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GAME CHANGER

THE INDIA CONSUMPTION STORY

`110 tn consumption market by 2025 2.5X the current size in real terms Premiumization to be the key trend Upgrade from low cost to high value products High, well-distributed growth critical Productive job opportunities essential

Introducing KIE’s RUPEES Estimator

Akhilesh Tilotia
akhilesh.tilotia@kotak.com +91-22-6634 -1139

Foreword
Buying power by the billion Slowly, but certainly, the story is unfolding: Indian consumption is meta-morphing. Already India is one of the largest global markets, but by 2025, we expect it to be two-and-a-half times larger. It will also be a vastly different, richer, more colorful market—for good reason. Incomes will increase dramatically, and most people will spend more than just to keep body and soul together. Higher incomes will open the sluice gates of far-reaching consumption change. KIE’s RUPEES Estimator, a predictive model that projects Indian consumption, among other things, anticipates significant transformation by 2025: The affluent will spend more on enhanced lifestyles, less on staples. That means more buying in sectors such as leisure, hotels, housing, household goods and healthcare. Indians will have more money in their pocket and the poorest of the poor class will shrink. The urban market will account for 60% of India’s consumption market, from less than 50% today, as rural areas morph into urban centers. Indian consumers will demand improved quality and more. Our model predicts a clamor for sub-categories of products, for differentiated products that cater to numerous consumer sub-groups. India will emerge, metamorphed, making it fertile soil for fresh, new brands. We are about to enter an era of buying power by the billion…

Contents
A market meta-morphing The RUPEES Estimator telescopes dramatic change Buying power by the billion: Bucks for luxe Growing gains: What people want Rural India morphs into mushroom towns GameChangers: How to nurture the metamorphosis Appendix: The birth of a model 5 11 15 19 23 27 29

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KOTAK INSTITUTIONAL EQUITIES RESEARCH

Chapter 1 A market meta-morphing
The Indian consumption market is emerging as a rich, multi-faceted entity, that will grow two-and-a-half times by 2025E, to Rs110 tn from Rs43 tn, right now. More Indians will have a pocketful of money and a long shopping list, spending disproportionately on leisure, hotels, housing, household goods, healthcare and more, but less on bare necessities and staples, as a proportion of consumption. How do we know? We present KIE’s RUPEES Estimator, a predictive model that plots India’s consumption story. It classifies households into: (1) Real-rich, (2) Upper class, (3) Prospering, (4) Evolving, (5) Emerging and (6) Surviving. However, inclusive growth (through productive job creation) is crucial to the stability of the process.

Buying power by the billion
By 2025E, more Indians will have a pocketful of currency and a heart full of dreams. That means a long shopping list. Some of the big items on that list will be (1) leisure, including hotels, (2) housing, education and healthcare and (3) communication, transport and other new categories, now small enough to be jotted under a Miscellaneous head. The share of staples and necessities will fall as a proportion of consumption spends. (see Exhibit 1).
Exhibit 1: The big winners in the Indian consumption story CAGR and market size of various commodities, March fiscal year-ends (at FY2010 prices) Big items on the shopping list will be (1) leisure, including hotels, (2) housing, education and healthcare, and (3) communication and transport
Growth Categories Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure Education Hotels Miscellaneous Total CAGR (%) 5.7 6.6 6.0 8.0 7.4 8.0 7.6 7.8 8.4 7.5 8.2 7.6 6.9 Rank 12 10 11 3 9 4 7 5 1 8 2 6 Market size (Rs bn) FY2011 17,190 1,056 2,348 5,012 1,848 2,152 3,715 1,136 1,550 1,198 1,319 4,766 43,291 FY2025 37,130 2,601 5,331 14,762 4,994 6,295 10,298 3,270 4,797 3,287 3,980 13,276 110,023 Opportunity (Rs bn) 19,940 1,545 2,983 9,750 3,145 4,143 6,584 2,134 3,247 2,089 2,661 8,511 66,732

Source: Kotak Institutional Equities estimates

What counts for consumption can also represent payment for capital value

What counts for consumption can also represent payment for capital value. In the housing component, for instance, a significant part of an Indian’s expenditure might include capital value (either as interest on loans or as rent). Therefore, growth in a sector (and its associated sectors, like finance) can be far more meaningful. Even if you consider other categories, such as education and car or two-wheeler purchases, finance can play an important role. Consequently, Miscellaneous will become a larger category of expenditure in India’s new scheme of things, and a significant proportion of the expenditure will be financial services like banking, investment and insurance. Segments like food and beverages, alcohol and tobacco and clothing and footwear will grow in their own right, by 5.5-6.6% a year, but as they trail overall spending growth, their proportion in the share of wallet will fall. Food and beverage, though, will be high on a consumer’s shopping list and account for a third of total spends.

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GAME CHANGER

When the middle classes evolve beyond survival…
India’s per capita income in FY2011 was Rs60,388. However, there is wide, and increasing, disparity of income: India’s Gini co-efficient (which measures the level of inequality in income distribution, in which 1 indicates complete inequality and 0 indicates equal income distribution across all people) was 0.395 in FY2010, having risen from 0.324 in FY1995. However, India’s large population and long tail of income distribution gives it a consumption market that houses a significant number of households across the spectrum (see Exhibit 2). We introduce the RUPEES Estimator (more details in the next section) to classify households into expenditure-based classes. Not surprisingly, there are more high-end urban households due to the dominance of the services economy in urban India as opposed to agriculture in rural areas.
Exhibit 2: India will see a huge uptick in rich households Distribution of Indian households by consumption expenditure, March fiscal year-ends, FY2010-25E (mn)
2011 2012 2013 2014 Rural households Real-rich Upper-class Prospering Evolving Emerging Surviving Total Real-rich Upper-class Prospering Evolving Emerging Surviving Total — — 5.5 6.2 21.2 — — 6.0 6.3 24.8 — 0.2 6.3 10.2 26.9 — 0.7 6.4 10.0 32.8 — 1.2 6.4 9.9 38.4 — 1.7 6.5 9.7 46.0 — 2.2 6.5 9.7 53.3 — 2.7 6.6 9.5 60.9 94.7 174.4 3.1 2.0 4.8 20.8 41.3 18.8 90.8 — 3.2 6.7 9.2 69.2 87.7 — 3.8 6.8 9.0 77.4 80.9 0.3 4.0 6.8 9.0 85.9 73.7 0.9 4.0 6.9 13.1 90.2 66.4 1.4 4.1 7.0 17.3 94.0 59.6 1.9 4.1 7.0 21.4 52.4 2.5 4.2 7.1 25.2 45.6 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

India’s large population and long tail of income distribution gives it a consumption market with a significant number of households across the spectrum

98.3 102.5

129.8 127.1 122.3 117.6 113.2 107.0 100.8 162.6 164.3 165.9 167.6 169.3 170.9 172.7 1.0 1.5 2.6 7.7 26.1 29.3 68.2 1.2 1.6 2.7 9.0 28.7 28.0 71.2 1.5 1.7 4.5 8.5 31.4 26.7 74.2 1.7 1.7 4.6 10.4 33.5 25.4 77.4 2.0 1.8 4.6 12.9 35.4 23.9 80.6 2.4 1.9 4.7 15.4 37.3 22.2 83.9 2.7 2.0 4.8 18.0 39.3 20.6 87.3

176.1 177.9 179.7 181.5 3.5 2.1 4.8 24.6 42.5 16.8 94.3 3.9 2.2 4.8 28.5 43.9 14.7 4.3 2.3 6.4 30.9 45.2 12.7 4.8 2.3 8.2 33.4 46.2 10.7

183.3 185.1 187.0 5.2 2.4 10.0 36.2 47.0 8.6 5.7 2.5 11.8 39.0 47.7 6.7 6.3 2.6 13.7 42.0 48.5 4.6

Urban households

98.0 101.7 105.5

109.5 113.5 117.6

Source: Kotak Institutional Equities estimates

By FY2019E, the number of households in the Surviving class—almost 70% of India’s current households (159 mn of the 231 mn households)—will be eclipsed by the Emerging class with each class having108 mn households. By FY2025E the Evolving and Emerging classes will comprise about 210 mn households (out of about 300 mn households). The top three classes will have grown more than 3X, to 36 mn households (11.9% of households) from an estimated 11 mn households today (4.6%).

The top three classes will have grown more than three fold, to 36 mn households

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…they grow with big buying power
Surviving households form the largest segment by value (28%) in a Rs43 tn Indian consumption market, today. By 2025E as economic growth, assuming it is reasonably well distributed, increases the number of the Emerging and Evolving middle-class households, they will command almost half the Rs110 tn market, and the Surviving class will account for only 3%. The top three classes, which now account for about 30% of the consumption basket, will account for about 43% by FY2025E. As the share of wallet shifts to high-end customers, per capita expenditure in each category will expand (see Exhibit 3). This will create sub-categories: we expect to see this, especially in categories that will lead growth, at above-average levels. Consider this: a Survivor spends about Rs600 a year on healthcare (a small proportion of a relatively small wallet) while a Real-rich person spends Rs45,000 a year. As people graduate into higher classes their approach to well being will undergo a sea change. They would focus on (1) disease prevention (also captured in the leisure category through health boutiques), (2) chronic diseases and (3) paying more for capital-intensive tests and procedures. In the new scheme of things, Indians are likely to spend more on such things.
Exhibit 3: More evenly spread consumption as India gets richer Consumption across classes, rural and urban India, March fiscal year-ends, FY2010-25E (Rs tn, at FY2010 prices)
Total Real-rich Upper-class Prospering Evolving Emerging Surviving 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2.7 2.5 7.7 6.7 11.4 12.4 3.3 2.6 8.2 7.3 12.7 12.0 46.0 3.9 3.1 10.0 8.8 13.7 11.4 50.9 4.7 3.9 10.1 9.5 15.4 10.8 54.4 5.4 4.6 10.1 10.6 17.0 10.3 58.0 6.2 5.4 10.1 11.6 18.9 9.6 61.8 7.0 6.3 10.1 12.6 20.8 8.9 65.7 7.9 7.1 10.1 13.7 22.7 8.2 69.7 8.8 7.8 10.1 15.2 24.5 7.5 74.0 9.7 8.6 10.1 16.8 26.3 6.8 78.3 11.5 9.0 11.4 17.7 28.1 6.1 83.7 13.7 9.0 13.0 20.3 28.9 5.4 90.3 15.9 9.1 14.5 23.0 29.6 4.7 18.1 9.3 16.0 25.7 30.3 4.0 20.6 9.3 17.5 28.2 31.0 3.4 110.0

With large parts of the market catering to high-end customers, there will be significant changes in the types of products and services and evolution of new sub-categories and in marketing and distribution

Grand Total 43.3

96.8 103.4

Source: Kotak Institutional Equities estimates

In the face of such a phenomenal increase in buying power, companies will usher in innovation to premium products and services, moving away from lower ticket sizes. With large parts of the market now catering to high-end customers, there will be significant changes in (1) the types of products and services on offer in each product and service category, (2) the evolution of new sub-categories and (3) the mode of appeal to customers (marketing) and reach (distribution).

RUPEES Estimator telescopes kaleidoscopic spending patterns…
India is evolving into new dimensions. Consumer needs and preferences are shifting and the change can only accelerate as consumer spends increase. However, this change is not uniform. Wide income disparity is throwing up kaleidoscopic spending patterns across consumer classes. KIE’s RUPEES Estimator, a predictive model, classifies households into six categories, based on their per capita spending capacity (see Exhibit 4): (1) Real-rich, (2) Upper class, (3) Prospering, (4) Evolving, (5) Emerging and (6) Surviving.

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GAME CHANGER

The RUPEES Estimator does not differentiate a class based on geographic location of rural or urban India, given the increasing reach of media (including television, mobile phones and internet). We believe aspirations will tend to be similar in rural and urban India and hence, we treat the rural Real-rich as having a similar consumption pattern as the urban Real-rich. We note that the figures presented in this report are in constant FY2010 terms.
Exhibit 4: The RUPEES framework Classifying Indian households in categories of monthly per capita expenditure, (FY2010, Rs)
Monthly expenditure From Real-rich Upper-class Prospering Evolving Emerging Surviving in PPP USD Real-rich Upper-class Prospering Evolving Emerging Surviving 3,000 2,000 1,000 500 250 — — 3,000 2,000 1,000 500 250 36,000 24,000 12,000 6,000 3,000 — — 36,000 24,000 12,000 6,000 3,000 50,000 30,000 18,000 9,000 4,500 1,500 30,000 20,000 10,000 5,000 2,500 — 30,000 20,000 10,000 5,000 2,500 To Annual expenditure From 360,000 240,000 120,000 60,000 30,000 — To — 360,000 240,000 120,000 60,000 30,000 Average 500,000 300,000 180,000 90,000 45,000 15,000

We believe aspirations will tend to be similar in rural and urban India

Source: Kotak Institutional Equities

…and abundant opportunity
The Indian consumption market is morphing into a bouquet of opportunities and all are invited to the party, especially (1) companies that can produce products and services for this huge, fractured market, and (2) investors seeking to invest in such companies. As (1) new categories (and increasingly differentiated sub-categories) of consumption open up and (2) the profile of consumers that companies cater to, changes, companies that develop appropriate strategies and execute them well will win. For investors, a guide-map of segments that represent threats or opportunities for portfolio companies is useful. The RUPEES Estimator predicts (1) the class of customers that will dominate the mind-share of companies, and (2) categories in which there will be enhanced activity.
The RUPEES Estimator predicts the class of customers that will dominate companies' mind-share, and categories in which there will be enhanced activity

The risk of lopsided prosperity… and how to mitigate it
India’s increasing Gini co-efficient depicts lopsided prosperity. Lopsided prosperity has created several classes, each with its own needs. This can take India along the same path as some larger countries/ economies with significant income disparity: Brazil’s Gini co-efficient was 0.518 in FY2010, China’s was 0.513 and the US’ was 0.471.

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The RUPEES Estimator assumes growth will be reasonably well spread, though not equally distributed. We take into account a skew in growth distribution: a household in a high consumption category would reap benefits of growth far better than a household in a low consumption category. Two points are important here: (1) Big buying power in the top 10 percentile. India starts off with reasonably high income inequality (see Exhibit 5). D9/D1 numbers (which measure the income difference between a person in the ninetieth percentile with one in the tenth percentile) is about 3 in rural India and 5 in urban India. But there is significant buying power in the D9-D10 category (households in the top 10 percentile, between the ninetieth and hundredth percentile), which accounts for the lopsided prosperity. (2) Insignificant difference between current and future inequality. When we account for a skew in projected household consumption, we project a society that will be more unequal by FY2025E, but not significantly so. The D9/D1 ratio, based on a base-case skew, moves to 3.5 for rural and 5.6 for urban India, not too far from current levels of 3 and 5 respectively.
Exhibit 5: We project a marginally more unequal society Estimates of incomes at various levels in rural and urban India, March fiscal year-ends, FY2011-25E (at FY2010 prices)
2011 Rural D9 D1 D9/D1 Urban D9 D1 D9/D1 6,235 1,237 5.0 6,564 6,910 7,274 7,657 8,060 8,485 8,932 1,292 1,349 1,409 1,471 1,537 1,605 1,676 5.1 5.1 5.2 5.2 5.2 5.3 5.3 9,403 9,898 10,419 10,968 11,546 12,155 12,795 1,750 1,827 5.4 5.4 1,908 5.5 1,993 5.5 2,081 5.5 2,173 5.6 2,270 5.6 2,988 963 3.1 3,145 3,311 3,486 3,669 3,863 4,066 4,280 1,006 1,050 1,097 1,145 1,196 1,249 1,304 3.1 3.2 3.2 3.2 3.2 3.3 3.3 4,506 4,743 1,362 1,422 3.3 3.3 4,993 1,485 3.4 5,256 1,551 3.4 5,533 1,620 3.4 5,825 1,692 3.4 6,132 1,767 3.5 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

As a reasonably well distributed growth story unfolds, the Survivor category will join the large household base of the bulging middle classes

Source: Kotak Institutional Equities calculations

As a reasonably well distributed growth story unfolds, the Survivor category will emerge into relative prosperity, joining the large household base of the bulging middle classes. If, however, growth were to be top-heavy, the consumption market may rise in value, but the number of Survivors will not decline as dramatically as projected. That’s a risk that could have unhappy consequences, ripping the social fabric. On the other hand, a more inclusive development story would make it easier to enhance growth (through hard decisions and reform). If the benefits of growth are not well shared, political discussion will gravitate towards distribution of the pie rather than its growth. One way to mitigate this risk is to get more households to take part in the bouquet of opportunity through the creation of jobs. India has spent significant resources on educating its demographic dividend. As the population bulge moves to the working age, it is imperative that an adequate number of jobs be generated.

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Chapter 2 RUPEES Estimator telescopes dramatic change
Prosperity changes spend trends. With increased prosperity, societies spend less on staples and increase discretionary spends as a percentage of their expenditure. We fed data on historical spends in India and in countries with different purchasing power parity-adjusted per capita income, into the RUPEES Estimator, to predict how Indian consumers will spend. The RUPEES Estimator can be a helpful tool in understanding the market opportunity. If you want to make your own assumptions, just ask for our model!

Increased income, altered aspirations
The Indian economy’s rapid growth over the past couple of decades has produced a big churn and per capita incomes now have much wider distribution. This means India has moved from having just Survivors and Real-rich to several consumer classes in between, each with its own rising aspirations. With barely a subsistence economy (Indians consumed more than three-fourths of their GDP until FY1982), there was not much left for capital formation and to spur economic growth. As the proportion
India has moved from having just Survivors and Real -rich to several consumer classes in between, each with its own rising aspirations

of consumption began to fall with a corresponding increase in capital formation, India’s growth began to improve, which has been easily visible over the past decade (see Exhibit 6).
Exhibit 6: India's share of consumption has fallen to more sustainable levels Composition of the Indian economy, March fiscal year-ends, FY1951-2011

100 80 60 40 20 0 1951 1954

Private consumption expenditure

Government expenditure

Gross capital formation

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

A more prosperous India’s spending on the bare necessities has fallen dramatically, as a percentage of its wallet

Source: CMIE

Change in spending patterns…
A more prosperous India’s spending on the bare necessities (food and clothing) has fallen dramatically, as a percentage of its wallet. 'Durables' and 'Miscellaneous goods and services' (according to the definitions of National Sample Survey Organisation, NSSO) have taken most of the increased spends, especially in urban India (see Exhibit 7), a trend slowly but surely taking place in rural India.

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2011

GAME CHANGER

Exhibit 7: India's consumption pattern has been evolving with reduced dependence on food purchases Consumption expenditure by categories, June year-ends, 1999-2010 (%)
Rural 1988 Cereals Gram Cereal substitutes Pulses and products Milk and products Edible oil Egg, fish and meat Vegetables Fruits and nuts Sugar Salt and spices Beverages, etc. Food total Pan, tobacco, intoxicants Fuel and light Clothing and bedding Footwear Durable goods Misc goods and services Non-food total Total expenditure 26.3 0.2 0.1 4.0 8.6 5.0 3.3 5.2 1.6 2.9 2.9 3.9 64.0 3.2 7.5 6.7 1.0 3.1 14.5 36.0 100.0 1994 24.2 0.2 0.1 3.8 9.5 4.4 3.3 6.0 1.7 3.1 2.7 4.2 63.2 3.2 7.4 5.4 0.9 2.7 17.3 36.9 100.0 2000 22.2 0.1 0.1 3.8 8.8 3.7 3.3 6.2 1.7 2.4 3.0 4.2 59.5 2.9 7.5 6.9 1.1 2.6 19.6 40.6 100.0 2005 18.0 0.1 0.1 3.1 8.5 4.6 3.3 6.1 1.9 2.4 2.5 4.5 55.1 2.7 10.2 4.5 0.8 3.4 23.4 45.0 100.0 2010 15.6 0.2 0.1 3.7 8.6 3.7 3.5 6.2 1.6 2.4 2.4 5.6 53.6 2.2 9.5 4.9 1.0 4.8 24.0 46.4 100.0 1988 15.0 0.2 0.1 3.4 9.5 5.3 3.6 5.3 2.5 2.4 2.3 6.8 56.4 2.6 6.8 5.9 1.1 4.1 23.2 43.7 100.0 1994 14.0 0.2 0.1 3.0 9.8 4.4 3.4 5.5 2.7 2.4 2.0 7.2 54.7 2.3 6.6 4.7 0.9 3.3 27.5 45.3 100.0 Urban 2000 12.4 0.1 — 2.8 8.7 3.1 3.1 5.1 2.4 1.6 2.2 6.4 47.9 1.9 7.8 6.1 1.2 3.6 31.3 51.9 100.0 2005 10.1 0.1 — 2.1 7.9 3.5 2.7 4.5 2.2 1.5 1.7 6.2 42.5 1.6 9.9 4.0 0.7 4.1 37.2 57.5 100.0 2010 9.1 0.1 — 2.7 7.8 2.6 2.7 4.3 2.1 1.5 1.5 6.3 40.7 1.2 8.0 4.7 0.9 6.7 37.8 59.3 100.0

Source: NSSO 66th round report, earlier surveys, KIE calculations

Just how much and what Indians consume, however, have been debated. NSSO surveys show rural and urban India spend 54% and 41% respectively, of their wallets on food and beverages (an average of about 50% of the overall Indian consumption basket), and Euromonitor estimates this to be about 30% of the Indian consumption pie. Besides, there is significant difference in the estimation of the pie that transportation commands. Exhibit 8 shows our estimates of where rural, urban and overall Indian consumption stand.
Exhibit 8: Our analysis has a reasonable resemblance to Indian consumption estimates Estimates of the break-up of India's consumption basket, March fiscal year-end, FY2011
KIE analysis Rural Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure Education Hotels Miscellaneous Grand total 43.2 2.5 5.8 10.5 4.1 4.5 8.1 2.4 3.1 2.6 2.7 10.4 100.0 Urban 35.8 2.4 5.0 12.8 4.4 5.5 9.1 2.9 4.1 2.9 3.4 11.7 100.0 All-India 39.7 2.4 5.4 11.6 4.3 5.0 8.6 2.6 3.6 2.8 3.0 11.0 100.0 24.0 100.0 37.8 100.0 9.5 8.0 4.8 6.7 Rural 53.6 2.2 5.9 NSSO Urban 40.7 1.2 5.6 Euromonitor All India 27.7 3.2 6.4 14.5 3.9 4.8 17.7 2.2 1.3 2.4 2.9 13.2 100.0

Just how much and what Indians consume has been debated. We present our estimates

Source: Euromonitor 'World Consumer Income and Expenditure Patterns', July 2011, NSSO, KIE estimates

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…across geographies
We examined how other economies have evolved. We infer from the consumption patterns of countries with purchasing power parity (PPP)-adjusted per capita income higher than India’s, the possible path of India's spending patterns. Exhibit 9 shows India is nearer countries like Indonesia and China, and is expected to achieve similar PPP-adjusted per capita income over 2-7 years. India will, however, take 28-40 years to reach the per capita income of OECD countries like South Korea, Japan and the US, but comparisons with them help to identify consumption patterns of India’s Real-rich, Upper and Prospering classes.
Exhibit 9: Global consumption patterns help to guide Indian projections Consumer spending across categories, calendar year-end, CY2010, (%)
2010 - PPP basis Indonesia Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure Education Hotels Miscellaneous Total Per capita income (PPP, US$) # of years to reach this stage 32.2 5.8 3.1 13.8 5.3 4.3 6.5 2.1 1.4 2.1 13.7 9.8 100.0 3,179 2 China 22.3 2.3 7.5 14.8 4.7 6.9 6.4 4.9 5.3 4.8 8.4 11.7 100.0 4,432 7 Korea 15.0 2.6 4.1 17.3 3.9 5.4 10.8 5.7 7.3 6.3 7.3 14.3 100.0 19,068 28 Japan 14.7 2.8 3.4 23.8 3.7 4.8 11.6 3.0 10.9 2.2 7.5 11.4 100.0 USA 6.8 2.1 3.5 19.1 4.2 20.3 9.7 2.3 9.3 2.4 6.2 14.1 100.0 2011 39.7 2.4 5.4 11.6 4.3 5.0 8.6 2.6 3.6 2.8 3.0 11.0 100.0 India 2017E 36.8 2.4 5.1 12.5 4.4 5.3 9.0 2.8 4.0 2.9 3.3 11.5 100.0 2025E 33.7 2.4 4.8 13.4 4.5 5.7 9.4 3.0 4.4 3.0 3.6 12.1 100.0

28,637 43,539 34 40

Source: Euromonitor, KIE estimates and calculations

In more advanced countries, there is relative dominance of certain categories across consumption patterns. The consistency of the dominant categories strengthens our assumptions that India’s growth story could follow a similar plot. Of course, the numbers serve only to highlight a broad trend: the US, for instance, spends a large proportion of its wallet on healthcare, compared with other countries, and South Koreans love their data plans so much that it shows in a higher spend on communications. The Indian market could surprise in some categories, given its peculiarities.

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Chapter 3 Buying power by the billion: Bucks for luxe
By 2025E the Indian consumption market will be two-and-a-half times bigger than it is today. The top three classes will account for about half the consumption, from less than a third currently and the Surviving class will emerge from a base of deprivation. Over our forecast period, we model consumption at 59-62% of GDP and assume long-term real growth of 7% on a population increase of 1% a year. To finance this growth, we expect India to continue with its current high savings rate.

The spend trend
We estimate what various Indian classes will spend on several categories, proportionately and in absolute terms, based on (1) the evolution of Indian consumption over time and (2) consumption spends of countries with similar PPP-adjusted per capita income.
Exhibit 10: The RUPEES wallet Proportion of annual per capita expenditure, wallet spend on categories
Proportion (%) Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure Education Hotels Miscellaneous Total Average income Rs Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure 75,000 10,000 22,500 85,000 30,000 45,000 55,000 20,000 30,000 20,000 25,000 82,500 500,000 60,000 6,000 13,500 51,000 15,000 24,000 33,000 12,000 18,000 12,000 13,500 42,000 300,000 54,000 4,500 8,100 27,000 8,100 10,800 18,000 5,400 9,000 5,400 7,200 22,500 180,000 36,000 2,250 4,500 10,800 3,600 4,050 8,100 2,250 3,600 2,250 3,150 9,450 90,000 20,250 1,125 2,250 4,950 1,800 1,800 3,600 1,125 1,350 1,125 1,125 4,500 45,000 7,500 375 1,050 1,125 600 600 1,050 300 300 375 300 1,425 15,000 Real-rich 15.0 2.0 4.5 17.0 6.0 9.0 11.0 4.0 6.0 4.0 5.0 16.5 100.0 500,000 Upper-class 20.0 2.0 4.5 17.0 5.0 8.0 11.0 4.0 6.0 4.0 4.5 14.0 100.0 300,000 Prospering 30.0 2.5 4.5 15.0 4.5 6.0 10.0 3.0 5.0 3.0 4.0 12.5 100.0 180,000 Evolving 40.0 2.5 5.0 12.0 4.0 4.5 9.0 2.5 4.0 2.5 3.5 10.5 100.0 90,000 Emerging 45.0 2.5 5.0 11.0 4.0 4.0 8.0 2.5 3.0 2.5 2.5 10.0 100.0 45,000 Surviving 50.0 2.5 7.0 7.5 4.0 4.0 7.0 2.0 2.0 2.5 2.0 9.5 100.0 15,000

It is important to appreciate this table proportionately and in absolute terms

Education Hotels Miscellaneous Total

Source: Kotak Institutional Equities estimates

It is important to appreciate this table both proportionately and in absolute terms. The ‘proportion’ dimension is easily understood and appreciated: as income increases, a larger proportion of the spend will move towards discretionary items. For necessities, the proportion begins to fall, driven by the fact that there is only so much (in absolute terms) that can be spent on a category. For example, in the food and beverage category, even though the absolute quantum increases across each consuming class, the overall annual spend of a person in the Realrich category is ‘only’ 10X the annual per capita spend of a Survivor, even though the average expenditure differential is 33X.

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For discretionary items, for example leisure, the logic works in reverse: the absolute amount a Real-rich member spends on this category vis-à-vis a Survivor is 100X, as the proportion of the wallet a Real-rich person spends is 6% while a Survivor spends 2%. The quantity of food, for example, that will be consumed per capita does not significantly change or the time spent on leisure does not materially increase, but the emphasis in the segments (as in almost all the others) will be in the quality of goods or services delivered or on the delivery process. In food, for example, there is a well-documented trend towards an increased protein-rich diet as opposed to a cereals-heavy diet and in leisure a trend of towards say, plush multiplex cinemas as opposed to stand-alone theaters, or foreign jaunts over local family vacations. As a larger proportion of the market moves away from basic necessities, we expect a significant rise in "premiumization".
As a larger proportion of the market moves away from basic necessities, we expect significant rise in premiumization

Beyond our daily bread
The overall tone of the Indian consumption market will move beyond requirements of daily necessities to more materialistic products. Given India’s size (number of households) and range of buying power, there will be a meaningful number of customers across the value chain in almost all categories. Hence, it will not be surprising to find the same categories being serviced by price-leaders and very brand-conscious companies. The relative monetary importance of the top-three classes cannot be overstated. The Real-rich, Upper class and Prospering classes put together, will, by FY2025E, command almost half the market by value even though they will account for less than one-eighth of the number of households. These classes (with PPP-adjusted per capita incomes equal to the current living standards of OECD countries) will be dominant consumption trend setters. Even though they will number less than one-eighth of the total number of Indian households, their absolute number will be 36mn, which is more than a third of all the households in the US currently and similar to the number of households in Japan, Germany and the UK. Meanwhile, the Evolving and Emerging classes (the middle class) will command an almost equal value of market share as the premium end. Companies will need to choose their market or develop differentiated brands to service the entire value chain.
The top three classes will have 36 mn households, which is more than a third of the households in the US and similar to the number of households in Japan, Germany and the UK

Focus on savings
We expect India to remain a high savings economy. To achieve 7% a year real growth India will need to have an investment rate of at least 28% of GDP (given India’s incremental capital-output ratio of about 4). We have taken India’s sustainable growth at only 7% a year, and not 9%, which was commonplace, until recently. For India to be self-reliant in funding growth (even as India liberalizes its FDI and FII norms), India will need to channelize its high savings into productive investments.

KOTAK INSTITUTIONAL EQUITIES RESEARCH

17

The current structure of India’s savings leaves a lot to be desired.
More than half of India's household savings goes into gold and real estate

(1) More than half the household savings (12.8% of 22.8% of GDP in FY2011) goes into gold and real estate. Such savings are either dead-weight losses or illiquid and do not create adequate incremental output. India needs to move its savings into financial assets so that it can improve productivity of savings. (2) The Government and its enterprises have been less than exemplary savers. With the Government’s fiscal deficit requiring constant financing, it has potential to (a) crowd-out private investment and (b) keep interest rates high. A fundamental shift in the profile of borrowers (with the Government being less of a borrower) can be a significant growth driver. With savings being the focus of the Indian citizen (prodded by the Government), we do not expect consumption as a proportion of GDP to grow meaningfully. We expect consumption to be in a 59-62% band and hence our estimates do not take into account that meaningful uptick is possible if Indian savingconsumption habits were to change.

Financing consumption
There are two ways to spend on a category that can expand: (1) a large proportion of current income can be diverted to the category or (2) through financing, if the category is amenable to it. In case of diverting
The amenability of a category to finance can offer greater impetus to its growth

current income into the category, growth would be limited by new consumers or old consumers increasing spends on the category. The amenability of a category to finance can offer greater impetus to growth of a category (which shows up in the consumption line item, even though this now becomes a play between a consumer’s P&L and balance sheet). Categories like housing including housing goods, transport, education, and to some extent, leisure, can see a disproportionate rise due to financing (some part of this is captured in the Miscellaneous line, which includes banking and financial services). However financing, especially of consumer products, can help to boost consumption spends if the expectation of (nominal) growth in the consumer’s income is more than the (nominal) cost of debt. This means that over time a consumer will have much better ability to pay for current consumption, making it sustainable. However, increased financing, not backed by an ability to repay, can create significant fluctuations in the growth pattern of these categories.

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GAME CHANGER

Chapter 4 Growing Gains
Looking at the individual categories of spending, we identify trends where there will be meaningful changes in the category of consumers. The over-arching themes are (1) the sum of money spent per-capita on a category will increase dramatically thereby requiring companies to innovate on providing better, improved or more premium products, and (2) new sub-categories of consumption will open up within each of these categories as an amalgam of consumer classes will require differentiated products. Here is the story in graphic detail.

KOTAK INSTITUTIONAL EQUITIES RESEARCH

19

FOOD and BEVERAGES Watch for protein-rich, packaged and ready-to-eat, “healthy” food
40,000 1,688 36,000 32,000 28,000 24,000 4,451 20,000 16,000 5,986 12,000 8,000 4,000 2,907 0 2,459 517 494 3,044 1,255 1,050 1,864 3,091 9,350 13,945

HOUSING Possible uptick in quality, improvements in neighborhood facilities
15,000 13,500 12,000 10,500 9,000 7,500 6,000 4,500 3,000 898 1,400 872 1,229 0 439 560 2012 1,522 1,067 1,190 2017 2025 3,503 668 3,388 253

3,409

2,286

2,626

11,292

1,517

1,584

5,728 5,058 5,252

1,500

2012

2017

2025

mISCEllANEOUS Banking and financial services and personal care to dominate
15,000 13,500 12,000 10,500 9,000 2,964 7,500 846 6,000 2,078 4,500 1,137 3,000 1,500 0 1,328 1,273 763 1,025 362 543 2012 1,268 879 1,155 2017 2025 3,400 1,305 2,188 321

TRANSPORT Significant potential for private vehicles and public transport
15,000 13,500 12,000 10,500 9,000 7,500 6,000 623 4,500 1,662 3,000 1,500 0 838 1,018 654 820 284 362 2012 1,138 1,015 690 770 2017 2025 2,266 1,025 1,751 2,541

3,099

236 2,479

All data in Rs bn (in FY2010 terms) 20
KOTAK INSTITUTIONAL EQUITIES RESEARCH

AlCOHOl and TOBACCO More refined products

ClOTHING and FOOTWEAR Branded products to flourish; fashion trends to be defined by Indians

7,000

7,000

6,000

6,000 236

5,000

5,000 1,549

4,000

4,000

3,000
84

3,000

623

1,411

2,000

775

2,000 838 1,000

1,039 788

1,000
299

223

706 438 186 412 2025

519 316 254 126 140 2017

636 363

632 419 457 282 315 2017 2025 927

0

318 182 205 5266 2012

0

369 116 148 2012

HOUSEHOlD GOODS Expect significant investments in household amenities, mechanization of domestic services
7,000 7,000

COmm UNI CATI ONS As more services move to mobile, data could be the big winner

6,000

6,000

5,000

135

5,000

4,000

1,240

4,000

3,000 356 2,000 479 1,000 506 950 291 0 369 129 198 2012 457 314 420 2017 831

1,129

3,000

68 775

788 466

2,000 178 1,000 239 318 182 246 103 132 2012 519 316 304 251 280 2017

706 525 373 824 2025

1,236

0

2025

All data in Rs bn (in FY2010 terms)
KOTAK INSTITUTIONAL EQUITIES RESEARCH

21

H E A lT H C A R E As the capital of chronic diseases, India will spend more on preventive medicine and healthcare
7,000 135 6,000 1,240 5,000 1,270 4,000 7,000

lEISURE Local and foreign tourism, recreational items (games, pets) to be in demand

6,000

5,000

68 930

4,000

3,000

356 831

1,050

3,000 178

1,129

2,000

479 509 327 492

569 609 502 630 2017

746

2,000

623 239 382 291 410 155 198 506 507 377 420 2017

875

1,000

1,000 1,854 0

559

1,236

0

207 296 2012

2025

2012

2025

HOTElS Creation of mid-end properties (2-3 stars) to dominate; catering to increase in value
7,000 7,000

E D U C AT I O N Demographic dividend to continue to spend on education

6,000

6,000

5,000

5,000

4,000

68 775

4,000

3,000
988

3,000

84 775

2,000

178 519 700 419

2,000 223 1,000 299 0 318 182 246 103 132 2012 519 316 304 251 280 2017

706 525 373 824 2025

1,000

239 318
254

443

406 282 350 2017 2025 1,030

0

328 116 165 2012

All data in Rs bn (in FY2010 terms) 22
KOTAK INSTITUTIONAL EQUITIES RESEARCH

Chapter 5 Rural India morphs into mushroom towns
Evolving India will also mean the emergence of mushroom towns. The urban market will account for more than 55% of the consumption market by FY2025E from less than half today and urban households will account for about 40% of the total number of households, up from 30% currently. The push towards urbanization will not come from an overspill into metros, but development of tier-II and tier-III cities. The emergence of growth hubs can offer stability to the growth story.

Serving up cities, with a capital C
Urban consumption growth will be marginally higher than rural consumption growth as more households emerge in urban India

The per capita income growth in India will come from (1) more families turning nuclear in urban India, (2) households moving to urban from rural areas and (3) more rural areas qualifying to be classified as urban as population growth makes towns/villages larger agglomeration units. The per capita income growth in India will come from (1) increased movement of labor from agriculture to the manufacturing and services sectors, which will tend to be in urban areas, or an urban sprawl around a zone of economic activity or (2) a big increase in agricultural productivity (not just in terms of fertility of land but in per capita terms). Agricultural per-capita income can grow significantly as people move away from farming. A new creature that emerges from societal reorganization will have a wing-span that will straddle a considerable geographic area. Rural hubs will bulge at the seams and burst on to the urban city space. Tier-II and tier-III towns will morph into larger metropolitan cities. For companies that means a larger number of differentiated markets with their own needs and preferences.

Town-led urban spread
India’s urbanization will be incremental in nature. Over the past 40 years, India has urbanized slowly (See Exhibit 11). But that is about to change.
Exhibit 11: Urbanization has been slow in India Urbanization and the rate of change, decades ending FY1971-2011
Urbanization rate (%) Annual rate of change (%) 0.34 0.24 0.21 0.33

India’s urbanization will be incremental in nature. The 2011 census highlighted that India was urbanizing at the margins

1971 1981 1991 2001 2011

19.9 23.3 25.7 27.8 31.2

Source: India Census, Indiastat

The 2011 census highlighted that India was urbanizing at the margins, and not by putting more pressure on mega-cities (see Exhibit 12). The only large city that has seen an uptick in its population growth, over the past decade, is Bangalore.
Exhibit 12: Growth of mega cities has slowed Population of various urban agglomerations, March fiscal year-ends, 1991-2011
Population (mn) 2011 Greater Mumbai UA Delhi UA Kolkata UA 18.4 16.3 14.1 2001 16.4 12.9 13.2 1991 12.6 8.5 11.0 Increase (%) 2011 12.1 26.7 6.9 2001 30.5 52.2 19.6

Notes: (a) UA denoted urban agglomeration (b) Other UA's have populations of less than 10 million

Source: Census of India

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GAME CHANGER

Census 2011 defines a town (regarded as an urban area) as a demarcated area whose population exceeds 5,000, among other criteria (as noted in the Appendix). About four-fifths of India’s rural population lives in towns smaller than this, according to the 2001 census, (data from the 2011 census are unavailable). We note that a statutory town is, in effect, a census town whose status has been recognized by a local state government and a municipality, corporation, cantonment board or whose town area committee has been notified. There has hardly been an increase in the number of villages in India.
Exhibit 13: Census towns are the new growth engines Number of towns and villages in India, census year-ends, 2001 and 2011
Increase 2001 Towns, of which - Statutory towns - Census towns Villages 5,161 3,799 1,362 638,588 2011 7,935 4,041 3,894 640,687 Absolute 2,774 242 2,532 2,099 Percentage 54 6 186 0

Source: Census of India

The increase in census towns indicates a more spread-out growth of India’s tardy rate of urbanization. The process is being driven by the nature of growth of the economy, which will become increasingly dependent on services as its engine of growth, and on agriculture as its largest employer. Unless there is a definite thrust towards a manufacturing-led economy, we do not expect the rate of India’s urbanization to change.

The increase in census towns indicates a more spread-out growth of India’s tardy rate of urbanization

The evolution of urban China
Four decades ago, China and India had a roughly similar proportion of urban populations. Today, more than half of China’s population lives in cities. Some commentators claim China’s rate of urbanization is understated as it does not include many migrant workers who go to urban areas as laborers. China’s urbanization was driven by the creation of employment opportunities in manufacturing and industry, which created an incentive to set up urban agglomerations in and around an economic activity of manufacturing. As the labor force moved out of agriculture and into industry, it made natural and economic sense to have clusters of growth. Given their size, the agglomerations quickly get classified as urban.

KOTAK INSTITUTIONAL EQUITIES RESEARCH

25

The markets... by size and segment
Exhibits 14 and 15 lay out how we expect the urban and rural markets to evolve. We expect rural households to increase their spending on housing, healthcare and leisure significantly and urban consumption will go up 3X in real terms in 15 years. From being a smaller market than the rural market currently, we expect the urban market to grow bigger than the rural market — trends in the 'richer' urban market will shape the aspirations of the rural market. We are not saying that the rural growth rate will slow: rural areas are morphing into urban areas, which is adding to urban consumption. More 'urban' consumption will mean easier distribution logistics for companies.

Exhibit 14: Expect rural households to up their spending on housing, healthcare and leisure significantly Consumption in rural India across categories, March fiscal year-ends, (Rs tn, 2010 prices)
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure Education Hotels Miscellaneous Grand total 9.8 0.6 1.3 2.4 0.9 1.0 1.9 0.5 0.7 0.6 0.6 2.4 22.8 10.2 0.6 1.4 2.5 1.0 1.1 1.9 0.6 0.8 0.6 0.7 2.5 23.7 11.0 11.4 11.8 12.4 0.6 1.5 2.8 1.1 1.2 2.2 0.6 0.9 0.7 0.7 2.7 0.7 1.5 3.0 1.1 1.3 2.3 0.7 0.9 0.7 0.8 2.9 0.7 1.6 3.3 1.2 1.4 2.4 0.7 1.0 0.8 0.8 3.1 0.7 1.6 3.5 1.3 1.4 2.6 0.8 1.1 0.8 0.9 3.3 12.9 0.8 1.7 3.7 1.3 1.5 2.7 0.8 1.1 0.9 1.0 3.5 32.0 13.4 0.8 1.8 4.0 1.4 1.6 2.9 0.9 1.2 0.9 1.0 3.6 33.5 13.9 0.9 1.8 4.2 1.5 1.7 3.0 0.9 1.3 1.0 1.1 3.8 35.2 14.5 15.0 15.9 16.8 0.9 1.9 4.4 1.6 1.8 3.2 1.0 1.4 1.0 1.1 4.0 0.9 2.0 4.7 1.7 1.9 3.4 1.1 1.5 1.1 1.2 4.3 1.0 2.1 5.2 1.8 2.1 3.7 1.2 1.6 1.2 1.3 4.7 1.1 2.2 5.6 1.9 2.3 4.0 1.3 1.7 1.3 1.4 5.0 17.6 18.4 1.1 2.4 6.0 2.1 2.5 4.3 1.3 1.9 1.4 1.6 5.4 1.2 2.5 6.4 2.2 2.7 4.5 1.4 2.0 1.5 1.7 5.8

26.0 27.4 28.8 30.4

36.8 38.8 41.8 44.7

47.6 50.4

Source: Kotak Institutional Equities estimates

Exhibit 15: Urban consumption will go up 3X in real terms in 15 years Consumption in urban India across categories, March fiscal year-ends, (Rs tn, 2010 prices)
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Food and beverages Alcohol and tobacco Clothing and footwear Housing Household goods Healthcare Transport Communications Leisure Education Hotels Miscellaneous Grand total 7.3 0.5 1.0 2.6 0.9 1.1 1.9 0.6 0.8 0.6 0.7 2.4 20.5 7.9 0.5 1.1 2.9 1.0 1.2 2.0 0.6 0.9 0.7 0.8 2.6 22.3 8.6 0.6 1.2 3.3 1.1 1.4 2.3 0.7 1.1 0.7 0.9 3.0 9.3 0.6 1.3 3.6 1.2 1.5 2.5 0.8 1.2 0.8 1.0 3.2 9.9 10.6 0.7 1.4 3.9 1.3 1.7 2.7 0.9 1.3 0.9 1.0 3.5 0.7 1.5 4.2 1.4 1.8 2.9 0.9 1.4 0.9 1.1 3.8 11.3 0.8 1.6 4.5 1.5 2.0 3.2 1.0 1.5 1.0 1.2 4.1 33.8 12.0 0.8 1.8 4.9 1.7 2.1 3.4 1.1 1.6 1.1 1.3 4.4 36.2 12.9 0.9 1.9 5.2 1.8 2.3 3.7 1.2 1.7 1.2 1.4 4.7 38.8 13.7 14.6 15.6 16.6 1.0 2.0 5.6 1.9 2.4 3.9 1.2 1.8 1.3 1.5 5.1 1.1 2.2 6.1 2.1 2.7 4.3 1.4 2.0 1.4 1.7 5.5 1.1 2.3 6.7 2.2 2.9 4.6 1.5 2.2 1.5 1.8 6.0 1.2 2.5 7.2 2.4 3.1 5.0 1.6 2.4 1.6 2.0 6.5 17.7 18.7 1.3 2.7 7.8 2.6 3.4 5.4 1.7 2.6 1.7 2.1 7.0 1.4 2.8 8.3 2.8 3.6 5.8 1.8 2.8 1.8 2.3 7.5

25.0 27.0 29.2 31.5

41.5 44.9 48.5 52.2

55.9 59.7

Source: Kotak Institutional Equities estimates

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KOTAK INSTITUTIONAL EQUITIES RESEARCH

Chapter 6 GameChangers: How to nurture the metamorphosis
A richer, more prosperous India will throw up scores of opportunities for companies and entrepreneurs, according to RUPEES Estimator. However, two assumptions are crucial: (1) economic growth must continue (on a long-term basis) at 7% a year and (2) the growth must be reasonably inclusive in nature. That means every class must benefit from growth. Therefore, it is crucial that the economy offers productive job opportunities. If it does not, the growth process may be neither stable nor inclusive.

GameChanger: A growing pie… it’s easier to share
Throughout the metamorphosis there are two big assumptions: (1) sustainable long-term growth of the Indian economy and (2) reasonable distribution of the fruits of that growth. The projections should be achievable as we have assumed (1) savings rate of only about 28%, which is significantly lower than the recent performance of Indian savers and (2) no improvement in capital-output ratio. Internal consumption, Government spending and increased exports should also help the economy to grow. But if the economy does not grow for some reason, it will amount to a stagnant pie of which more people will want a share. It is easier to share a growing pie and hence the focus must remain on economic growth. Over several reports we have highlighted the need for significant reforms in crucial markets like land, labor and capital.

GameChanger: A well divided pie
The perceived and actual equality of the division of the pie is important to (1) continue fostering aspirations and (2) keep in check social unrest. The significant disconnect in the average per capita income (and consumption) in rural and urban India highlights the need for inclusive growth. There are two ways to narrow this gap: (1) by transferring resources from the section of society that is doing well (tax the rich and give the poor) or (2) by creating sustainable income streams for those who have not benefited, or integrated, with market-oriented reforms over the past two decades. India has followed the former strategy over the past few years and will require significant effort at the grass-roots level to push for the latter. This will require that the Indian economy creates enough employment opportunities in the manufacturing and services sectors so that people pull out of the less productive agriculture sector. Creating these opportunities will require an efficient (1) land acquisition framework, (2) ease-of-business policies, (3) skill development and employment-matching mechanisms.

GameChanger: Addressing raw material and energy challenges
One of the concerns India will have to address is increased consumption of (1) raw material and (2) energy. India will need to work towards an environmentally sustainable way to satisfy its consumption upswing from the perspectives of (1) an improved global environment and (2) to avoid the price rise that raw material and energy could see due to increased demand.

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Appendix The birth of a model

How we put together the RUPEES Estimator
Expenditure over income. Statistical agencies find it easier to collect and disseminate data based on consumption patterns (and not income). This is simply because consumption is more easily visible and people and households are more willing to discuss it, rather than their income. It is typically assumed that the distribution of the consumption pattern reflects the economy’s income pattern. This may or may not be true, simply because different households may have different attitudes and priorities with respect to savings (the biggest reason for incomes and consumption to differ). For our purposes however, having an idea about consumption works well as we are only interested in the consumption market. Based on Monthly Per Capita Expenditure (MPCE) data compiled and distributed by the National Sample Survey Organization (NSSO) on the deciles-wise distribution of households by income, we construct and project (based on our growth and skew estimates) the distribution (number) of households across deciles over the forecast period. We define the cut-off of each decile in our calculation. We define the boundaries of the classes in the RUPEES Estimator, according to the quantum of consumption. We essentially work backward from the purchasing-power-parity adjusted annual per capita expenditure converting it into annual Rupee consumption and work back, to get the MPCE boundaries. Starting at the lowest consumption class, the Survivors, we typically double consumption limits to obtain the boundary for the next class. For the Upper class, we do not double the limits, as then the absolute magnitude of the incomes covered would be very large. We take economies that have similar PPP-adjusted per capita expenditure to get a sense of the consumption basket in each class. We estimate the PPP-adjusted per capita consumption of the Real-rich to be near the per capita consumption in the US currently. Reconciling different figures. We note that we face a very common issue: if one adds together the consumption across the various household deciles, one does not reach the consumption figure as tabulated by national accounts, with the NSSO data under-estimating overall consumption. We correct this, using two techniques: (1) NSSO data are available only until about the ninetieth percentile and do not look at the wide observable disparity in the top-10 percentile. We take into account the disparity in this group to arrive at a more granular picture of household distribution. (2) Even taking this into account does not restore the balance and hence we apply a ‘scaling-up’ factor to reconcile the NSSO data with national accounts. We expect this scale-up number to gradually fall. Making sense of different patterns. We return to NSSO to check how the consumption pattern has been evolving in urban and rural India: we use trend-line data for the past three decades to identify the changes in share of wallet of consumption categories. It is interesting to note that the focus of NSSO on staples has been so high that the food category has been divided into 12 sub-categories even as the share of wallet is now moving to Miscellaneous. We juxtapose this with trends in other countries, with different per capita consumptions currently (sourced from Euromonitor). We treat the Indian consumption market as an amalgam of consuming categories and hence it is instructive to see how consumers across the globe (with different purchasing powers) spend their money. This provides a framework when we assign wallet-share to consumption categories in the Indian market.

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GAME CHANGER

Tying this up with the population numbers. This exercise is done separately for rural and urban India. From the recent Census of India, we have the number of people in urban and rural India in FY2011, and based on technical estimates made by the census team, we have an estimate of India’s population of 1.4 bn people by FY2025. Using these and an estimate of the number of households, we project the number of households in rural and urban India and the number of their constituents. We expect (see Exhibit 16) the number of households to increase to 305 mn by FY2025 (187 mn rural and 118 mn urban) from 231 mn currently (163 mn rural and 68 mn urban). We expect the average household size to shrink to 4.4 and 4.8 for rural and urban respectively by FY2025 from the current 5.1 and 5.5. These calculations provide a reasonable break-up of India’s 1.4 bn population in FY2025E, implying 40% urbanization in FY2025E from the present 31%.
Exhibit 16: Urbanization will increase by 10 percentage points by 2025E Estimatied number of households and their sizes in India, March fiscal year-ends, FY2011-25E
2011 2012 Number of households (mn) Rural Urban Grand total % urban Rural Urban Rural Urban Grand total % urban 163 68 231 30 5.1 5.5 833 377 31 164 71 235 30 5.1 5.5 833 390 32 166 74 240 31 5.0 5.4 833 402 33 168 77 245 32 5.0 5.4 833 415 33 169 81 250 32 4.9 5.3 833 428 34 171 84 255 33 4.9 5.3 833 441 35 173 87 260 34 4.8 5.2 833 454 35 174 91 265 34 4.8 5.2 832 468 36 176 94 270 35 4.7 5.1 832 481 37 178 98 276 36 4.7 5.1 832 495 37 180 102 281 36 4.6 5.0 832 509 38 181 106 287 37 4.6 5.0 832 523 39 183 109 293 37 4.5 4.9 832 537 39 185 113 299 38 4.5 4.9 832 551 40 187 118 305 39 4.4 4.8 832 565 40 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

People per household

Number of people (mn)

1,210 1,223 1,235 1,248 1,261 1,274 1,287 1,300 1,314 1,327 1,341 1,355 1,369 1,383 1,397

Source: NSSO - 66th round, Census 2010, KIE estimates and calculations

Rural and urban. The definition of rural and urban India, that we use, is the same that the Census uses. A ‘census town’ is defined as having (1) a population of more than 5,000, (2) with 75% or more male working population engaged in non-agricultural activities and (3) density of population of at least 400 per sq km. This is an urban area and places that do not meet these criteria are classified as ‘rural’. With agriculture employing about 57% of the Indian labor force, it typically becomes difficult to have places where three-fourths or more of the male working population have non-agricultural work. This not only creates issues with a more appropriate rural-urban classification but also identifies the point of stress: if more people are not weaned from farming, the ability to connect more people to the growth story may become difficult. Household numbers. Over the forecast period, we expect the overall number of households to increase (as it has done historically) by 2% a year. We expect rural household numbers to grow 1% a year and hence, urban household numbers to grow at twice the overall rate. With (1) declining fertility and (2) an increasing number of nuclear families, the number of people per household is expected to fall significantly.

KOTAK INSTITUTIONAL EQUITIES RESEARCH

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A tight band. Once the consumption wallet of a consumer in a given household is defined, aggregating such wallets over the distribution of different households in urban and rural India is easily achieved, which gives us the distribution of the consumption market in a matrix of consumption across different classes of consumers and categories of consumption. We ensure that overall consumption-to-GDP ratio does not stray from the 59-62% of the GDP band. Real numbers. The growth we assume in our model is ‘real’ and hence we do not take into account inflation. This also means that the projected numbers are in terms of the Rupee’s purchasing power in FY2010. The nominal market size may end up being significantly larger, due to the impact of inflation.

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KOTAK INSTITUTIONAL EQUITIES RESEARCH

Have you read our recent GamecHanGers?

September 2011

“The Next Big Things” identifies 14 companies helping shape India’s growth story and who could be the next darlings of the Street!

April 2011 ‘The Great Unskilled: Can we fix it?’ examines India’s challenge in making its ‘productive’ population employable

Jan 2011 X Factor’ looks at India’s need to increase manufactured goods in its export base

Nov 2010 ‘M2’ examines how mobile money is going to catalyze the race to trade with the Indian consumer

Sept 2010 ‘The Time is Ripe’ highlights opportunities in agriculture thanks to technology and processing

May 2010 ‘Indian Household Savings’ highlights that US$10 tn is up for grabs in the next 15 years May 2010 ‘Deluge of Opportunity’ examines developments that could make water a viable business proposition April 2010 ‘365 million’ analyses India’s readiness for its forthcoming demographic dividend

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GAMECHANGER VOL III.I - APRIL 2012 Copyright 2010 Kotak Institutional Equities (Kotak Securities Limited). All rights reserved.

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