Macro Advisor Snapshot

Dashboard
Spring, 2013

Dashboard India (Spring 2013)

Recent data trending much softer in Indiaeconomy vulnerable to further short-horizon reversals
Service sector growth, long the mainstay of overall growth, is quickly decelerating Manufacturing lull due to power outages and slow new-order growth Domestic auto sales shrank for the first time in a decade on weak consumer and business confidence

Inflation persistence will limit the RBIs policy flexibility Food price inflation driving wedge between WPI and CPI

Despite the severity of the economic slowdown, RBI still acutely aware of upside inflation risks

Balance of payment trends are particularly worrying

Trade balance data looks awfulhigh oil prices threaten further deterioration Foreign inflows , which have so far held, could quickly reverse

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Collecting and processing the vast amount of relevant data that determine global trends is the great challenge of executing a global allocation (macro) strategy. In order to produce high quality returns, an investment team needs an established procedure for collecting data, converting it into information, and then forming investment themes based on that information. Our economic databaseDashboardconsists of twenty countries and another twenty individual global economic data series. Dashboard is the foundation of our primary research effort and a key input in our investment process. Our senior markets analyst, Eva Yun, manages this process and has an important role in ensuring procedural consistency and discipline in idea generation. In Open MarketDashboard, we will present regular snapshots of the trends on which we are focusing. This series will complement our other research efforts by providing investors with a short-form summary of themes and ideas that will impact global investment trends over time.

Gravelle Pierre, CFA

Figure 1. India Data Set Broadly Slowing

Real headline growth is quickly decelerating. Slowdown is broadwatch Services.
Percent 25 20 10 15 8 10 5 0 4 India GDP % YoY India GDP Forecasts 2 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13 -10 Mar-05 Mar-07 Mar-09 -5
India GDP (Svcs) % YoY India GDP (Mftr) % YoY India GDP (Ag.) % YoY

Percent 12

Mar-11

Mar-13

Source: Central Statistical Organization (CSO), Bloomberg Notes: QoQ GDP growth weakest in 15 quarters. Optimistic forecasts driving record portfolio inflows. Govt measures to boost economy over past 6 months include easing restrictions on foreign investment in retail, civil aviation, and insurance and pension sectors

Source: CSO Notes: %-age of GDP: Svcs 56.4%; Mftr 26.4%; Ag 17.2%. Last PMI survey notes service sector activity slowed notably due to deceleration in new business flows. RBI acknowledged service sector growth slowest in decade.

Industrial production oscillating around zero.

Percent 25 20 15 10 20 5 0 -5 -10 Jan-06 Jan-08 Jan-10 Jan-12 0 -20 -40 Jan-06 India IP % YoY Percent 80 60 40

Capital goods data signals weak investment growth.

India IP (Consumer Gds) % YoY India IP (Capital Gds) % YoY

Jan-08

Jan-10

Jan-12

Source: CSO Notes: Economy buffeted by weak cap investment and faltering consumer demand. Still, IP has been erratic of late with no perceptible trend.

Source: CSO Notes: Manufacturing (76% of IP), is dragging headline lower. Watch auto sales for signs of faltering consumer/business confidence.

Figure 2. Inflation Trend Bears Close Scrutiny

Percent 25 20 15 8 10 4 5 0 -5 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 0

Food price pressures may limit RBIs ability to cut rates

Food Price Inflation % YoY

Percent 16

Food prices driving wedge between wholesale and consumer prices

WPI % YoY CPI % YoY

12

-4 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Source: Bloomberg Notes: Food accounts for +50% of average hshld spendingsustained higher prices can lead to wage pressures. Govt subsidies also mean food inflation worsens fiscal deficit. Cereals and proteins driving prices higher.

Source: Bloomberg Notes: According to RBI, the wedge is exacerbating the challenge for monetary management in anchoring inflationary expectations.

Percent 10

Wholesale prices have previously been a focal point for the RBI...
RBI Policy Rate (LHS) WPI Inflation % YoY (RHS) 12 10

Percent 10

and based on WPI, real rates have been increasing.

10yr Rates - nominal (LHS) 10yr Rates - real (RHS) 8 6 4

9 8

8 6 7 4 6 2 6 5 0 -2 Jan-07 Jan-09 Jan-11 Jan-13 5 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 7 8

2 0 -2 -4

4 Jan-05

Source: Bloomberg Notes: As noted, WPI/CPI divergence will limit RBIs ability to ease in spite of the economic slowdown.

Source: Bloomberg, our calculations Notes: Higher real rates during a slowdown is the opposite of what India needs. Yet, rising CPI limits policy options.

Figure 3. Balance of Payments Trends Cause for Concern

Import growth is steadily outpacing exports
Billion $ 50 Merch. Exports US$ Merch. Imports US$ 40 -5

resulting in deteriorating trade balance...

Billion $ 0

30

-10

20

-15

10

-20 Trade Balance US$

0 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

-25 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Source: Bloomberg Notes: Oil accounts for 36% of imports. So, while the market (and the government) has been focusing on gold imports, higher oil prices could further worsen trade balance, Watch Indias crude basket Bloomberg [IOBPOIL INDEX].

Source: Bloomberg Notes: 1991 financial crisis in India driven by similar BOP trends...high oil import bill, collapsing exports and investor flight (which has yet to occur in 2013).

and an awful current account trend.

Billion $ 10 5 -1 0 -5 -10 -3 -15 -20 -25 -5 -30 -35 Mar-05 Mar-07 Mar-09 Mar-11 -6 Mar-13 -10 -8 -4 -6 -4 -2 -2 0 Percent Current Account $ Billion Current Account % GDP 0 Percent 2

Lack of fiscal improvements creates further macro vulnerabilities.

Budget Deficit as % GDP

Mar-05

Mar-07

Mar-09

Mar-11

Mar-13

Source: Bloomberg Notes: Record portfolio inflows in light of worsening balance of payments typically precedes instability.

Source: Bloomberg Notes: Budget skepticism on ambitious government revenue assumptions and hefty spending targets leading into 2014 elections. Govt did recently slash diesel subsidies which will help. 4.8% is current target.

Figure 4. Foreign Capital Flooding into India

Foreign capital again flooding into India.
Billion $ 25 20 15 10 50 5 0 -5 -10 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13 0 -50 -100 1992-93 1997-98 2002-03 2007-08 2012-13* FDI Inflows (Quarterly) FII Inflows (Quarterly) Billion $ 200 150 100 FII Total Inflows (Annual)

Hot money inflows at record highs.

Source: Bloomberg Notes: In Sep 2012, the government unleashed a barrage of economic reforms described as big bang. Key reforms include investment access to build supermarkets/retail stores, civil aviation and pension and insurance sectors.

Source: Bloomberg Notes: As in other emerging economies, reform agenda is driving investor interest. Ratings agencies are not nearly as optimistic. S&P and Fitch recently issued negative outlooks and Moody cautions on government finances.

Billion $ 40 30 20 10 0 -10 -20

Foreign investor optimism bolstered by reform agenda...

Percent

Percent 40 30

but weak macro fundamentals can spark sharp reversal.

FII Monthly Equity Inflows (LHS) Sensex Index (RHS) 25

FII Total Inflows (Monthly)

20 20 10 0 10 -10 -20 Jan-07 Jan-09 Jan-11 Jan-13 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 5 15

Jan-05

Source: Bloomberg Notes: This will be a big problem if investor inflows slow.

Source: Bloomberg

Figure 4. Valuations Still ReasonableThough Not Inexpensive

Valuations across Indian indices
Sensex (Actual Level) P/E of 18 P/E of 15 P/E of 12

Index 30000

Index 9000 8000 7000 6000 5000 4000 3000

still look reasonable.

NSE (Actual Level) P/E of 18 P/E of 15 P/E of 12

25000

20000

15000

10000

5000

2000 1000 Jan-07 Jan-09 Jan-11 Jan-13 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

0 Jan-05

Source: Bloomberg Notes: On a first pass, valuations look reasonable, but they are not inexpensive relative to peers (MSCI exJapan averages 12.8x.)

Source: Bloomberg

Weak rupee may be signaling imminent correction lower. Index USD/INR

115 Rupee Real Effective FX Rate (LHS) USD/INR (RHS) 110 55 60

Billion $ 350

Keep close watch on US$ reserves.

India FX Reserves US$

300

105 50 100 45 95 40 150 200 250

90

85 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

35

100 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Source: Bloomberg, Reserve Bank of India

Source: Bloomberg

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Gravelle Pierre is the Founder and Chief Portfolio Manager of Iron Harbor. gpierre@iharborcap.com Jacqueline Hayot is the Chief Operating Officer of Iron Harbor. jhayot@iharborcap.com Christopher Nicholson is the Senior Portfolio Strategist of Iron Harbor. cnicholson@iharborcap.com Eva Yun is the Senior Markets Analyst of Iron Harbor. eyun@iharborcap.com Aditi Thapar, PhD is the Head of Global Economics for Iron Harbor. economics@iharborcap.com

The views expressed herein are for information purposes only and ARE NOT intended as trading or investment recommendations. Iron Harbor Capital Management IS NOT a Commodities Trading Advisor and IS NOT offering these views as investment advice or as a solicitation for investment.