24 August 2015 Asia Pacific/India Equity Research Thematic Research

India Market Strategy Research Analysts STRATEGY

Neelkanth Mishra 91 22 6777 3716 [email protected] Trip report: Three days in Bihar Prateek Singh 91 22 6777 3894 [email protected] Figure 1: Parties jostling to establish their developmental credentials Ravi Shankar 91 22 6777 3869 [email protected]

Source: Credit Suisse

■ Presidential Contest; "Sweep" likely. In the upcoming Bihar polls, what matters in our view is a stable government. The contest is now just Modi vs Nitish: it should be close in terms of votes, but decisive in seats. The discourse is encouragingly development-focused. May-14 vote shares may change: some defections; Nitish supporters unhappy with RJD alliance; RJD voters don't like Nitish; BJP's "central" votes won't repeat. BJP has its nose ahead: higher spending power, and preferred by the youth (key swing vote). ■ The "State" is getting built. Rapidly. Bihar has the smallest "state" by far (a fifth of the national average): too few police personnel, teachers, state transport, etc. We learnt the reasons go back to British times: severe de- industrialisation and a land tenure system that did not need administrative machinery. It's getting built rapidly: police staffing is up 40% (2007-13), pupil-teacher ratio is down 40% despite a 62% surge in enrolment, and road connectivity, critical for the "state" to reach people, is improving dramatically. ■ The "Power" of power and phones. 16% of households were electrified in 2011, 45% now (5% added in the last three months), and 100% is targeted in another 3.5 years. Power consumption is up 3x since 2007, and could be up another 3x by FY19—supported by rising subsidies (SEB losses in control). Tele-density rising sharply as well. Rising productivity in Bihar good for consumption: buy HUL, Maruti, Asian Paints, Ultratech, Havells, Kajaria.

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24 August 2015 Focus charts

Figure 2: Bihar is under-policed even compared to India Figure 3: Police staffing up sharply since 2006

5 200 80 0.8

4 160 70 0.7

3 120 60 0.7

2 80 50 0.6

1 40 40 0.6

0 0 30 0.5 DL PU HP HA UT AS CH JH MH KE TN KA GU RA OR AP MP UP WB BI 2005 2006 2007 2008 2009 2010 2011 2012 2013

Police Personnel per 1000 People (2011) GSDP Per Capita (Rs '000, 2011, RHS) Policemen ('000) Per 1000 people (RHS)

Source: MOSPI, Census 2011, Credit Suisse Source: MOSPI Statistical Yearbook, Credit Suisse

Figure 4: Strong teacher hiring => enrolment, low PTR Figure 5: State highway quality up; slowing of late

22 Strong PTR improvement (RHS axis in reverse) 44 5000 70% kms Bihar State Highways PTR=Pupil-Teacher Ratio (low is good) 60% 20 50 4000 18 56 50% 3000 40% 16 62 2000 30% 14 68 20% 12 74 1000 10% 10 80 0 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2008 2009 2010 2011 2012 2013 Single Lane- Double Lane+ Double Lane+ share (RHS) I-VIII Enrollment (mn) PTR (Rev, RHS) Source: DISE Flash Statistics on Education, Credit Suisse Source: Basic Road Statistics, MoRTH, Credit Suisse

Figure 6: Rapid increase in households' electrification Figure 7: Driving a sharp increase in power demand 25 100% Forecasts after 3,500 mn HHs FY2015 20 80% 3,000 Peak Demand Met (MW) 15 60% 2,500

10 40% 2,000

5 20% 1,500

0 0% 1,000 2011 2012 2013 2014 2015 2016 2017 2018 2019 500 Households Electrified (mn) % of Total HHs (RHS) Apr-06 May-07 Jun-08 Jul-09 Aug-10 Sep-11 Oct-12 Nov-13 Dec-14

Source: Census 2011, Credit Suisse estimates Source: CEA, Sigma Insights, Credit Suisse

Figure 8: SEB losses in check; subsidy burden rising Figure 9: Teledensity in Bihar rising from very low levels

50 Removal of inactive subscribers Rs bn 60% 180% 40 50% 160% 30 40% 140% 20 30% 120% 10 SEB losses after Tele-Density FY13 not known yet 20% 100% 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 10% 80% Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12 Sep-13 Jun-14 Mar-15 State Utilities' Reported Losses (Rs bn) Subsidy (Rs bn) Bihar Rural India Urban India (RHS)

Source: PFC State Utilities Report, Budget Documents, Credit Suisse Source: Trai, Credit Suisse

India Market Strategy 2 24 August 2015 Pictures

Figure 10: Pappu Yadav's anti-corruption poster Figure 11: Lalu Yadav defending his rule (1989-2004)

Source: Credit Suisse; "How can Bihar grow with so much corruption" Source: Credit Suisse; "Gave voice to the poor; they call it Jungleraj"

Figure 12: Even near national highways "new" soft drinks Figure 13: Produced in Rajasthan

Source: Credit Suisse; No Coke/Pepsi available: distribution lacking Source: Credit Suisse; Domestic producers filling in

Figure 14: Education of all kinds is big business Figure 15: Private skill development institutes filling in

Source: Credit Suisse (Para Medical college, English classes, etc.) Source: Credit Suisse (Private ITI training Fitters and Electricians)

Figure 16: English education sells—"Stanford" in Sasaram Figure 17: Rains deficient but rivers and irrigation helping

Source: Credit Suisse Source: Credit Suisse

India Market Strategy 3 24 August 2015 Trip Report: Three days in Bihar Presidential contest: A "Sweep" likely The Bihar assembly elections due in Oct/Nov are extremely important: it has a large and Bihar elections matter in our poor population, and in our view needs an able and stable state government. The markets view because it is a large though are anchored to implications of these elections for the central government, and on and poor state; market politics within the BJP. Our meetings suggested results would reflect local choices, and anchored to implications for are not a referendum on the central government's performance thus far. Many observers the central government; believed that the BJP can considerably outspend JD(U)+RJD: in our view, this can be a contest to be close in votes, significant advantage despite the JD(U) relying on some clever tactics in advertising. but decisive in seats. Despite the large number of parties in the fray, the contest has shaped up as Modi vs Contest already a Modi vs Nitish. Most observers felt that the contest would be close in terms of votes, but decisive in Nitish Presidential contest; terms of seats. Also encouragingly, the discourse among the people and on billboards is electoral discourse all about all progressive, as parties jostle to prove supremacy on their development credentials. development Earlier arch-enemies Nitish Kumar (JD(U) and Lalu Yadav (RJD) have come together, but Starting with the May-14 their votes won't simply add up: (1) Nitish supporters fear law and order would worsen if vote shares is perilous: both the RJD is part of the government. There seems to be no anti-incumbency, but aspirations RJD and JD(U) have lost have already moved higher: e.g., now that schools are open, education quality is in focus; leaders, and many of their (2) Some important leaders have defected away; (3) Caste remains important but its supporters may not vote for relevance is weakening, particularly among the youth. Inter-caste marriages in Bihar were the alliance; BJP unlikely to 6% in 2005 and likely higher now; (4) "youth" (first-time voters are 15% of total) is likely to get the "central" votes it got be the swing vote: the BJP has an edge here. On the other hand, CSDS estimates nearly last year a fourth of BJP's votes in May-14 came for change at the centre and may not repeat. Altogether, in this closely contested race, the BJP has its nose ahead: it has stronger BJP has its nose ahead in finances, a better appeal to the youth, and benefits from the inability of the opposition to this race: Can spend more, consolidate all the votes they got separately in the May-14 elections. A lot though can liked by the youth change from here, particularly as candidate selection gets finalised. The “State” is getting built: Rapidly The "state", i.e. the governance infrastructure in Bihar, is under-developed: state government Governance infrastructure in employees (per unit population) are only a fifth of the national average—too few police Bihar is underdeveloped for personnel, teachers, etc. We learnt the reasons go back to British times: (1) severe de- many historical reasons industrialisation; (2) a land tenure system that did not need them to set up administrative machinery; (3) poor public investment post-independence; and (4) delayed social change. In the last eight years, the “state” is getting built rapidly—police stations are getting built, In the last 8 years, the police staffing is up sharply; there has been a spurt in teacher hiring, and despite a 62% surge "state" is getting built in school enrolment, pupil-teacher ratio has fallen by 40% (learning outcomes though are still rapidly: Police, education, weak). Similarly, road connectivity—critical for the “state” to reach people (for health, law and road network, etc. order, electrification, etc.)—improved dramatically, though the pace has slowed of late. The "Power" of power and phones Electrification and tele-density are important drivers of productivity, and on both Bihar lags the Percentage of households rest of India by a large margin. The gap though has been narrowing, as a "dark" state lights electrified moving from just up. The state targets universal electrification by FY19, from just 16% in 2011—5% of 16% in 2011 to 100% by households were electrified in just 1Q FY16, and 15%-plus is the target for each year. Power 2019; Teledensity rising demand has tripled since 2006, and the state utility is targeting a further tripling in the next from 30% in 2010 to over four years. There is a sharp jump in subsidy, though this goes straight from the budget: SEB 50% now, and rising losses are in check. The state is sharply increasing investments in substations (ADB and Central help) to cut technical losses, and improving billing and collection efficiency. Teledensity is also up from just 30% in 2010 to 50%-plus now, and the network is still expanding. The best stock-market play on rising productivity in Bihar is in consumption.

India Market Strategy 4 24 August 2015 Presidential contest; “Sweep” likely We were in Bihar during 9-11 August. We landed in Varanasi, and drove through Sasaram and Gaya to Bodh Gaya, where we spent the night. The next morning we drove to Patna, and met business leaders, bureaucrats, journalists and politicians over the next two days. Assembly elections in Bihar are likely in late October/early November this year. In our view, the elections matter because Bihar has 100 mn people (same ballpark as Mexico, larger than Germany), and per capita GDP of Somalia. Improvement can only come about with a stable and able state government. The markets seem to be anchored to implications for the central government—if BJP loses, perceptions and more could change at the centre; if it wins, it could strengthen the party and its current leadership. No anti-incumbency, but aspirations already higher Everyone we met, be they small tea-shop owners, proprietors of “line hotels” (highway-side eateries), private security guards, journalists, police officers, academicians, politicians, bureaucrats, or even some BJP leaders (in private), the incumbent Chief Minister Nitish Kumar (JD(U)) was described as a “clean” (i.e. not corrupt) and efficient administrator. Now completing his second term (ten years), he is credited for the significant improvement in law and order. For the man on the ground in a state where much of private sector employment is self-employment in micro-enterprises, this helps economically— restaurants/push-carts can stay open longer and cars can stay on the road till late in the night.

Figure 18: Despite the surge, Bihar only 23% of India avg. Figure 19: Power demand growth picked up from Jan-14 900 24% 45% Per Capita Power Consumption (kWh) 800 23% 40% 35% 700 22% 30% 21% 600 25% 20% 500 20% 19% 400 15% 18% 10% 300 17% 5% 200 16% 0% 100 15% -5% 0 14% -10% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16TD Jul-07 May-08 Mar-09 Jan-10 Nov-10 Sep-11 Jul-12 May-13 Mar-14 Jan-15

Bihar India Avg. As % of India Avg. (RHS) Bihar All India

Source: Sigma Insights, Credit Suisse Source: CEA, Credit Suisse Most were pleasantly surprised by the 18-20 hours of electricity availability, when just two years back, grid power supply was as good as non-existent: per capita consumption is up sharply (Figure 18). The change in the power situation is discussed in detail in the third section of this report, but electorally it suffices that growth in power demand in Bihar is significantly outpacing the anaemic situation elsewhere in the country (Figure 19). There seems to be therefore no meaningful “anti-incumbency” factor that generally emerges after ten years of the same leader's rule. That said, on many fronts, aspirations are already re-set, e.g. in education, while 7-8 years ago, the complaint could have been of there being no government schools or teachers, now demand is for quality education. Nearly a fifth of the teachers hired (62,000 out of 300,000) had fake degrees, and TV news programmes had demonstrated the illiteracy of many teachers.

India Market Strategy 5 24 August 2015

Modi vs Nitish contest; decisive verdict likely As we will discuss in the following paragraphs, there are several moving parts in this election. However, the election has already shaped up into a Presidential-style contest between Narendra Modi of the BJP and Nitish Kumar of the JD(U). This is clear from the discourse on the ground, as well as on billboards (Figure 20). Interestingly, while the BJP posters had the party symbol (the Lotus), none of the billboards with Nitish Kumar mentioned the party or the party symbol (Figure 21). This seems to be emerging as a trend in Indian politics: given the rising need for accountability in political leadership, personalities matter more than parties—individuals can be held responsible, whereas parties are diffuse entities. Among other things, this increases the chances of decisive electoral verdicts. That is, even if the vote shares are close, the share of seats (given India's "first past the post system") is decisive. Most people we talked to felt that a 180-50 or a 50-180 verdict was likely for BJP+/JD(U)+.

Figure 20: Billboards reinforce a Presidential-style Figure 21: Nitish Kumar posters don’t mention the party contest

Source: Credit Suisse Source: Credit Suisse Changing electoral discourse: All about development

Figure 22: BJP posters mostly about development Figure 23: RJD challenging BJP's development claims

Source: Credit Suisse Source: Credit Suisse As against the politics of identity (of caste or religion) that Bihar has become known for, in all our meetings (except for analysts, strategists and journalists), the issues were about

India Market Strategy 6 24 August 2015 roads, electricity and education. The billboards and promises too appeal to the more progressive considerations, jostling to prove supremacy on who can provide the most development. In Figure 20, the message on the top translates to "We won't get fooled (by false development promises), we will get Nitish to victory", while the second message (from the BJP) translates to "A slogan from every corner that Bihar is on the path to change". Both billboards in Figure 21 show Nitish Kumar, with the one on the left saying "To keep Bihar moving forward, Nitish Kumar once again", and the one on the right saying "For good times in Bihar, Nitish Kumar". Figure 22 shows a BJP billboard saying "Fast development needs BJP government this time". Even the RJD is taking on the BJP's promises with Figure 23 saying "Less work, more talk: is this how you will bring the good days?" Even Pappu Yadav, earlier of the RJD, and who has had many lawsuits against him (including murder, of which he was acquitted for a lack of evidence), raises the issue of corruption in Bihar in his posters (Figure 24: "How can Bihar progress if there is corruption at every step").

Figure 24: Pappu Yadav's anti-corruption poster Figure 25: Lalu Yadav defending his rule

Source: Credit Suisse Source: Credit Suisse Even Lalu Yadav's defence of his rule (Figure 25), which has been widely criticised for very poor law and order, does not focus on caste wars, but instead on the poor-rich divide "When we gave a voice to the poor, you called it Jungle-raj (rule)". The JD(U) + RJD alliance isn’t even close to 1 + 1 = 2 The rationale for earlier arch-enemies Nitish Kumar (Chief Minister from 2004 to 2015) and Lalu Yadav (who ruled the state himself or by proxy from 1989 to 2004) forming an electoral alliance was that their combined vote share in the May-14 Parliamentary elections was higher than the BJP-led alliance's (Figure 27). However, as the Nitish Kumar-led JD(U), Lalu Yadav-led RJD and the Congress (INC) had contested the May-14 elections separately, the BJP-led alliance (i.e. BJP + LJP + RLSP) got 31 of 40 seats (Figure 26). However, we found several reasons why the underlying assumption that votes could just be added up may not hold. That is, a supporter of Nitish Kumar would continue to vote for him even if he was in alliance with Lalu Yadav, and vice versa. To start with, there were absolutely no billboards or posters that talked of the alliance between the two parties. That it was an alliance stitched at the top but open at the bottom was repeatedly reinforced.

India Market Strategy 7 24 August 2015

Figure 26: BJP-led alliance swept the seats in May-14 Figure 27: Helped by opposition fragmentation in votes

INC, 2 NCP, 1 Others 17% BJP JD(U), 2 30%

RJD, 4 INC NDA: 39% Oppn: 8 NDA: 31 8% Oppn: 45%

RLSP, 3 BJP, 22 JD(U) LJP 16% 6% RLSP LJP, 6 RJD 3% 20% Seats won in 2014 Lok Sabha Elections in Bihar: Total 40 Vote share in 2014 Lok Sabha Elections in Bihar

Source: Election Commission, Credit Suisse Source: Election Commission, Credit Suisse 1) Fear a return of "Gundaraj" (rule by the goons) Among the people we met, there was near universal apprehension that the abysmal law and order situation when Lalu Yadav was the Chief Minister (directly or by proxy: 1989- 2004) would make a comeback even if Nitish Kumar was the CM. While there was also universal acknowledgement that during Nitish Kumar's term (Chief Minister from 2004 to 2015 with a brief interregnum in 2014), law and order had improved dramatically, the recent deterioration has sown doubts in the minds of the people. In the public mind, this is already linked to the JD(U) allying with the RJD in late 2013, after the BJP withdrew support. Some police officials suggested that the weakening could be attributed to the brief period of administrative uncertainty when Jitan Ram Manjhi was the CM (May-14 to Feb-15). They also said that the worsening in perception was greater than in reality, but when people vote, perceptions matter. 2) Caste equations and vote banks: Still as rigid? Caste equations affect voting behaviour all over India, but in Bihar, the influence of caste is considered particularly strong. Not surprisingly, caste arithmetic dominates analysis. Figure 28: Estimated population split by caste Figure 29: Estimated preference for caste groups in 2014 Kurmi-Koeris 7% Dalits 42% 20% 10% 28% Yadavs Lower OBCs 14% 31% Muslims 2% 21% 64% 13%

Yadavs 19% 12% 64% 5%

Lower OBCs 53% 18% 10% 19% Upper Caste 15% Kurmi-Koeris 26% 30% 15% 29%

Muslims Upper Caste 78% 8% 5% 9% 17% Dalits 16% 0% 20% 40% 60% 80% 100% Split of Bihar's 65mn voter base by caste In GE 2014, % votes to BJP+ JD(U) RJD+ Others

Source: CSDS-Lokniti, Credit Suisse estimates Source: CSDS-Lokniti, Credit Suisse estimates

India Market Strategy 8 24 August 2015

Tempting as it is, it would be wrong to extrapolate the 2014 caste arithmetic (Figure 28 shows the estimated population split by caste, and Figure 29 their voting preferences as estimated by CSDS-Lokniti in a post-poll survey). Two key reasons for this are as follows:

■ CSDS estimates 1 that in May-14, over a fourth of the voters in Bihar voted for a change at the national level, implying that their behaviour may differ in state-level elections. In the Odisha and Andhra Pradesh assembly elections, which occurred simultaneously with the May-14 Parliamentary elections, the voting behaviour differed.

■ There have been several changes in parties: RJD lost the support of Pappu Yadav, who broke away due to internal succession issues and formed his own party. In East Bihar, an area that he hails from, RJD+ had done well in May-14 both in terms of vote share, as well as seats (5 out of 7). He is clearly campaigning against RJD+JD(U). Further, a section of the Dalits are believed to have moved away from the JD(U) as Jitan Ram Manjhi split away from it to form his own party and join the BJP alliance. It is generally assumed that upper castes would prefer BJP+, whereas Muslims would vote against it and for the RJD—the two groups have similar population and a similar skew in voting patterns (Figure 30), effectively cancelling each other out in a head-to-head contest. Similarly, Yadavs are considered to be solidly behind the Lalu Yadav-led RJD. However, some of these caste calculations can turn on their head, particularly as new parties like Pappu Yadav's new party, as well as the AIMIM are out soliciting the Muslim vote in Bihar2. That none of Nitish Kumar posters mentions the electoral alliance can also work against him getting the Yadav votes that would have gone to the RJD.

Figure 30: Community-related voting strongholds Figure 31: % of inter-caste marriages as in 2005-06

90% 25% *LS: Lok Sabha, AS: Assembly 80% % Inter-Caste Marriages (NFHS-3)

70% 20% 60%

50% 15% 40%

30% 10% 20%

10% 5% 0% LS '99 AS '00 LS '04 AS Feb AS Oct LS '09 AS '10 LS '14 '05 '05 0%

Yadavs for RJD+ Muslims for RJD+ Upper Castes for BJP+

BI

IN

JH

DL

UT TN PB KE KA AS AP

HA HP UP RA

MP GU OR CG

MH GO WB Source: CSDS-Lokniti, Credit Suisse estimates Source: National Family Health Survey-III, Credit Suisse 3) The Youth as the "swing" vote; BJP has an edge Of the various determinants of voting behaviour—caste, religion, gender and age—age is the factor that can and is changing the most. Even ten years ago, 6% of marriages in Bihar were inter-caste (Figure 31), implying that a growing number of voters may disregard caste. The results of the fourth National Family Health Survey (NFHS) are not out yet, but given social changes, inter-caste marriages are likely to have become more common.

1 The Hindu, 23 May 2014, http://www.thehindu.com/opinion/op-ed/bihar-interpreting-the-massive- mandate/article6037680.ece 2 IBN Live, http://www.ibnlive.com/news/politics/bjp-eyes-gains-as-asaduddin-owaisi-and-pappu-yadav- give-jitters-to-jdu-rjd-in-bihars-seemanchal-1046549.html

India Market Strategy 9 24 August 2015

Nearly 10mn may be voting for the first time in the 2015 assembly elections (Figure 32). Most analysts and strategists that we talked to believed that the youth would be the key "swing" vote, i.e. the group whose voting preferences would be hard to strait-jacket. Given the relatively more modern campaign of the BJP, and the aspirational pitch of the Prime Minister, most felt that the BJP had the edge among the youth. While the "socialists" (RJD and JD(U) leaders) do not actively appeal to the youth, many first-time voters would be the earlier beneficiaries of the "cycle scheme": the Nitish Kumar government (2005-10) had given free cycles to students, particularly girl students.

Figure 32: High percentage of first-time voters Figure 33: "Lower OBCs" or EBCs' voting preferences

10 15.4% 60% mn *LS: Lok Sabha, AS: Assembly 50% 9 15.2%

40% 8 15.0% 30%

7 14.8% 20%

6 14.6% 10%

0% 5 14.4% LS '99 AS '00 LS '04 AS Feb AS Oct LS '09 AS '10 LS '14 2005 2010 2015 '05 '05

First Time Voters (mn) As % of Voter Base (RHS) Lower OBC for RJD+ Lower OBC for BJP+

Source: Census 2011, Credit Suisse estimates Source: CSDS-Lokniti, Credit Suisse 4) EBCs not one "vote bank"; hard to call The second large category where voter decisions are not as certain is the "Lower OBCs" or the extremely backward castes (EBCs). In popular discourse, this group was nurtured by Nitish Kumar, but has been successfully courted by the BJP, as seen in the voting preferences over the past 15 years (Figure 33). However, this is a highly fragmented group, with a large number of castes, each of which has a different driver. This is also a group that changes preferences very quickly. Conclusion: BJP ahead now, but things can change Most observers believed that BJP can significantly outspend the JD(U)+RJD combined. In our view, that gives it a distinct edge. The JD(U) is relying on clever use of social media, as well as strategic buying of traditional media, but shortage of campaign funds would start hurting closer to the elections. Moreover, they have little control on candidate selection and campaigning in assembly constituencies that their partners would contest from: JD(U), RJD and the Congress have decided to contest in 100, 100 and 40 seats, respectively. Altogether, in this closely contested race, the BJP has its nose ahead: it has stronger finances, a better appeal to the youth, and benefits from the inability of the opposition to consolidate all the votes they got separately in the May-14 elections (even voters who like Nitish Kumar are fearing a worsening of law and order due to his alliance with Lalu Yadav). However, the tactics of candidate selection can meaningfully impact the results. While the role of caste may be weakening, it is an important factor: party strategists talked of the BJP fielding Yadav candidates where the JD(U) fielded non-Yadav candidates (implying that the Yadav votes would be less loyal to the JD(U) than to RJD even though they were in the same alliance). Such mistakes could backfire. Further, messaging also needs to be careful—despite the discomfort of his allying with the RJD, there seemed to be enormous goodwill for Nitish Kumar: head-on criticism of his tenure it was felt could backfire.

India Market Strategy 10 24 August 2015 The "State" is getting built: Rapidly Bihar, with a population nearly as large as Mexico's, is by far the poorest state in India, with a per capita GDP close to that of Somalia or Ethiopia, and less than 40% of India. On all but a few socio-economic parameters, it brings up the rear. Under the same political system since independence as other Indian states, why has Bihar lagged behind? Administrative infrastructure decades behind India As discussed in our note "The surge of the states" last month, the "state", i.e. the governance infrastructure, is the weakest in Bihar. It has the fewest state government employees by far (Figure 34: just 2.1 employees per ‘000 population, half of UP, the second lowest), and in particular w.r.t. the police force, at 0.72 per ‘000 population in 2013—just 40% of India’s average (Figure 35). There are too few teachers, abysmal staffing in urban governance, and pretty much no state transport corporation (most bus services are private).

Figure 34: High state gov't employment drives high GDP Figure 35: Police employment vs per capita GDP of states

40 200 5 200

35 180 160 4 160 30 140 25 120 3 120 20 100

15 80 2 80 60 10 40 1 40 5 20

0 0 0 0 HP UT DL TN PU KA KE HA MH AS RA AP OR GU MP JH CH WB UP BI DL PU HP HA UT AS CH JH MH KE TN KA GU RA OR AP MP UP WB BI

State Empl. Per '000 People (incl. Quasi) GSDP Per Capita (Rs '000) Police Personnel per 1000 People (2011) GSDP Per Capita (Rs '000, 2011, RHS)

Source: MOSPI, Census 2011, Credit Suisse estimates Source: MOSPI Statistical Yearbook, Credit Suisse estimates Catching-up on a long historical deficit As noted economist Dr Saibal Gupta explained, roots of the problem go a long way back:

■ British Rule in India spread from the east to the west/north: the process of de- industrialisation in the east, therefore, started many decades before it hurt other parts of India. Further, areas in UP, Bihar and MP had led the mutiny of 1857 against the British rule, and faced the brunt of British oppression thereafter.

■ The Land Tenure System: initially the British adopted a "Permanent Settlement" system to collect taxes, where landlords were to give a fixed sum to the British. In this way, the British had to deal with a relatively small number of counter-parties. The counter-parties, or the zamindaars (landlords), were too small to build administrative infrastructure. By the time the British reached the west, the north and the south, their taxation (like in the Ryotwari system) evolved to taxing the farmer directly. They were thus required to set up an administrative infrastructure (starting with the "collector", as the district administrator in India is still called). When India gained independence, these areas had much better administration than the east.

■ Public Investment in Independent India: in addition to the much maligned "freight equalisation" policy that was only discontinued in 1993 (critical inputs like coal and steel would cost the same all over India—this nullified Bihar/Bengal's geographical

India Market Strategy 11 24 August 2015

advantage of being in proximity to iron ore, coal and other minerals), even programmes like the green revolution (1960s) were taken up in areas that already had irrigation, given the constraints that the economy faced.

■ Pattern of Social Movement: in most parts of India, the anti-Brahmin movement became an industrial movement (e.g. the sugar cooperatives in Maharashtra) and drove prosperity. However, no such movement happened in Bihar till very late. In fact, when it did happen politically, it did so through a "cockneyisation" of politics, where the leaders weren’t believers in/gainers from the inter-dependency in economies. Even while this weakened the "state" between 1989 and 2004, the process of democratisation continued. That brought to fore Nitish Kumar, who has been re- building the state. Along with building the arms of the “state” (as we discuss in this section), he has ensured that the cabinet functions, and even though his authority may have diminished post the break-up with the BJP (as the government went from 90% majority to the majority of a few fickle seats), administrative control is far better than a decade back. As discussed in the first section, the electoral and political discourse is all around development, even if the arithmetic still uses caste as a counting block. "State" machinery starting to get built: Police One sign of an under-developed "state" machinery is clearly a smaller than necessary police force. It goes without saying that without an adequate police force, as well as police stations (a proxy for police infrastructure), it is difficult to have good law and order. And without law and order, few businessmen will get the confidence to invest. In the 2007-13 period, the state government added 142 police stations (Figure 36), and perhaps more importantly, the quality of police stations is being improved (we heard 600 are being upgraded). In the same period, the government has added 21,000 more policemen, taking Bihar's police penetration to 0.71 per 1,000 population from just 0.56 (Figure 37). The ratio is still half the rate of India (1.4), which itself is far behind what is perhaps necessary (the ratio in the US and Japan is 2, despite much better infrastructure that would make the average US/Japanese police person much more productive than an Indian policeman).

Figure 36: Police stations getting added Figure 37: Police staffing up sharply

910 9.2 80 0.8

890 9.0 70 0.7 870 8.8 850 60 0.7 830 8.6

810 50 0.6 8.4 790 40 0.6 8.2 770

750 8.0 30 0.5 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2005 2006 2007 2008 2009 2010 2011 2012 2013

No of police stations Police Station per mn people (RHS) Policemen ('000) Per 1000 people (RHS)

Source: NCRB (Crime In India), Credit Suisse Source: NCRB (Crime In India), Credit Suisse

India Market Strategy 12 24 August 2015

Staffing in Education has increased, outcomes lag

Figure 38: Spurt in new teacher hiring Figure 39: Showing up in better enrolment and PTR 500 4.0 22 44 Strong PTR improvement (RHS axis in reverse) PTR = Pupil-Teacher Ratio (low is good) 20 50 400 3.5

18 56 300 3.0 16 62 200 2.5 14 68

100 2.0 12 74

0 1.5 10 80 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Teachers ('000) Teachers per 1000 People (RHS) I-VIII Enrollment (mn) PTR (Rev, RHS)

Source: DISE Flash Statistics on Education, Credit Suisse Source: DISE Flash Statistics on Education, Credit Suisse Similarly, there has been a surge in teacher hiring (Figure 38): nearly 300,000 teachers were hired. This has started to inflate the salary bill, and the recent decision to formalise contract teachers is expected to raise the salary bill significantly going forward. There have also been many scandals around teacher hiring, including where 62,000 of these were found to have fake degrees. In the amnesty scheme announced (i.e. if you give up your job voluntarily, you won’t be prosecuted for submitting a fake degree), apparently 17,000 have volunteered to give up their jobs. The quality of teaching has also not improved. However, enrolment is up from 13 mn to 21 mn, and yet, the pupil-teacher ratio is down from nearly 80 to nearly 50 (Figure 39). This is still very high even by Indian standards, implying that more work needs to be done on this front. Road connectivity allows the state better reach

Figure 40: National highways quality up, length still low Figure 41: State highway quality up; slowing of late

4500 70% 5000 70% kms Bihar National Highways kms Bihar State Highways 4000 4500 60% 60% 3500 4000 50% 3000 3500 50% 40% 3000 2500 40% 2000 30% 2500 30% 1500 2000 20% 1000 1500 20% 10% 500 1000 10% 0 0% 500 2008 2009 2010 2011 2012 2013 0 0% Single Lane Two Lane 2008 2009 2010 2011 2012 2013 4 Lane+ Two Lane + Share (RHS) 4 Lane + Share (RHS) Single Lane- Double Lane+ Double Lane+ share (RHS)

Source: Basic Road Statistics (MoRTH), Credit Suisse Source: Basic Road Statistics (MoRTH), Credit Suisse Another area of improvement has been roads, though as elsewhere, a lot more needs to be done. In addition to the obvious benefits for residents and for land prices, roads allow the government’s administrative machinery to reach people better. This matters for all of health, education, tax administration and electrification, among other things.

India Market Strategy 13 24 August 2015

Not only does Bihar have the lowest density of state and national highways (per unit population), their quality is poor too. For example, despite the substantial improvement in 2- and 4-laning of its national highways (Figure 40), only 64% of the national highways in Bihar are 2-laned (vs 75% for India), and only 18% are 4-laned (vs 24% for India).

Figure 42: Bihar still lags other states in SHs density … Figure 43: … and also in NHs density

400 250

350 200 300

250 150 200

150 100

100 50 50

0 0 UT KA MH GU HP CH GO RA MP TN KE AP HA AS OR JH PU WB BI UP HP UT GO JK OR RA AS CH KA JH MP TN HA GU AP PU KE BI MH UP WB

State Highway Density km/mn people National Highway Density km/mn people

Source: Basic Road Statistics (MoRTH), Credit Suisse estimates Source: Basic Road Statistics (MoRTH), Credit Suisse estimates Similarly, while the quality of state highways has also improved substantially from 2008 (Figure 41: a reality not lost on most voters we met), the total length is still a third of that in Rajasthan, and one-eighth of that in Maharashtra (Figure 42). The slowdown in improvement in recent years has also been noticed by people (Figure 43 is only one example we observed on the road and may not necessarily be representative). This slowdown is (a bit unfairly, in our view) being attributed to Nitish Kumar’s alliance with the RJD: “Look, the moment he allied with Lalu, road construction slowed”.

Figure 44: A road section where construction has stopped Figure 45: Healthy rural road construction since 2006

40 10 PMGSY in Bihar 35 9 8 30 7 25 6 20 5

15 4 3 10 2 5 1 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Kms Completed ('000) Habitations Connected ('000) (RHS)

Source: Credit Suisse Source: PMGSY, Credit Suisse estimates Bihar has also built the fourth highest length of rural roads under PMGSY (Prime Minister’s Rural Roads Scheme, launched in 1999), with activity picking up from 2005, when Nitish Kumar took over. This is a classic example of how one just needs better administration to take advantage of the available funds. 33,000kms of all-weather roads under this scheme have connected 9,000 habitations the first time (Figure 44). The recent announcement to build another 22,500kms (announced by the PM) should accelerate the process.

India Market Strategy 14 24 August 2015 The “Power” of Power and Phones Electrification and tele-density, in our view, are important drivers of productivity, and on both (Figure 46, Figure 47), Bihar lags the rest of India by a large margin.

Figure 46: Less than 30% of HHs electrified in 2011 Figure 47: Very poor tele-density vs national average

Source: Census 2011, Credit Suisse Source: Trai, Credit Suisse A “dark” state now lighting up While power availability even for electrified houses is a challenge in India, a surprisingly low number of households were electrified in 2011. However, the situation is rapidly improving (Figure 48), driving a tripling of power demand since 2006 (Figure 49).

Figure 48: Rapid increase in HH electrification Figure 49: Driving a sharp increase in power demand

25 100% 3,500 Forecasts mn HHs after FY2015 3,000 20 80%

2,500 15 60% 2,000 10 40% 1,500

5 20% 1,000

0 0% 500 2011 2012 2013 2014 2015 2016 2017 2018 2019 Apr-06 May-07 Jun-08 Jul-09 Aug-10 Sep-11 Oct-12 Nov-13 Dec-14

Households Electrified (mn) % of Total HHs (RHS) Peak Demand Met (MW)

Source: Census 2011, Credit Suisse estimates Source: CEA, Sigma Insights, Credit Suisse

India Market Strategy 15 24 August 2015

Electrification has improved from 3 mn households in the 2011 census to above 9 mn now, and is expected to reach 15 mn by March 2017, and 100% by March 2019. The Energy Secretary of Bihar told us that 1.1 mn HHs had been electrified in just the first three months of this financial year. The government has been running "connection melas" (Connection Fairs), where people are attracted by a promise of a power connection without bribes. The cost of the connection is collected from the first two power bills. In parallel, there is an effort on power generation/procurement: the state was earlier focusing on self-sufficiency in power generation, but given the surfeit of generation capacity currently available, has focused on sourcing power, and is now confident of meeting 9500-10,000MW of demand by 2019, i.e. a further tripling of demand in four years. Challenges in transmission and in cutting losses The state has already increased transmission capacity from a mere 700MW in 2005 to 4000MW now, improving from 42 grid substations to 97 now, with 39 more under construction. They have a Rs40 bn budget for transmission (ADB + state funding). Worryingly though, the efficiency of SEBs in cutting losses hasn't improved (Figure 50): PAT losses excluding subsidies have kept pace with the total income of the SEBs. In what can be termed a healthier approach to SEB balance sheet management, the subsidies are explicit, and the SEB balance sheets are not under as much stress (Figure 51).

Figure 50: Worryingly, losses almost equal collections Figure 51: SEB losses in check; subsidy burden rising

50 50 45 Rs bn 40 40 35 30 30 25 20 20 15 10 10 SEB losses after FY13 not known yet 5 0 0 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 2014 2015 2016

Income excl. Subsidy PAT Loss excl. subsidy State Utilities' Reported Losses (Rs bn) Subsidy (Rs bn)

Source: PFC State Utilities Reports, Credit Suisse Source: PFC State Utilities Report, Budget Documents, Credit Suisse The state therefore has a lot of ground to cover on all of technical losses, billing efficiency and collection efficiency.

■ Technical losses: while the rule of thumb of distribution is that an 11kV feeder should be of 11km length, and a 33kV feeder of 33km length, the average length of 11kV feeders in Bihar is 97km, and that of 33kV feeders is 84km. This raises AT&C losses, and makes repairs very difficult. The ministry recently did a district-wise mapping, and realised they need 300 more power substations, which require Rs60 bn of capex. This has also been tied up, with assistance from Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY) scheme of the central government (60:40 funding by centre and state).

■ Billing efficiency: is currently just 72-74%. They are targeting a level of 95%.

■ Collection efficiency: is currently 80-82%, but should be 100%. There is attention on this, and in the last three months, billing has increased by Rs700 mn (~15% we estimate).

India Market Strategy 16 24 August 2015

Teledensity rising rapidly from very low levels Bihar (the circle is Bihar + Jharkhand) remains the last bastion for telecom companies, with teledensity much below the national average, even though it has risen sharply in the past six years (Figure 52). Bihar is also now the second largest state in terms of incremental subscriber growth. This is one of the few circles that is still seeing voice revenues rise.

Figure 52: Teledensity in Bihar rising from very low levels Figure 53: Now 12% of incremental subscriber growth AS Others 60% 180% HP Removal of inactive subscribers 3% 2% UP RJ 3% 15% 4% OR 50% 160% 4% DL 6% BI 40% 140% 12% KA 6% 30% 120% GU WB Tele-Density 6% 20% 100% 10% MH 6% MP 10% 80% AP 8% Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12 Sep-13 Jun-14 Mar-15 7% TN 8% Bihar Rural India Urban India (RHS) Share of Incremental 65mn Subscribers in 2015

Source: Trai, Credit Suisse Source: Trai, Credit Suisse For telecom companies, the Bihar + Jharkhand circle is a Rs100 bn market, growing at 12% YoY, with 99% of the customers pre-paid. While Airtel, the market leader, has near- universal coverage, the second and third placed companies are still at 70% coverage by area—this number is rising steadily. Among other things, improving power availability is helping telecom companies cut operating costs (earlier all towers ran on diesel gensets).

India Market Strategy 17 24 August 2015

Companies Mentioned (Price as of 23-Aug-2015) Asian Paints (ASPN.BO, Rs886.55) Bharti Airtel Ltd (BRTI.BO, Rs369.7) Havells India Ltd (HVEL.BO, Rs265.35) Hindustan Unilever Ltd (HLL.BO, Rs881.7) Kajaria Ceramics Limited (KAJR.BO, Rs709.75) Maruti Suzuki India Ltd (MRTI.BO, Rs4569.05) Ultratech Cement Ltd (ULTC.BO, Rs2971.75)

Disclosure Appendix Important Global Disclosures Neelkanth Mishra and Ravi Shankar, each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12 -month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.

Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 52% (29% banking clients) Neutral/Hold* 33% (39% banking clients) Underperform/Sell* 12% (33% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individua l factors.

India Market Strategy 18 24 August 2015

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and- analytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. See the Companies Mentioned section for full company names The subject company (HLL.BO, ULTC.BO, BRTI.BO) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (HLL.BO) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (HLL.BO) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (HLL.BO, MRTI.BO, ULTC.BO, BRTI.BO) within the next 3 months. Please visit https://credit-suisse.com/in/researchdisclosure for additional disclosures mandated vide Securities And Exchange Board of India (Research Analysts) Regulations, 2014 Credit Suisse may have interest in (HLL.BO, MRTI.BO, ASPN.BO, ULTC.BO, HVEL.BO, KAJR.BO, BRTI.BO) As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (ASPN.BO). Arnab Mitra worked as an employee in Hindustan Unilever.

For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit- suisse.com/disclosures or call +1 (877) 291-2683. Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (HLL.BO, MRTI.BO, ASPN.BO, ULTC.BO, HVEL.BO, KAJR.BO, BRTI.BO) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.credit- suisse.com/sites/disclaimers-ib/en/canada-research-policy.html. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities (India) Private Limited ...... Neelkanth Mishra ; Ravi Shankar ; Prateek Singh

For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit- suisse.com/disclosures or call +1 (877) 291-2683.

India Market Strategy 19 24 August 2015

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