Modi’s third year begins: A fillip to the economy this year will come mostly from a consumption-led demand boost driven largely by easing liquidity conditions, lower interest rates, better rural incomes following normal rains and higher disposable incomes with the kicking in of the Seventh Pay Commission award.
That’s the perfect storm policymakers in Government are waiting for.
The “game changer,” according to Nilesh Shah, Managing Director, Kotak Mutual Fund, will be a move to a neutral or positive liquidity situation in the system from a deficit that prevailed between 2010 and now. “The expectation based on RBI indications is more open market operations (OMOs) to cut the deficit from Rs 1,16,000 crore now to zero by year-end,” he says.
RBI manages money supply through OMOs by buying/selling government securities from/to banks. When RBI sells securities, excess liquidity is sucked out. When it buys g-secs from banks, it infuses liquidity. So far this financial year, RBI has infused Rs 40,000 crore and has announced the purchase of another Rs 15,000 crore g-secs on May 25.
“With a multiplier effect of 4, this will mean Rs 4 lakh crore additional liquidity over a period of time. This will bring huge positiveness in the entire economy,” Shah says. Besides, this will not only bring down interest rates, but also result in better transmission of policy rate cuts. “Earlier, when RBI cut policy rates in a deficit situation, it was akin to pushing the accelerator with handbrakes up. Going forward, there will be no handbrakes and the impact of rate cut will be magnified,” he says.
The RBI had cut rates by 125 basis points in 2015-16 but banks passed on only 60 basis points citing tight money supply conditions. On April 6, the repo rate (the rate at which the RBI lends to banks) was cut by another 25 basis points, bringing down the policy interest rate to a five-year low of 6.5%.
RBI Governor Raghuram Rajan also adopted an “accommodative” stance, with markets hoping for another 25 basis points cut during the year. “Interest rate cuts will play out this year on the back of easy liquidity conditions,” says DK Joshi, chief economist with rating agency Crisil.
The Seventh Pay Commission award (23.6% hike) with arrears from January 2016 will also see 3.4 crore employees and pensioners (Centre, states and PSUs) spend more money on a variety of goods. “This means higher consumption similar to what happened in the past. But the previous two Pay Commission awards came with a lag of two years. So the arrears were large. This time, it will not be so,” says Pronab Sen, former Chief Statistician, government of India and now Country Director, International Growth Centre, a think tank based at LSE, run in partnership with University of Oxford.
The biggest impact of the Pay Commission awards will be in the housing segment in smaller cities.
“Most people spend it on pre-paying home loans, making down payments for homes or buying cars,” said Sen. The incremental spending would be the highest on food, housing, transportation, jewellery and entertainment based on the NSSO Consumption Survey 2011-12, says Neelkanth Mishra, in a Credit Suisse report on the impact of the Seventh Pay Commission. He expects the economy to see a Rs 4.5-lakh crore boost over the next two years if the government finally ends up increasing pays by 3-5% more than the recommendations.
But Sen says that with an estimated 40% government staff now part of the National Pension System (NPS), a larger portion of their incomes is expected to be saved for the future than being spent. “They do not get defined benefits (it has been 12 years since new government employees have been moved to a market-linked pension NPS since January 2004). To maintain their current standard of living, they will need to save more than those who benefited from the earlier Pay Commissions.”
While urban consumer spending has held steady over the last two years, rural incomes have remained stressed following two consecutive years of drought. In fact, rural wages have remained stagnant, and in real terms, possibly declined, despite benign inflation.
Even for market leader Maruti Suzuki, maintaining the national average of sales and compensating for dull sales, has required the car maker to cover many more villages and take extra sales reach-out efforts, said a senior executive of the company, who did not wish to be named. Rural India contributes almost 30% to total sales of Maruti Suzuki, which has an overall market share of 46% in the passenger cars segment. The passenger car industry itself has growth just 7% against a long-term average growth rate of 12-13%.
Some experts, who track rural India closely, however, say the dynamics have changed over the last decade.
“It’s no longer a sleepy old place. True, two bad monsoons has impacted the rural economy. True, 75% of working population is engaged in agriculture, but it is the smallest contributor to rural GDP. That’s why a drought makes a farmer lose not just his income but also confidence,” says Pradeep Kashyap, Founder-CEO, MART, a consulting firm with clients across sectors including banks and insurance firms, auto and FMCG companies.
“A decade ago, just 11% of rural workers had salaried jobs. This has doubled to 22%. What this essentially means is that one in five families has regular income coming into the household. After work, he returns to the village and the purchasing power of this money is higher,” says Kashyap. He believes that India is really a consumption demand story, and says it’s a mistake to treat rural India as a block.
Within agriculture, food grains is the worst affected, where the output has seen a 2-3% drop. “But agriculture is not foodgrains alone. It’s just a third of the agri economy. In fact, for the first time, horticulture — fruits, vegetables, flowers and spices — output was higher (280 million tonnes) than food grains (260 million tonnes) in 2015-16. Similarly, dairy and poultry, accounting for another third of the agri economy, has done exceedingly well,” Kashyap says suggesting that income of those engaged in horticulture and dairy has not been hit even during drought years.
Adi Godrej, Chairman, Godrej Group, agrees. “Rural demand is not low. Earlier, rural demand growth was double that of urban demand. Now its equal. So, it has slowed down.” He, however, adds that the monsoon will play a very critical role in lifting sentiments. “Last year (2015-16) was particularly bad because a drought came on the back of a bad monsoon. I see a turnaround now only when the new monsoon comes,” he says.