India: Rural Economy Skids

Rural India: At the crossroads After seven years of frenetic growth, the rural and semi-urban India story now faces a serious challenge, as the old construct of pilfered subsidy cash being used to buy land, gold, SUVs, cars, 2Ws, electricals and other aspirational items by the rural elite comes to an end. The NDA will gradually unveil new rules which will govern rural growth henceforth. However, even if one takes an optimistic view of the NDA’s as yet unproven execution skills, it will take at least 2-3 quarters for the NDA construct – centered on capex and DBT – to bite. In the meantime, the unwinding of the previous UPA construct will condemn a range of reasonably well-managed companies to a spate of poor results. 

Growth in rural India was fuelled by a blast of subsidies The average top-line growth of 15.2% YoY recorded in the FMCG space over FY09-15 was driven mainly by the dramatic levels of subsidies pumped into the rural economy by the previous Government. For instance, India’s subsidy bill under the UPA regime grew at a staggering CAGR of 19% p.a. during FY05-14 (see Exhibit A on the right). Most research studies suggest that ~40% of the subsidies disbursed by the Central Government are lost in the form of leakages. This in turn implies that ~US$17bn or 0.8% of GDP alone was pilfered in FY15 itself, thereby buoying the incomes of the top tiers of the rural economy.

 The NDA Government seems to have hit the brakes on these subsidies  Despite creating allocations for subsidies and plan spends in the FY16 Union Budget, the new Government seems to have hit the brakes on subsidy spends and MSP hikes. As per the latest data available, total expenditure growth over Apr-Dec 2014 was at 6% YoY vs budget estimates of 13% YoY and the ten-year average growth rate of 13% YoY. Similarly, Minimum Support Prices (MSPs) for rice and wheat grew at 4% YoY in FY15 vs an average growth of 9% YoY in the previous decade (see Exhibit C on the right). This combined with poor monsoons and global moderation in food prices has weakened rural demand.   

Whilst the lower tier of rural India may recover, this will take time  Whilst the effects of weak monsoon and weak commodity prices might be temporary, the Government is set to use the DBT platform to plug leakages and to better target subsidy spends. Whilst the plugging of leakages will adversely affect the top tier of the rural economy, the lower tiers will benefit owing to the superior targeting. Furthermore, in a bid to create jobs, the Modi Government is likely to administer a ‘big push’ to the infrastructure sector (see our note dated 16 February for details) which will buoy the rural economy, albeit with a lag.   

Investment implications Even if we assume that the NDA moves swiftly on DBT and big-ticket capex focused on road building and low-cost housing, we are likely to see a lull for 26 quarters, during which the old game of pilfering subsidies comes to an end with the new construct yet to fire. The companies which appear to be the most exposed are those that have relied heavily on rural India to drive their growth through the downturn including M&M (MM IN, unrated) as SUVs and tractors account for ~70% of its total volumes, Maruti (MSIL IN, SELL) as ~30% of its revenues comes from rural sales, HUL (HUVR IN, SELL) as 40% of its revenues come from rural segments, Colgate (CLGT IN, SELL) as 35% of its revenues come from rural segments, MMFS (MMFS IN, SELL) as >95% of its loan book is driven by rural India, Havells (HAVL IN, SELL) as ~30% of its revenues come from rural India, Ambuja (ACEM IN, SELL) as ~35% of revenues come from rural segments and Ramco Cements (TRCL IN, SELL) as ~35% of its revenues come from rural segments.