WWRR Vol.2.007

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Contents
Special Reports
Strategy
Daily Alerts
Results
Strategy: Slow boil
Sun Pharmaceuticals: Operationally in line
Grasim Industries: Strong quarter led by VSF and Chemicals
Tata Chemicals: Consumers hold the key
INDIA DAILY
August 16, 2018 India 14-Aug 1-day 1-mo 3-mo
Sensex 37,852 0.6 3.6 6.5
Nifty 11,435 0.7 3.8 5.9
Global/Regional indices
Dow Jones 25,162 (0.5) 0.4 1.6
Nasdaq Composite 7,774 (1.2) (0.4) 5.1
FTSE 7,498 (1.5) (1.3) (3.1)
Nikkei 22,179 (0.1) (1.9) (2.4)
Hang Seng 27,221 (0.4) (4.6) (12.5)
KOSPI 2,240 (0.8) (3.1) (8.9)
Value traded – India
Cash (NSE+BSE) 338 358 334
Derivatives (NSE) 7,495 5,581 4,044
Deri. open interest 4,110 3,743 3,957
Godrej Agrovet: A mixed bag
Forex/money market
Change, basis points
Sunteck Realty: Gearing up
Vardhman Textiles: Weak results
Sadbhav Engineering: Deleveraging benefits
Ashoka Buildcon: Most factors in favor
India Cements: Volumes good, margins weak
Company alerts
ICICI Bank: Revitalizing the bank
Economy alerts
Economy: Input prices' inflation eases on base effect
14-Aug 1-day 1-mo 3-mo
Rs/US$ 70.3 (4) 176 255
10yr govt bond, % 8.1 (1) (1) 4
Net investment (US$ mn)
13-Aug MTD CYTD
FIIs (133) 274 (140)
MFs 2 22 11,140
Top movers
Change, %
Best performers 14-Aug 1-day 1-mo 3-mo
RCOM IN Equity 21 0.5 71.4 96.7
SUNP IN Equity 602 6.7 12.7 27.6
RIL IN Equity 1,211 1.9 12.5 26.6
DABUR IN Equity 453 2.7 23.3 22.8
SBIN IN Equity 295 0.3 17.2 21.3
Worst performers
JPA IN Equity 13 (0.4) (7.5) (26.3)
TTMT/A IN Equity 135 (0.4) (5.1) (26.3)
VEDL IN Equity 215 (0.6) 4.2 (22.8)
JSP IN Equity 200 (0.2) 1.8 (21.5)
TTMT IN Equity 249 0.0 (1.3) (19.8)
Kotak Institutional Equities Research
kotak.research@kotak.com . Mumbai: +91-22-4336-0000
For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES.
REFER TO THE END OF THIS MATERIAL.

Company Report
Strategy
INDIA
INDIA
August 16, 2018
BSE-30: 37,852
Slow boil. 1QFY19 net profits of the Nifty-50 Index grew 12.3%, 2% above our
estimates while net profits of KIE coverage universe grew 12.5%, 14.4% above our
expectations due to lower losses of certain PSU banks (ex-financials 0.6% above
expectations). We model 20% growth in net profits of the Nifty-50 Index for FY2019
(down from 23% before 1QFY19 results season) and 24% for FY2020. However,
valuations are heady and macro weak and faces growing risks from a large number of
global issues.
Too many macro variables—hope for the best
We see increased volatility and macro risks over the next few weeks from (1) potential escalation
in US-China trade issues, (2) possible ‘hard’ sanctions on Iran leading to sharp decline in Iran oil
exports and higher crude oil prices and (3) possible EM contagion given Turkey’s fragile
macroeconomic situation and weak macroeconomic positions of several EMs. India’s delicate
macroeconomic position will be hurt by higher oil prices given oil’s large influence over CAD/BoP
(currency), GFD (bond yields) and inflation (interest rates).
Cyclical recovery versus structural recovery; positive underlying trends in 1QFY19 results
1QFY19 results showed solid improvement in volumes across sectors although the growth figures
are flattered by a low base (1QFY18 was pre-GST quarter). We note that 2-year growth numbers
(CAGR) are quite mediocre, raising concerns about the strength and sustainability of the ongoing
economic recovery, which is led by consumption demand. On the other hand, the Indian
banking NPLs seem to be peaking and resolutions moving ahead, a good sign.
Convergence of multiples between ‘growth’ and ‘value’ stocks
We expect further re-rating of certain banks, gas and metal companies on positive sector- and
company-specific developments, leading to some convergence between the valuations of the
expensive ‘growth’ (‘quality’) stocks and inexpensive ‘value’ stocks. Further deterioration in the
macro could delay the ‘convergence’ but also pose risks to rich valuations of ‘growth’ stocks.
The market has so far ignored India’s weak macro and rewarded the IT sector with a massive
re-rating given currency-led higher earnings. The Indian market has delivered 9% return in INR
terms and (-)1% return in USD terms CYTD18, lest we celebrate.
Valuations are rich for the broad market and super-rich for ‘favored’ stocks
The Nifty-50 Index trades at 21.8X FY2019E ‘EPS’, supported by the super-rich valuations of
private banks and NBFCs, consumer staple and discretionary stocks and even certain IT stocks.
We expect 20% and 24% growth in net profits of the Nifty-50 Index for FY2019 and FY2020,
largely driven by banks (rebound in net profits of ‘corporate’ banks), IT, metals & mining and oil
& gas. Lower LLPs drive the profits of ‘corporate’ banks and weaker INR of the latter three.
INSIDE
1QFY19 net profits
of Nifty-50 Index
increased 12.3%,
2% above
expectation…pg36
FY2019E net profits
of Nifty-50 Index to
grow 20%...pg21
Nifty-50 Index
trading at 21.8X
FY2019E ‘EPS’
.................. pg16
Sanjeev Prasad
sanjeev.prasad@kotak.com
Mumbai: +91-22-4336-0830
Sunita Baldawa
sunita.baldawa@kotak.com
Mumbai: +91-22-4336-0896
Anindya Bhowmik
anindya.bhowmik@kotak.com
Mumbai: +91-22-4336-0897
Kotak Institutional Equities
Research
Important disclosures appear
at the back
For Private Circulation Only. In the US, this document may only be distributed to QIBs (qualified institutional buyers) as defined under rule 144A of the Securities Act of 1933. This document is not for public distribution
and has been furnished to you solely for your information and may not be reproduced or redistributed to any other person. The manner of circulation and distribution of this document may be restricted by law or
regulation in certain countries, including the United States. Persons into whose possession this document may come are required to inform themselves of, and to observe, such restrictions.

Strategy
India
MARKET VIEW: UNCERTAIN MACRO WITH PLENTIFUL RISKS
The performance of the market for the rest of the year will depend on (1) strength of economic recovery
(cyclical versus structural recovery), (2) level of crude oil prices, which will shape India’s macro and
(3) convergence or divergence of multiples between ‘growth’ and ‘value’ stocks. Politics will also become
important by the end of the year. The Indian market trades at expensive multiples (19.8X 12-month forward
P/E), pulled up by the very high multiples of ‘growth’ (‘quality’) stocks.
Weak macro and growing risks
The performance of the Indian market over the next few months would depend on
(1) strength of ongoing economic recovery, (2) level of crude oil prices, which will shape
India’s macro through its influence on CAD, inflation and GFD, (3) global risk sentiment in
the context of escalating global trade tensions and growing EM problems and (4)
convergence of multiples between ‘growth’ and ‘value’ stocks, if any, or continued
divergence of multiples between the two buckets of stocks as has been the case for the past
several months.
We believe the current economic recovery is somewhat embellished by the low base of
1HCY18, crude prices may have a large influence on India’s macro if the Iran-US situation
were to deteriorate into ‘hard’ sanctions on exports of oil from Iran and EM challenges may
act as headwinds for the broader market. Nonetheless, multiples between ‘growth’ and
‘quality’ stocks may converge on possible sector-specific and stock-specific developments
that may give more confidence to the market about ‘value’ stocks in general.
Cyclical recovery may more accurately describe ongoing economic recovery. We
believe that part of the ongoing economic recovery simply reflects recovery of a low base
in 1HCY17 as economic activity was affected by demonetization (announced on
November 8, 2016) and GST (implemented from July 1, 2017). We note that the yoy
growth for several consumer staple products (staples and discretionary items) has been
quite impressive for the past three quarters (3QFY18, 4QFY18 and 1QFY19). In particular,
we note that 1QFY18 quarter was the pre-GST quarter and volumes were particularly
subdued due to pre-GST de-stocking by the entire manufacturing and distribution chain.
However, the growth is less impressive on a 2-year CAGR basis for the same quarters (see
Exhibit 1), which may more accurately represent the real strength of the economic
recovery. More importantly, we note that comparisons will become progressively tougher
from 2QFY19. Volume growth figures could disappoint versus Street’s lofty expectations
unless the recovery is led by new job creation and investment and not simply a
normalization of demand conditions post the twin ‘blows’ of demonetization and GST.
KOTAK INSTITUTIONAL EQUITIES RESEARCH 3

India
Strategy
Exhibit 1: Volume growth for consumer products is generally unimpressive on a 2-year CAGR basis
Volume growth of automobile and consumer companies, 1QFY17-1QFY19 (%)
Automobiles
1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2-y CAGR
Ashok Leyland 16.8 (12.5) 7.4 9.9 (12.1) 20.3 40.8 24.2 49.9 14.8
Bajaj Auto- 2Ws 13.0 23.5 (3.3) (11.8) (22.3) 0.8 1.5 20.4 39.3 4.0
Hero Motocorp 6.6 17.2 (12.7) (5.8) 6.1 11.3 16.4 22.9 13.7 9.9
Maruti Suzuki 5.4 18.5 3.9 14.8 14.3 19.4 12.4 11.6 25.9 20.0
Mahindra & Mahindra 13.4 16.4 (11.7) (9.1) (6.0) 16.9 1.5 10.0 9.0 1.2
Consumer staples
Bajaj Corp. - Almond Drop Hair Oil 2.2 1.6 1.6 (7.1) (6.6) 6.5 4.5 6.9 11.2 1.9
Britannia Industries - Domestic 8.0 8.0 2.0 2.0 2.0 6.0 13.0 12.5 12.0 6.9
Colgate - Overall 6.0 4.0 4.0 (3.0) (5.0) (1.0) 12.0 4.0 4.0 (0.6)
Colgate - Toothpaste 5.0 4.0 4.0 (3.0) (5.0) (1.0) 12.0 4.0 4.0 (0.6)
Dabur - Domestic 4.1 4.5 4.5 2.4 (4.4) 7.2 13.0 7.7 21.0 7.6
GSK Consumer 0.0 (3.0) (17.0) (0.7) (3.0) 2.4 17.0 8.0 12.8 4.6
GCPL - Soaps 10.0 (5.0) (5.0) 5.0 (8.0) 12.0 15.0 12.0 12.0 1.5
HUL (FMCG business) 4.0 (1.0) (1.0) 4.0 — 4.0 11.0 11.0 12.0 5.8
Marico - Domestic 8.0 3.4 3.4 10.0 (4.0) 8.5 9.4 1.0 12.4 3.9
Marico - Parachute 7.0 (6.0) (6.0) 15.0 (5.0) 8.0 15.0 (5.0) 9.0 1.8
Marico - Saffola 11.0 8.0 8.0 6.0 (3.0) 9.0 — (1.0) 10.0 3.3
Marico - Value-added hair oils 9.0 11.0 11.0 10.0 (6.0) 8.0 8.0 11.0 15.0 4.0
Consumer discretionary
Asian Paints 12.0 12.0 12.0 9.0 2.0 9.0 6.0 10.0 13.0 7.4
ITC - Cigarettes 3.0 4.0 4.0 — 2.0 (8.0) (5.0) (5.0) 1.0 1.5
Jubilant Foodworks - SSG (3.2) 4.2 4.2 (7.5) 6.5 5.5 17.8 26.5 25.9 15.8
Pidilite - Domestic consumer business 9.0 7.8 7.8 6.0 — 15.0 23.0 13.0 20.0 9.5
Titan - Jewelry 6.0 (32.0) (32.0) 37.0 49.0 49.0 6.0 6.0 (2.6) 20.5
Source: Companies, Kotak Institutional Equities
It would be interesting to see how the market reacts to weaker yoy growth numbers from
2QFY19 onwards. In our view, the expansion in the multiples of the ‘growth’ stocks may
also represent a more expansive view of growth by the market, buoyed by the strong yoy
growth in volumes for the past three quarters.
Crude prices may spike if the US was to impose ‘hard’ sanctions on Iran. We note
that any ‘hard’ sanctions by the US government on oil exports from Iran may result in a
dramatic decline in Iran oil exports, which will upset global oil supply-demand balance.
The next phase of US sanctions effective November 5, 2018 specifically target Iran’s oil
industry and among other things include sanctions against (1) purchase of oil from
National Iranian Oil Company and other Iranian oil & gas companies and (2) transactions
by foreign financial institutions with the Central Bank of Iran and designated Iranian
financial institutions.
We note that Iran’s oil exports of 2.2 mn b/d in 1HCY18 (see Exhibit 2 for Iran’s
production and exports of oil since January 2015) is quite large compared to available
spare capacity of the OPEC (see Exhibit 3 for global oil supply-demand balance and OPEC
spare capacity). Other oil producers may find it hard to offset any cut in Iran oil exports
beyond 0.5 mn b/d. The continued decline in Venezuela oil production (see Exhibit 4) may
further aggravate global oil supply.
4 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Jan-15
Mar-15
May-15
Jul-15
Sep-15
Nov-15
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Jan-17
Mar-17
May-17
Jul-17
Sep-17
Nov-17
Jan-18
Mar-18
May-18
Strategy
India
Exhibit 2: Iran’s oil exports are at 2.2 mn b/d in 1HCY18
Monthly production and exports from Iran, calendar year-ends, 2015-18 (mn b/d)
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
-
Iran oil production
Exports
Source: OPEC, Kotak Institutional Equities
Exhibit 3: OPEC implied spare capacity could decline sharply with lower Iran oil production
Estimated global crude demand, supply and prices, calendar year-ends, 2012-22E
Demand (mn b/d)
2012 2013 2014 2015 2016 2017 2018E 2019E 2020E 2021E 2022E
Total demand 90.7 91.7 93.0 95.0 96.2 97.7 99.1 100.5 101.6 102.6 103.7
Yoy growth 1.2 1.1 1.2 2.0 1.2 1.5 1.4 1.4 1.2 1.0 1.1
Supply (mn b/d)
Non-OPEC 52.5 54.5 57.0 58.1 57.4 58.2 60.2 62.0 62.4 62.8 63.2
Yoy growth (0.4) 2.1 2.4 1.1 (0.7) 0.8 2.0 1.8 0.3 0.4 0.4
OPEC
Crude 32.1 30.6 30.5 31.8 32.8 32.3 32.0 32.0 32.0 32.0 32.0
NGLs 6.4 6.2 6.3 6.6 6.8 6.9 6.9 7.0 7.1 7.2 7.3
Total OPEC 38.4 36.8 36.8 38.4 39.6 39.2 38.9 39.0 39.1 39.2 39.3
Total supply 90.9 91.3 93.7 96.5 97.0 97.4 99.1 101.1 101.5 102.0 102.5
Total stock change 0.2 (0.5) 0.7 1.5 0.8 (0.3) 0.0 0.6 (0.1) (0.6) (1.2)
OPEC crude capacity 35.8 35.2 35.2 35.2 35.9 35.6 35.1 34.9 35.9 36.0 36.2
Implied spare capacity 3.9 4.1 5.5 4.8 3.9 2.9 3.1 3.5 3.7 3.4 3.0
Demand growth (yoy, %) 1.3 1.2 1.4 2.2 1.2 1.6 1.4 1.4 1.1 1.0 1.1
Supply growth (yoy, %)
Non-OPEC (0.8) 3.9 4.5 1.9 (1.2) 1.5 3.4 3.1 0.5 0.7 0.7
OPEC 7.4 (4.4) 0.0 4.5 3.1 (1.0) (0.7) 0.2 0.3 0.1 0.2
Total 2.5 0.4 2.7 2.9 0.5 0.5 1.8 1.9 0.4 0.5 0.5
Dated Brent (US$/bbl) 112 109 99 52 44 54 57 73 68 65 65
World GDP growth (%) 3.4 3.3 3.6 3.4 3.2 3.7 3.9 3.9 3.7 3.8 3.8
Notes:
(a) OPEC production data includes Indonesia in 2012 and Gabon from 2013 onwards.
Source: IEA, Kotak Institutional Equities estimates
KOTAK INSTITUTIONAL EQUITIES RESEARCH 5

Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16
Nov-16
Dec-16
Jan-17
Feb-17
Mar-17
Apr-17
May-17
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
Nov-17
Dec-17
Jan-18
Feb-18
Mar-18
Apr-18
May-18
Jun-18
India
Strategy
Exhibit 4: Sharp decline in oil production from Venezuela due to ongoing socioeconomic crisis
Monthly production of crude oil in Venezuela, January 2016 onwards (mn b/d)
3.0
2.5
Venezuela oil production
2.0
1.5
1.0
0.5
-
Source: OPEC, Kotak Institutional Equities
India’s macro position would worsen if oil prices were to shoot above US$80/bbl. We
note that a US$10/bbl change in crude oil prices results in (1) 50 bps impact on CAD/GDP;
we model 2.8% CAD/GFD at US$72.5/bbl Dated Brent crude price; see Exhibit 5, (2) 30
bps impact on inflation; we model 4.6% average CPI inflation for FY2019; see Exhibit 6
and (3) modest impact on GFD through higher subsidies on kerosene and LPG; we model
gross under-recoveries at `460 bn versus the government’s provision of `265 bn. GFD
could rise further if the government was to reduce taxes on diesel and gasoline in order
to mitigate the impact of higher oil prices.
6 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Exhibit 5: India's external vulnerabilities will be higher at higher oil prices
India's balance of payments, March fiscal year-ends, 2014-19E (US$ bn)
2019E
2014 2015 2016 2017 2018 Oil@67.5/bbl Oil@72.5/bbl Oil@80/bbl
Current account (32.4) (26.8) (22.2) (15.3) (48.7) (70.8) (78.2) (89.5)
GDP 1,858 2,038 2,103 2,270 2,602 2,758 2,758 2,758
CAD/GDP (%) (1.7) (1.3) (1.1) (0.7) (1.9) (2.6) (2.8) (3.2)
Trade balance (147.6) (144.9) (130.1) (112.4) (160.0) (186.5) (194.0) (205.2)
Trade balance/GDP (%) (7.9) (7.1) (6.2) (4.9) (6.2) (6.8) (7.0) (7.4)
- Exports 319 317 266 280 309 331 334 337
- oil exports 63 57 31 32 39 41 43 47
- non-oil exports 255 260 236 249 270 290 290 290
- Imports 466 461 396 393 469 518 528 542
- oil imports 165 138 83 87 109 132 142 157
- non-oil imports 301 323 313 306 360 386 386 386
- gold imports 29 34 32 28 34 34 34 34
Invisibles (net) 115 118 108 97 111 116 116 116
- Services 73 77 70 67 78 80 80 80
- software 67 70 71 70 72 74 74 74
- non-software 6.0 6.2 (1.8) (2.6) 5.4 5.5 5.5 5.5
- Transfers 65 66 63 56 62 66 66 66
- Income (net) (23) (24) (24) (26) (29) (30) (30) (30)
Capital account 48.8 89.3 41.1 36.5 91.4 42.0 42.0 42.0
Percentage of GDP 2.6 4.4 2.0 1.6 3.5 1.5 1.5 1.5
Foreign investment 26 73 32 43 52 20 20 20
- FDI 22 31 36 36 30 30 30 30
- FPI 5 42 (4) 8 22 (10) (10) (10)
- Equities 14 15 (4) 9 2 (2) (2) (2)
- Debt (8) 26 (0) (1) 21 (8) (8) (8)
Banking capital 25 12 11 (17) 16 12 12 12
- NRI deposits 39 14 16 (12) 10 9 9 9
Short-term credit (5.0) (0.1) (1.6) 6.5 13.9 6.0 6.0 6.0
ECBs 11.8 1.6 (4.5) (6.1) (0.2) 2.0 2.0 2.0
External assistance 1.0 1.7 1.5 2.0 2.9 2.0 2.0 2.0
Other capital account items (10.8) 1.1 3.3 7.6 6.2 — — —
E&O (0.9) (1.1) (1.1) 0.4 0.9 — — —
Overall balance 15.6 61.4 17.9 21.6 43.6 (28.8) (36.2) (47.5)
Memo items
Average USD/INR 60.5 61.2 65.4 67.2 64.5 67.6 67.6 67.6
Average Brent (US$/bbl) 107.6 86.5 47.5 49.0 57.6 67.5 72.5 80.0
Source: RBI, Kotak Institutional Equities estimates
KOTAK INSTITUTIONAL EQUITIES RESEARCH 7

Jan-14
Apr-14
Jul-14
Oct-14
Jan-15
Apr-15
Jul-15
Oct-15
Jan-16
Apr-16
Jul-16
Oct-16
Jan-17
Apr-17
Jul-17
Oct-17
Jan-18
Apr-18
Jul-18
Oct-18
Jan-19
India
Strategy
Exhibit 6: Upside risks to inflation from crude price, INR weakness and higher-than-usual MSP hikes
Headline and core CPI inflation (%)
10
CPI inflation
Core CPI inflation
8
6
4
Mar-19: 5.1
Mar-19: 4.8
2
0
Source: CEIC, Kotak Institutional Equities estimates
In our view, valuations of several stocks could see a de-rating in case (1) India’s
macroeconomic conditions were to deteriorate on the back of significantly higher crude
oil prices (US$15/bbl or more from current levels) and/or (2) earnings were to disappoint.
The market perhaps believes that India’s macroeconomic situation will improve over the
next few months and/or earnings growth would be strong enough to offset any macrorelated
concerns including higher interest rates/cost of capital.
EM contagion (if any). The market would also have to contend with (1) any contagion
effect of the troubles in the Turkish economy with rapid deterioration in the
macroeconomic position of the country and (2) weakness in global economy on
escalation of global trade issues, which could result in a risk-off sentiment for EMs. As
such, EMs have been very poor performers over the past year or so, lagging the strong
performance in DMs and US markets (see Exhibit 7).
8 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Exhibit 7: Emerging markets have massively underperformed developed markets in the past year
Performance (not annualized) of emerging and developed markets over period of time (%)
Developed markets
1-mo 3-mo 6-mo YTD 1-yr 3-yr 5-yr 1-mo 3-mo 6-mo YTD 1-yr 3-yr 5-yr
Australia 0 3 8 4 10 18 22 (1) 0 (0) (3) 2 16 (3)
France (0) (2) 6 2 6 9 33 (2) (6) (2) (3) 2 12 14
Germany (1) (4) 2 (4) 2 13 48 (3) (8) (6) (9) (1) 16 27
Hong Kong (3) (11) (7) (7) 2 16 23 (3) (11) (7) (8) 1 14 22
Japan (1) (2) 5 (2) 14 9 63 0 (3) 2 (0) 13 22 43
Singapore (1) (8) (5) (5) (2) 4 1 (1) (10) (9) (7) (3) 6 (7)
UK (0) (1) 7 (1) 4 17 18 (3) (6) (2) (6) 2 (5) (3)
US (Dow Jones) 1 2 2 2 15 44 67 1 2 2 2 15 44 67
US (S&P500) 1 4 6 6 14 35 70 1 4 6 6 14 35 70
MSCI World (0) 0 2 1 9 22 41
Emerging markets
% change in local currency % change in USD
Brazil 1 (9) (4) 1 13 63 52 (0) (15) (19) (14) (8) 44 (9)
MSCI China (5) (13) (9) (8) 4 25 37 (5) (13) (10) (9) 3 24 36
India 4 6 8 9 17 34 99 2 3 (0) (1) 7 25 74
Indonesia (3) (1) (12) (9) (1) 26 23 (4) (4) (18) (15) (9) 19 (12)
Korea (2) (8) (6) (8) (3) 14 17 (2) (12) (9) (13) (2) 19 16
Malaysia 4 (3) (3) (1) 1 12 (0) 2 (7) (6) (2) 6 11 (20)
Mexico 1 5 2 (1) (5) 11 16 (1) 7 (2) 1 (12) (5) (23)
Philippines 2 (5) (12) (12) (5) 2 14 2 (6) (15) (18) (9) (12) (6)
Russia (10) (9) (12) (7) 4 29 (19) (10) (9) (12) (7) 4 29 (19)
Taiwan (0) (0) 4 2 6 30 37 (1) (3) (1) (2) 4 36 34
Thailand 3 (4) (6) (3) 9 20 17 3 (7) (11) (5) 8 27 10
MSCI EM (3) (9) (10) (10) (1) 21 9
Source: Bloomberg, Kotak Institutional Equities
A further strengthening of the US dollar relative to EM currencies on the back of
continued strength in the US economy (see Exhibit 8) and subsequent rate hikes by the
US Fed could further weigh on EMs. Many EMs face different challenges ranging from (1)
threat of further US sanctions (Russia, Turkey) to vigorous US trade actions (China), (2)
high overall and external debt relative to the size of the GDP (many EMs) and (3) high
CAD and GFD (Argentina, Brazil, India, South Africa, Turkey).
Exhibit 8: Recent data shows steady growth in the US economy
Trend in key economic variables for the US economy
Monthly indicators Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18
Average private earnings (yoy, %) 2.6 2.6 2.8 2.4 2.4 2.7 2.8 2.6 2.7 2.6 2.7 2.7 2.7
Conference Board consumer confidence (X) 120.0 120.4 120.6 126.2 128.6 123.1 125.4 130.8 127.7 125.6 128.0 126.4 127.4
Core PCE (yoy, %) 1.4 1.3 1.4 1.4 1.5 1.5 1.5 1.5 1.8 1.8 2.0 1.9
CPI (yoy,%) 1.7 1.9 2.2 2.0 2.2 2.1 2.1 2.2 2.4 2.5 2.8 2.8 2.9
Core CPI (yoy, %) 1.7 1.7 1.7 1.8 1.7 1.8 1.8 1.8 2.1 2.1 2.2 2.3 2.3
Housing starts (SAAR, '000) 1,185 1,172 1,158 1,265 1,303 1,210 1,334 1,290 1,327 1,276 1,337 1,173
Industrial production (yoy, %) 1.6 0.9 1.1 2.6 3.5 3.1 3.2 3.8 3.6 4.7 3.2 3.6
ISM manufacturing (X) 56.3 58.8 60.8 58.7 58.2 59.3 59.1 60.8 59.3 57.3 58.7 60.2 58.1
ISM non-manufacturing (X) 53.9 55.3 59.8 60.1 57.4 55.9 59.9 59.5 58.8 56.8 58.6 59.1 55.7
Non-farm payrolls ('000) 190 221 14 271 216 175 176 324 155 175 268 248 157
Participation rate (%) 62.9 62.9 63.1 62.7 62.7 62.7 62.7 63 62.9 62.8 62.7 62.9 62.9
Personal savings rate (% of disposable income) 3.5 3.5 3.0 3.0 2.6 2.5 3.0 3.3 3.2 3.0 3.2
Retail sales excl. automobiles (sa, yoy, %) 3.7 4.6 5.7 5.5 7.1 6.3 4.8 5.7 5.3 5.1 7.1 7.0
S&P house price index (yoy, %) 5.8 5.8 6.2 6.4 6.4 6.3 6.4 6.7 6.7 6.7 6.5
Unemployment rate (%) 4.3 4.4 4.2 4.1 4.1 4.1 4.1 4.1 4.1 3.9 3.8 4.0 3.9
Quarterly indicators Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18
CAD/GDP (%) (2.4) (2.4) (2.4) (2.4) (2.3) (2.4) (2.3) (2.4) (2.3)
GFD/GDP (%) (2.5) (2.8) (3.1) (3.1) (3.4) (3.7) (3.4) (3.4) (3.7) (3.7)
Real GDP (SAAR, qoq, %) 0.6 2.2 2.8 1.8 1.2 3.1 2.8 2.3 2.2 4.1
Source: Bloomberg, CEIC, Kotak Institutional Equities
KOTAK INSTITUTIONAL EQUITIES RESEARCH 9

Malaysia
Turkey
South Africa
Malaysia
Turkey
South Africa
Mexico
Thailand
Indonesia
Mexico
Brazil
China
Thailand
Indonesia
Philippines
India
India
Philippines
China
Brazil
Brazil
Malaysia
China
Thailand
Philippines
Turkey
India
South Africa
Thailand
China
Mexico
Indonesia
Philippines
Malaysia
Indonesia
Turkey
India
South Africa
Brazil
Mexico
India
Strategy
On the external front, India is relatively better off with low external debt-to-GDP and
short-term external debt-to-GDP ratios (see Exhibit 9 for a summary of India’s external
debt position relative to other EMs) versus other EMs although it does have a relatively
high CAD (see Exhibit 10), which could worsen if crude oil prices were to rise substantially
from current levels. India also has persistently high GFD although this is less of an issue in
the current macro-environment with more external than internal challenges. Lastly, most
of India’s public debt is financed by internal borrowings.
Exhibit 9: India’s external debt position superior to other EM countries
External debt/GDP, short-term debt/GDP, short-term debt/forex reserves and forex reserves/imports of various countries, calendar year-end, 2017 (%)
80
70
60
50
External debt/GDP (%)
30
25
20
Short-term external debt/GDP (%)
40
30
20
10
15
10
5
0
0
100
Short-term debt/forex reserves (%)
20
Forex reserves/Import (months)
80
16
60
12
40
8
20
4
0
0
Notes:
(a) Short-term debt is on the basis of original maturity. In most cases, actual short-term debt repayment (within one year) based on residual maturity of debt will be higher.
Source: World Bank, RBI, Kotak Institutional Equities
Exhibit 10: India has a high CAD/GDP ratio compared to other economies
CAD/GDP ratio, calendar year-ends, 2009-19E (%)
2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E
Argentina 2.2 (0.4) (1.0) (0.4) (2.1) (1.6) (2.7) (2.7) (4.8) (5.1) (5.5)
Brazil (1.6) (3.4) (2.9) (3.0) (3.0) (4.2) (3.3) (1.3) (0.5) (1.6) (1.8)
China 4.8 3.9 1.8 2.5 1.5 2.2 2.7 1.8 1.4 1.2 1.2
India (2.8) (2.8) (4.3) (4.8) (1.7) (1.3) (1.1) (0.7) (2.0) (2.3) (2.1)
Indonesia 1.8 0.7 0.2 (2.7) (3.2) (3.1) (2.0) (1.8) (1.7) (1.9) (1.9)
Korea 3.7 2.6 1.6 4.2 6.2 6.0 7.7 7.0 5.1 5.5 5.8
Malaysia 15.0 10.1 10.9 5.2 3.5 4.4 3.0 2.4 3.0 2.4 2.2
Mexico (0.9) (0.5) (1.0) (1.5) (2.4) (1.8) (2.5) (2.1) (1.6) (1.9) (2.2)
Philippines 5.0 3.6 2.5 2.8 4.2 3.8 2.5 (0.3) (0.4) (0.5) (0.6)
Russia 3.8 4.1 4.7 3.2 1.5 2.8 5.0 2.0 2.6 4.5 3.8
South Africa (2.7) (1.5) (2.2) (5.1) (5.9) (5.3) (4.4) (3.3) (2.3) (2.9) (3.1)
Taiwan 10.4 8.3 7.8 8.9 10.0 11.7 14.3 13.6 13.8 13.6 13.5
Thailand 7.9 3.4 2.5 (0.4) (1.2) 3.7 8.0 11.7 10.8 9.3 8.6
Turkey (1.8) (5.8) (8.9) (5.5) (6.7) (4.7) (3.7) (3.8) (5.5) (5.4) (4.8)
Notes:
(a) Data for India as of March fiscal year-ends.
Source: IMF, Kotak Institutional Equities
10 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Politics—market seems quite relaxed about it. The market will increasingly focus on
three state elections (Chhattisgarh, Madhya Pradesh and Rajasthan), which are due in
December 2018/January 2019 where BJP is the incumbent ruling party. These states were
also big contributors to the BJP’s strong performance in the 2014 general elections.
A favorable outcome for the BJP in the state elections will assuage any residual concerns
about the performance of the BJP in the next general elections (due in April/May 2019)
and the electoral prospects of the BJP and the ruling-coalition (NDA) post its recent
electoral losses in by-elections to the lower house of parliament and in the Karnataka
state elections. However, the market could get jittery if the BJP were to lose two states
while the loss of three states would be a catastrophic event for the market.
A weak performance of the BJP in the forthcoming state elections (although less likely)
would intensify speculation about the electoral prospects of the BJP in the 2019 elections,
especially if national and regional opposition political parties were to form opportunistic
alliances against the BJP in the forthcoming general elections, drawing from the template
of the Karnataka state election where the second- and third-largest parties (INC and JD(S))
combined to form a government at the expense of the BJP despite the BJP being the
largest party with 104 seats in the 222-seat state assembly.
As of now, the market firmly believes that the same BJP-led coalition will form the next
government too albeit with fewer seats for the BJP. We note that the BJP has a slender
majority in the lower house of parliament currently (it lost a few seats in recent byelections)
and its utter dominance in several states makes it vulnerable to loss of a few
seats in those states (see Exhibit 11).
KOTAK INSTITUTIONAL EQUITIES RESEARCH 11

India
Strategy
Exhibit 11: BJP crosses half-way mark of 272 seats on its own
Current number of seats in Lok Sabha by states
Name of state Members INC BJP
Andhra Pradesh 25 0 2
Arunachal Pradesh 2 1 1
Assam 14 3 7
Bihar 40 2 22
Chhattisgarh 11 1 10
Goa 2 0 2
Gujarat 26 0 26
Haryana 10 1 7
Himachal Pradesh 4 0 4
Jammu and Kashmir 6 0 3
Jharkhand 14 0 12
Karnataka 28 9 15
Kerala 20 8 0
Madhya Pradesh 29 3 26
Maharashtra 48 2 22
Manipur 2 2 0
Meghalaya 2 1 0
Mizoram 1 1 0
Nagaland 1 0 0
Odisha 21 0 1
Punjab 13 4 1
Rajasthan 25 2 23
Sikkim 1 0 0
Tamil Nadu 39 0 1
Telangana 17 0 1
Tripura 2 0 0
Uttar Pradesh 80 2 68
Uttarakhand 5 0 5
West Bengal 42 4 2
Name of UT
Andaman and Nicobar Islands 1 0 1
Chandigarh 1 0 1
Dadra and Nagar Haveli 1 0 1
Daman and Diu 1 0 1
Delhi 7 0 7
Lakshadweep 1 1 0
Puducherry 1 1 0
Total 543 48 272
Chhattisgarh, Gujarat, MP, Rajasthan and UP 171 8 153
Source: Lok Sabha, Kotak Institutional Equities
Valuations are expensive for the market as a whole
We find the valuations of the Indian market to be rich (see Exhibit 12) and note the
significant disconnect between high equity market valuations and weak macroeconomic
outlook, as can be seen in the divergence between bond and equity yields (see Exhibit 13).
12 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Aug-03
Aug-04
Aug-05
Aug-06
Aug-07
Aug-08
Aug-09
Aug-10
Aug-11
Aug-12
Aug-13
Aug-14
Aug-15
Aug-16
Aug-17
Aug-18
Strategy
India
Exhibit 12: We expect earnings of the Nifty-50 Index to grow 19% in FY2019 and 24% in FY2020
Valuation summary of Nifty-50 sectors (full-float basis), March fiscal year-ends, 2018-20E (based on current constituents)
Mcap.
Adj. mcap.
Earnings growth (%) PER (X) EV/EBITDA (X) Price/BV (X) Div. yield (%)
(US$ bn) (US$ bn) 2018 2019E 2020E 2018 2019E 2020E 2018 2019E 2020E 2018 2019E 2020E 2018 2019E 2020E 2018 2019E 2020E
Automobiles 99.3 54.6 (1.5) 15.0 26.8 24.3 21.2 16.7 10.3 9.0 7.4 3.4 3.1 2.7 1.0 1.0 1.2 14.1 14.5 16.2
Banking 330.4 245.9 (16.9) 44.8 72.9 43.3 29.9 17.3 — — — 3.3 2.9 2.5 0.6 0.6 0.9 7.6 9.6 14.6
Cement 26.2 9.9 (4.4) 23.8 30.9 33.1 26.7 20.4 16.2 10.3 9.0 2.2 2.0 1.9 0.3 0.3 0.3 6.6 7.7 9.2
Consumers 138.9 70.2 13.4 14.8 14.2 50.2 43.7 38.3 34.0 29.0 25.2 13.5 12.4 11.3 1.2 1.3 1.6 26.9 28.3 29.5
Energy 185.2 77.5 (0.2) 7.4 5.0 13.5 12.6 12.0 8.8 7.6 7.1 1.8 1.6 1.5 2.4 2.0 2.1 13.1 12.9 12.4
Industrials 25.1 22.1 22.4 21.7 10.9 24.2 19.9 18.0 20.3 16.1 15.5 3.5 3.2 2.9 1.3 1.8 2.0 14.5 16.0 16.0
Infrastructure 11.1 4.1 (2.1) 1.2 21.1 20.2 19.9 16.5 13.6 13.6 11.3 3.7 3.2 2.7 0.5 0.5 0.5 18.2 15.8 16.4
Media 7.1 4.0 7.8 11.3 17.0 34.2 30.7 26.3 22.2 19.1 16.1 6.5 5.8 5.1 0.5 0.9 1.1 19.1 18.8 19.3
Metals & Mining 53.1 22.2 24.5 56.8 10.9 13.3 8.5 7.6 7.4 5.6 5.1 1.8 1.6 1.5 3.9 4.7 5.7 13.9 19.4 19.9
Pharmaceuticals 38.9 21.0 (33.8) 11.9 38.3 35.0 31.3 22.6 19.4 16.4 12.2 3.4 3.1 2.8 0.6 0.6 0.8 9.8 10.0 12.4
Others 4.4 3.2 21.1 14.0 12.1 14.2 12.5 11.1 9.9 8.5 7.2 3.4 2.8 2.3 1.3 1.6 1.8 23.9 22.4 21.0
Technology 200.5 84.8 1.0 12.6 9.4 23.0 20.4 18.7 16.7 14.0 12.7 5.5 4.9 4.5 1.3 2.0 3.2 23.9 23.8 24.2
Telecom 28.5 10.1 (26.8) (97.2) 373.6 44.9 1,626.1 343.4 8.1 9.3 8.1 2.3 2.4 2.5 2.4 1.2 0.7 5.1 0.1 0.7
Utilities 32.5 12.7 (0.3) 25.5 8.5 12.9 10.3 9.5 9.7 7.9 7.2 1.5 1.3 1.2 3.3 3.1 3.3 11.3 13.0 13.0
Nifty-50 Index 1,181 642 (2.1) 19.7 23.6 24.6 20.5 16.6 12.0 10.1 9.1 3.1 2.8 2.5 1.4 1.5 1.9 12.6 13.6 15.3
Nifty-50 Index (ex-energy) 996 565 (2.9) 24.6 29.9 29.0 23.3 17.9 13.6 11.3 10.0 3.6 3.2 2.9 1.2 1.4 1.8 12.5 13.9 16.3
RoE (%)
Notes:
(a) We used consensus numbers for Indiabulls Housing Finance and Kotak Mahindra Bank.
Source: Kotak Institutional Equities estimates
Exhibit 13: Earnings yields have been broadly stable over the past several months despite a sharp
increase in bond yields
Nifty earnings yield and bond yield, March fiscal year-ends, 2004-19 (%)
16
Yield gap (%) Earnings yields (%) India 10-y G-Sec yields (%)
12
8
4
0
(4)
(8)
Source: Bloomberg
The Indian market has traded historically at much lower levels (see Exhibit 14 for the 12-
month forward valuation parameters on full-float basis). We note that the market’s (1)
recent performance (see Exhibit 15 for contribution of various stocks to the Nifty-50 index’s
CYTD performance) has been driven by and (2) expensive valuations are supported by rich
valuations of certain stocks in the private financials, consumer staples and discretionary
sectors, RIL and IT stocks.
KOTAK INSTITUTIONAL EQUITIES RESEARCH 13

RIL
INFO
TCS
HDFCB
ITC
HDFC
KMB
HUVR
BAF
MM
IIB
YES
ICICIBC
BJFIN
Aug-03
APNT
TECHM
Aug-04
AXSB
HCLT
Aug-05
SUNP
IHFL
TTAN
Aug-06
COAL
CIPLA
Aug-07
GAIL
UTCEM
LT
Aug-08
LPC
DRRD
Aug-09
EIM
ADSEZ
Aug-10
PWGR
WPRO
Z
Aug-11
SBIN
UPLL
Aug-12
NTPC
BHIN
HMCL
Aug-13
IOCL
GRASIM
Aug-14
HNDL
TATA
Aug-15
MSIL
ONGC
BJAUT
Aug-16
BPCL
HPCL
Aug-17
BHARTI
VEDL
Aug-18
TTMT
India
Strategy
Exhibit 14: Valuation of the Indian market is well above historical levels
12-m rolling forward PE of Nifty-50 Index, March fiscal year-ends, 2004-19 (X)
24
P/E (X) Avg Mean+1SD Mean-1SD
20
16
12
8
4
Source: Bloomberg, Kotak Institutional Equities
Exhibit 15: A handful of companies contributed to Nifty's CYTD18 returns
CYTD contribution of Nifty-50 Index
300
250
Index points
200
150
100
50
-
(50)
(100)
(150)
Source: Bloomberg, Kotak Institutional Equities
Despite the strong headline performance of the market with the Nifty-50 Index being up 9%
CYTD, mid-cap. and small-cap. stocks have struggled in general as also have many large-cap.
stocks (see Exhibit 16). In USD terms, the BSE mid-cap. index is down 17% CYTD and the
BSE small-cap. index down 21%. Even with the Nifty-50 Index, a few stocks have performed
extraordinarily well (up 30-60% CYTD) while a few in the downstream oil & gas and metals
& mining sectors are down sharply (20-40%). Exhibit 17 shows the diverse performance of
the constituents of the Nifty-50 Index CYTD and the stark gap in valuations.
14 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Exhibit 16: Large-caps have outperformed mid/small-caps in the past few months
Performance of various sectoral indices versus BSE-30
Auto
Capital goods
% Change 1 month
Realty
BSE Smallcap
Sensex
IT
Metal
Healthcare
O&G
BSE Midcap
Banks
FMCG
Realty
Metal
Capital goods
BSE Smallcap
Auto
% Change 3 months
BSE Midcap
O&G
Sensex
Banks
FMCG
Healthcare
IT
(2) 0 2 4 6 8
Realty
% Change 6 months
Metal
BSE Smallcap
Capital goods
O&G
Auto
BSE Midcap
Healthcare
Banks
Sensex
FMCG
IT
(20) (15) (10) (5) 0 5 10 15 20 25 30
(10) (5) 0 5 10 15
% Change YTD
Realty
Metal
BSE Smallcap
Auto
BSE Midcap
O&G
Capital goods
Healthcare
Banks
Sensex
FMCG
IT
(30) (20) (10) 0 10 20 30 40
Source: Bloomberg, Kotak Institutional Equities
KOTAK INSTITUTIONAL EQUITIES RESEARCH 15

Jun-10
Jun-10
Jun-10
Sep-10
Sep-10
Sep-10
Dec-10
Dec-10
Dec-10
Mar-11
Mar-11
Mar-11
Jun-11
Jun-11
Jun-11
Sep-11
Sep-11
Sep-11
Dec-11
Dec-11
Dec-11
Mar-12
Mar-12
Mar-12
Jun-12
Jun-12
Jun-12
Sep-12
Sep-12
Sep-12
Dec-12
Dec-12
Dec-12
Mar-13
Mar-13
Mar-13
Jun-13
Jun-13
Jun-13
Sep-13
Sep-13
Sep-13
Dec-13
Dec-13
Dec-13
Mar-14
Mar-14
Mar-14
Jun-14
Jun-14
Jun-14
Sep-14
Sep-14
Sep-14
Dec-14
Dec-14
Dec-14
Mar-15
Mar-15
Mar-15
Jun-15
Jun-15
Jun-15
Sep-15
Sep-15
Sep-15
Dec-15
Dec-15
Dec-15
Mar-16
Mar-16
Mar-16
Jun-16
Jun-16
Jun-16
Sep-16
Sep-16
Sep-16
Dec-16
Dec-16
Dec-16
Mar-17
Mar-17
Mar-17
Jun-17
Jun-17
Jun-17
Sep-17
Sep-17
Sep-17
Dec-17
Dec-17
Dec-17
Mar-18
Mar-18
Mar-18
Jun-18E
Jun-18E
Jun-18E
Jun-18A
Jun-18A
Jun-18A
India
Strategy
1QFY19 RESULTS ANALYSIS: BETTER THAN EXPECTATIONS
1QFY19 net profits of the KIE universe increased 12.5% yoy, led by double-digit growth in net income of
almost every sector helped by the low base of 1QFY18. Net income of the KIE universe came in 14.4% ahead
of our expectation, led by better-than-expected results of banks, especially of PSU banks, which reported
lower-than-expected losses. Net profits of the BSE-30 Index and Nifty-50 Index grew 0.6% (3.1% below
estimates) and 12.3% (2% ahead of estimates).
1QFY19 results: Net profits of the BSE-30 Index increased 0.6% yoy
Exhibit 45 presents the quarterly trend in earnings growth of the BSE-30 Index.
Adjusted net profits of the BSE-30 Index increased 0.6% yoy versus our expectation of 3.8%
yoy increase. Adjusted net profits of the Nifty-50 Index increased 12.3% yoy versus our
expectation of 10.1% yoy increase. However, excluding banking stocks, net income of the
BSE-30 Index and Nifty-50 Index increased 17.4% yoy and 27% yoy. High credit costs and
provisions in case of Axis Bank, ICICI Bank and SBI dragged the yoy performance of BSE-30
Index and Nifty-50 Index.
Exhibit 45: 1QFY19 adjusted net profits of the BSE-30 Index increased 0.6% yoy versus our expectations of 3.8% increase
Adjusted net income growth of BSE-30 Index (%)
40
BSE-30 Index earnings growth (%)
30
20
10
0
9.2
3.8 0.6
(10)
(20)
(9.8)
50
BSE-30 Index earnings growth ex-energy (%)
40
30
20
10
0
(5.1) (7.2)
(10)
50
BSE-30 Index earnings growth ex-energy, ex-banks (%)
40
30
20
10
18.3
12.5
0
(10)
(20)
(30)
Source: Kotak Institutional Equities estimates
36 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Net profits versus expectations for BSE-30 Index and Nifty-50 Index. Exhibit 46
compares 1QFY19 adjusted net profits of the BSE-30 stocks with 1QFY18, 4QFY18 and
1QFY19E adjusted net profits while Exhibit 47 compares 1QFY19 adjusted net profits of
the Nifty-50 Index with 1QFY18, 4QFY18 and 1QFY19E adjusted net profits.
Exhibit 46: 1QFY19 results of the BSE-30 Index were below expectations
Comparison of 1QFY19 net income of BSE-30 stocks, actual versus expected
Adjusted net income (Rs bn) Change (%)
Growth (%)
Company Sector Jun-17 Mar-18 Jun-18A Jun-18E A versus E yoy qoq 2y CAGR
Bajaj Auto Automobiles 9.5 10.8 11.2 12.5 (10) 18 3 7
Hero Motocorp Automobiles 9.1 9.7 9.1 10.1 (10) (1) (6) 1
Mahindra & Mahindra Automobiles 7.5 11.2 12.6 11.4 11 67 12 25
Maruti Suzuki Automobiles 15.6 18.8 19.8 24.0 (18) 27 5 15
Tata Motors Automobiles 2.1 30.2 (12.0) (5.1) (134) (681) (140) NM
Axis Bank Banking 13.1 (21.9) 7.0 0.2 4,021 (46) 132 (33)
HDFC Banking 14.2 28.5 21.9 22.5 (3) 54 (23) 8
HDFC Bank Banking 38.9 48.0 46.0 46.9 (2) 18 (4) 19
ICICI Bank Banking 20.5 10.2 (1.2) 0.4 (402) (106) (112) NM
IndusInd Bank Banking 8.4 9.5 10.4 10.0 4 24 9 25
Kotak Mahindra Bank Banking 13.5 17.9 15.7 15.2 4 17 (12) 21
State Bank of India Banking 20.1 (77.2) (48.8) (52.6) 7 (343) 37 NM
Yes Bank Banking 9.7 11.8 12.6 12.0 5 31 7 31
Asian Paints Consumers 4.2 4.8 5.6 5.4 3 31 16 2
Hindustan Unilever Consumers 12.9 14.1 15.7 16.4 (4) 21 11 18
ITC Consumers 25.6 29.3 28.2 27.3 3 10 (4) 9
ONGC Energy 38.8 59.2 61.4 70.0 (12) 58 4 20
Reliance Industries Energy 80.2 94.4 94.6 95.0 (0) 18 0 15
L&T Industrials 8.9 31.7 12.1 11.4 6 36 (62) 41
Adani Ports and SEZ Infrastructure 7.7 9.3 6.9 7.7 (10) (10) (25) (8)
Coal India Metals & Mining 23.5 12.9 37.8 30.2 25 61 192 11
Tata Steel Metals & Mining 15.4 32.6 22.8 32.4 (30) 49 (30) 168
Vedanta Metals & Mining 15.3 24.2 15.3 25.1 (39) 1 (37) 58
Sun Pharmaceuticals Pharmaceuticals 5.3 10.5 9.8 8.9 11 87 (6) (31)
Infosys Technology 34.8 36.9 36.1 37.1 (3) 4 (2) 3
TCS Technology 59.5 69.0 73.4 69.5 6 23 6 8
Wipro Technology 20.8 18.0 21.2 20.0 6 2 18 2
Bharti Airtel Telecom 4.1 4.1 (5.4) (4.5) (20) (232) (232) NM
NTPC Utilities 26.2 25.4 25.9 27.5 (6) (1) 2 5
Power Grid Utilities 19.8 18.5 22.4 20.5 9 13 21 12
BSE-30 Index 585 602 588 607 (3.1) 0.6 (2.3) 1.1
BSE-30 Index (ex-energy) 466 449 432 442 (2.3) (7.2) (3.7) (3.2)
BSE-30 Index (ex-banks) 447 576 525 553 (5.1) 17.4 (8.9) 7.1
BSE-30 Index (ex-banks, energy) 328 422 369 388 (4.9) 12.5 (12.7) 3.5
Notes:
(a) Kotak Mahindra Bank is not under KIE coverage. We used consensus estimates.
Source: Bloomberg, Companies, Kotak Institutional Equities estimates
KOTAK INSTITUTIONAL EQUITIES RESEARCH 37

India
Strategy
Exhibit 47: 1QFY19 results of the Nifty-50 Index were moderately above estimates led by the strong performance of the downstream oil
stocks (large adventitious gains)
Comparison of 1QFY19 net income of Nifty-50 stocks, actual versus expected
Adjusted net income (Rs bn) Change (%)
Growth (%)
Company Sector Jun-17 Mar-18 Jun-18A Jun-18E A versus E yoy qoq 2y CAGR
Bajaj Auto Automobiles 9.5 10.8 11.2 12.5 (10) 18 3 7
Eicher Motors Automobiles 4.6 6.5 5.8 6.0 (3) 25 (11) 24
Hero Motocorp Automobiles 9.1 9.7 9.1 10.1 (10) (1) (6) 1
Mahindra & Mahindra Automobiles 7.5 11.2 12.6 11.4 11 67 12 25
Maruti Suzuki Automobiles 15.6 18.8 19.8 24.0 (18) 27 5 15
Tata Motors Automobiles 2.1 30.2 (12.0) (5.1) (134) (681) (140) NM
Axis Bank Banking 13.1 (21.9) 7.0 0.2 4,021 (46) 132 (33)
Bajaj Finance Banking 6.0 7.2 10.2 8.2 25 69 41 55
Bajaj Finserv Banking 5.8 6.9 8.3 7.7 7 41 20 24
HDFC Banking 14.2 28.5 21.9 22.5 (3) 54 (23) 8
HDFC Bank Banking 38.9 48.0 46.0 46.9 (2) 18 (4) 19
ICICI Bank Banking 20.5 10.2 (1.2) 0.4 (402) (106) (112) NM
Indiabulls Housing Finance Banking 7.9 10.3 10.5 9.4 12 34 2 29
IndusInd Bank Banking 8.4 9.5 10.4 10.0 4 24 9 25
Kotak Mahindra Bank Banking 13.5 17.9 15.7 15.2 4 17 (12) 21
State Bank of India Banking 20.1 (77.2) (48.8) (52.6) 7 (343) 37 NM
Yes Bank Banking 9.7 11.8 12.6 12.0 5 31 7 31
Grasim Industries Cement 3.5 5.9 6.4 5.1 25 85 9 42
Ultratech Cement Cement 8.9 7.1 6.0 5.8 2 (33) (16) (12)
Asian Paints Consumers 4.2 4.8 5.6 5.4 3 31 16 2
Hindustan Unilever Consumers 12.9 14.1 15.7 16.4 (4) 21 11 18
ITC Consumers 25.6 29.3 28.2 27.3 3 10 (4) 9
Titan Company Consumers 2.8 3.4 3.5 3.7 (5) 26 4 36
BPCL Energy 7.4 26.7 22.9 18.5 24 208 (14) (6)
GAIL (India) Energy 9.0 9.9 12.6 10.2 23 40 27 22
HPCL Energy 9.2 17.5 17.2 13.7 25 86 (2) (9)
IOCL Energy 26.7 51.7 68.3 50.1 36 156 32 (9)
ONGC Energy 38.8 59.2 61.4 70.0 (12) 58 4 20
Reliance Industries Energy 80.2 94.4 94.6 95.0 (0) 18 0 15
L&T Industrials 8.9 31.7 12.1 11.4 6 36 (62) 41
Adani Ports and SEZ Infrastructure 7.7 9.3 6.9 7.7 (10) (10) (25) (8)
Zee Entertainment Enterprises Media 3.1 3.9 3.5 3.8 (8) 12 (12) 2
Coal India Metals & Mining 23.5 12.9 37.8 30.2 25 61 192 11
Hindalco Industries Metals & Mining 3.9 3.8 4.1 5.6 (27) 5 10 19
Tata Steel Metals & Mining 15.4 32.6 22.8 32.4 (30) 49 (30) 168
Vedanta Metals & Mining 15.3 24.2 15.3 25.1 (39) 1 (37) 58
UPL Others 4.4 9.3 5.1 4.7 8 14 (45) 15
Cipla Pharmaceuticals 4.1 1.5 4.5 3.2 38 9 191 14
Dr Reddy's Laboratories Pharmaceuticals 0.6 3.0 4.6 3.1 48 672 51 90
Lupin Pharmaceuticals 3.6 4.0 2.0 3.5 (42) (44) (50) (52)
Sun Pharmaceuticals Pharmaceuticals 5.3 10.5 9.8 8.9 11 87 (6) (31)
HCL Technologies Technology 21.7 22.3 24.0 22.3 8 11 8 8
Infosys Technology 34.8 36.9 36.1 37.1 (3) 4 (2) 3
TCS Technology 59.5 69.0 73.4 69.5 6 23 6 8
Tech Mahindra Technology 8.0 12.2 9.0 8.7 4 13 (26) 10
Wipro Technology 20.8 18.0 21.2 20.0 6 2 18 2
Bharti Airtel Telecom 4.1 4.1 (5.4) (4.5) (20) (232) (232) NM
Bharti Infratel Telecom 6.6 6.6 6.4 6.2 3 (4) (3) (8)
NTPC Utilities 26.2 25.4 25.9 27.5 (6) (1) 2 5
Power Grid Utilities 19.8 18.5 22.4 20.5 9 13 21 12
Nifty-50 Index 733 822 823 807 2.0 12.3 0.1 1.1
Nifty-50 Index (ex-energy) 561 563 546 549 (0.6) (2.8) (3.0) (0.7)
Nifty-50 Index (ex-banks) 575 771 730 727 0.5 27.0 (5.3) 4.3
Nifty-50 Index (ex-banks, energy) 403 512 453 469 (3.4) 12.4 (11.4) 3.9
Notes:
(a) Indiabulls Housing Finance and Kotak Mahindra Bank in Nifty-50 Index are not under KIE coverage. We have used consensus estimates.
Source: Bloomberg, Companies, Kotak Institutional Equities estimates
38 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Among Nifty-50 Index stocks that outperformed our estimates at the net income level
were: (1) Axis Bank, (2) BPCL, HPCL and IOCL (large adventitious gains), (3) Cipla (higher
other income), (4) DRRD (higher gross margin, lower-than-expected R&D, lower tax) and
(5) M&M (lower-than-expected other expenses).
On the other hand, a few stocks underperformed our estimates: (1) Bharti Airtel, (2) ICICI
Bank (high provisions), (3) Lupin (sharp decline in the US revenues due to competitive
pressures, market changes and lack of specific market opportunities), (4) Maruti Suzuki
(higher-than-expected increase in other expenses), (5) ONGC (decline in other income and
a higher tax rate), (6) Tata Motors (weaker-than-expected performance of JLR led by onetime
de-stocking in China and higher-than-expected hedge and forex losses) and (7)
Vedanta (lower zinc volumes, forex losses)
EBITDA in line with our expectations. Adjusted EBITDA of the BSE-30 Index increased
27.8% yoy versus our expectations of 26.8% yoy increase. The strong yoy growth reflects
(1) low base in 1QFY18 in the case of several domestic consumption sectors and (2)
higher commodity prices and profitability (oil & gas sector). Exhibit 48 compares 1QFY19
EBITDA of the BSE-30 Index with 1QFY18, 4QFY18 and 1QFY19E EBITDA. Out of the 22
non-finance companies in the BSE-30 Index, six companies beat our estimates by more
than 5% but six companies missed our EBITDA estimates by more than 5%.
Exhibit 48: 1QFY19 EBITDA of the BSE-30 Index was in line with estimates
Comparison of 1QFY19 EBITDA of BSE-30 stocks, actual versus expected
Adjusted EBITDA (Rs bn) Change (%) Growth (%)
Company Sector Jun-17 Mar-18 Jun-18A Jun-18E A versus E yoy qoq
Bajaj Auto Automobiles 9.4 13.2 12.8 15.1 (15) 37 (3)
Hero Motocorp Automobiles 13.0 13.7 13.8 14.3 (4) 6 0
Mahindra & Mahindra Automobiles 14.3 19.9 21.1 20.3 4 47 6
Maruti Suzuki Automobiles 23.3 30.2 33.5 35.8 (6) 44 11
Tata Motors Automobiles 49.6 108.9 54.3 58.7 (7) 9 (50)
Asian Paints Consumers 6.7 8.4 8.7 8.3 5 31 4
Hindustan Unilever Consumers 18.7 20.5 22.5 23.5 (4) 21 10
ITC Consumers 37.5 41.4 42.0 40.1 5 12 1
ONGC Energy 98.8 113.8 147.3 155.7 (5) 49 29
Reliance Industries Energy 125.5 184.7 206.6 187.7 10 65 12
L&T Industrials 20.6 53.9 29.1 24.5 19 42 (46)
Adani Ports and SEZ Infrastructure 15.7 19.3 15.9 14.1 13 1 (18)
Coal India Metals & Mining 27.6 (16.0) 40.7 36.6 11 47 354
Tata Steel Metals & Mining 49.7 65.0 64.7 73.6 (12) 30 (0)
Dr Reddy's Laboratories Pharmaceuticals 3.1 5.5 7.6 6.9 9 148 37
Sun Pharmaceuticals Pharmaceuticals 11.0 16.8 16.1 15.2 6 47 (5)
Infosys Technology 45.6 49.3 49.7 49.9 (0) 9 1
TCS Technology 74.1 86.5 90.7 89.1 2 22 5
Wipro Technology 26.9 25.1 25.0 27.5 (9) (7) (0)
Bharti Airtel Telecom 77.6 69.3 67.3 65.7 2 (13) (3)
NTPC Utilities 50.4 59.1 59.5 58.8 1 18 1
Power Grid Utilities 62.0 65.2 71.4 70.5 1 15 9
BSE-30 Index 861 1,054 1,100 1,092 0.8 27.8 4.4
BSE-30 Index (ex-energy) 637 755 746 749 (0.3) 17.2 (1.2)
Source: Companies, Kotak Institutional Equities estimates
We do the same exercise for the Nifty-50 Index in Exhibit 49. For the Nifty-50 Index,
adjusted EBITDA increased 35%, 3.7% ahead of expectation. Of the 39 non-finance
companies in the Nifty-50 Index, 13 beat our estimates by more than 5%, while 10
missed our EBITDA estimates by more than 5%.
KOTAK INSTITUTIONAL EQUITIES RESEARCH 39

India
Strategy
Exhibit 49: 1QFY19 EBITDA was ahead of estimates
Comparison of 1QFY19 EBITDA of Nifty-50 stocks, actual versus expected
Adjusted EBITDA (Rs bn) Change (%) Growth (%)
Company Sector Jun-17 Mar-18 Jun-18A Jun-18E A versus E yoy qoq
Bajaj Auto Automobiles 9.4 13.2 12.8 15.1 (15) 37 (3)
Eicher Motors Automobiles 6.2 8.0 8.1 8.0 1 30 2
Hero Motocorp Automobiles 13.0 13.7 13.8 14.3 (4) 6 0
Mahindra & Mahindra Automobiles 14.3 19.9 21.1 20.3 4 47 6
Maruti Suzuki Automobiles 23.3 30.2 33.5 35.8 (6) 44 11
Tata Motors Automobiles 49.6 108.9 54.3 58.7 (7) 9 (50)
Grasim Industries Cement 5.6 8.4 10.5 8.4 26 90 25
Ultratech Cement Cement 15.6 17.0 16.2 15.5 5 4 (5)
Asian Paints Consumers 6.7 8.4 8.7 8.3 5 31 4
Hindustan Unilever Consumers 18.7 20.5 22.5 23.5 (4) 21 10
ITC Consumers 37.5 41.4 42.0 40.1 5 12 1
Titan Company Consumers 3.9 4.6 5.0 5.3 (6) 27 9
BPCL Energy 12.3 37.2 38.8 29.6 31 216 4
GAIL (India) Energy 17.0 17.0 22.4 18.6 21 32 32
HPCL Energy 16.3 29.2 31.9 25.7 24 96 9
IOCL Energy 51.9 106.5 125.8 94.4 33 142 18
ONGC Energy 98.8 113.8 147.3 155.7 (5) 49 29
Reliance Industries Energy 125.5 184.7 206.6 187.7 10 65 12
L&T Industrials 20.6 53.9 29.1 24.5 19 42 (46)
Adani Ports and SEZ Infrastructure 15.7 19.3 15.9 14.1 13 1 (18)
Zee Entertainment Enterprises Media 4.8 5.1 5.7 5.8 (2) 17 12
Coal India Metals & Mining 27.6 (16.0) 40.7 36.6 11 47 354
Hindalco Industries Metals & Mining 11.5 12.6 13.3 15.5 (15) 15 5
Tata Steel Metals & Mining 49.7 65.0 64.7 73.6 (12) 30 (0)
Vedanta Metals & Mining 48.7 78.4 62.8 66.8 (6) 29 (20)
UPL Others 7.5 12.2 8.5 8.3 1 13 (30)
Cipla Pharmaceuticals 6.5 5.6 7.3 7.0 4 12 30
Dr Reddy's Laboratories Pharmaceuticals 3.1 5.5 7.6 6.9 9 148 37
Lupin Pharmaceuticals 7.7 7.1 5.3 8.0 (34) (31) (26)
Sun Pharmaceuticals Pharmaceuticals 11.0 16.8 16.1 15.2 6 47 (5)
HCL Technologies Technology 26.8 30.4 32.3 31.1 4 20 6
Infosys Technology 45.6 49.3 49.7 49.9 (0) 9 1
TCS Technology 74.1 86.5 90.7 89.1 2 22 5
Tech Mahindra Technology 9.3 14.1 13.6 12.9 5 45 (4)
Wipro Technology 26.9 25.1 25.0 27.5 (9) (7) (0)
Bharti Airtel Telecom 77.6 69.3 67.3 65.7 2 (13) (3)
Bharti Infratel Telecom 15.8 15.9 15.2 15.5 (2) (4) (5)
NTPC Utilities 50.4 59.1 59.5 58.8 1 18 1
Power Grid Utilities 62.0 65.2 71.4 70.5 1 15 9
Nifty-50 Index 1,128 1,463 1,523 1,468 3.7 35.0 4.1
Nifty-50 Index (ex-energy) 807 975 950 957 (0.7) 17.8 (2.5)
Source: Companies, Kotak Institutional Equities estimates
Many of the companies in the Nifty-50 Index outperformed at the EBITDA level. Among
the notable outperformers were (1) BPCL and HPCL (large adventitious gains versus large
adventitious losses in 1QFY18), (2) DRRD (higher gross margin, lower R&D expenses), (3)
RIL (sharp increase in petrochemical contribution) and (4) L&T (margin improvement).
Among the companies that missed were (1) Bajaj Auto (led by deterioration in the product
mix and increase in discounts), (2) Hindalco (higher-than-expected alumina transfer price
from Utkal Alumina resulted in lower EBITDA of standalone company), (3) Lupin (sharp
decline in the US business) and (4) Tata Motors (lower-than-expected results at JLR).
Reported net income of the Nifty-50 Index increased 5.9% yoy and 6.1% qoq.
Exhibit 50 shows the reported net income of the Nifty-50 Index for 1QFY18, 4QFY18 and
1QFY19. A few companies had large extraordinary items in 1QFY19. (1) Adani Ports
booked forex MTM loss of `3.8 bn in 1QFY19 on US$-denominated loans as per Ind-AS
prescription, (2) Bharti Airtel had exceptional items of `6.4 bn for network re-farming and
up-gradation program, levies and taxes pertaining to internal restructuring and litigationrelated
assessment and integration-related cost, (3) Tata Motors reported forex losses
related to revaluation of current assets and liabilities (working capital) and (4) Tata Steel
reported `3.7 bn of forex losses at its SE Asian operations.
40 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Strategy
India
Exhibit 50: Reported net income of the BSE-30 Index increased 5.9% yoy and declined 6.1% qoq
Comparison of 1QFY19 reported net income of Nifty-50 stocks
Reported net income (Rs bn)
Growth (%)
Company Sector Jun-17 Mar-18 Jun-18 yoy qoq
Bajaj Auto Automobiles 9.9 10.8 11.2 13 3
Eicher Motors Automobiles 4.6 4.6 5.8 25 25
Hero Motocorp Automobiles 9.1 9.7 9.1 (1) (6)
Mahindra & Mahindra Automobiles 7.5 11.5 12.6 67 9
Maruti Suzuki Automobiles 15.6 18.8 19.8 27 5
Tata Motors Automobiles 31.8 21.3 (19.0) (160) (190)
Axis Bank Banking 13.1 (21.9) 7.0 NM NM
Bajaj Finance Banking 6.0 7.2 10.2 69 41
Bajaj Finserv Banking 5.8 6.9 8.3 41 20
HDFC Banking 14.2 28.5 21.9 54 (23)
HDFC Bank Banking 38.9 48.0 46.0 18 (4)
ICICI Bank Banking 20.5 10.2 (1.2) (106) (112)
Indiabulls Housing Finance Banking 7.9 10.3 10.5 34 2
IndusInd Bank Banking 8.4 9.5 10.4 24 9
Kotak Mahindra Bank Banking 13.5 17.9 15.7 17 (12)
State Bank of India Banking 20.1 (77.2) (48.8) NM NM
Yes Bank Banking 9.7 11.8 12.6 31 7
Grasim Industries Cement 3.5 3.7 6.4 85 72
Ultratech Cement Cement 8.9 4.9 6.0 (33) 23
Asian Paints Consumers 4.3 4.8 5.6 31 16
Hindustan Unilever Consumers 12.8 13.5 15.3 19 13
ITC Consumers 25.6 29.3 28.2 10 (4)
Titan Company Consumers 2.7 2.8 3.5 31 24
BPCL Energy 7.4 26.7 22.9 208 (14)
GAIL (India) Energy 9.0 10.2 12.6 40 23
HPCL Energy 9.2 17.5 17.2 86 (2)
IOCL Energy 45.5 52.2 68.3 50 31
ONGC Energy 38.8 59.2 61.4 58 4
Reliance Industries Energy 91.1 94.4 94.6 4 0
L&T Industrials 8.9 31.7 12.1 36 (62)
Adani Ports and SEZ Infrastructure 8.2 12.1 10.1 22 (17)
Zee Entertainment Enterprises Media 2.5 2.3 3.3 30 41
Coal India Metals & Mining 23.5 12.9 37.8 61 192
Hindalco Industries Metals & Mining 2.9 3.8 4.1 43 10
Tata Steel Metals & Mining 9.2 101.9 19.5 113 (81)
Vedanta Metals & Mining 15.3 32.7 15.3 1 (53)
UPL Others 4.7 7.4 5.1 8 (31)
Cipla Pharmaceuticals 4.1 1.5 4.5 9 191
Dr Reddy's Laboratories Pharmaceuticals 0.6 3.0 4.6 672 51
Lupin Pharmaceuticals 3.6 (7.8) 2.0 (44) 126
Sun Pharmaceuticals Pharmaceuticals (4.2) 13.3 9.8 331 (26)
HCL Technologies Technology 21.7 22.3 24.0 11 8
Infosys Technology 34.8 36.9 36.1 4 (2)
TCS Technology 59.5 69.0 73.4 23 6
Tech Mahindra Technology 8.0 12.2 9.0 13 (26)
Wipro Technology 20.8 18.0 21.2 2 18
Bharti Airtel Telecom 3.7 0.8 1.0 (74) 17
Bharti Infratel Telecom 6.6 6.1 6.4 (4) 5
NTPC Utilities 26.2 29.3 25.9 (1) (12)
Power Grid Utilities 19.8 18.5 22.4 13 21
Nifty-50 Index 776 875 822 5.9 (6.1)
Source: Companies, Kotak Institutional Equities
KOTAK INSTITUTIONAL EQUITIES RESEARCH 41

India
Strategy
Exhibit 51 compares reported net income of the Nifty-50 Index with adjusted net income.
We remove extraordinary items, such as prior-period items, while computing adjusted
EBITDA and net income (adjusted for tax impact) but do not remove additional branding
costs, employee costs or foreign currency-related gains or losses. These represent normal
costs of doing business. Finally, banks reported very high loan-loss provisions over the past
few quarters pertaining to fresh impaired assets but we treat this as a normal P&L item and
anyway, P&Ls of banks are less relevant compared to their balance sheets.
Exhibit 51: Few cases of one-off items in 1QFY19
Adjusted and reported net income of the Nifty-50 stocks, 1QFY19 (Rs mn)
Net income
Company Sector Adjusted Reported Difference
Bajaj Auto Automobiles 11,152 11,152 —
Eicher Motors Automobiles 5,762 5,762 —
Hero Motocorp Automobiles 9,092 9,092 —
Mahindra & Mahindra Automobiles 12,572 12,572 —
Maruti Suzuki Automobiles 19,753 19,753 —
Tata Motors Automobiles (11,973) (19,024) (7,051)
Axis Bank Banking 7,011 7,011 —
Bajaj Finance Banking 10,180 10,180 —
Bajaj Finserv Banking 8,258 8,258 —
HDFC Banking 21,900 21,900 —
HDFC Bank Banking 46,014 46,014 —
ICICI Bank Banking (1,196) (1,196) —
Indiabulls Housing Finance Banking 10,547 10,547 —
IndusInd Bank Banking 10,357 10,357 —
Kotak Mahindra Bank Banking 15,745 15,745 —
State Bank of India Banking (48,759) (48,759) —
Yes Bank Banking 12,604 12,604 —
Grasim Industries Cement 6,426 6,426 —
Ultratech Cement Cement 5,984 5,984 —
Asian Paints Consumers 5,580 5,580 —
Hindustan Unilever Consumers 15,670 15,290 (380)
ITC Consumers 28,187 28,187 —
Titan Company Consumers 3,492 3,492 —
BPCL Energy 22,933 22,933 —
GAIL (India) Energy 12,593 12,593 —
HPCL Energy 17,192 17,192 —
IOCL Energy 68,313 68,311 (2)
ONGC Energy 61,439 61,439 —
Reliance Industries Energy 94,590 94,590 —
L&T Industrials 12,148 12,148 —
Adani Ports and SEZ Infrastructure 6,907 10,065 3,158
Zee Entertainment Enterprises Media 3,472 3,259 (213)
Coal India Metals & Mining 37,843 37,843 —
Hindalco Industries Metals & Mining 4,135 4,135 —
Tata Steel Metals & Mining 22,803 19,540 (3,263)
Vedanta Metals & Mining 15,330 15,330 —
UPL Others 5,091 5,100 9
Cipla Pharmaceuticals 4,456 4,456 —
Dr Reddy's Laboratories Pharmaceuticals 4,561 4,561 —
Lupin Pharmaceuticals 2,001 2,001 —
Sun Pharmaceuticals Pharmaceuticals 9,825 9,825 —
HCL Technologies Technology 24,031 24,031 —
Infosys Technology 36,120 36,120 —
TCS Technology 73,400 73,400 —
Tech Mahindra Technology 8,994 8,994 —
Wipro Technology 21,205 21,205 —
Bharti Airtel Telecom (5,363) 973 6,336
Bharti Infratel Telecom 6,380 6,380 —
NTPC Utilities 25,881 25,881 —
Power Grid Utilities 22,405 22,405 —
Source: Companies, Kotak Institutional Equities estimates
42 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Economy
ECONOMY INSIGHT August 13, 2018
The intensifying macro risks in India
Even as GDP growth is likely to surprise on the upside in FY19, we
highlight five rising macro risks which the stock market appears to be
unnaturally sanguine about. Besides the all-too-familiar risk of India’s
‘twin deficits’ raring their ugly heads, three other macro risks that need
to be watched closely are: (1) India’s household savings to GDP ratio
and financial savings to total savings ratio could dip if inflation rises,
restricting equity market inflows; (2) in the upcoming General Elections,
the NDA’s seat count could drop to sub-220 levels if the BJP is unable
to block opposition alliance formation; and (3) the assumption of power
in Pakistan by an Army-backed coalition government could translate
into structural escalation of Indo-Pak hostilities in the medium term.
GDP growth will surprise on the upside in FY19…
GDP growth in India appears set to surprise on the upside in FY19 as an
election-focused Government pulls out all stops to gratify the voter and
stimulate consumption growth (Ambit estimate is 7% for FY19 v/s 5.8% in
FY18). However, it is worth noting that the stock market seems to be more than
adequately discounting this economic buoyancy as the Sensex is currently
trading at a 37% premium to 9 EMs’ median P/E as compared to the 5-year
average of 18%. Given that the market clearly seems to be building in a bluesky
scenario for the Indian economy, we highlight 5 macro risks building up
that could precipitously affect investor appetite for Indian stocks.
…but five big macro risks are slowly but surely escalating
Over and above the risk of India’s twin deficits rising, we highlight three other
noteworthy macro risks that are currently in the making.
Firstly, India’s household savings to GDP ratio currently stands at a 20-year
low. If inflation rises hereon owing to the fiscal pump-priming, then not only
can the household savings ratio come under greater duress but worryingly the
proportion of ‘financial savings’ in total savings could fall, limiting domestic
flows into the Indian stock market.
Secondly, our work with renowned psephologist Rajeeva Karandikar suggests
that in a worst case scenario, the NDA’s seat count could dip to as low as 213
seats (vs the halfway mark of 273 seats) if the opposition is able to stitch up a
handful of clever alliances in states like Uttar Pradesh and Maharashtra whilst
the BJP on the other hand divorces its regional allies.
Lastly, over the next few years, there is a serious risk of Indo-Pak hostilities
rising structurally as a government beholden to the Pakistani army control of
the tinderbox-like state of Pakistan.
Investment implications
Even as GDP growth in FY19 will be a non-issue as the Government injects a
record fiscal stimulus, we worry that the stock market is in overvalued territory
and is perhaps allocating an unduly low weightage to the increasing macro
risks listed above. Given this scenario, we would urge investors to only invest in
Good & Clean stocks to limit downside risks. Furthermore, given the rising risk
of fiscal profligacy and given the risk of financial saving inflows slowing, we
urge investors to be cautious regarding their NBFC sector exposure.
Consumption (especially rural) and quality industrial plays (like cement and a
few road builders) could be another set of ideas to invest in.
Risk#1: A rise in inflation tends to
boosts demand for physical savings
CPI (YoY, in %)
Source: CEIC, Ambit Capital research, Note: HH
refers to households.
Risk#2: 5 key Indian states could yield
only 95 seats in a worst case scenario
in CY19 (vs 184 in CY14)
State
15%
10%
5%
0%
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
CPI (Left scale)
Total
seats
NDA
2014
NDA
Worst case
for 2019
Uttar Pradesh 80 73 35
Maharashtra 48 41 19
Andhra Pradesh 25 17 2
Gujarat 26 26 19
Madhya Pradesh 29 27 20
Total 208 184 95
Source: Rajeeva Karandikar’s estimates, Ambit
Capital research
Risk#3: India’s twin deficits likely to
deteriorate in FY19
Fiscal
deficit
Current Account
Deficit
FY15 4.1% 1.4%
FY16 3.9% 1.1%
FY17 3.5% 0.7%
FY18 3.5% 1.9%
FY19 E 3.6% 2.8%
Source: CEIC, Ambit Capital research
Research Analysts
Ritika Mankar Mukherjee, CFA
+91 22 3043 3175
ritika.mankar@ambit.co
Sumit Shekhar
+91 22 3043 3329
sumit.shekhar@ambit.co
20%
15%
10%
5%
0%
HH physical savings (Right scale)
HH physical savings
(as % of GDP)
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Economy
India trades at a record valuation relative
to peers
Even as the Sensex typically trades at a premium to peers, it is currently trading at a
higher-than-normal premium relative to Emerging Market (EM) peers. For instance,
from a 5-year average perspective, India typically traded at a premium of 18% to the
median P/E of nine EMs. However, today India trades at a whopping 37% premium to
median P/E of these 9 EMS (see exhibits below).
Exhibit 1: From a 5-year average perspective, India traded
at a premium of 23% to the median P/E of 9 EMs
Exhibit 2: Today, India trades at a whopping 56%
premium to median P/E of these 9 EMS
5yr average PE (in times)
25
20
15
10
5
0
South Africa
India
Philippines
Thailand
Malaysia
Egypt
Indonesia
China
Korea
Turkey
Median
Current PE (in times)
25
20
15
10
5
0
South Africa
India
Philippines
Thailand
Malaysia
Egypt
Indonesia
China
Korea
Turkey
Median
Source: CEIC, Bloomberg, Ambit Capital research
Source: CEIC, Bloomberg, Ambit Capital research
Note: We have used Sensex for India, Shanghai Stock exchange stocks for China, IDX for Indonesia, FTSE/JSE
for South Africa, KOSPI for Korea, Borsa Istanbul for Turkey, The Egyptian Exchange for Egypt, Bursa
Malaysia for Malaysia, Philippine Stock exchange for Philippines and The Stock exchange of Thailand for
Thailand.
In fact, by India’s own historical standards, the Sensex is richly valued. The Sensex is
currently trading at a 21% premium to its 10-year average P/E ratio (see exhibit
below).
Exhibit 3: The Sensex is currently trading at a 21% premium to its own long-term
average P/E
Sensex trailing P/E
30
26
22
18
14
10
Jul-08
Dec-08
May-09
Oct-09
Mar-10
Aug-10
Jan-11
Jun-11
Nov-11
Apr-12
Sep-12
Feb-13
Jul-13
Dec-13
May-14
Oct-14
Mar-15
Aug-15
Jan-16
Jun-16
Nov-16
Apr-17
Sep-17
Feb-18
Jul-18
Sensex traling P/E
10 yr. avg. P/E
Source: Bloomberg, Ambit Capital research
From a fundamentals perspective, the consensus is building in an earnings growth
rate of 23% YoY, which is higher than 15% YoY growth we expect for FY19 – which
also marks a 5-year high (see exhibit below).
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Economy
Exhibit 4: We expect Sensex earnings to grow at 15% YoY in FY19 as against
consensus earnings estimates of 23%
30%
24%
23%
23%
Sensexearnings growth
(YoY change, in %)
20%
10%
0%
-10%
-20%
FY08
6%
FY09
2%
FY10
11%
FY11
9%
FY12
14%
FY13
8%
FY14
FY15
FY16
-11%
4% 4%
FY17
FY18
15%
FY19 (Ambit)
FY19 (Consensus)
Source: Bloomberg, Ambit Capital research. Note: FY19 earnings estimates are that of Ambit
Even as the Sensex’s valuations clearly seem to be benefitting from record investor
optimism, it is worth noting that with the exception of India’s GDP growth, several
macro variables are precariously poised. Besides the well-known risk associated with
India’s twin deficits flaring up in a pre-General Election year, in this note we highlight
three sets of unexpected macro risks that need to be closely watched as they have the
potential of damaging investor appetite for Indian equities.
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Economy
The 5 big macro risks confronting India
Over and above the risk of India’s twin deficits rising, we highlight three other
noteworthy macro risks that are currently in the making.
• Macro risk#1: A structural rise in inflation (owing to an aggressive fiscal
stimulus) could cause Indian households’ savings to GDP ratio to dip to
dangerously low levels. Moreover, there tends to be a strong negative correlation
between the inflation rate and the allocation made by households to financial
asset classes. The combination of these forces (of savings ratio continuing to
decline and proportion of financial savings falling) could jeopardize the buoyant
financial savings flows which have been supporting the Indian stock market.
• Macro risk#2: Our work with renowned psephologist Rajeeva Karandikar
suggests that the top 7 Indian States that together yielded a whopping 226 seats
to the NDA in the 2014 General Elections could end up delivering only 126 seats
if the BJP is unable to block opposition alliance formation and itself walks out of
marriages with regional partners.
• Macro risk#3: The assumption of power in Pakistan by an army-backed coalition
government could translate into the escalation of Indo-Pak as well as Sino-Pak
hostilities in more ways than one.
• Macro risk#4 & 5: The rise in India’s twin deficits (fiscal and current account)
could pose a risk to the nascent recovery.
In the subsequent section, we elaborate on these five risk factors.
Macro risk#1: Can India’s financial savings deluge continue ad infinitum?
“We are not to judge thrift solely by the test of saving or spending. If one spends what
he should prudently save, that certainly is to be deplored. But if one saves what he
should prudently spend, that is not necessarily to be commended. A wise balance
between the two is the desired end.”
-Owen D. Young, American industrialist,
businessman, lawyer and diplomat
India has experienced a financial savings deluge over the last 2 years as Indian
households steadily increased the allocation of financial savings in total savings. Even
as the ratio of financial savings has been rising steadily in Indian households’ pie by
an average of 70bps per annum over FY02-17, this rate shot up to 180bps per
annum over FY12-17 (see exhibit below).
Exhibit 5: The ratio of financial savings to total savings rose to an unprecedented
level of 62% in FY16
Ratio of financial savings to
physcial savings (in%)
65%
60%
55%
50%
45%
40%
45% 45%
48%
FY02
FY03
FY04
43%
FY05
50%
49%
52%
FY06
FY07
FY08
43%
FY09
48%
FY10
48%
45%
43%
FY11
FY12
FY13
52% 52%
62%
FY14
FY15
FY16
57%
FY17
Source: CEIC, Ambit Capital research.
These increased financial savings have translated into a dramatic rise in flows into the
financial system (see exhibits below).
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Economy
Exhibit 6: All sorts of financial assets began attracting more flows between FY12-17
Change in financial assets
(as % of GDP)
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
FY12 FY13 FY14 FY15 FY16 FY17
8%
6%
4%
2%
0%
Change in bank deposits
(as % of GDP)
Life insurance fund
Shares & debentures
Provident and pension fund
Bank deposits (Right scale)
Source: RBI, Ambit Capital research.
As is well known, concomitantly the flow of savings into physical assets abated rapidly
(see exhibit below).
Exhibit 7: Households shunned real estate as an asset class
Exhibit 8: Gold as an asset class also lost attractiveness
2.0%
1.8%
3.5%
Value of new projects in
real estate (as % of GDP)
1.6%
1.2%
0.8%
0.4%
0.0%
0.9%
0.6%
0.4%
0.3%
0.1% 0.2% 0.1%
3.0%
2.5%
2.0%
1.5%
1.0%
3.1%
2.9%
2.4%
2.1%
1.5% 1.7% 1.5%
1.2% 1.3%
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY10
FY11
FY12
FY13
FY14
FY15
FY16
Value of Gold imports
(as % of GDP)
FY17
FY18
Source: CMIE, Ambit Capital research.
Source: CEIC, Ambit Capital research.
Even as this re-allocation away from physical savings and towards financial savings is
popularly attributed to the Modi-led Government’s crackdown on black money, it is
worth noting that historically in India there has existed a strong positive correlation
between the inflation rate and the ratio of physical savings in total savings.
For instance, during the period of high inflation spanning FY05-13, households
allocated more funds to physical assets potentially to hedge against inflation to rising
prices (see exhibit below).
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Economy
Exhibit 9: Whilst rising inflation tends to boost demand for
physical savings…
Exhibit 10: …falling inflation tends to boost demand for
financial savings
CPI (YoY, in %)
16%
12%
8%
4%
0%
20%
15%
10%
5%
0%
HH physical savings
(as % of GDP)
CPI (YoY, in %)
12%
8%
4%
0%
20%
15%
10%
5%
0%
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
HH physical savings
(as % of GDP)
FY12
FY13
FY14
FY15
FY16
FY17
Source: CEIC, RBI, Ambit Capital research
CPI (Left scale)
HH physical savings (Right scale)
CPI (Left scale)
HH physical savings (Right scale)
Source: CEIC, RBI, Ambit Capital research
Conversely, when inflation began cooling over FY14-17, households began allocating
lesser savings to physical assets (see exhibit above).
In fact, even cross-country evidence suggests that households tend to favour physical
savings during periods of high/rising inflation and then favour financial savings
during periods of low/falling inflation (see exhibit below).
Exhibit 11: Cross-country suggests that physical savings rise as inflation rises, whilst financial savings tend to rise when
inflation falls
Paper
Key relevant finding
Savings, Financial Development and
Economic Growth in the Arab Republic of
Egypt Revisited (World Bank, April 2017)
Private saving in India (World Bank, 1998)
Inflation, Uncertainty, and Saving Behavior
since the Mid-1950s (NBER, October
1977)
Inter-relationship between economic
growth, savings and inflation in Asia (IIM
Ahmedabad, July 2008)
Source: Various Academic publications, Ambit Capital research
“Inflation brings about ample uncertainty in future income streams and can thus lead to higher
saving on the basis of precautionary grounds. This may be particularly true for households in
developing countries whose income prospects are much more uncertain than their counterparts in developed
countries. Second, inflation could influence saving through its impact on real wealth. If consumers attempt to
maintain a target level of wealth or liquid assets relative to income, saving will rise with inflation.”
“Inflation is included as a proxy for uncertainty in financial markets. It also represents in some
sense the real rate of return on household physical saving. The positive coefficients on these variables
suggest that saving increases in response to greater uncertainty in financial markets (precautionary motive),
deeper (and more diversified) financial intermediaries, and larger rates of return (which implies that the
substitution effect outweighs the income effect of an interest rate rise).”
Inflation is viewed as an undesirable phenomenon, and its presence is associated with increased pessimism
about economic conditions, which may lead to increased saving for precautionary reasons. Thus, inflation is
a proxy for attitudes about economic conditions, particularly uncertainty. This hypothesis is unsatisfactory,
however, because it relies upon a tenuous psychological link between inflation and uncertainty to explain
the increase in saving in inflationary times
In the wake of high inflation, households direct their savings from financial to physical assets and consumer
durables, then due to consumption associated with these consumer durables, present savings will decline.
Also, due to increased uncertainty, the utility from holding wealth declines leading to increased consumption
and decreased savings.
Thus, if inflation were to rise over the next few years - as is forecasted by RBI’s survey
of professional forecasters as well (see exhibit below) and as is expected by Indian
households (see exhibit below) - then the trend seen so far of rising financial savings
could halt or in a worst case undergo a mild reversal.
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Economy
Exhibit 12: Inflation is likely to trend upwards as per RBI’s
survey of forecasters
Exhibit 13: Consumers expect inflation to rise going
forward
CPI forecast
(RBI's professional
forecasters survey)
5.2%
4.8%
4.4%
4.7%
4.3%
4.8%
5.1%
CPI expectation (in %)
12%
10%
8%
6%
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
Nov-17
Dec-17
Jan-18
Feb-18
Mar-18
Apr-18
May-18
Jun-18
4.0%
2QFY19 3QFY19 4QFY19 1QFY20
Current
1 Year ahead
3 months ahead
Source: RBI, Ambit Capital research
Source: RBI, Ambit Capital research
In fact history also suggests that Indian households’ savings to GDP ratio tends to fall
when unemployment rises (see exhibits below).
Exhibit 14: Low employment growth is accompanied by a decline in the households
savings ratio
Employment CAGR (in %)
3%
2%
1%
0%
FY94-00
FY00-05
FY05-10
FY10-12
6%
4%
2%
0%
-2%
Change in HH savings to
GDP (in %)
Source: NSSO, CEIC, Ambit Capital research
Employment CAGR (Left scale)
Change in HH savings to GDP (Right scale)
With India’s household savings to GDP ratio already being at a 20-year low (see
exhibit below), the deterioration of the employment situation and/or a rise in inflation
situation could jeopardise the savings ratio itself.
Exhibit 15: India’s household savings ratio currently stands at a 20-year low of 16%
30%
25%
HH savings
(as % of GDP)
20%
15%
10%
5%
0%
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Total HH savings HH Financial savings HH Physical savings
Source: CEIC, Ambit Capital research, Note: HH stands for Households.
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Economy
The above stated dynamics assume importance given that the Indian market has
been able to sustain its steep valuations only owing to the support extended by
Domestic Institutional Investors (DIIs) even as India has fallen out of favour with
Foreign Institutional Investors (FIIs) (see exhibit below).
Exhibit 16: The recent rally in the stock markets have been driven by DIIs rather than the FIIs
100,000
80,000
60,000
40,000
20,000
-
(20,000)
Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18
FII/FPI Investment in Equity - 6m aggregate
Domestic MF Investment in Equity - 6m aggregate
Nifty Midcap P/B
BSE Smallcap P/B
3.5
3.0
2.5
2.0
1.5
1.0
0.5
-
Source: Bloomberg, AMFI, Ambit Capital research.
The above dynamics of financial savings flows abating can said to be already playing
out in FY19 YTD as compared to FY12-17 as evident from equity inflows, bank
deposits growth and SIP flows moderating over FY18-19 (see exhibit below).
Exhibit 17: After the deluge spanning FY12-17, flows into
bank deposits and equity markets moderated in FY18-19
Exhibit 18: In fact even SIP equity flows have started
moderating
Bank deposits
(as % of GDP)
72%
70%
68%
66%
FY13
FY14
FY15
FY16
FY17
FY18
FY19 YTD
1.8%
1.2%
0.6%
0.0%
-0.6%
Net equity inflows
(as % of GDP)
Net equity inflows
(3M avg., INRbn)
300
250
200
150
100
50
-
Jun-16
Sep-16
Dec-16
Mar-17
Jun-17
Sep-17
Dec-17
Mar-18
Jun-18
25%
20%
15%
10%
5%
0%
SIP as % of inflows
(3M moving avg, in%)
Bank deposits (Left scale)
Net equity inflows (Left scale)
Equity inflows (Right scale)
SIP (Right scale)
Source: CEIC, AMFI, Ambit Capital research
Source: AMFI, Ambit Capital research
The quantification – The household financial savings pool could be lesser by
1.8% of GDP if this risk plays out
In the section below we have simulated two scenarios (best case and the base case)
to estimate the ratio of net financial savings to physical savings by FY22. Whilst the
base case that is more realistic and plausible, the best case is what the market seems
to be assuming is the base case. This analysis suggests that if the base case was to
pan out then it would yield financial savings flows that are lesser to the tune of 1.8%
of GDP as compared to the best case.
The best case is premised on trends from FY12-17 continuing over FY17-22
Between FY12 and FY17, the ratio of net financial savings to total savings shot up 11
percentage points to 42%. The market seems to believe that the trends from FY12-17
will seamlessly continue with the same force over FY17-22. In such a scenario, the
net financial savings to total savings ratio is assumed to rise to f 56% by FY22 as
against 42% in FY17 (see exhibit below).
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Economy
Exhibit 19: In a best case scenario ratio of net financial savings to total savings will rise to 56% by FY22
The case that the market is working
FY12 FY13 FY14 FY15 FY16 FY17 FY18 (E) FY19 (E) FY20(E) FY21 (E) FY22 (E)
with : Best case (INR tn)
Gross savings 20.7 22.4 22.9 24.4 24.5 24.8 25.7 26.7 27.7 28.8 29.8
Financial savings 9.3 10.6 11.9 12.6 15.2 14.0 15.3 16.7 18.2 19.8 21.6
Financial liabilities 2.9 3.3 3.6 3.8 3.9 3.7 4.0 4.2 4.4 4.6 4.9
Net financial savings 6.4 7.3 8.3 8.8 11.3 10.3 11.4 12.5 13.8 15.2 16.7
Physical savings 14.2 15.0 14.5 15.6 13.2 14.5 14.4 14.2 13.9 13.6 13.1
Net financial savings ratio to total
savings (in %)
31% 33% 36% 36% 46% 42% 44% 47% 50% 53% 56%
Nominal GDP 87 99 112 125 138 153 171 191 213 238 266
Net financial savings to GDP (in %) 7.4% 7.4% 7.4% 7.1% 8.2% 6.8% 6.7% 6.6% 6.5% 6.4% 6.3%
Gross savings to GDP (in %) 24% 22% 20% 20% 18% 16% 15% 14% 13% 12% 11.2%
Memo item: Bank deposits 61.7 70.5 80.3 88.9 96.6 107.5 114.8 127.3 141.2 156.7 173.8
Source: CEIC, Ambit Capital research, Note: All data is for households and actuals are currently only available till FY17.
Exhibit 20: Assumptions underlying the best case scenario
1. Gross savings is expected to grow at the 5 year average growth rate of 3.8%
2. Financial savings is expected to grow at the 5 year average growth rate of 9%
3. Financial liabilities is expected to grow at the 5 year average growth rate of 5.4%
4. GDP is assumed to grow at the same pace of 11.8% which was recorded over FY12-17.
5. Bank deposits is expected to grow at the 5 year average growth rate of 11%
Source: Ambit Capital research
The base case scenario – With inflation rising, trends seen over FY12-17
moderate
As highlighted in the section above, the market appears to be oblivious to the fact
that the pace of the shift away from physical towards financial savings seen over
FY12-17 was unprecedented and cannot be expected to continue ad infinitum. If
inflation picks up from hereon, households will again shift towards physical assets as
far as savings are concerned.
In such a scenario, the ratio of net financial savings to total savings will increase to
just 47% instead of 56% that the best case scenario delivers (see exhibit below). This
analysis suggests that if the base case was to pan out then it would yield financial
savings flows that are lesser to the tune of 1.8% of GDP (or (US$56.6bn) as
compared to the best case.
Exhibit 21: In a base case scenario, past trends regarding the pace of growth of financial savings are assumed to moderate
The realistic case that the market should
work with : Base case (INR tn)
FY12 FY13 FY14 FY15 FY16 FY17 FY18 (E) FY19 (E) FY20(E) FY21 (E) FY22 (E)
Gross savings 20.7 22.4 22.9 24.4 24.5 24.8 25.3 25.8 26.3 26.9 27.4
Financial savings 9.3 10.6 11.9 12.6 15.2 14.0 14.5 15.1 15.6 16.2 16.7
Financial liabilities 2.9 3.3 3.6 3.8 3.9 3.7 3.8 3.8 3.8 3.9 3.9
Net financial savings 6.4 7.3 8.3 8.8 11.3 10.3 10.8 11.3 11.8 12.3 12.8
Physical savings 14.2 15.0 14.5 15.6 13.2 14.5 14.5 14.6 14.6 14.6 14.6
Net financial savings ratio to total savings (in %) 31% 33% 36% 36% 46% 42% 43% 44% 45% 46% 47%
Nominal GDP 87 99 112 125 138 153 171 191 213 238 266
Net financial savings to GDP (in %) 7.4% 7.4% 7.4% 7.1% 8.2% 6.8% 6.3% 5.9% 5.5% 5.2% 4.8%
Gross savings to GDP (in %) 24% 22% 20% 20% 18% 16% 15% 14% 12% 11% 10.3%
Memo item: Bank deposits 61.7 70.5 80.3 88.9 96.6 107.5 114.8 125.6 137.5 150.4 164.6
Source: CEIC, Ambit Capital research, Note: All data is for households and actuals are currently only available till FY17.
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Economy
Exhibit 22: Assumptions underlying the base case scenario
1. Gross savings is assumed to grow at 2% which is lower than the 5 year average growth rate of 3.8% but
is higher than the annual rate of decline in the gross savings growth rate at 1.7%.
2. Financial savings is assumed to grow at 3.6% which is lower than the 5 year average growth rate of 9%
but is higher than the annual rate of decline in the gross savings growth rate at 5.4%
3. Financial liabilities is assumed to grow at 0.9% which is lower than the 5 year average growth rate of
5.4% but is higher than the annual rate of decline in the gross savings growth rate at 4.5%.
4. GDP is assumed to grow at the same pace of 11.8% which was recorded over FY12-17.
5. Bank deposits is expected to grow at 9% which is lower than the 5 year average of 11%
Source: Ambit Capital research
Macro risk#2: The Government of the day delivers sub-220 seats in CY19
“The story the data tells us is often the one we’d like to hear, and we usually make sure
that it has a happy ending.”
-Nate Silver, The signal and the noise (2012)
The investor community at large appears to be certain that the Modi-led National
Democratic Alliance (NDA) will be able to win a second term in office and will be able
to do so with a comfortable majority of 300-380 seats (vs the 336 seats it currently
has in the 543 seat Lok Sabha - see Appendix on page 23 for details). Such an
outcome will be ideal from the perspective of the Indian stock market as it will ensure
continuity and stability under political strongman Narendra Modi.
However, we highlight that this blue sky scenario may be in jeopardy if two highly
plausible sets of factors play out, namely:
• Factor#1: Adverse-coalition dynamics play-out for the BJP
If the BJP is unable to retain coalition partners (in heavy-weight states like
Maharashtra) or find a coalition partner in Andhra Pradesh and if the Congress in
fact is able to stitch up or retain clever pre-poll alliances (in states like UP,
Maharashtra, West Bengal, Tamil Nadu and Andhra Pradesh), then the NDA’s seat
count in 2019 could diminish drastically from its current levels.
• Factor#2: Anti-incumbency affects the BJP seat count adversely
A degree of anti-incumbency playing out could mean that the BJP’s own tally
diminishes from the peaks achieved in the Lok Sabha Elections of 2014.
If indeed these two forces were to be in action then our analysis based on the
psephological inputs from Rajeeva Karandikar suggests that the NDA’s seat count
could dip to as low as 213 seats, which is 60 seats short of the half way mark of 273
(see page 13 and 14 for details).
The section below quantifies how the above two dynamics could adversely affect the
BJP’s seat count.
7 Indian states can make or break the NDA’s seat tally in CY19
Focusing on the status of the (1) coalition force and (2) anti-incumbency force in 7
states spanning Uttar Pradesh (UP), Rajasthan, Gujarat, Maharashtra, Madhya
Pradesh (MP), Karnataka and Rajasthan is instructive.
These 7 states together yielded the NDA 67% of its 2014 seat count. In the worst case
scenario where both the coalition force and the anti-incumbency force play out then
these 7 states could deliver only 126 seats for the NDA in 2014, which marks a
reduction of 100 seats from the 226 seat count managed by the NDA in CY14 (see
exhibit below).
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Economy
Exhibit 23: In the worst case scenario, the NDA’s seat count could dip by 100 seats in
the top 7 states that yielded 226 seats to the party in the 2014 Lok Sabha Elections
80
73
NDA's seat count
60
40
20
0
-20
-40
-60
Source: Rajeeva Karandikar, Ambit Capital research
In specific,
35
Uttar Pradesh
41
19
Maharashtra
17
2
Andhra Pradesh
26 27 25
19 20 19
2014 Lok Sabha 2019 worst case for BJP Change
17
12
Opposition unity could cause NDA’s seat count in Uttar Pradesh to drop from
73 to 35 seats
After BJP’s double-sweep in the CY14 Lok Sabha elections and then the CY17 UP
assembly elections, the SP and BSP first experienced a bout of relief during the urban
local body polls in CY17. The two regional parties entered into an agreement and
were able to then defeat the BJP in the Gorakhpur and Phulpur Lok Sabha bypolls.
The combine of regional parties received another booster when they were able to
include RLD in this alliance as well and then won the Kairana Lok Sabha by-election
as well as the Noorpur assembly election in CY18.
Against this backdrop of having tasted victory as a united front against the BJP, it is
possible that the SP-BSP duo combines forces with the Congress as well as RLD ahead
of the 2019 elections. Such a development which is completely unrelated to the BJP’s
own performance can then seriously dent the BJP’s seat count.
According to Rajeeva Karandikar, the psephologist we worked with for the 2019
forecast, this could result in almost halving of the BJP’s seat count from 73 to 35.
Gujarat
Madhya Pradesh
Rajasthan
Karnataka
Breaking its alliance in Maharashtra combined with opposition unity could
cause NDA’s seat count to drop from 41 to 19 seats
BJP president Amit Shah last month is said to have instructed BJP’s Maharashtra
functionaries that they should be prepared for the possibility of contesting the Lok
Sabha and Assembly elections without any alliance.
Parting ways with its erstwhile ally Shiv Sena could prove to be a costly error for the
BJP as this could lead to a part of the BJP’s voteshare being eaten into by the Shiv
Sena. Furthermore, the INC and NCP combine could experience its voteshare
increasing owing to a divorce between the BJP and Shiv Sena.
According to Rajeeva Karandikar, this could result in halving of the BJP’s seat count
from 41 seats to 19 seats.
Breaking its alliance in Andhra Pradesh combined with opposition unity
could cause NDA’s seat count to drop from 17 to 2 seats
The broad dynamics at play in Andhra Pradesh for the BJP are similar to the
happenings in Maharashtra. The BJP has parted ways with its regional ally whilst the
Congress can join hands with a regional party like the TDP or the YSRC. The
simultaneous play of these forces could once again cost the BJP dearly.
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In Karnataka, opposition unity and a degree of anti-incumbency could cause
NDA’s seat count to drop from 17 to 12 seats
To quantify the potential anti-incumbency that plays out in Karnataka, we assume
that the BJP loses 3.5% voteshare which is half of the 7% voteshare loss it
experienced from the Lok Sabha elections of 2014 to the Assembly Election of 2018.
This combined with the assumption that the Congress and JDS contest elections
together could dent the BJP’s seat count by 5 seats.
Anti-incumbency could cause NDA’s seat count in Gujarat, Rajasthan and MP
to be eroded from 78 to 58 (out of 80 seats on offer)
The BJP was able to pull off a miraculous clean sweep in the states of Gujarat,
Rajasthan and Madhya Pradesh in the CY14 Lok Sabha Elections when it won 78 of
the 80 seats these 3 large states offer. A head-to-head clash with the Congress in
three states that have experienced heightened agricultural distress and have a high
Dalit population to boot could result in the combined seat count that these three
states offer reducing to 58 seats in CY19 (as compared to 78 seats in CY14).
It is worth noting that this assumption is not as penalizing for the BJP as it sounds
because even after building in a degree of anti-incumbency, we assume that the BJP
wins 73% of the 80 seats on offer.
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Economy
Exhibit 24: If the BJP is unable to prevent the opposition from forming alliances and arrest anti-incumbency, then the NDA
seat count could dip to as low as 213 seats
2014 Lok Sabha Actual Worst case scenario for BJP
States
Total Seats
BJP
BJP_ A
INC
INC_A
Others
BJP
BJP_A
INC
INC_A
Others
Delta vs 2014
Assumptions made
Andhra Pradesh 25 4 13 0 8 2 2 9 12 -15
The BJP has no ally in Andhra Pradesh following
TDP’s public exit in March 2018. The INC on the
other hand is able to forge an alliance with TDP or
the YSRC.
Andaman and Nicobar 1 1 0 1 0 0 No change assumed from CY14.
Arunachal Pradesh 2 1 1 0 1 1 0 0 No change assumed from CY14.
Assam 14 7 3 4 6 4 4 -1
Bihar 40 22 9 2 5 2 20 7 5 8 0 -4
Chandigarh 1 1 0 1 -1
Anti-incumbency results in the reduction of BJP’s seat
count by 1 seat.
The BJP+JDU+LJP combine lose 4 seats whilst the
INC+RJD gain
Based on the setback BJP received in Punjab we
assume that a party like AAP potentially wins this
seat.
Chhattisgarh 11 10 1 0 8 3 0 -2 Marginal loss of vote for BJP / gain for INC
Dadra and Nagar Haveli 1 1 0 1 0 0 No change assumed from CY14.
Daman and Diu 1 1 0 1 0 0 No change assumed from CY14.
Delhi 7 7 0 3 1 3 -4
Goa 2 2 0 1 1 0 -1
Gujarat 26 26 0 19 7 0 -7
Haryana 10 7 1 2 4 3 3 -3
Himachal Pradesh 4 4 0 2 2 0 -2
Jammu and Kashmir 6 3 3 2 2 2 -1
AAP is able to make a dent in the BJP stronghold
thereby resulting in a loss of 4 seats for the BJP.
The BJP loses 1 seat to the Congress owing to a
degree of anti-incumbency.
Anti-incumbency plays out and the BJP loses 7 seats.
The BJP lost 11% seat share in the Assembly Elections
of 2017 as compared to the General Election of 2014
whilst the Congress gained 8%. Since we believe that
people vote differently at a Lok Sabha election, we
assume that the BJP loses 5.5% and INC gains 4%.
Anti-incumbency results in the reduction of BJP’s seat
count by 3 seats.
Anti-incumbency results in the reduction of BJP’s seat
count by 2 seats.
Making and then breaking its alliance with the PDP
costs BJP 1 seat.
Jharkhand 14 12 2 8 4 2 -4
The INC aligns with the RJD/JMM and brings down
the BJPs seat count by 4 seats.
Source: Rajeeva Karandikar’s psephological work, Ambit Capital research. Note: BJP refer to Bharatiya Janata Party, BJP_A refers to BJP’s alliance partners,
INC refers to Indian National Congress and INC_A refers to INC’s alliance partners.
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Economy
2014 Lok Sabha Actual Worst case scenario for BJP
States
Total Seats
BJP
BJP_ A
INC
INC_A
Others
BJP
BJP_A
INC
INC_A
Others
Delta vs
2014
Assumptions made
Karnataka 28 17 9 2 12 10 6 0 -5
We assumed that BJP loses 3.5% seatshare which is half of
the 7% seatshare loss it experienced from the Lok Sabha
elections of 2014 to the Assembly Election of 2018.
Kerala 20 8 4 8 10 5 5 0 INC gains at the expense of left front
Lakshadweep 1 1 1 0 No change assumed from CY14.
Madhya Pradesh 29 27 2 0 20 9 0 -7 INC makes serious dent in this BJP stronghold.
Maharashtra 48 23 18 2 4 1 19 0 12 10 7 -22
BJP and Shiv Sena contest separately thereby yielding an
advantage to the INC+NCP combine.
Manipur 2 2 0 2 0 0 No change assumed from CY14.
Meghalaya 2 1 1 0 1 1 0 0 No change assumed from CY14.
Mizoram 1 1 0 1 0 0 No change assumed from CY14.
Nagaland 1 1 0 1 0 0 No change assumed from CY14.
Orissa 21 1 20 3 8 10 0 2
The BJP is able to build its seat count by 1 seat. The INC and
BJD on the other hand, come together as part of nationwide
grand alliance.
Puducherry 1 1 0 1 0 0 No change assumed from CY14.
Punjab 13 2 4 3 4 1 2 8 2 -3
Rajasthan 25 25 0 19 6 0 -6
The INC gains at the expense of AAP, SAD and BJP based on
popularity of the state government
Anti-incumbency results in the reduction of BJP’s seat count
by 6 seats.
Sikkim 1 1 0 1 0 0 No change assumed from CY14.
Tamil Nadu 39 1 1 37 0 0 10 22 7 -2
Telangana 17 1 1 2 13 1 0 3 13 0 -1
The INC and DMK contest as allies and make deep inroads
thereby resulting in a loss of 2 seats for BJP.
The INC and TRS forge an alliance and sweep the polls in
the newly formed State.
Tripura 2 2 2 0 No change assumed from CY14.
Uttar Pradesh 80 71 2 2 5 35 0 8 37 0 -38
Uttarakhand 5 5 0 3 2 0 -2
West Bengal 42 2 4 0 36 8 7 27 0 6
All India 543 284 52 44 13 150 200 13 132 147 51 -123
The INC+SP+BSP forge a grand alliance and make a
serious dent in BJP seats to the tune of 38 seats.
Anti-incumbency results in the reduction of BJP’s seat count
by 2 seats.
Even as the INC and TMC contest together, nonetheless, the
BJP gains 6 seats.
Source: Rajeeva Karandikar’s psephological work, Ambit Capital research Note: BJP refer to Bharatiya Janata Party, BJP_A refers to BJP’s alliance partners,
INC refers to Indian National Congress and INC_A refers to INC’s alliance partners.
August 13, 2018 Ambit Capital Pvt. Ltd. Page 14

Macro risk#3: The possibility of Pakistan’s internal problems
spilling into India
“Ideological polarization and the fear of Indian hegemony, coupled with generous
assistance from foreign allies, have helped Pakistan survive but the country remains a
land of alarm, insecurity and instability.”
- Haqqani, Husain (2018) in Reimagining
Pakistan – Transforming a dysfunctional
nuclear state
Even as Pakistan has technically survived several doomsday prophecies made
regarding its future, two sets of factors that have come to the fore recently could
mean that the nuclear-armed Islamic state begins posing a significant threat to
India’s internal security and stability.
The section below describes this risk in detail.
Factor#1: The new Pakistani government is completely beholden to the
Pakistani army
A democratically elected leader who is beholden to the Pakistani army’s wishes and
desires is the best outcome that Pakistan’s military establishment could have hoped
for and, arguably, the worst outcome that the Indian administration could have
ended up with.
This is because the democratic veil that Pakistan now wears will mean that
international opinion cannot be rallied against its deviant behavior as easily as it
could have been done in case it was operating directly under a military dictator.
At the same time, it is well-established that Imran Khan’s victory in Pakistan’s
elections held in July 2018 was facilitated and ensured by the Pakistani army (see
exhibit below). This dynamic will ensure that Imran Khan is permanently obligated to
the military for running external policy as well as his domestic policy.
Economy
Exhibit 25: Imran Khan will be unduly and permanently obligated to the military as his win was undeniably orchestrated
by the Pakistani army
Headline
Description
Pakistan army will lurk within Imran Khan’s
regime
Source: July 27, 2018; Hindustan Times
available at: https://goo.gl/2bnmz9
Why does the army need Imran Khan to rule
Pakistan?
Source: July 28, 2018; The times of India
available at:
(https://goo.gl/KxyQ7p)
His Master's Voice: Imran Khan is only the
new mask on Pakistan's old face
Source: August 01, 2018; DailyO available
at:
(https://goo.gl/zh398T)
Pakistan's Sham Election
Source: July 27, 2018; Foreign Affairs
available at:
(https://goo.gl/sdRzFK)
Source: Media reports, Ambit Capital research
“There are several accounts suggesting that the army has seized power through an election manipulated
and navigated to help the former cricketer’s Pakistan Tehreek-e-Insaaf (PTI). The pitch was seemingly
curated to suit the PTI’s ‘cricket bat’ election symbol against contenders from whose ranks electable
candidates were coerced and threatened to switch allegiances. Widely suspected in these defections,
meant to help Imran and weaken his opponents, was the hand of the Pakistani deep state”
“Imran Khan is new, popular and listens to the Army. He is starting out on the big seat the same way
Zulfiqar Ali Bhutto and Nawaz Sharif did: Army backed to cut popular civilian politicians to size”
“The initial impressions suggest that Imran Khan will indeed be different from Nawaz, though only more
suppliant of the army’s policy towards India. There is likely to be more coherence in civil-military relations
in Pakistan, unlike the embarrassing leaks published by Dawn, which clearly indicated a schism in the
past. Imran’s delicate majority in the days to come, potentially with army-coerced support, could further
limit his manoeuvring space. This leaves little leeway for Imran to bowl his dipping in-swingers, even with
the new ball”
“Those of us who have watched Pakistan for decades, however, viewed the election with a more jaundiced
eye. It was marked by appalling levels of electoral violence, including an election day suicide bombing in
Quetta that killed at least 31. Second, the result was predetermined by Pakistan’s powerful army, which
engaged in electoral malfeasance for months leading up to the election and on election day itself. The
army was hell-bent upon securing Khan’s victory and even encouraged political parties with overt ties to
terrorist groups to field several hundred candidates, alongside some 1,500 candidates tied to Pakistan’s
right-wing Islamist parties”
Given that the Pakistani military establishment’s raison d'être thus far has been to
destabilize India’s internal as well as external balance (see exhibit below), its rise to
prominence is bound to exacerbate India’s security-related problems.
August 13, 2018 Ambit Capital Pvt. Ltd. Page 15

Exhibit 26: The Pakistani Army has backed some of the most profound terrorist attacks on India
Event
Ahmedabad Bombings (July
2008)
(https://goo.gl/yKH29P)
Mumbai Attack (November
2008)
(https://goo.gl/vu12Ds)
Description
Source: Media reports, Ambit Capital research
Economy
The 2008 Ahmedabad bombings were a series of 21 bomb blasts that hit Ahmedabad, India, on 26 July 2008, within a
span of 70 minutes. Fifty-six people were killed and over 200 people were injured (https://goo.gl/yKH29P).
The 2008 Mumbai attacks were a group of terrorist attacks that took place in November 2008, when 10 members
of Lashkar-e-Taiba, an Islamic terrorist organisation based in Pakistan, carried out a series of 12 coordinated shooting and
bombing attacks lasting four days across Mumbai.164 people died and 308 were wounded (https://goo.gl/vu12Ds).
Factor#2: With Sharif’s fall being driven by his reconciliatory stance towards
India, Pakistan’s civilian government is likely to adopt a hostile stance
towards India
Pakistan’s former PM Nawaz Sharif (June 2013 to July 2017) had worked hard to
improve Indo-Pak relations during the initial years of his tenure (see exhibit below).
Exhibit 27: Nawaz Sharif had worked hard to improve Indo-Pak relations during the
initial years of his tenure
Event
Description
PM Modi’s swearing in Defying the Pakistani Army, Nawaz Sharif attended the swearing in ceremony of
(May 2014)
PM Modi in May 2014 along with other SAARC leaders.
In a surprise incident, Mr. Sharif hosted PM Modi in Lahore at his house on the
Hosting PM Modi in
occasion of his birthday. This incident too like the earlier one, did not go down
Lahore (December 2015)
well with the Army and the Islamic fundamentalists in Pakistan.
Source: Media reports, Ambit Capital research
This antagonized the Pakistani army and in more ways than one. Nawaz Sharif’s
meeting with PM Modi in May 2014 marked simultaneously (1) the beginning of the
end of Nawaz Sharif’s career as the PM of Pakistan and (2) the beginning of a
marked rise in terrorist attacks on India. Not only did Nawaz Sharif face hostility from
the Pakistani army, media as well as judiciary, Pakistan-based militants carried out a
series of deadly attacks in India, signaling to the civilian government that it is the
army which calls the shots in Pakistan and not the civilian government (see exhibit
below).
Exhibit 28: The Pakistani Army triggered a series of deadly terrorist attack on India from May 2014 onwards
Event
Description
Gurdaspur attack (July 2015)
(https://goo.gl/tp7WZt)
Pathankot attack (January 2016)
(https://goo.gl/kPTA5n)
Uri Attack (September 2016)
(https://goo.gl/QeNT77)
Source: Media reports, Ambit Capital research
On 27 July 2015, three gunmen dressed in army uniforms opened fire on a bus and then attacked the Dina
Nagar police station in Gurdaspur district of Punjab, India. The attack resulted in the death of three civilians and four
policemen, including a superintendent of police; 15 others were injured. All three attackers were killed in the operation,
which lasted almost 12 hours (https://goo.gl/tp7WZt).
The 2016 Pathankot attack was a terrorist attack committed on 2 January 2016 by a heavily armed group which
attacked the Pathankot Air Force Station, part of the Western Air Command of the Indian Air Force. Four attackers and
two security forces personnel were killed in the initial battle, with an additional security force member dying from
injuries hours later (https://goo.gl/kPTA5n)
The 2016 Uri attack was an attack by four heavily armed militants on 18 September 2016, near the town of Uri in
the Indian state of Jammu and Kashmir. It was reported as "the deadliest attack on security forces in Kashmir in two
decades. The militant group Jaish-e-Mohammed was blamed by India of being involved in the planning and execution
of the attack (https://goo.gl/QeNT77).
Apart from the systematic aggression meted out to India, the Pakistani army also
made sure that Nawaz Sharif is rendered toothless in the Pakistani political arena
with the former PM put behind bars ahead of the July 2018 elections (see exhibit
below).
Exhibit 29: The Pakistani army ensured that former PM Nawaz Sharif is rendered toothless in the Pakistani political arena
Head
Details
Propping up of Imran Khan by
the Pakistani Army
(https://goo.gl/nFQiU4)
Panama papers leak
(https://goo.gl/LNm9g4)
Taming the Pakistani media
(https://goo.gl/3izmPT)
Source: Media reports, Ambit Capital research
As Nawaz Sharif locked his horns with the Army over various issues (including that of bringing ousted General Musharraf
to justice), the Pakistani Army started propping up Imran Khan to counter Nawaz Sharif.
The Pakistani Army exploited the Panama papers to the fullest, first forcing Sharif via protests by the PTI (Imran Khan’s
Party), to hold a judicial inquiry, and subsequently by leaning on the judiciary to fast-track the proceedings and declare
the three-time PM guilty. The judiciary, which has been the handmaiden of the Pakistani army since the first coup d’état
in the 1950s, dislodged Sharif on the flimsiest legal grounds. Both Nawaz Sharif and his daughter Maryam were arrested
on the airport and sent to jail when they were returning from abroad
The Pakistani Army went on a overdrive to tame the media and used it to the benefit its chosen leader Imran Khan
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Economy
The clear narrative that the Pakistani army has built as Sharif’s downfall played out
was that, whoever tries to mend ties with India will be ruthlessly subverted. Given this
episode and given that the new PM owes his allegiance to the Pakistani Army, in best
case Pakistani hostilities towards India remains at the same level and in a worst case
Pakistani hostilities towards India are likely to deteriorate.
Macro risk #4: And then the well-known problem of India’s twin deficits…
“There is a joke in economics about the drunk who loses his keys in the street but only
looks for them under the light posts. When asked why, he says, ‘that’s where the light
is.’ That’s the problem with the deficit”
- Christina Romer, Garff B. Wilson Professor of
Economics at the University of California,
Berkeley and a former Chair of the Council of
Economic Advisers in the Obama
administration
It is well-known that whenever GDP growth India rises as a result of Government
pump-priming (as opposed to autonomous private-sector driven forces), it is by
definition accompanied by a widening of India’s fiscal deficit as well as import bill;
this in turn results in widening of current account deficit (CAD). Whenever such a
phenomenon is at play, if at all oil prices are high (or rising), then the twin deficit
problem gets exacerbated further as this manifests itself in the form of a higher oil
import bill, higher petroleum subsidy bill and pressure to cut excise duty on oil
products.
Even as GDP growth is likely to a non-issue this year, India once again finds itself
edging closer to the all-too-familiar-problem of its twin deficits widening. Besides the
above stated phenomenon, the ongoing Sino-US trade war only adds to the existent
build-up of risks on the twin deficit front.
The section below explains the risk arising due to rising twin deficits.
The risk of fiscal slippage appears meaningful for FY19
Given spending compulsions in an election year, the Government is likely to spend
generously in FY19.
The risk to the fiscal deficit emanates from four sets of factors, namely:
• Food subsidy bill rising: The Central Government’s food subsidy bill is likely to
be much higher than the budgeted amount given the 17% weighted average MSP
hike announced for Kharif crops that was announced in July 2018. The MSP
policy could cost the Government anywhere between Rs400bn-800bn (i.e. 0.3%-
0.6% of GDP) extra over and above the budgeted Rs1.7trillion depending on the
exact shape of the procurement policy that the Government is expected to
announce in September 2018.
• Petroleum-related woes: The Government has assumed a crude oil price of
US$65/barrel for FY19 budget (as against the crude oil price of US$57/barrel
recorded in FY18 and the YTD average of US$74/barrel). Based on this
assumption, the Government has budgeted Rs249bn (0.15% of GDP) for
petroleum subsidies. Our Oil & Gas analyst believes that if oil prices average at
US$80/barrel in FY19, then the petroleum subsidy bill could see a jump of
Rs150bn (or 0.09% of GDP).
• It is worth noting that that the Government has been collecting hefty excise duty
from petroleum products. In the wake of rising crude prices, if the Government is
forced to cut excise duty then it will have to forego substantial revenue. Our Oil &
Gas analyst believes that every Re1 cut in excise duty for both petrol and diesel
will result in a revenue loss of Rs260bn (or 0.16% of GDP).
• Disinvestment revenues falling short: Though we are not building in any
shortfall in disinvestment revenues in FY19, it is worth noting that the
Government has budgeted a whopping Rs800bn as proceeds from
disinvestments. Given uncertainty surrounding the capital markets and given that
only Rs92bn of disinvestment revenue has been raised thus far, it seems highly
likely that the Government will fall short of the disinvestment target it has set for
itself.
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Economy
• Shortfall on account of GST revenues: The Government has engineered a
major rollback in the GST regime since October 2017. Over 200 items have been
shifted from the 28% bracket to 18% bracket during this period. Moreover, the
Government has also eased the compliance burden significantly for small and
medium businesses (see exhibit below).
Exhibit 30: The Government has given a host of concessions to small and medium
businesses
GST-related exemptions to the SMEs
- Allowed businesses with annual turnover less than Rs2crores to pay GST and file returns once a quarter
(as compared to the previous requirement to pay monthly).
- Allowed businesses with revenues less than Rs20lakhs to operate without a GST number and without any
obligation for businesses transacting with these sub-Rs20lakh to bear the GST burden for these
transactions.
- Reduced the tax rate from 28% to 18% on a range of items, most notably chocolates, washing powder,
shampoos, aftershave, deodorants, granite and marble.
- Cut the rate of tax for small businesses where there will be a uniform rate of 1%
(0.5% Central tax plus 0.5% State tax) on the “composition scheme” for dealers and manufacturers.
Manufacturers under this scheme earlier paid 2% (1% Central tax plus 1% State tax) of the turnover.
Restaurant Services pay 5% (2.5% Central tax plus 2.5% SGST) of the turnover and this remains
unchanged.
-The GST council has also allowed businesses under composition scheme to not file details of their
purchases
Source: Media reports, Ambit Capital research
Such a wide-ranging rollback regarding the GST structure is bound to adversely
affect GST collections for FY19. Given that the required run-rate for meeting the
full year GST revenue target for the Centre stands at Rs620bn and given that the
actual run rate so far stands at Rs540bn, we believe the Central Government
could undershoot the full year target by Rs400bn.
Given these four factors that could prevent the Central Government from meeting its
fiscal target, we believe that the Government will deliver a fiscal deficit of 3.6% of
GDP in FY19 as against the budgeted 3.3% of GDP (see exhibit below).
Exhibit 31: Fiscal slippage to the tune of 30bps is likely in FY19
` trillion
FY17
(Actuals)
FY18
(RE)
FY19
(BE)
FY18
(Ambit)
Comments
Total Expenditure (A=B+C) 19.8 22.2 24.4 24.7 We expect the Government to exceed total expenditure by Rs300bn
Revex (B=1+2+3+4+5) 16.9 19.4 21.4 21.9
We expect petroleum subsidies to go up by Rs150bn in FY19 as the oil
Petroleum Subsidy (1) 0.3 0.2 0.2 0.4 price is likely to be significantly higher than the Government’s
assumption of US$65/barrel in FY19
Food Subsidy (2) 1.1 1.4 1.7 2.1
Food subsidies are expected to increase by Rs400bn as against the
budgeted numbers owing to the MSP hikes announced in July 2018.
Fertilizer subsidies (3) 0.7 0.6 0.7 0.7
We assume that the fertilizer subsidy outgo remains the same as
budgeted.
Interest payments (4) 4.8 5.3 5.8 5.8
We assume that the interest expense outgo remains the same as
budgeted.
Discretionary revex (5) 10.1 11.8 13.0 12.9
Owing to higher expenditure on food and petroleum subsidies, we
expect the Government to cut discretionary revex by Rs100bn.
Capex (C) 2.8 2.7 3.0 2.8
We expect Government to cut capex by Rs200bn in FY19 given the
pressure to spend more on revex items.
Total Receipts (D = 7 + 8 + 9+ 10) 14.4 16.2 18.2 18.1 We expect total receipts to fall short by Rs100bn in FY19.
Net tax revenue (7) 11.0 12.7 14.8 14.7 We expect net tax revenue to fall short by Rs100bn in FY19
Gross Tax Revenue 17.1 19.4 22.7 22.5 We expect Gross Tax Revenue to fall short by Rs200bn
Corporate Tax 4.8 5.6 6.2 6.2
We expect Government to meet its corporate tax revenue targets for
FY19.
Income Tax 3.6 4.4 5.3 5.5
We expect Government to exceed its income tax collections target by
Rs200bn.
Indirect taxes 8.6 9.4 11.2 10.8
In the wake of GST concessions we believe that the Government’s
Indirect tax collections will be lesser by Rs400bn in FY19.
Disinvestment (8) 0.4 1.0 0.8 0.8
We make the generous assumption that the Central Government meets
its disinvestment target in FY19.
Telecom-related receipts (9) 0.7 0.3 0.5 0.5 We expect Government to meet its telecom receipts target in FY19.
Other receipts (10) 2.3 2.2 2.1 2.1
Fiscal Deficit (as a % of GDP) 3.5% 3.5% 3.3%
We expect Government to deliver a fiscal deficit of 3.6% of GDP in FY19
3.6%
as opposed to the budgeted target of 3.3%.
Fiscal Deficit 5.4 5.9 6.2 6.6 In absolute term, we expect fiscal deficit to overshoot by Rs400bn.
Nominal GDP 151.0 167.8 187.2 187.2 Nominal GDP is expected to grow at 11.5% in FY19
Source: Union Budget documents, Ambit Capital research.
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Economy
CAD set to expand meaningfully in FY19
In a base case scenario, assuming oil prices average at US$80/barrel and India’s
GDP growth is recorded at 7% YoY in FY19,we expect India’s CAD to widen to 2.8%
of GDP in FY19 as against 1.9% of GDP in FY18 (refer to our May 22 note titled
‘FY19 Current Account Deficit of 2.8% of GDP for details).
The exhibit below shows how this base case calculation is premised on gold import
growth rate slowing down, oil import growth rising owing to higher oil prices, core
import growth rising owing to higher GDP growth and export growth remaining
moderate(see exhibit below).
Exhibit 32: In a base case, India’s CAD is likely to be recorded at 2.8% of GDP in
FY19
Item FY16 FY17 FY18 FY19 E
Merchandise exports (YoY) -15% 5% 10% 10%
Merchandise imports (YoY) -15% 1% 20% 15%
Core imports (YoY) -3% 1% 17% 8%
Gold imports (YoY) -8% -13% 22% 0%
Oil Imports (YoY) -40% 5% 25% 40%
Net services surplus (as % of GDP) 5.1% 4.3% 4.1% 4.2%
CAD (USD billion) 23.1 15.9 49.4 78
CAD (as % of GDP) 1.1% 0.7% 1.9% 2.8%
Memo items
Average oil price (USD/barrel) 47 49 57 80
Real GDP growth in India (YoY) 8.2% 7.1% 6.7% 7.0%
Global GDP growth rate (YoY) 3.5% 3.2% 3.8% 3.9%
Source: CEIC, Ambit Capital research
However, if oil prices were to rise from the average levels recorded so far, then
India’s CAD could widen from the base case scenario built above.
As the table below shows, every $10 increase in oil prices tends to drive up CAD by a
net of ~20bps (see exhibit below).
Exhibit 33: Every US$10/barrel increase in crude prices pushes up CAD by ~20bps
Crude prices
(in US$ per barrel)
Oil imports growth
(YoY change, in %)
CAD
(in US$ bn)
CAD
(as % of GDP)
60 0% 61 2.2%
70 38% 69 2.5%
80 (base case) 40% 78 2.8%
90 45% 84 3.0%
Source: CEIC, Ambit Capital research
An additional risk is imposed by the ongoing trade war underway between the US
and China. It seems highly unlikely that India will benefit from this situation for two
sets of reasons.
Firstly, Chinese exports that are currently attracting penalizing import duties from the
US are primarily in the textiles and leather sectors. These sectors appear to be the
exact sectors in which India’s competitive advantage has deteriorated over the past
few years (see exhibits below).
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Economy
Exhibit 34: Countries like Vietnam and Bangladesh…
% Share in world exports of
textiles, clothing and
footwear
5
4
3
2
1
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2015
Bangladesh India Vietnam
Source: Livemint, Ambit Capital research
Exhibit 35: … have taken over India in labour intensive
exports
Ratio of a country's share in
world apparel exports to the
country's share in overall world
exports
40
30
20
10
0
India
China
2000 2015
Source: Livemint, Ambit Capital research
Vietnam
Bangladesh
Secondly, there seems to be a broad consensus amongst trade economists and trade
bodies that such a trade war involving two economies that together account for more
than 39% of global GDP is bound to depress global GDP growth (see exhibit below).
Exhibit 36: Trade war between US and China could have serious impact on global GDP
Source
Comment
World Trade Organisation (July, 2018)
“An escalating trade war between China, the US and the EU is putting global economic growth in jeopardy
and the effects are already beginning to show”
International Monetary Fund (June 2018)
IMF director Christine Lagarde said a trade war would lead to "losers on both sides" and have a "serious"
impact
World Bank (June 2018)
“A worldwide escalation of the trade tensions between the US and its major trading partners would have
consequences for global trade equivalent to the 2008 financial crisis”
Source: Media reports, Ambit Capital research
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Economy
Appendix 1: Abbreviations used to denote
various political parties
Exhibit 37: List of political parties mentioned in the note
Abbreviation
Party
BJP
INC
TDP
YRS
JDU
RJD
LJP
JMM
AAP
SS
JDS
AGP
NCP
SAD
BJD
TRS
Bharatiya Janata Party
Indian National Congress
Telugu Desham Party
Yuvajana Shramika Rythu Congress Party
Janta Dal United
Rashtriya Janata Dal
Lok Janshakti Party
Jharkhand Mukti Morcha
Aam Aadmi Party
Shiv Sena
Janta Dal Secular
Assam Gana Parishad
Nationalist Congress Party
Shiromani Akali Dal
Biju Janata Dal
Telangana Rashtra Samiti
TMC
Trinamool Congress Party
Source: Election Commission of India, Ambit Capital research
August 13, 2018 Ambit Capital Pvt. Ltd. Page 21

Economy
Appendix 2: The Best Case scenario for the
BJP in the CY19 General Elections
Exhibit 38: The Best Case Scenario for the NDA will yield…. (contd.)
States
Total Seats
2014 Lok Sabha Actual Worst Case for INC / Best case for BJP IN 2019
BJP
BJP_a
INC
INC_a
Others
BJP
BJP_a
INC
INC_a
Others
Delta vs
2014
Details
Andhra Pradesh 25 4 13 0 8 5 10 2 8 -2
Andaman and
Nicobar
Arunachal
Pradesh
The BJP forms an alliance with one of TDP
/ YRS whilst the INC has no ally.
1 1 0 1 0 0 No change assumed from CY14.
2 1 1 0 1 1 0 0 No change assumed from CY14.
Asom (Assam) 14 7 3 4 8 3 2 1 4
Bihar 40 22 9 2 5 2 20 13 2 5 0 2
Chandigarh 1 1 0 1 -1
The BJP with AGP strengthens and moves
ahead.
The BJP+JDU+LJP alliance forges ahead of
the INC+RJD combine.
Chhattisgarh 11 10 1 0 10 1 0 0 No change assumed from CY14.
Dadra and
Nagar Haveli
1 1 0 1 0 0 No change assumed from CY14.
Daman and Diu 1 1 0 1 0 0 No change assumed from CY14.
Delhi 7 7 0 5 0 2 -2 BJP loses 2 seats to AAP.
Goa 2 2 0 2 0 0 No change assumed from CY14.
Gujarat 26 26 0 23 3 0 -3
INC makes marginal gains as compared
to last Lok Sabha elections
Haryana 10 7 1 2 7 1 2 0 No change assumed from CY14.
Himachal
Pradesh
Jammu and
Kashmir
4 4 0 4 0 0 No change assumed from CY14.
6 3 3 3 3 0 No change assumed from CY14.
Jharkhand 14 12 2 12 2 0 0 0
Karnataka 28 17 9 2 16 7 5 -1
Kerala 20 8 4 8 1 7 5 7 1
Lakshadweep 1 1 1 0
Madhya Pradesh 29 27 2 0 25 4 0 -2
Maharashtra 48 23 18 2 4 1 22 16 5 5 0 -3
BJP retains its hold. Even as the INC
+RJD+ JMM align but do not make
meaningful inroads in BJP seats.
The INC+JDS state government falls. The
INC and JDS then fight separately and the
BJP retains its hold in 2014.
The left front makes inroads into the INC’s
base and the BJP walks away with a seat.
INC does not make significant gain, but
local reasons, BJP loses couple of seats
BJP and Shiv Sena iron out differences and
fight together retaining most of the seats
Manipur 2 2 0 2 0 0 No change assumed from CY14.
Meghalaya 2 1 1 0 1 1 0 0 No change assumed from CY14.
Mizoram 1 1 0 1 0 0 No change assumed from CY14.
Nagaland 1 1 0 1 0 0 No change assumed from CY14.
Source: Rajeeva Karandikar’s psephological work, Ambit Capital research Note: BJP refer to Bharatiya Janata Party, BJP_A refers to BJP’s alliance partners,
INC refers to Indian National Congress and INC_A refers to INC’s alliance partners.
August 13, 2018 Ambit Capital Pvt. Ltd. Page 22

Economy
Exhibit 39: …. The alliance 376 seats in the 543 seat Lok Sabha
Worst Case for INC / Best case for BJP
2014 Lok Sabha Actual
IN 2019
States
Total Seats
BJP
BJP_A
INC
INC_A
Others
BJP
BJP_A
INC
INC_A
Others
Delta vs
2014
Comments
Orissa 21 1 20 12 2 7 11
No alliances are formed. The BJP makes serious
inroads in BJD strong holds.
Puducherry 1 1 0 1 0 0 No change assumed from CY14.
Punjab 13 2 4 3 4 3 4 4 2 1
Rajasthan 25 25 0 23 2 0 -2
Both BJP and INC register marginal gains at the
expense of AAP.
The INC does not make significant gain, but for
local reasons, BJP loses few seats.
Sikkim 1 1 0 1 0 0 No change assumed from CY14.
Tamil Nadu 39 1 1 37 3 22 5 8 1 23
Telangana 17 1 1 2 13 2 12 3 0 12
The BJP and AIADMK contest as allies and win
significant seats.
The BJP and TRS forge an alliance and sweep
the polls.
Tripura 2 2 2 0
Uttar Pradesh 80 71 2 2 5 60 2 4 14 -11
Uttarakhand
(Uttaranchal)
5 5 0 5 0 0
West Bengal 42 2 4 0 36 15 3 24 13
All India 284 52 44 13 150 290 86 64 23 80 40
No grand alliance is formed but the BJP’s tally
comes down from its peak.
The INC and TMC fight separately and the BJP
makes big gains.
The BJP retains its hold; the INC+RJD+JMM
align but do not make meaningful inroads into
BJP’s seats.
Source: Rajeeva Karandikar’s psephological work, Ambit Capital research, Note: BJP refer to Bharatiya Janata Party, BJP_A refers to BJP’s alliance partners,
INC refers to Indian National Congress and INC_A refers to INC’s alliance partners.
August 13, 2018 Ambit Capital Pvt. Ltd. Page 23

INSTITUTIONAL EQUITY RESEARCH
MPC Minutes
Not‐so‐hawkish minutes (like the policy statement) to a
hawkish decision
INDIA | INDOMOMICS | Update
In the monetary policy earlier this month, RBI raised repo rate by 25bps and left the policy
stance unchanged at ‘neutral’. Except Ravindra Dholakia, all the members favoured the rate
hike. Members favoured rate hike on account of MSP hike announcement and rising
inflationary expectations. Members opined that two consecutive rate hikes will help
contain inflation near 4% target. While growth remains positive, members are divided
about its sustenance and the impact of global trade restrictions. Other reasons cited for the
rate hike are: higher core inflation, inflation expectations, closing output gap, and
strengthening growth trends. Neutral stance continued to be favoured due to uncertainty
on oil prices, trade wars, MSP impact, and global market volatility.
While the statements makes it clear that RBI will be taking a pause at least for a few
policies, considering the uncertainty on currency, we retain our stance of 0‐25bps rate hike
for the rest of FY19. We are not worried about MSP led food inflation as its expected to be
muted, if implemented through price deficiency mechanism. Yield gap influenced decision
making will continue to play a larger role even if inflation stays in the anticipated zone.
16 August 2018
Anjali Verma(+ 9122 6667 9969)
anverma@phillipcapital.in
Views of the six policy members:
Chetan Ghate (government) – NEUTRAL – 25bps hike
• Demand conditions have continued to improve. Consumer and business confidence has
picked‐up.
• Overall, growth signals are strong. Most indicators of the output gap suggest that it is
closing. PFCE is the largest growth contributor, while mild tapering is visible. Economy
will be further buoyed by political business cycle.
• Closing output gap is reflected in Core CPI rising beyond 6%. Inflation (ex‐food, fuel, HRA)
base will be favourable for next 12‐months – is a positive. Positive food inflation is a
puzzle. Crude prices have inched lower, on average basis, it remains high.
• Inflationary expectations have hardened. Likely upside risk to inflation from MSP – thus
the rate hike should be front loaded as an insurance policy.
Pami Dua (government) – NEUTRAL/HAWKISH – 25bps hike
• Core inflation and inflation expectations have hardened. Upside inflation risk persist from
fiscal slippage, MSP hike, higher commodity prices, fiscal slippage, and weaker Rupee.
Downside risk from lower GST rates and good monsoon.
• There are positive signs of economic growth reflected in business and consumer
confidence index. Downside risk to growth from trade wars impacting India’s exports.
• With upside risks to inflation and current elevated inflation expectations, 25bps rate hike
is appropriate along with the neutral stance.
Ravindra Dholakia (government) – DOVISH – No change
• Inflation is below expectation and RBI’s guidance of further rise in inflation owing MSP
hike may not be proven right as no one has any clarity on MSP impact, thus it will be
inappropriate to base rate decision on MSP (considering the extent of lack of clarity).
• Apart from above, rate hike should not be done due to following factors:
o 12‐month inflation expectations declined, assumption that last 25bps rate hike
will not work, reduction in GST rates, favourable CPI base going ahead.
o Government retains focus on fiscal consolidation, election year need not mean
fiscal slippage. Real policy rate is already positive and high vs. other countries.
o Oil prices have not further risen. Downside risk exists to growth incrementally,
led by strong global growth not sustaining, less capacity investment by
corporate indicating output gap to widen and not close.
Page | 1 | PHILLIPCAPITAL INDIA RESEARCH

MONETARY POLICY INDONOMICS
Michael Patra (RBI) – HAWKISH – 25 bps rate hike
• Inflation up in Q1, it may soften in 2Q but will likely rise in 2H. Lack of clarity on
sustainability of low international crude oil prices.
• Global financial volatility adding to inflationary risk.
• Upside risk to inflation from MSP.
• Inflationary expectations are high and corporate are facing higher input cost
pressures.
• Risks have risen to RBI’s missing the inflation target and willing to allow
deviations to persist.
• Economic growth to trend higher in FY19. International crude prices and global
spillovers from trade wars, monetary policy normalisation and geopolitical
tensions present significant risks to growth prospects.
• Cumulative impact of two rate hikes should be able to address inflationary
concerns while vigil is maintained to inflationary trends.
Viral Acharya (RBI) – HAWKISH – 25bps hike
• While headline inflation is soft it remains above 4%, core inflation elevated.
Inflation expectations survey reflects hardening of prices.
• Risk prevails from MSP hike and its impact while RBI’s projections consider the
normal impact of MSP hike.
• While international oil prices have softened, Indian oil basket is elevated.
• More worried about upside inflationary risks than the downside risk as growth
pick‐up is sustainable.
• Two cumulative rate hikes will be able to rein in the inflation with a lag, in the
interim, need to remain vigilant on the inflationary impact of trade wars,
Urjit Patel (RBI) – HAWKISH – 25bps hike
• Core inflation is elevated, food inflation below expectations.
• Both upgrade and downside risk to inflation from MSPs, oil, financial market
volatility, inflation expectations, fiscal slippage, and second round impact of HRA.
• Domestic economic growth impulses are strengthening. Clearer signs of revival in
the investment cycle. Services sector is resilient and credit growth has picked up.
• Neutral stance with 25bps rate hike will provide flexibility to react to evolving
situation. Rate hike is a necessary step towards securing mandated 4% inflation
target.
Page | 2 | PHILLIPCAPITAL INDIA RESEARCH

8/17/2018 Making a Market
The Irrelevant Investor
Making a Market
Posted July 31, 2018 by Michael Batnick
One of the concerns that people have expressed over the rise of index investing is
that it will prevent true price discovery, if it isn’t doing so already. With fewer and
fewer people doing fundamental research and more people only acting as price
takers, at what point do prices truly separate from the economic realities of the
business? This is the visual that really gets these fear juices flowing.
I believe this idea that prices will no longer accurate represent a company’s true
worth are overblown.
In The Index Revolution, Charlie Ellis writes
http://theirrelevantinvestor.com/2018/07/31/making-a-market/ 1/9

8/17/2018 Making a Market
“First, while index funds and exchange traded funds (ETFs) now approach 30
The Irrelevant Investor
percent of stock market assets, their turnover is so small compared to that of active
investors that they account for less than 5 percent of trading, and trading is what
sets prices”
While active is losing market share to indexes, they’re still aggressively setting
prices. In June, 205 million shares of Disney were traded. This represents 13.8% of
the total shares outstanding. Bank of America traded 1.38 billion shares in June,
also coincidentally representing 13.7% of total outstanding shares (these were the
first two stocks I randomly picked).
Charley Ellis told Ted Seides, “In the early 1960s I came into the investment
management business, there were no courses at the Harvard business school on
investment management.” Nobody wanted to go into finance in the 50s and early
60s (read The Go-Go Years if you’re interested in learning more). But finance
became a very lucrative career, and by 1985 there were ten times as many mutual
funds as there were in 1960. Today there are more than 8,000.
In a New York Times article from 1984, Mutual Funds Trail S.& P. 500, Michael
Blumstein wrote:
“For the fifth consecutive quarter, the average gain for equity funds failed to
match the Standard & Poor’s index of 500 stocks” This didn’t surprise me, after all
we’re all aware of the fact that most funds don’t beat the index. I was surprised
however, to read this:
“For the last 10 years…equity funds have increased 453.84 percent, compared with
a rise of 326.46 percent for the S. & P. 500” (Over the same time, CRSP 6-10
returned 986%, which likely explains much of the outperformance).
http://theirrelevantinvestor.com/2018/07/31/making-a-market/ 2/9

8/17/2018 Making a Market
The number of mutual funds tripled between 1975 and 1985, and as competition
The Irrelevant Investor
exploded there was less alpha (not really alpha but that’s for a different post) to go
around.
Which brings us to today. I think a reasonable case can be made that one of the
primary reasons it has become so difficult to beat the market is because there is
too much price discovery, leaving very little opportunities to exploit.
Here are a few data points on Facebook’s volume after it reported earnings on
Thursday:
100 years ago, during all of 1918, 142 million shares were traded on the New
York Stock Exchange. Last Thursday, after reporting earnings, 169 million
shares of Facebook were traded.
The average daily volume on the New York Stock Exchange in 1990 was 156
million shares. Again, Facebook traded 169 million shares on Thursday.
The average daily volume on the New York Stock Exchange in 1980 was 44
million shares. Facebook traded more than 40 million shares in the first ten
minutes on Thursday
Lest you think Thursday was an extreme outlier, it was the tenth highest volume
day for Facebook, so not entirely off the charts.
How many actual buyers and sellers does it take to come to a reasonable
approximation of underlying value? I’m not sure this can be quantified, but
yesterday on the NYSE alone, 14,000 shares were traded every second.
The chart below shows how NYSE volume has grown over time (thank you Nick).
http://theirrelevantinvestor.com/2018/07/31/making-a-market/ 3/9

8/17/2018 Making a Market
The Irrelevant Investor
If you believe at all that markets function properly, whether it’s the housing
market, a fish market, or the stock market, then you should believe that we have
more than enough buyers and sellers to function properly. I’m not suggesting that
prices are right 100% of the time or that there won’t be further dislocations like
May 2010 and August 2015, but of all the things to worry about, price discovery is
fairly low down the list.
Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy
or sell any securities, please see my Terms & Conditions page for a full disclaimer.
Now go talk about it.
FACEBOOK TWITTER LINKEDIN
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8/17/2018 The Lira Has Plummeted, and It’s Turkey’s Fault - Geopolitical Futures
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The Lira Has Plummeted, and It’s Turkey’s Fault
That the U.S. didn’t create Turkey’s economic vulnerabilities won’t stop Washington from exploiting them.
Xander Snyder
| August 10, 2018
(http://twitter.com/intent/tweet?url=https://geopoliticalfutures.com/lira-plummeted-turkeys-fault-1/)
As the U.S. and Turkey squabble (https://geopoliticalfutures.com/turkey-us-off-relationship/) over issues such as American
pastors, F-35 deliveries, and the finer points of the Syrian civil war (https://geopoliticalfutures.com/us-turkish-relationsbruised-not-broken/),
the Turkish lira has gone from steady decline to precipitous fall. It has declined roughly 40 percent
since the beginning of the year and roughly 14 percent since the beginning of the day. Many have blamed this financial
calamity on the Trump administration. After all, it has placed sanctions on a few Turkish officials, it has threatened to
remove Turkey from a program that allows it to export some products to the U.S. duty-free, and just today, it announced it
would double steel and aluminum tariffs.
The U.S. is often a strawman for the poor performances of struggling economies. And to be sure, the measures Washington
has imposed are not good for the Turkish economy. But Turkey’s economic problems are structural
(https://geopoliticalfutures.com/turkey-case-study-borrowers-dilemma/), and the lira has been declining since the beginning
of the year. Washington’s moves against Turkey are punitive, but they aren’t the causes of Turkey’s economic problems.
They are a consequence of them – namely, Turkey’s dependence on external debt, and therefore its dependence on foreign
reserves. The U.S. sees in Turkey a weakness it can exploit.
(https://geopoliticalfutures.com/wp-content/uploads/2018/08/turkish_lira.png)
(click to enlarge (https://geopoliticalfutures.com/wp-content/uploads/2018/08/turkish_lira.png))
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8/17/2018 The Lira Has Plummeted, and It’s Turkey’s Fault - Geopolitical Futures
Indeed, Turkey’s economic growth since 2002 has been fueled largely by external debt – that is, debt denominated in a
foreign currency. Turkey’s low saving rate means that, despite high interest rates, there was not enough local capital in the
Turkish financial system to provide enough loans to spur growth. So it borrowed from foreign countries. The problem with
debt denominated in a foreign currency is that it becomes much harder to pay down when the currency in question
weakens. Such is Turkey’s dilemma.
(https://geopoliticalfutures.com/wp-content/uploads/2018/08/External-debt-to-GDP.png)
(click to enlarge (https://geopoliticalfutures.com/wp-content/uploads/2018/08/External-debt-to-GDP.png))
To hedge against the risk from external debt, Turkey built up its foreign reserves. But it did so in a novel way. The Turkish
central bank’s reserve option mechanism permits Turkish banks to hold capital reserves
(https://geopoliticalfutures.com/foreign-debt-price-turkeys-rise-power/) in not just Turkish lira, but also foreign currencies
(and gold). However, if banks substitute foreign currencies for the lira as their reserves, they must deposit that foreign
currency at the central bank. This means that a substantial portion of the foreign reserves held at the central bank isn’t
simply something the bank can buy or sell as it chooses. It also comprises a portion of the capital reserves of the Turkish
banking system.
As the lira declined this year, the central bank reduced the reserve option mechanism’s foreign exchange ratio, meaning that
it allows less foreign currency to be held as reserves at the central bank in substitution for lira reserves. In May, this figure
was reduced from 55 percent to 45 percent, and earlier this week, it was reduced to 40 percent. This can basically be
thought of as selling foreign reserves to boost the lira. Earlier this week, it seemed to work as the lira briefly gained strength.
But since many of these headline foreign reserves are basically borrowed by the central bank from individual Turkish banks,
the decline in this ratio also represents a general weakening of the Turkish banking system.
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8/17/2018 The Lira Has Plummeted, and It’s Turkey’s Fault - Geopolitical Futures
(https://geopoliticalfutures.com/wp-content/uploads/2018/08/decline-of-currencies.png)
(click to enlarge (https://geopoliticalfutures.com/wp-content/uploads/2018/08/decline-of-currencies.png))
As the week went on, the lira continued to fall, proving that the reserve option mechanism is ineffective and thus removing
one tool the government thought it had to maintain foreign reserves. (Turkey’s foreign reserves have fallen from $95 billion
to $78 billion since the beginning of 2017.) To stem the decline of the lira, Ankara may have to make the politically unpopular
decision to raise interest rates (https://geopoliticalfutures.com/turkey-test-limits-presidential-power/). President Recep
Tayyip Erdogan has discouraged further increases for fear that it will reduce the availability of credit Turkey needs to grow.
Of course, none of these developments are purely economic. A poor economy affects Turkey’s military capabilities and its
politics. A weak currency means that, as more money must be dedicated toward foreign debt service, less money will go
toward more productive areas of the economy. Declining economic activity will impact tax revenue, which will in turn put
pressure on Turkey’s military spending – hence Turkey’s growing urgency to develop a domestic defense industry that
depends less on imports. If the economy becomes unduly weak, and if Erdogan is not able to convince the country that its
economic woes are solely America’s fault, then Turks may begin to question why the government is spending so much in
Syria.
The president’s efforts in that regard will only aggravate tensions between the U.S. and Turkey – a curious strategy,
considering the general frailty of the Turkish economy. The alliance between these sometimes-partners seems more
tenuous every day.
Editor’s note: The graphic in an earlier version of this analysis contained an incorrect lira-to-dollar conversion rate. We regret
the mistake, which has been corrected on site.
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Brexit – on the road to transition?
London Economics Team
16 August 2018
Contents
1
2
3
4
5
6
7
Where are we now?
Timetable, key dates and the road to Brexit
Trade model options
Government White Paper proposal
Ground to cover in talks
Potential outcomes
Government and political sensitivities
Brexit – on the road to transition? | 2

Where are we now?
Brexit – on the road to transition? | 3
The road to our withdrawal…
Article 50
Ends Mar 2019
Transition
Period
30 Mar 2019 – 31 Dec
2020
Temporary
Customs
Arrangement
(TCA)?
01 Jan 2021 – 31 Dec
2021
Permanent end
state
31 Dec 2021 onwards?
• UK triggered a 2 year
negotiating window
with the EU, which will
formally end 29 March
2019.
• UK remains an EU
member throughout
this period.
• Commons to vote on
Withdrawal Treaty and
‘future arrangements
framework’ ahead of
ratification of EU
(Withdrawal
Agreement) Bill before
29 March 2019
• UK leaves EU on 29
March 2019.
• Officially known in
Westminster as
‘phased
implementation’.
• Access to the EU
single market and
current customs
arrangements will
continue to apply.
• UK will be able to sign,
but not implement
trade deals with non-
EU countries.
• The UK and the EU will
try and finalise its
future trade
arrangements during
this period.
• Applies if there is no
agreed solution over
Northern Ireland/
Republic of Ireland
border. UK TCA
proposal includes.
• Key elements
• Avoidance of a hard
border.
• UK to remain in a
customs union with
EU.
• Ability to sign Free
Trade Agreements
(FTAs) with the rest of
the world.
• Not yet agreed, EU
rejects the inclusion of
a firm date.
• UK government White
Paper set out UK’s
‘future vision’.
• Not agreed with the
EU.
• Key elements
• Trade deal for goods?
• A common rule book
for goods?
• Facilitated Customs
Arrangement? UK
proposing to collect
tariffs for EU for 3 rd
party countries.
• Proposed new
economic and
regulatory
arrangement in
financial services?
Brexit – on the road to transition? | 4

Where are we now?
Sequencing of talks
Phase 1
Withdrawal
Exit charges
EU migrant rights
Ireland- relationship ROI/NI
Phase 2
Future relationship
Phase 3
Transition
Trade talks?
Ratify through
Westminster, European
Parliament, (EU27
parliaments?)
Trade, regulation,
financial services…
Phased
implementation
plans
Ratification
Ex-EU trade talks
Withdrawal
Phase 1 of talks agreed in Dec i.e. ‘divorce bill’, EU citizens’
rights & Republic of Ireland (RoI)/Northern Ireland (NI)
relationship (as yet unsolved).
Draft agreement on ‘transition’ published in March.
Transition period lasts until end-2020.
Much detail still without formal agreement, esp. RoI/NI
‘backstop’. Can there be a frictionless border without an
EU/UK customs union? NI/GB ‘border’ political red line.
Future arrangements
Cabinet White Paper (Chequers proposal) set out UK’s
vision of future arrangements.
Proposed trade deal in goods, services arrangements lack
detail.
EU has intimated it cannot accept UK customs partnership
proposals.
Article 50
• Agreement on all 3 phases had been sought by the October 2018 EU
summit, but there is now talk of an additional November Summit.
• Future trade arrangements talks still at an early stage.
• September Tory party conference may present renewed problems for
Prime Minister May - possible leadership challenge.
Brexit – on the road to transition? | 5
Withdrawal Treaty
UK/EU talks
What has been
agreed
• A final agreement on the exit terms and (any) future access
arrangements with the EU would most likely be needed by the end of
this year, in order to provide enough time for ratification before the UK
leaves the EU on 29 March 2019.
• UK Parliament has been promised a “meaningful vote” on the
proposal.
• The EU has stated that 80% of the Withdrawal Treaty has been
agreed.
• In March 2018 the UK and EU reached an agreement on a 21 month
transition period ending in December 2020. The UK made
concessions on EU citizens rights during the period. The Brexit bill is
around £39bn.
• The EU agreed its guidelines around the framework for the future
UK-EU relationship but progress on future trading arrangements is
slow.
Outstanding issues
on Withdrawal
Treaty
• Of the remaining 20% outstanding, avoiding a border between
Northern Ireland and the Republic of Ireland remains a major
stumbling block.
• Other remaining points are generally less contentious but
nevertheless include issues such as the sovereignty of Gibraltar and
UK military bases in Cyprus.
Brexit – on the road to transition? | 6

Northern Ireland
Northern Ireland remains a significant sticking point in negotiations, the problem is rooted in the UK’s desire to be
outside a customs union with the EU, whilst maintaining an open border.
All sides agree there can be no return of a hard border between Northern Ireland and the Republic of Ireland.
And that the Good Friday Agreement cannot be undermined.
However the UK wants to reject a customs union in order to strike trade deals across the World. But the
idea of customs checks at the NI/ROI border is politically and practically unpalatable.
The EU has proposed that Northern Ireland remains within the EU’s common regulatory area for goods
and customs. The UK has rejected this, as it would create an East/West border between Northern
Ireland and the UK mainland – this is a red line for the government which is in a supply and confidence
arrangement with the DUP (Democratic Unionist Party).
The UK government has proposed an alternative plan (Temporary Customs Arrangement) which would
see customs rules extended until Dec-2021 as a way to avoid a hard border until a permanent solution
can be agreed. The EU has not accepted the UK proposal here - it is concerned that this is time limited
and therefore not a feasible backstop.
Wider issues over regulations also remain.
Brexit – on the road to transition? | 7
Brexit requires considerable domestic legislation
Legislative Bills
EU Notification of Withdrawal Act 2017
• Received Royal Assent 16 March 2017
EU (Withdrawal) Act 2018
• Received Royal Assent 26 June 2018
Nuclear Safeguards Act 2018
• Received Royal Assent 26 June 2018
Taxation (Cross-border Trade) Bill
• Set to be debated in the Lords (4 Sep 18)
Trade Bill
• Set to be debated in the Lords (11 Sep 18)
Agriculture Bill
• White Paper published 27 Feb 2018
Immigration Bill
• To be presented in the Autumn
Fisheries Bill
• White paper published 4 July 2018
EU (Withdrawal Agreement) Bill
• The UK and EU are still negotiating the final 20%
Passing domestic legislation is taking up significant
amounts of parliamentary time. 112 hours# just for the
EU Withdrawal Bill.
There are several other supporting bills which needed
to be passed by Parliament for Brexit. Each represents
a political hurdle and a chance for Tory rebels to make
a point.
Parliamentary arithmetic complicates matters with the
government having a very slim 12 seat majority (This
is only with DUP support).
The final text of the withdrawal agreement will need to
pass through both the House of Commons and the
House of Lords and gain Royal Assent before 29
March 2019.
The EU will also need to ratify the final terms, although
the exact procedure is still unclear, i.e. whether
ratification via all 27 national parliaments will be
required.
# Institute for Government estimate of time in the House of Commons
Brexit – on the road to transition? | 8

Timetable, key dates and the road to Brexit
Brexit – on the road to transition? | 9
Brexit timetable in summary
EU Leaders’
Summit
Withdrawal
Bill
EU Leaders’
Summit
Chequers
Cabinet
Summit
White
paper
Informal EU
Summit
Tory
conference
October
Summit
Possible
November
Summit
December
Summit
Ratification of
Withdrawal
UK leaves
the EU
Transition
ends
TCA
23 Mar Jun 29 Jun
6 Jul
12 Jul
20 Sep
2018
30 Sep – 3 Oct
18-19 Oct unconfirmed 13-14 Dec
Jan/Feb
2019
29 Mar
2019
31 Dec
2020
Through
2021
Future Dates
Tory Party
Conference
Barnier’s target
December EU
Leaders Summit
Ratification
UK leaves EU
Transition period
ends
TCA (Temporary
Customs
Arrangement)
30 Sep – 3 Oct Oct/Nov 13-14 Dec Jan 2019 29 Mar 2019 31 Dec 2020 Through 2021
The Tory party
conference in
Birmingham could
present an
opportunity for a
leadership challenge.
Michel Barnier’s
(Chief EU
negotiator) target
for agreeing
withdrawal
agreement. Timing
for agreement
looks to be slipping
from Oct to
Nov/Dec.
This is the last
European Council
of 2018 and would
probably be the
last chance to
settle a deal.
Final withdrawal
agreement will
need to be ratified
by the UK
Parliament. There
are still some
question marks
over the ratification
process in the EU.
UK will leave the
EU on 29 March
2019, after the 2-
year Article 50
period ends.
Scheduled to end in
December 2020.
Plan would be for
the UK to
subsequently enter
into its ‘Permanent
End State’ at this
point. If one is
agreed by this
point, if not then a
TCA will apply.
To come into force
if ‘Permanent End
State’ not ready.
Historic events
UK triggers Article 50 EU Leaders Summit EU Withdrawal Bill EU Leaders’ Summit
Chequers Cabinet
summit
UK Government White
Paper
29 Mar 2017 23 Mar 2018 Jun 2018 29 Jun 2018 6 July 2018 12 July 2018
The UK formally
notified the EU of its
intention to withdraw
from the EU.
Provisionally agreed
EU directives on trade
negotiations and 21
month transition
period.
EU Withdrawal Bill has
passed the House of
Commons and Lords
and received Royal
Assent.
No agreement
between leaders given
the lack of progress on
future arrangements.
Agreed a formal UK
position on the ‘future
vision’ of UK’s
arrangements with the
EU.
Government details its
proposed future
relations with the EU.
Agreed at Chequers
summit (6 July).
Brexit – on the road to transition? | 10

Nothing is agreed until everything is agreed
There are three phases of talks, all
are related.
• The negotiations are being progressed in phases, but there are not
separate isolated agreements on each. They will all need to be put
together at the end, with horse trading likely across all elements.
The financial settlement may not be
final.
• The UK’s Brexit financial settlement agreed in phase one of talks could
come back on the table as a bargaining chip in phase three (phased
implementation plans, ECJ…).
• The EU’s financial framework (2021-2027) is being negotiated and talks
over rising cash demands are fraught – any UK financial offering could
help here (UK settlement only covers commitments to end-2020 so far).
NI/RoI border issues still dominate.
• The NI/RoI backstop was fudged in political terms earlier in the year, but
the UK and EU are still far apart on a detailed level agreement. Talks on
this continue to dominate all other discussions at present.
EU Summits loom large with
everything on the table.
Conclusion
• What the EU is willing to offer in terms of future trading arrangements
will clearly depend on the cash settlement, the role of the ECJ agreed
and, whether a settlement has been reached, on the NI/RoI border.
• The EU Summit in October/November/December has been a focal
point for all these issues coming together.
• If all the elements are not agreed, earlier ‘agreements’ will also fall
apart- could be back at square one.
Brexit – on the road to transition? | 11
Trade model options
Brexit – on the road to transition? | 12

European Commission – options for a future relationship….
Source: Michel Barnier’s presentation to European Council -15 December 2017
Brexit – on the road to transition? | 13
What sort of access
Single Market access Non-EU trade Free movement
of labour
Social
/labour law
EU Law/
regulation
EU budget
contributions
EU
Full access to the single market,
without any tariff or non-tariff
barriers. Development of a single
market in services continues, no
exact timetable for completion.
External agreements are made
on a common EU basis, with
agreements with 45 countries
(not including European
Economic Area (EEA)) currently
in place. Makes negotiations
lengthy and prevents countries
from making their own
agreements.
EU citizens are
able to move
unimpeded
across member
states.
All.
All member states
are represented in
the decision
making, must also
comply with all
rules unless
specific opt outs
agreed.
All member states
obliged to contribute
to the EU budget.
EEA
Tariff free access, although goods
must pass through customs
procedures, which Norwegian
companies have cited as an issue.
Services trade conducted on the
same basis as EU members.
Agreements are made under
bilateral agreements or
European Free Trade Association
(EFTAs). EFTA currently has
preferential agreements with 35
countries including Canada.
EU free
movement of
labour rules
apply to EEA
members.
All.
Not represented in
decision making.
Must however
adopt almost all
legislation.
Contributions made to
EU programmes,
such as the ‘EEA
Grants’.
Switzerland
Tariff free access as part of bilateral
agreements. Adherence to EU
principles of free movement of
labour, capital, customs procedures
a condition. No general agreement
on free movement of services .
Switzerland has the ability to
negotiate its own trade policies,
through EFTA or bilaterally.
Currently has unilateral
agreements with Japan and
China.
Bilateral
agreement with
EU forced
Switzerland to
accept free
movement,
although they
are permitted
limited
safeguards.
No.
No influence in
decision making.
Not bound to
comply with EU.
However Swiss
legislation tends to
mirror EU in order
for continued
access.
As with EEA
countries, Switzerland
makes contributions
to enlargement and
social cohesion funds
as part of its bilateral
agreements. Recent
contributions average
around £420m/yr.
Canada +++ Free trade agreement in goods -
tariffs cut to 0% (in 99% of goods).
Major non-tariff barriers removed,
but customs procedures still a
requirement.
EU-Canada Comprehensive
Economic and Trade Agreement
(CETA) included an accord over the
liberalisation of services trade, but
a UK deal would require a far more
detailed services agreement.
Ability to strike independent trade
deals with countries around the
world.
No right of free
movement of
labour.
No.
CETA only a
includes limited
amount of
regulatory
recognition for
goods. Very little in
terms of services
alignment.
No budget
contributions. EU
could demand
‘voluntary’
contributions to
certain programmes
in return for closer
arrangement than
Canada.
Brexit – on the road to transition? | 14

What sort of access continued…
Single Market access Non-EU trade Free movement of
labour
Social
/labour law
EU Law/
regulation
EU budget
contributions
Norway-
’bespoke’
Under a ‘Norway plus’
model UK would retain tariff
free access to the EU single
market. However as it is not
part of the customs union,
border customs checks
would be required. Poses an
issue for Northern Ireland.
Also note does not cover
agriculture and fisheries.
UK should be free to agree
independent FTAs with other
countries.
Norway adheres to
free movement of
labour, a clear red
line for the UK.
UK would
want
independence
of social/
labour law.
Not represented in
decision making.
Must however
adopt almost all
legislation. UK
would want more
freedom, rather
than simply being
a rule taker.
EU seeks ‘voluntary’
contributions to
certain programmes.
Norway contributes
0.16% of its annual
GDP compared with
the UK’s 0.25%.
Bespoke FTA -
comprehensive
or trade line
Access would depend on
details of agreement – could
be wide ranging or specific
to certain goods or services.
Agreement would potentially
favour the EU’s interests
given its market size.
Conducted through FTAs,
separate bilateral agreements
and on a ‘Most Favoured Nation’
basis.
No right of free
movement between
the UK and EU.
No.
No influence in
regulation. Need
for a degree of
equivalence.
No EU budget
contributions but
another financial
contribution may be
requested.
WTO (World
Trade
Organisation)
Would be conducted under
‘Most Favoured Nation’
arrangement- determines
tariffs and quotas. Services
trade covered by the
General Agreement on
Trade in Services (GATS).
Independent FTAs, trade
conducted on Most Favoured
Nation basis in line with WTO
rules.
No right of free
movement between
the UK and EU.
No.
No influence in
regulation. Need
for a degree of
equivalence.
No.
Turkey
Under customs union rules,
goods receive full access.
Agricultural goods and
services are not covered.
Subject to the EU’s tariff on
processed agricultural and
industrial goods. It must also
negotiate its own FTAs.
No right of free
movement.
No.
No influence in
regulation. Need
for a degree of
equivalence.
No.
Brexit – on the road to transition? | 15
Government White Paper proposal
Brexit – on the road to transition? | 16

What does the government want? Summary of Brexit White Paper:
Agreed at Chequers Summit 6 July 2018
• Free trade. Proposed a free trade area for goods with the EU, rather than full
single market access. Seeking different arrangements for services.
• Customs. UK would collect tariffs on behalf of the EU for goods passing through
its territory (also proposes reciprocity), but would be free to levy its own and sign
trade deals. This would be achieved using a Facilitated Customs Arrangement
which uses yet-undeveloped technology.
• Regulation. A “common rulebook” for goods would see the UK commit to
“continued harmonisation” with the EU, but would be free to set its own regulation
for services. Judges in the UK would need to follow the ECJ’s lead with regard to
disputes over the common rulebook.
• Migration. End to freedom of movement, but introduce a “mobility framework”
that would "allow [UK and EU] citizens to travel freely, without a visa, for tourism
and temporary business activity.”
How has the EU received the White Paper?
• Michel Barnier (chief EU Brexit negotiator) argues that the UK’s proposal for free
trade in goods (but not of people and services) as well as collecting EU tariffs
without being part of the EU’s legal system would cause the bloc to “lose control
of its borders and laws.”
• Key issue is disagreement over the best way to avoid a hard border between the
Northern Ireland and the Irish Republic. Lately Barnier is reportedly ready to
soften his stance by showing some flexibility in being “ready to improve the text”
of its proposal – he is acutely aware of potential UK political meltdown.
Brexit – on the road to transition? | 17
Ground to cover in talks
Brexit – on the road to transition? | 18

Critical points to be agreed with the EU
Future trading arrangements - Goods
• The UK plans to leave the Single Market and the Customs Union, but it is yet to agree a framework for
trade here forward. The government is proposing the establishment of a free trade area for goods.
However the EU remains uncomfortable with UK proposals on collection of tariff revenue on its behalf as
well as over the regulatory requirements the UK would face. Huge issue for all UK borders.
Future arrangements - Services
• A separate set of access and regulatory arrangements for service firms needs to be agreed. The
emphasis is on preserving regulatory and supervisory cooperation, maintaining financial stability, market
integrity and consumer protection. There is much ground to cover here.
Dispute resolution and the European Court of Justice
• The UK and EU still need to finalise the means for the resolution of disputes. The UK has been pushing
for joint reference to the Court of Justice of the European Union as the interpreter of EU rules.
Northern Ireland and Republic of Ireland border
• A ‘backstop’ needs to be settled upon which would provide a temporary means to avoiding a hard NI/RoI
border, if a permanent settlement is not in place ready for the end of the transition phase.
Foreign policy, defence and development
• Here, the UK government proposes “continued consultation, development of shared capabilities and
combining efforts”– discussions need to agree, for example, a Security of Information Agreement that
facilitates the sharing of information and intelligence.
Migration
• The UK government is seeking to end ‘free movement’ and intends to set out the details of its future
immigration system “in due course”. However, depending on the UK’s demand on access to EU markets
for goods, it may find some further push back on its plans to end free movement.
Citizens’ rights
• The UK and the EU have already reached an agreement to work on the same basis as now up until the
end of December 2020 - permanent right to reside for citizens already in the UK. But there is no plan
beyond this.
Brexit – on the road to transition? | 19
The possible paths for Brexit…
Illustration is not exhaustive
Mitigation options
enacted to avoid
‘cliff edge’
No deal
UK leaves with
no deal and no
mitigating factors
No
No
No
Off the shelf
trade model
e.g. EEA
Transition
phase
Possible
Temporary
Customs
Arrangement
Permanent
new endstate
Yes
Yes
Yes
Customs/trade
arrangement
reached
UK and EU
parliaments
ratify the
deal
Yes
No
Article 50
period
extension?
2 nd
referendum??
Brexit – on the road to transition? | 20

Potential outcomes
Brexit – on the road to transition? | 21
What Brexit outcomes might mean….
Model Consequences Market implications
EEA model/
bespoke trade
deal, customs
arrangement
agreed upon
Here the UK enters a 21 month transition before
it enters an EEA / bespoke arrangement. Ties
with the EU are maintained e.g. tariff free access
for goods. Firms will be able to continue trading
seamlessly and doing business with the rest of
the bloc.
Very close ties with EU. We would expect the Bank
of England to continue along a path of gradual policy
tightening and sterling to rise materially from current
levels ($1.27 and 89.5p against the euro).
No deal with
mitigation steps
In this situation there would also be no future
partnership arrangement, but the UK and EU
might take steps to avoid a cliff edge. Here a
transition period might go ahead and the UK
would have time to set up its WTO tariff structure
and prepare border checks etc.
Here we would expect a material hit to the economic
outlook, with sterling also lower. Possibility of UK
rate cut. More QE purchases might also be on the
table.
No deal (cliff edge)
UK businesses and households would find
significant disruption and face blockages when
attempting to do business with and service EU
(and some overseas) businesses and
households. Trade may be severely impeded.
The UK economy would likely contract. Sterling
would be sharply lower when compared against a
more market access friendly Brexit. UK interest rates
could well be cut and QE purchases restarted,
adding to downward pressure on sterling.
Brexit – on the road to transition? | 22

Parliament’s role in approving a Brexit deal
Parliament is to be given a “meaningful vote” on the final Brexit package. This will be a “compound vote”, a single vote on
both the withdrawal agreement and the UK’s future relationship with the EU.
So what say will Parliament actually have?
• The vote is intended to be a take it or leave it decision.
• If Parliament did vote to reject the package the government could go back and amend the proposal, but the scope
for doing so late in the day would be limited. So by voting to ‘leave it’, Parliament risks a ‘no deal’ outcome.
Can Parliament reject ‘no deal’?
• The EU Withdrawal Act states that in three instances (see below #), the Government would have to make a
statement to Parliament setting out what it intended to do next.
• Note that that the EU Withdrawal Act states this would be a motion in “neutral terms”. A motion expressed in
“neutral terms” can have no amendments tabled to it, though the Speaker would get the final say.
An (!) humble address…
• Experts in parliamentary procedure have suggested “an humble address” could be used to force the
government to act on the will of Parliament.
• An humble address is a request from the Commons that the Queen, through her Ministers, perform a specific act
and not doing so would put the Crown and the Commons in conflict. Labour has used this twice in recent months.
The three instances #:
Parliament has decided not to pass the Government’s motion to approve the withdrawal agreement and future
framework.
Before 21 January 2019, the Government tells Parliament that no agreement can be reached.
If after 21 January 2019, no agreement has been reached.
Brexit – on the road to transition? | 23
Government and political sensitivities
Brexit – on the road to transition? | 24

Can the government last?
When could Theresa May face a Tory leadership challenge?
• Key Brexit legislation returns to the Commons in September, which may widen divisions in the Tory party. Conservative
Party Conference (30 Sep – 3 Oct) might be seized by MPs looking to challenge the PM.
• Requires 15% of Tory MPs (i.e. 48) to write to Sir Graham Brady (Chairman of backbench 1922 Committee).
• The exact number of letters already held by Sir Graham is unknown, but numerous sources suggest it is around 40.
A Tory leadership contest can be triggered in two ways
1
Leader of the party resigns
Shortlist of candidates are whittled
down to two by Conservative MPs
Final two candidates are
put to a member ballot
2
15% of Conservative MPs write to the
Chairman of the 1922 Committee
Vote of confidence in
the party leader
PM loses
PM wins
Vote of confidence cannot take place for another 12 months
Who might vie for the Tory leadership?
?
Boris Johnson
Sajid Javid
Michael Gove
Jeremy Hunt
A. N. Other
Could there be an early election? Fixed-term Parliaments Act 2011 requires either:
• Two-thirds of MPs agree to a motion in the House of Commons, or;
• No confidence motion passes and no alternative government is confirmed within 14 days.
Early election is not in Conservative Party interests given Labour’s standing in the polls.
Brexit – on the road to transition? | 25
Conservatives face the threat of Labour and a recovering UKIP….
Source: Britain Elects
Sources: ORB
Brexit – on the road to transition? | 26

Final points
Our central case is that enough meat is put onto the bones of an agreement to allow the UK to
enter Brexit transition on 30 March 2019, but timescales are tight.
Fine print details to be settled during transition will be considerable.
We would not rule out a challenge to PM May’s leadership this autumn.
Despite rhetoric on both sides of the channel, it is not in anyone’s interest for a ‘no
deal’. UK budget contributions remain the UK’s strongest card.
Does Greece offer a precedent? The various bailout negotiations were typically settled at
the eleventh hour. The ‘Troika’ (European Commission, ECB, IMF) were clearly the
stronger party in the talks.
EU27 collectively held fast so far in talks. As time goes on, is there a greater pressure on
national governments to settle? Politics always more important than processes.
Brexit – on the road to transition? | 27

8/17/2018 Chinese electric car startup Xiaopeng is now valued at $3.6 billion — Quartz
WHAT A BET
A Chinese electric car startup that has delivered zero cars is now
valued at $3.6 billion
By Echo Huang • August 6, 2018
O f the stage, into the real world.
AP PHOTO/NG HAN GUAN
How deeply convinced investors are of the strength of China’s electric vehicle market? They’ve put hundreds of
millions of dollars into EV startups that have yet to mass produce their vehicles.
The latest example is Xiaopeng Motors, an Alibaba-backed EV startup that completed a four billion yuan ($580
million) funding round last week. The latest investment has given the 4-year-old EV carmaker a market valuation
of more than 25 billion yuan ($3.6 billion). But the company hasn’t yet delivered a single vehicle to its customers,
who have pre-ordered more than 6,000 of its G3 electric sports utility vehicle since pre-sales began earlier this
year. Xiaopeng, also known as Xpeng, said it expects to deliver at least a thousand (link in Chinese, paywall) of
the SUVs by the end of this year.
Xpeng is one of several high-pro le EV startups to spring up in recent years thanks to China’s support of the new
energy vehicles market, which includes pure battery vehicles and plug-in hybrids. The support, in the form of
subsidies and other incentives, is part of the country’s effort to spur local innovation through its Made-in-China
2025 (paywall) plan, and to ght air pollution. Along with investments from tech giants like Alibaba and Tencent,
companies such as Xpeng have taken their prototypes to world-class platforms like the Las Vegas Consumer
Electronics Show. At the conference, Xpeng displayed the G3, which features a 360-degree camera on its roof that
can take photos and videos, and a pollution monitor.
Latest Featured Obsessions Emails Editions
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8/17/2018 Chinese electric car startup Xiaopeng is now valued at $3.6 billion — Quartz
The G electric vehicle.
But producing the cars at scale seems to be harder than raking in investor millions, and some startups have been
struggling to ramp up production after promises to deliver cars this year or next (link in Chinese).
NIO, a Shanghai-based EV startup which led for an IPO in the US earlier this year, had postponed delivery of its
pure battery EV series ES8 from April to late May, when it delivered 10 (link in Chinese) of the vehicles. Backed by
search engine giant Baidu and social media behemoth Tencent, NIO has a private valuation of more than $1
billion.
NIO has delivered 1,000 vehicles as of July, and its factory is making at least 80 cars (link in Chinese) a day to
deliver 10,000 orders this year. NIO’s founder Li Bin is con dent enough of his production schedule that he
invited Xpeng’s founder He Xiaopeng to bet against him, (link in Chinese) after the latter said on WeChat that no
Chinese EV startup is likely to achieve such a production volume this year. (The stakes aren’t high—the loser will
give the winner a car.)
WM Motor, another EV unicorn based in Shanghai, has also said it will deliver 10,000 units (link in Chinese)
starting next month. The company didn’t immediately respond to queries.
Time is ticking for the startups as China has been opening its relatively protected auto market this year. Many
Chinese EV startups put their SUVs at a price range between 200,000 to 400,000 yuan ($29,220 to $58,440). While
that gives them an advantage over a Tesla Model X sold in China, which starts from 897,900 yuan ($131,000), that
gap might narrow sooner than they’d like. Tesla is in the process of setting up a factory in China, which could
allow its locally made cars to be exempt from import taxes, making them cheaper for Chinese buyers.
tesla, alibaba, tencent, shanghai, baidu
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8/17/2018 The U.S. Trade Deficit Isn’t Caused by Low American Savings - Carnegie Endowment for International Peace
China Financial Markets
The U.S. Trade Deficit Isn’t Caused by Low
American Savings
Michael Pettis
A recent article by Joseph Stiglitz suggests that the United States runs a current account deficit because
its people save too little to fund domestic investment. In fact, he may have it backwards: Americans may
save too little precisely because the United States runs a current account deficit.
August 08, 2018 Comments (20)
Economist Joseph Stiglitz recently published an interesting piece in Project Syndicate called “The US is at Risk of Losing a Trade War
with China.” I am always surprised by claims that deficit countries like the United States stand to lose more from a trade war than
surplus countries (that is certainly not what history suggests). I suspect it is because many commentators just do not understand why
China is so susceptible to a trade war and why Beijing is so worried. Otherwise, I agree with much of what Stiglitz says about tariffs in
the article (as I usually do). This includes the article’s main point—that tariffs are likely to have a limited or even adverse impact on
U.S. and Chinese overall imbalances, even if they ostensibly improve bilateral imbalances. His article begins by saying this:
e “best” outcome of President Donald Trump’s narrow focus on the US trade de cit with China would be impro ement in the bilateral balance, matched
by an increase of an equal amount in the de cit with some other country (or countries). In fact, signi cantly reducing the bilateral trade de cit will pro e
difficult.
Regular readers of my blog know that I have made many similar arguments. In April 2017, for example, I explained why clumsy
attempts to reduce the large U.S. bilateral trade deficit with Mexico are likely actually to increase the U.S. deficit with the rest of the
world by more than they reduce the U.S. deficit with Mexico. This may seem counterintuitive at first, but there is nothing complicated
about the logic that drives this process. It only seems counterintuitive because the trade models most people carry around in their
heads involve implicit assumptions that used to be true but no longer are. Because these assumptions are almost never explicitly
stated, it’s easy to fail to notice how changes in the dynamics of global trade and investment have made the old models that drive the
debate obsolete.
The same dynamics apply to trade with China, as Stiglitz points out. While tariffs on Chinese imports are likely to reduce the bilateral
U.S. trade deficit with China, they are unlikely to reduce the overall U.S. deficit, nor will they reduce the overall Chinese surplus.
Tariffs will merely cause shifts in global trade patterns that might raise prices on some goods marginally but that do not affect the
underlying causes of the imbalances.
Do Americans Save Too Little?
But for all my agreement with Stiglitz on how tariffs affect trade, I disagree with him on what drives U.S. trade imbalances and, more
generally, on balance-of-payments dynamics. Stiglitz argues that the United States has been running trade deficits mainly because
Americans save too small a share of their income.
i
According to this logic, if Washington wants to reduce its deficits, it must
implement policies that force up U.S. savings:
e US has a problem, but it’s not with China. It’s at home: America has been saving too little. Trump, like so many of his compatriots, is immensely
shortsighted. If he had a whit of understanding of economics and a long-term vision, he would have done what he could to increase national savings.
would have reduced the multilateral trade de cit.
at
The United States has indeed been saving “too little.” But it is easy to show that under certain conditions—ones that most of us,
perhaps even Stiglitz, would agree characterize today’s global economy—low U.S. savings are an automatic consequence of
balance-of-payments pressures originating abroad.
In fact, the same basic arithmetic shows that the United States cannot raise domestic savings relative to domestic investment (that is
to say, it cannot reduce its trade deficit) without addressing problems that do indeed originate in China, and in all the other major
surplus countries. The United States, in other words, doesn’t have a trade deficit because it saves too little: it saves too little because
it has a trade deficit.
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8/17/2018 The U.S. Trade Deficit Isn’t Caused by Low American Savings - Carnegie Endowment for International Peace
Again, I know that this may seem at first incredibly counterintuitive. (And here, inevitably, someone will foolishly intone that no one is
putting a gun to a U.S. consumer’s head and forcing him or her to buy a flat-screen television.) But in fact this claim follows inexorably
from the basic balance-of-payments arithmetic.
Before going on to explain why, I should point out that Stiglitz is not the only one who believes that low U.S. savings cause U.S. trade
deficits. This has been an almost overwhelming consensus among economists and analysts for decades. In May 2017, for example,
two other eminent economists, George P. Schultz and Martin Feldstein, proposed a seventy-word explanation of “everything you need
to know about trade economics. . .” They wrote:
If a country consumes more than it produces, it must import more than it exports. at’s not a rip-off; that’s arithmetic. If we manage to negotiate a
reduction in the Chinese trade surplus with the United States, we will have an increased trade de cit with some other country. Federal de cit spending, a
massive and continuing act of dissaving, is the culprit. Control that spending and you will control trade de cits.
While Stiglitz argues that Washington must implement policies that raise national savings to reduce the U.S. trade deficit, Schultz and
Feldstein are more specific and far more ideological: they state that Washington must reduce go ernment dissaving by reducing the
fiscal deficit.
Either way, these economists agree that only by taking steps to force Americans to save more—whether U.S. households,
businesses, or the government—can Washington prompt the U.S. trade deficit to contract. They argue that this line of reasoning
follows inevitably from the accounting identities that explain the relationship between savings, investment, and trade deficits.
A Hidden Assumption
I have often argued that economists too easily make categorical statements when they should be making conditional ones. Stiglitz,
Schultz, Feldstein, and others base their argument on the accounting identity in which a country’s current account deficit is always
and exactly equal to the excess of domestic investment over domestic savings. (For those who are interested, in a May 2017 blog
response to the Schultz and Feldstein article, I list and explain the very simple equations behind the relevant accounting identities.)
The point is that U.S. investment has exceeded U.S. savings for decades, and the accounting identities let us see that, as long as this
is true, the United States must run a current account deficit exactly equal to the gap between investment and savings. Narrow the gap
between the two, Stiglitz argues, and you automatically reduce the U.S. deficit. This is true by definition.
Because very few economists would recommend reducing investment, Stiglitz then takes what seems like the logical next step. He
argues that if the United States were to implement policies that caused U.S. savings to rise, the resulting higher savings would reduce
the gap between U.S. investment and U.S. savings. Doing this, in turn, would reduce the U.S. current account deficit. In theory, this
could perhaps be done by reducing the fiscal deficit, by making it harder for consumers to borrow, by increasing business profits at
the expense of workers, or by increasing income inequality more generally.
But there is a hidden assumption at work here. It turns out that policies that increase domestic savings in the relevant sector of the
economy would narrow the investment-savings gap only if U.S. investment and savings were wholly determined by domestic forces. If
that were the case, it would also mean that Americans imported foreign capital specifically to bridge this investment-savings gap. To
put it slightly differently, increasing domestic savings would narrow the investment-savings gap only if foreigners exported capital to
the United States mainly in the form of trade finance, and only if this trade finance were designed specifically to fund the trade deficit
or to fund the difference between domestic U.S. investment and domestic U.S. savings (which would amount to the same thing).
This is how the world used to work, but that is no longer true today. Economists too often fail to identify explicitly the assumptions that
allow their models to work. This is probably why so many economists retain an obsolete model of balance-of-payments dynamics.
Why Does Capital Actually Flow to the United States?
There are, in fact, two very different explanations of why foreign savings flow into the United States, and each has completely
different implications:
1. One explanation assumes that trade or capital imbalances originate in the United States, perhaps because Americans save too
little and consume too much, in which case the rest of the world accommodates these imbalances. According to this explanation,
the United States has domestic investment needs that cannot be satisfied by domestic savings, so Americans must bid up the cost
of capital to attract foreign savings to fund the gap. This was almost certainly the case for much of the nineteenth century.
2. The other explanation assumes that trade or capital imbalances originate abroad. The thinking goes that the United States
accommodates these imbalances, partly because it has very deep, liquid capital markets with highly credible governance, and
partly because of its role as the capital shock absorber of the world. According to this explanation, surplus countries—usually, I
might add, because of policies that suppress domestic consumption—have savings that exceed their domestic investment needs
and must export these excess savings abroad to run trade surpluses and avoid unemployment. These surplus countries prefer to
export a substantial portion of their excess savings to the United States and, as they do so, they push down the cost of capital.
The first explanation—which was valid for most of modern history—assumes that most capital flows consist essentially of trade
finance. The second explanation—which was probably valid in the late nineteenth century and has now become valid again since the
late twentieth century—assumes that most capital flows are driven by central banks, sovereign wealth funds, capital flight, and
investors managing their capital. The presumption is that these capital flows represent independent investment decisions based on
expectations of risk and returns.
Whichever explanation is correct, it is clear that the world must balance. And unless we believe that balance is achieved by an
extraordinary coincidence at every point in time, causality must flow one way or the other. There is nothing in the accounting identity
that tells us which way causality runs, but run it must.
It is wholly incorrect to assume, however—as most economists implicitly do—that it is the rest of the world that automatically
accommodates U.S. imbalances. It could easily be the reverse. And I think it is very likely the reverse that holds true, given that
interest rates do not typically rise as U.S. trade deficits rise. Interest rates suggest very strongly that capital isn’t sucked into the United
States from abroad, but rather is pushed into the United States from abroad.
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8/17/2018 The U.S. Trade Deficit Isn’t Caused by Low American Savings - Carnegie Endowment for International Peace
More importantly, capital flows into the United States do not consist only of trade finance. Instead, this influx does indeed consist
mainly of independent investment decisions driven by central banks, sovereign wealth funds, capital flight, and investors managing
their capital. Because of the depth and quality of its financial markets, the United States acts as an investor of last resort, absorbing
excess foreign savings that need a safe home.
Whichever explanation any reader might prefer, my point is not to assert that one or the other is right. It is rather to insist on a fact that
any trade model must recognize explicitly: a world in which U.S. capital imports are determined abroad, by countries and investors
seeking to manage their excess savings, works very differently from one in which U.S. capital imports are determined domestically, as
a reflection of structurally low U.S. savings rates that require the country to import foreign capital.
In the latter case, Stiglitz would be correct to argue that policies that force up U.S. savings must reduce the gap between savings and
investment, and so must reduce the current account deficit. In the former case, however, the U.S. capital account surplus (that is,
imports of foreign capital) is determined by conditions abroad, which in turn determine the gap between U.S. investment and U.S.
savings. In this case, because policies aimed at increasing domestic savings have no predictable effect on the U.S. capital account
surplus, the gap between U.S. savings and U.S. investment will remain unchanged, as will the current account deficit.
Will Raising U.S. Savings Cause Investment to Rise?
To put it in simpler terms, assume for a moment that foreigners have $100 in excess savings that they have decided to invest in the
United States. Obviously, this creates a $100 U.S. capital account surplus and a corresponding $100 current account deficit; this also
requires that U.S. investment exceed U.S. savings by exactly $100.
What would happen if, as Stiglitz proposes, Washington were to implement policies that are designed to raise U.S. savings by say
$20? If foreigners continued to direct $100 of their excess savings to purchasing U.S. assets, the gap between U.S. investment and
U.S. savings would not drop to $80, as Stiglitz assumes. It would still remain at $100 dollars because this gap is determined by the
decision abroad to invest $100 in the United States.
How is it possible that savings rise without contracting the savings-investment gap? It turns out that if Washington were to implement
policies designed to raise U.S. savings by $20, and if the gap between savings and investment were to remain unchanged at $100,
there are basically two ways that the new policies could be accommodated (or some combination of the two):
1. In the first instance, U.S. investment would rise by $20 as Americans took advantage of the higher domestic savings to increase
domestic investment. This would be true if the United States were a developing country in which desired investment exceeded
actual investment, but the country was limited by insufficient domestic and foreign savings. In that case, both savings and
investment would rise by $20, and the current account deficit would be unchanged.
2. But in the second case, if savings are already plentiful and interest rates are low, to the extent that all desired investment has been
funded, U.S. investment wouldn’t rise. If the gap between U.S. investment and U.S. savings is unchanged (and investment doesn’t
rise), then savings cannot rise. This means that policies designed to raise U.S. savings by $20 can only cause savings in one part
of the economy to rise by $20 while simultaneously causing savings in another part to decline by exactly the same amount.
This is the tricky part that is almost always missed. Policies designed to increase savings will only do so if the additional savings
fund additional investment or are exported abroad. Otherwise, they simply cause savings to rise in one sector of the economy and
to decline in another, as I explained in a May 2016 blog entry called “Why a Savings Glut Does Not Increase Savings.”
There are two important points here. First, if the U.S. capital account surplus is determined by conditions abroad—which is almost
certainly the case—policies designed to raise U.S. savings will have no impact on the U.S. trade deficit. This is because (contrary to
conventional opinion), in today’s world, the capital account drives the trade account, not the other way around. Again, this may seem
counterintuitive, but I explain why this must be the case in a February 2017 blog entry called “Why Peter Navarro is Wrong on Trade.”
Second, this doesn’t mean that policies designed to raise U.S. savings will have no impact at all on the economy. What matters is
whether or not these policies result in higher investment. If they do, the U.S. economy is probably better off. This is basic supply-side
economics. But if these policies don’t result in higher investment, then the U.S. economy is almost certainly worse off.
Before I explain why these policies would leave the U.S. economy worse off, let me explain why investment is unlikely to rise. In a
world characterized by excess savings, there is unlikely to be a significant amount of unfulfilled U.S. investment needs. The United
States does need to invest in infrastructure, to be sure, but its failure to do so is political, not because of a lack of capital. In fact,
capital is easily available to any credible U.S. borrower (and to quite a few noncredible ones) at the lowest rates in history, no less.
And yet rather than invest massively in productive projects, U.S. companies (and those of most advanced economies) refuse to raise
money to invest and instead sit on hoards of cash for which they seem unable to find productive use.
Increasing U.S. Savings Means Higher Unemployment or More Debt
This is why policies designed to raise U.S. savings are likely to leave the country’s economy worse off. If Washington were to cut the
fiscal deficit, or to reduce taxes on the rich so as to increase income inequality, the result would not be higher domestic investment
(as the supply-siders say) or a smaller current account deficit (as Stiglitz says). The result would be either higher unemployment or
higher debt.
Why? Let’s return to the previous example. Assume Washington were to implement policies designed to raise U.S. savings by $20. If
foreigners or conditions abroad determine the U.S. capital account surplus, there will be no reduction in the U.S. trade deficit. Living
in a world of excess savings means that there is no pent-up demand for the additional productive U.S. investment that could
theoretically be unleashed by a potential $20 increase in savings, so investment cannot rise.
But the gap between investment and savings must remain unchanged (because there was no change in the amount of money
foreigners invested in the United States). This being the case, policies designed to raise U.S. savings by $20 inevitably can only
cause savings in one part of the economy to rise by $20 while simultaneously causing savings in another part to decline by exactly
the same amount. Total national savings cannot rise if the trade deficit doesn’t contract and if investment doesn’t rise.
How can policies that cause a $20 rise in U.S. savings in one sector of the economy also cause a $20 decline in savings in some
other sector of the economy? I have discussed this issue before, perhaps most extensively in a May 2016 blog entry. To put it briefly,
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8/17/2018 The U.S. Trade Deficit Isn’t Caused by Low American Savings - Carnegie Endowment for International Peace
such policies can result in a rise in unemployment, which reduces household savings, or the policies can increase household debt by
lowering interest rates, expanding credit, or setting off wealth effects.
This is the main point I hope to make here. Policies that Washington implements to try to raise U.S. savings rates can have very
different effects on the U.S. economy, some benign but some very damaging. The outcome depends on underlying conditions that are
implicit in the assumptions behind the balance-of-payments model that we use. We can broadly summarize the implicit assumptions
and their consequences in this way:
1. If foreigners exported capital to the United States mainly to finance the U.S. trade deficit, policies designed to raise U.S. savings
would cause the U.S. trade deficit to contract.
2. If foreigners export capital to the United States mainly to dispose of excess domestic savings, and if desired investment in the
United States exceeds actual investment, policies designed to raise U.S. savings will cause U.S. investment to rise but will have no
impact on the trade deficit.
3. If foreigners export capital to the United States mainly to dispose of excess domestic savings, and if there is no shortage of capital
in the United States, meaning that desired investment in the country is broadly in line with actual investment, policies designed to
raise U.S. savings will have no impact on the trade deficit but will cause an increase in either U.S. unemployment or U.S. debt.
What Can Washington Do?
So what are the policy implications if Washington is serious about reducing the current account deficit? Again, it depends on which
underlying conditions apply.
1. If foreigners exported capital to the United States mainly to finance the U.S. trade deficit, Washington must implement policies that
force up the domestic savings rate if it wants to reduce the trade deficit.
2. But if foreigners export capital to the United States mainly to dispose of excess domestic savings, Washington must implement
policies that make it harder for foreigners to dump excess savings in the United States or policies that make it easier for Americans
to send these flows abroad. Only by reducing net foreign capital inflows will Washington be able to drive down the trade deficit.
(One way Washington might be able to reduce foreign capital inflows would be to require that central banks no longer accumulate
U.S. dollars in their reserves but rather that they accumulate a synthetic currency that is backed by all major global currencies—
perhaps even the International Monetary Fund’s Special Drawing Right (SDR).)
If I am right, then it is not the case that the United States runs a current account deficit because Americans save too little. It is the
reverse: Americans save too little because the United States runs a current account deficit or because it runs a capital account
surplus: foreign capital inflows automatically depress U.S. savings.
As counterintuitive as this conclusion may seem, this is the implication of very plausible assumptions about how the world works. The
reason most economists are not aware of this is simply because they have not made explicit the assumptions that underlie the
models they use. Consequently, they have not recognized how changes in global markets have made their models obsolete.
Aside om this blog I write a monthly newsletter that co ers some of the same topics co ered on this blog. ose who are interested in receiving the
newsletter should write to me at chin npettis@yahoo.com, stating affiliation.
Notes
i
In this sentence’s reference to trade deficits, the term current account deficit would be more correct, but for the purposes of this
essay we can ignore the difference between the two.
More on:
BALANCE SHEET FRAGILITY CONSUMPTION GLOBAL TRADE
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8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
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She Posed for a Free Photo Shoot, Now
Her Face is Showing Up Everywhere
AUG 02, 2018 MICHAEL ZHANG
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Shubnum Khan
is a South African author and artist
with a warning she learned
who’s going public
the hard way: be very careful to read the fine print when signing a photographer’s model release.
Khan says that about six years ago, a friend of hers spotted an ad promoting immigration in a
Canadian newspaper. The woman in the ad looked strangely like Khan. Studying the photo more
closely, Khan realized that it was her.
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8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
Shubnum Khan
@ShubnumKhan
So today I'm going to tell you the story of How I Ended Up with
my Face On a McDonald's Advert in China - A Cautionary Tale.
Six or so years ago, a friend in Canada posted a pic on my FB
wall to say she found an advert of me promoting immigration in a
Canadian newspaper.
4:26 PM - Jul 28, 2018
21.9K 14.7K people are talking about this
After being confused for a while as to why her face would appear in an immigration ad on the other
side of the world, Khan was reminded by a friend that they had done a photo shoot a few years prior
with a photographer who had promised free professional portraits.
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The unnamed photographer had said he was working on a project called “100 Faces Shoot” that
involved creating portraits of people of all ages and races. Khan posed for three photos: a straightfaced
one, a smiling one, and a “crazy” one.
young friends and I were excited,” Khan . “We signed a release form at the start (I thought
writes
“[My]
it was to give him permission to use the photos for his portfolio). We didn’t read the small print. I
know. It was stupid.”
“It’s very quick – you sign a piece of paper, you go in, the photographer says smile for a picture,”
.
tells BBC News
Khan
What Khan says she wasn’t told verbally was that the photos would be sold as stock photos. While
she was initially amused about the idea that her face was being used all over the world, she soon felt
differently when she saw how often the images were being licensed without her having any control
over their use or receiving any money from it.
Through reverse image searches, Khan has discovered her face being used in countries across the
globe for a countless range of products and purposes.
https://petapixel.com/2018/08/02/she-posed-for-a-free-photo-shoot-now-her-face-is-misused-everywhere/ 2/21

8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
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Some are more innocent…
A sedation dentistry ad.
Others involve Photoshopped versions of Khan’s face to sell things like skin brightening complexes:
https://petapixel.com/2018/08/02/she-posed-for-a-free-photo-shoot-now-her-face-is-misused-everywhere/ 3/21

8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
Khan’s face now appears on the covers of books and magazines:
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other ads and uses aren’t as innocent: Khan by the photographer that she had signed
was told
But
away rights to “distortion of character including false names.”
Khan is Seng Bonny, a leader of Cambodian tours.
https://petapixel.com/2018/08/02/she-posed-for-a-free-photo-shoot-now-her-face-is-misused-everywhere/ 4/21

8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
Khan is Phoebe Lopz, a campaign manager in San Francisco.
Khan has also discovered how prevalent fake testimonials are online and in advertisements. She has
found herself being presented as a foster carer and child tutor.
https://petapixel.com/2018/08/02/she-posed-for-a-free-photo-shoot-now-her-face-is-misused-everywhere/ 5/21

on a French dating website. The text roughly translates to: “I’m
Khan
do not click too hard I’m fragile. Here I am looking prince
here,
8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
https://petapixel.com/2018/08/02/she-posed-for-a-free-photo-shoot-now-her-face-is-misused-everywhere/ 6/21

of my dreams, who comes on his white horse to steal my
charming
heart…”
8/17/2018 She Posed for a Free Photo Shoot, Now Her Face is Showing Up Everywhere
“The testimonials are the most shocking for me,” Khan tells BBC News. “I thought I understood how
stock images work, you know, like having a picture of a house to illustrate a house. But it was so
dishonest, I never knew you could use stock images with false testimonials and fake names.”
“So beside the fact that all of us were never paid for ANY of these advertisements, there’s also the
and downright dishonesty of promoting these products,” Khan . “Eventually I
writes
misleading
contacted the photographer and said I didn’t know I signed up for any of this.”
The photographer explained that it was all legal, but he agreed to take the photos of Khan down
from his websites.
“The thing is I’ve laughed over the years about this and it’s a great party story and I do find some of
the images hilarious and I still laugh when people find me randomly advertising for teeth implants
browsing a paper in New York,” Khan
, “but now that I’m older and more assertive
concludes
while
and aware of power plays and manipulation I can easily see how we were all used – a whole gallery
of free photographs for this photographer to sell and we haven’t made a cent for all the things
WE’VE advertised. […]
“Also this could have gone badly – my photo could have come up in a wrong place […]
“So, if anything use my story as a cautionary tale. Don’t sign up for free photoshoots, read what you
sign and also don’t believe most of the things you read on the internet.”
TAG S : B E WA R E , M O D E L R E L E AS E , P SA , R E L E AS E , S H U B N U M K H A N , STO C K P H OTO , STO C K P H OTO G R A P H Y , WA R N I N G
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