to trust.)
7
See Appendix: Inflation and Explaining P/E
January 18, 2022
DON’T EXPECT THE FED TO END THIS BULL

ANYTIME SOON
Jeff Buchbinder, CFA, Equity Strategist, LPL Financial
Ryan Detrick, CMT, Chief Market Strategist, LPL Financial
The Federal Reserve (Fed) has engineered a massive hawkish shift, causing a bit more stock market
volatility recently. But how worried should investors be? Here we take a look back at historical
performance for stocks before, after, and much after initial Fed rate hikes to help reassure any
nervous investors out there. We also take a quick look at what the Fed pivot could mean for
growth/value and large cap/small cap trends given the maturing business cycle.
MASSIVE HAWKISH SHIFT

With the recent pivot by Jay Powell and Company at the Fed, rate hikes have been getting a
lot of attention. And rightly so, given the bond market has gone from pricing in one 2022 rate
hike just a few months ago to now pricing in three to four. That’s one of the most dramatic
hawkish shifts by the Fed in a short period of time that we’ve ever seen, so some market jitters
are not surprising.
HOW MUCH SHOULD WE WORRY?

A look back at history may help calm some investors’ jitters around the start of Fed rate hikes.
As we wrote in our Outlook 2022: Passing the Baton, stocks tend to do well leading up to initial
Fed rate hikes. There we highlighted the average 15% gain during the 12 months ahead of the
initial hike of an economic cycle, including gains in all nine cases back more than 60 years.
This makes sense given it takes a strengthening economy to create the job gains and inflation
the Fed needs to see to take away the punchbowl. We see the first rate hike coming in either
March or May, and with the S&P 500 Index up nearly 20% since March of 2021, and more than
10% since May 2021, those gains may already have occurred.
Looking beyond the initial hike, on our LPL Research blog last week we looked at how stocks
performed during various periods after the Fed starts to hike rates. The story is similar, with the
S&P 500 up an average of 7.5% six months later and 10.8% over the next 12 months
historically. Stock were up all eight times one year after those initial hikes going back to the
early 1980s. So based on history, the start of a rate hiking campaign by the Fed should not be
too worrisome for investors.
1 Member FINRA/SIPC
LOOKING OUT LONGER TERM
But what does the hike mean further out, say 2023 and beyond? In Outlook 2022, we noted
that initial Fed rate hikes can help us mark where the economy is in its cycle. The start of rate
hikes typically happens in the early-to-middle stages of the cycle, where stocks historically see
solid gains as we are forecasting for 2022.
But we can extend this exercise further and look at how stocks have done from the initial rate
hike of a cycle until the end of the accompanying bull market, as we have done in [Figure 1].
Those first rate hikes have been followed by an average gain of 67% before the subsequent
bull market peak. For those keeping score at home, that would take the S&P 500 to over 7,700
(no, that is not a forecast) before the next 20% or more decline.
On average, after rate hikes start, bull markets have run for about three to four years (or 40
more months) before peaking, with the longest in the late 1990s at six years (72 months)
between the 1994 hike and the bull market top in March of 2000.
We can also look at where in economic cycles these first rate hikes occurred based on the
dates of the economic expansion. This can give us a rough idea of how much more economic
growth we might expect after the Fed starts hiking rates.
This exercise reveals that, on average, expansions were 40% completed upon arrival of the
Fed’s first hike. However, the August 1983 hike occurred only about one-quarter of the way
through that expansion, which we think is more representative of how long this unusual cycle
may last. We’re not even two years in and we think this cycle has a few more years left.
2 Member FINRA/SIPC
IMPLICATIONS FOR THE GROWTH-VALUE ROTATION
After growth stocks performed so well throughout much of the pandemic, value stocks have
shown signs of life recently. Year to date the Russell 1000 Value Index has gained 1%, ahead
of the more than 5% drop in the 1000 Growth Index. That follows about four percentage points
of outperformance by value in December.
As shown in [Figure 2], the relative strength of value stocks has been closely tied to the yield
curve, or the difference between 2-year and 10-year U.S. Treasury yields. A steeper yield curve
tends to be good for financials, the biggest value sector, so this makes sense.
One of the reasons we squared up our views on the growth and value styles this month in our
latest Global Portfolio Strategy report is because we think the opportunity for yield curve
steepening may be somewhat limited now that the Fed pivot has occurred and the bond market
is pricing in more than three rate hikes for 2022. If the 10-year yield doesn’t get much higher
than 2% this year, as we expect, and the Fed follows through with a series of hikes and maintains
its credibility as an effective inflation fighter, then the yield curve may actually flatten.
We are not worried about an inverted yield curve signaling recession, but we are skeptical that
value stocks will continue to outperform at such a strong pace for much longer even with support
from strong, though slower, economic growth and a likely further rise in interest rates.
3 Member FINRA/SIPC
SCALES MAY BE TILTING TOWARD LARGE CAPS
Small cap stocks have historically done better early in economic expansions, so as this cycle
matures, large caps may have an edge. While we do not fear an impending recession, we do
believe tighter monetary policy marks the economy’s progress toward mid-cycle. As such, we
have become a bit less enamored with small caps, taking our view down from positive to
neutral this month.
While small caps have historically performed well in inflationary environments, this cycle is
unique and we believe larger companies are better positioned for the current environment of
supply chain challenges and labor shortages (where a big chunk of the inflation is coming
from). In addition, weakness in biotech and other more speculative, richly valued pockets of
the market, should it continue, will make it difficult for smaller cap stocks to keep up with their
mostly higher quality, better-resourced large cap peers.
CONCLUSION
The Fed has engineered a massive hawkish pivot, contributing to an increase in volatility
recently. But a look back at history provides some reassurance, as stocks have historically
performed well leading up to and after the first rate hike of a cycle, with significant upside
before eventual bull market tops. Bottom line, even with rate hikes coming soon, we think this
economic cycle and bull market have quite a bit left in the tank.
4 Member FINRA/SIPC
EVEN FOR Microsoft, which boasts a market value of $2.3trn, $69bn is a lot of money.
On January 18th the firm said it would pay that sum—in cash—for Activision Blizzard, a
video-game developer. It is by far the biggest acquisition in the video-game industry’s
history, and the largest ever by Microsoft, more than twice the size of its purchase in 2016
of LinkedIn, a social network (see chart). The move, which caught industry-watchers by
surprise and propelled Activision Blizzard’s share price up by 25%, represents a huge bet
on the future of fun. But not, perhaps, a crazy one.
Gaming was a big, fast-growing business even before the pandemic. Lockdowns bolstered
its appeal—to hardened gamers with more time on their hands and bored neophytes alike.
Newzoo, an analysis firm, reckons revenues grew by 23% in 2020, to nearly $180bn. That
growth has attracted the attention of other tech titans, including Apple, Netflix and
Amazon, all of whom have dipped their toes into the market in recent years.
Microsoft has been in the business for two decades. It earns $15bn a year from games,
mostly thanks to its Xbox console. It has made a string of gaming acquisitions since 2014,
when Satya Nadella, its chief executive, took the reins. Assuming it is not blocked by
regulators, who are watching big tech with a beady eye, this deal would cement its
position. Once completed in 2023, it will make Microsoft the third-largest video-gaming
firm by revenue, behind only Tencent, a Chinese giant, and Sony, Microsoft’s perennial
rival in consoles.
Big acquisitions are always risky. Like most companies, Microsoft has a spotty record.
Activision Blizzard’s share price slid by around 40% between a peak last February and the
deal’s announcement, as it was embroiled in a sexual-harassment scandal. Player numbers
have slipped from 530m a month in 2015 to 390m, and some recent games have had mixed
reviews. Pessimists could argue that the company is overvalued. Optimists, who see annual
revenues of $8bn and net profit margins of around 30%, might counter that it is cheap.
Most important, Activision Blizzard has lots of content—and in video games, as in all of
media, content is king, says Piers Harding-Rolls of Ampere Analysis, another research
firm. Like the movie business, where “Star Wars” films, even bad ones, are reliable
money-spinners, video games rely increasingly on “franchises”—popular settings or brands
that can be squeezed for regular instalments. Activision Blizzard offers, among others,
“Call of Duty”, a best-selling series of military-themed shoot-’em-ups, “Candy Crush”, a
popular pattern-matching mobile game, and “Warcraft”, a light-hearted fantasy setting.
The deal may help Microsoft broaden its reach beyond consoles, says Julianne Harty of
Newzoo. King, a mobile-focused unit of Activision Blizzard, boasts around 245m monthly
players of its games, most of whom tap away at “Candy Crush”. It is also a strike against
Sony, whose share price fell by 10% on news of the deal. If Microsoft controls the rights to
“Call of Duty”, it can decide whether or not to allow the games to appear on Sony’s rival
Play Station machine. When Microsoft bought ZeniMax Media, another gaming firm, for
$7.5bn in 2020, it said it would honour the terms of ZeniMax’s existing publishing
agreements with Sony, but that Sony’s access to ZeniMax’s new games would be
considered “on a case-by-case basis”.
It also fits Microsoft’s long-term ambition to become the dominant player in a gaming
market that it hopes still has plenty of room to grow. (Mr Nadella, inevitably, gushed about
the virtual-reality “metaverse”.) The firm is bundling content and pushing the “Game Pass”
subscription service, which offers console and PC gamers access to a rotating library of
titles—which usually cost $40-60 each—for $10 a month. Adding Activision Blizzard’s
catalogue to the service could boost its appeal.
In the longer term, Microsoft hopes to use its Azure cloud-computing arm to do for video
games what Netflix did for films and TV. In 2020 it launched a game-streaming add-on to
Game Pass that beams high-end games across the internet to a phone, TV or desktop.
Running a game’s code in the cloud removes the need to own a powerful, pricey console or
PC. The technology is tricky. Still, Microsoft hopes that as it matures, it will draw in more
players, especially in middle-income countries where smartphones are common but
consoles rare. Although other firms, including Sony, Amazon and Nvidia, offer similar
services, none looks as well-placed as Microsoft. The software giant combines a strong
content library and decades of experience in gaming with the world’s second-largest cloud
operation behind Amazon.
Microsoft’s big bet may persuade rivals they, too, need to snap up content while they can.
The gaming industry was already seeing plenty of merger activity. Last year five deals
worth $1bn or more were inked. On January 10th Take-Two Interactive, a game developer
and publisher, spent $13bn on Zynga, a maker of mobile games. Sony will be feeling
vulnerable after Microsoft’s deal. Amazon, Apple or Netflix may decide that now is the
time to show that they are serious about the business. Consolidation looks like the name of
the game.

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What We Are Reading - Volume 2.097

• India: The odds of an investment upswing HSBC Global Research

India: The odds of an Economics

Hopes for an investment revival

Many are predicting a rapid rise in India’s investment cycle.

For one, it is urgently needed in order to sustain growth. Let us explain.

From the lens of our model

But will the hopes of an investment revival come to bear?

But will there be a rise going forward?

Table 1: Our investment model … Chart 5: … has a good fit

Source: CEIC, Refinitiv Datastream, www.policyuncertainty.com , HSBC

Investment prospects – Will it? Won’t it?

-3.0 3.0 -20 60

1.0 -2.0 0.0

Chart 13: Breakdown of India’s labour force (% share of total)

Source: PLFS, NSS and census data, HSBC calculations

What’s holding back future growth prospects?

What can the budget do right?

Is all bleak? We think not.

And it can start with the budget to be announced on 1 February.

But is it possible to pursue each of these simultaneously? We believe yes. Table 3

Non-tax revenue receipts 2081 2747 2826 1.1% 1.2% 1.1%

A. Total Receipts 16897 21307 24117 8.6% 9.1% 9.2%

B. Total Expenditure 35112 36544 39929 17.8% 15.7% 15.3%

Fiscal Financing FY21 FY22 FY23

How about reforms?

Table 4: India's key macroeconomic forecasts

India Market Strategy

Please select Sector | Strategy

Source: Credit Suisse estimates

India gaining share in manufacturing exports. India’s share of global merchandise

Source: Trademap, Credit Suisse estimates Source: Credit Suisse estimates

0 0.0% Split of US$10bn of

Source: Credit Suisse estimates Source: Credit Suisse estimates

India Market Strategy 2

PLI schemes: A year’s delay

Exports can add meaningfully to growth

India Market Strategy 3

India gaining share in electronics, chemicals

Gains in electronics, chemicals, autos, apparel

2001 2010 2019 2001 2010 2019

India Market Strategy 5

300 2021: Extrapolated from 11 months data

Electronics: Large opportunity, a steady ramp up

India Market Strategy 6

India Market Strategy 7

Handsets 1,400 40%

Figure 24: Several non-PLI firms expanding capacity too

Source: Govt. of India, News Reports, Credit Suisse

India Market Strategy 8

Apparel/textiles: Can India step out of the stasis?

15 Cotton Apparel -0.6

India Market Strategy 9

India Market Strategy 10

Opportunity in autos as much local as global

India Market Strategy 11

Source: SIAM, Credit Suisse estimates Source: Credit Suisse estimates

India Market Strategy 12

50,000 50% 25%

40,000 40% 20%

30,000 30% 15%

20,000 20% 10%