GDP growth of 8.9% in 2QFY11 is a resounding validation of the India growth story. India has effectively endured a global crisis and the worst drought in 30 years. It continues to be one of the fastest growing economies – its GDP is likely to grow at ~9% in FY11 and well into FY12. Growth should rise to double digits, on track with the higher growth trajectory of the last decade. In short, India is well on its way to the next trillion dollars of GDP.

We published our first note on the concept of NTD (next trillion dollars of India's GDP) in 2007. The core NTD thesis is this: It took India about 60 years post independence to clock the first trillion dollars of GDP. With nominal GDP growth of 14-15%, at constant exchange rates, India's next trillion dollars (NTD) will come in just 5-7 years. We juxtapose the NTD idea with the GDP growth experience of China to arrive at India's GDP of almost US$5 trillion by 2020.

The addition of the next trillion dollars to India’s GDP has exponential growth implications for several businesses. Consider this: India's current gross domestic saving is at 34% of GDP. In line with long-term trend, we expect this to rise steadily to 40% by 2020. This translates to cumulative decadal saving of over US$10 trillion, compared to US$2.7 trillion during the decade to 2010. The large savings pool presents a huge opportunity for many businesses. Applying a trended growth rate correlated to GDP, in the decade to 2020, business opportunity will be five times and profits six times the previous decade.

India enjoys a special demographic advantage. With over 200 million households, India is not only a huge consumer market but also an attractive investment destination. Its consumer market is projected to become the fifth largest by 2025, worth more than US$1,500 billion. India’s total commerce, which was estimated at US$2.3 trillion in 2007, is expected to triple by 2025, making it larger than the current size of the UK market in terms of purchasing power parity. India might well be at the helm of a radical realignment of the global economy!

However, the journey is unlikely to be smooth – a number of speed-breakers and roadblocks will be encountered along the way. The fallout of the lack of radical reforms has shown up in high consumer inflation, which though trending down, continues to persist. Rising global commodity ( including oil )prices are adding further fuel to the fire. Interest rates are headed up. The speed with which India’s reforms process is progressing is less than desirable. Adapting to changes in global economic trends and their impact – wild gyrations in exchange rates, fight of capital, for instance – is becoming more challenging. Macroeconomic and business headwinds apart, markets have reason to be concerned about the serious and relentless issues of corporate and political governance, which India is currently embroiled in.

A serious challenge that faces India is ensuring that the fruits of progress are not restricted to just a few. The bottom one-third of India’s 1-billion-plus population still lives below a contentiously-defined "poverty line". It is this section of the population that is most impacted by inflation. Even basic healthcare and education is not available to a large section of the population. The prevailing economic and social inequality is already fuelling social unrest and insurgencies in various pockets of the country. If there is further increase in the rich-poor divide, it could fuel further discontentment and prove to be disruptive. Besides the threat of internal conflicts, it is equally important for India to be adequately prepared for possible external aggression. Relations with neighboring countries, especially Pakistan and China, need to be effectively managed.

The government’s attempts to reach out to the poor are proving to be ineffective. Subsidies do not reach the people they are targeted at. For instance, kerosene is under-priced because it is supposed to be used by the poor for cooking and lighting and also aimed at discouraging the use of wood for burning. However, it is illegally diverted to adulterate diesel and petrol because of price differentials and is smuggled out of the country. Similarly, diesel prices have still not been fully deregulated due to the direct impact of higher diesel prices on inflation. Diesel is used to power generator sets used in irrigation and to fuel trucks that carry agricultural products, raw material and finished products. However, the unintended beneficiaries are owners of luxury cars and SUVs, who can do without the fuel subsidy.

India levies high taxes on petroleum products – half of the selling price of petrol and nearly a third of the price paid by consumers of diesel goes towards various imposts levied by the state and central governments. However, instead of paring taxes on petroleum products, the government has chosen to shift the burden on to consumers. I am not saying that I am opposed to fuel price deregulation or that I would like auto fuel subsidies to continue. High petro-product subsidies have a negative impact on India’s fiscal health, which too eventually culminates in higher inflation. I am merely implying that a more holistic approach to fuel pricing – including the possibility of lower imposts on petro products – is necessary in India’s context.

It is necessary that the government’s thrust on infrastructure development continues. While projects such as the Golden Quadrilateral and the North-South and East-West corridors are laudable, sustenance of India’s growth story will depend to a large extent on continued investment in infrastructure. Also, several regional biases have crept up in the years following India’s independence. There are pockets that have not flourished as much as the rest of the country – the North-East states and the BIMARU states, for instance.

Even in the more progressive states, development expenditure has been concentrated in a few urban centers. This is evident in the stark difference between the city of Mumbai and the rest of Maharashtra. Lop-sided development comes with its own set of social issues – one that makes regular news is the issue of migrant labor. Looking at human resources in general, while India’s educated population is sizeable, the industry often complains about acute skill shortage. Education and training is an area where much needs to be done.

Food security is another issue that India needs to wake up to. While India is agriculturally well-endowed, 60% of its total cropped area is not irrigated and dependent on a four month-long monsoon during which period 80% of the year's total precipitation takes place. In the years when the monsoon is abundant and regular, there is good crop output. But when the monsoon plays truant or is inadequate, the crop output is poor. There is a need to develop extensive irrigation infrastructure throughout the country. Policies relating to agricultural produce – fertilizer subsidy, administered pricing mechanism, public distribution system – need to be re-examined.

One roadblock that India needs to demolish quickly is rampant corruption. Serious and relentless issues of corporate and political governance have been coming to light. Such brazen acts of corruption are a big deterrent to national prosperity and can damage the brand India story. However, there appear to be no serious deterrents to corruption, which often goes unpunished. While India needs a total overhaul of its anti-corruption delivery system, it is even more important to revamp the education system. Without a holistic education system, India’s greatest strength – its army of young people – could turn out to be its greatest weakness!

The Indian economy is no longer at the crossroads; rather, it is on the right path to sustainable growth. GDP growth of 8.9% in 2QFY11 is a resounding validation of the India growth story – it has effectively endured a global crisis and the worst drought in 30 years. India continues to be one of the fastest growing economies in the world – its GDP is likely to grow at ~9% in FY11 and well into FY12. Growth should rise to double digits, on track with the higher growth trajectory of the last decade. However, the journey is unlikely to be smooth.

The fallout of the lack of radical reforms has shown up in high consumer inflation, which though trending down, continues to persist. Rising global commodity prices are adding further fuel to the fire. Interest rates are headed up. The speed with which India’s reforms process is progressing is less than desirable. Macroeconomic and business headwinds apart, markets have reason to be concerned about the serious and relentless issues of corporate and political governance, which India is currently embroiled in. While it will continue to encounter speed-breakers and roadblocks, India is well on its way to the next trillion dollars of GDP.

We published our first note on the concept of NTD (next trillion dollars of India's GDP) in 2007. The core NTD thesis is this: It took India about 60 years post independence to clock the first trillion dollars of GDP. With nominal GDP growth of 14-15%, at constant exchange rates, India's next trillion dollars (NTD) will come in just 5-7 years. We juxtapose the NTD idea with the GDP growth experience of China to arrive at India's GDP of almost US$5 trillion by 2020.

As we have pointed out time and again, the addition of the next trillion dollars to India’s GDP has exponential growth implications for several businesses. Evidence of this is already springing up. Consider this: the number of passenger cars sold in October 2010 was 182,992, the highest ever in a calendar month in India’s history. The Society of Indian Automobile Manufacturers (SIAM) forecasts that passenger car sales for the year ending March 2011 should grow by at least 25%. The Indian passenger car market is likely to triple over the next decade to six million cars a year. It is no surprise, therefore, that India has turned into a major battleground for global vehicle manufacturers such as Ford, Renault-Nissan, General Motors and Volkswagen.

India enjoys a special demographic advantage. With over 200 million households, India is not only a huge consumer market but also an attractive investment destination. Its consumer market is projected to become the fifth largest by 2025, worth more than US$1,500 billion. India’s total commerce, which was estimated at US$2.3 trillion in 2007, is expected to triple by 2025, making it larger than the current size of the UK market in terms of purchasing power parity. India might well be at the helm of a radical realignment of the global economy!

Growth broad-based, expect FY11 GDP growth of 9%



India's 2QFY11 GDP growth at 8.9% (MOSL 9%, Consensus 8.2%) signifies (1) economy operating close to potential, and (2) resounding validation of the India growth story. While agriculture and services expectedly turned up, industry also performed well. Most importantly private consumption is back and the government is only gradually withdrawing its fiscal support. We expect GDP to grow at ~9% in FY11 and well into FY12.



Cyclical upturn drives GDP growth to ~9%, as expected

- 2QFY11 GDP growth was 8.9% (MOSL 9%, consensus 8.2%), which was in line with expectations.

- Simultaneously 1QFY11 GDP was revised to 8.9% from 8.8%. Thus 1HFY11 growth was a healthy 8.9%.

- The cyclical upturn has taken GDP close to the potential 9% and seems to have stabilized at that level.



All sectors and components of GDP do well

- Notably all three sectors of the GDP performed well.

- Agriculture (4.4%) turned up due to bumper Kharif harvest on the back of a good monsoon.

- Notwithstanding the sharp fluctuations in monthly IIP figures, industry posted a healthy 8.9% growth. This was driven by IIP growth of 15% in July, but it subsequently decelerated.

- Service sector grew by 9.8%, remaining close to double-digit level. The sub-group of trade, hotels, transport and communication, which constitutes nearly equivalent weight in the overall GDP as that of the industrial sector (including construction), registered 12.1% growth, perhaps receiving a boost from the Commonwealth Games. This is the only notable sub-sector that bucked the seasonal 2QFY11 downturn by a wide margin, pulling up overall GDP.

- The expenditure side of GDP revealed a noticeable turnaround for private consumption expenditure, even on a QoQ basis, which augurs well for future growth.

- The government has continued to support the economy, indicating it will spend the excess amount received from one-time 3G/BWA revenue and collections due to higher tax buoyancy.

- Investments slowed down, perhaps due to the monsoons delaying a few construction and project-related activities.



Expected growth close to 9% despite near-term setbacks

- We have revised our FY11 growth projections to 9% from 9.1%, led by a recent slowdown in IIP, which we hold is not yet conclusive due to data issues related to the indicator.

- Buoyancy in the agriculture and services sectors will continue, as indicated by the outlook for the Rabi crop and most lead indicators of service sector.

- The recent spate of governance issues (that have yet to significantly dent actual projects on ground) could dampen sentiment in the near term. However, the sheer volume of ongoing projects (~US$2.6t) could keep the investment story going for a long time. Some setback in the mining and electricity sectors notwithstanding, the industrial sector can still pull off high single-digit growth due to the revival of exports.

- A turnaround of private final consumption indicates the durables and FMCG sectors will do well. Moderation in inflation would help these industries to grow.

- Supplementary demands put up by the government to Parliament in two phases demonstrate that the government will not withdraw its fiscal support though it will contain it to pre-announced levels. This augurs well for consumption demand, as there has been a bulge in welfare payments, and for attracting private investment in the PPP format.