While the recent budget has been rightly applauded for its adherence to fiscal consolidation, investors do not seem to have gauged the likely enormity of a major policy shift and the momentum of national discourse towards agriculture and the rural economy. As equity investors we need to spot inflection points early and position portfolios accordingly. Consequently, investors must not ignore the beginning of a strong policy tailwind blowing in the direction of rural India, where 68% of the country lives and which employs close to 55% of the country’s labour force.
We have observed that a well implemented rural initiative has resulted in a sharp uptick in rural consumption growth and rising agricultural incomes earlier. Additionally, as per India Development Report, a unit injection in agriculture sector generated a significant multiplier of 0.77x and 0.79x for industry and services sector in the economy. Until the current budget, government policy had been focused on public spending on infrastructure through re-channelising the savings on oil towards infrastructure building. We believe that a conscious focus on rural India and the thrust on improving agricultural incomes will now remain at the core of the Modi administration’s economic and political strategy for the rest of the term.
With constrained elbow room on fiscal policy and the conscious decision to resist a fiscal stretch to fund a large quantum of public spending on infrastructure (to offset continuing absence of private sector investments), investor expectations of India making a crossover from consumption to investments, is now likely to be deferred. While the government is not stepping back and is maintaining its spending on infrastructure, flat allocations in current year to plan capital expenditure will not be sufficient to raise Gross Fixed Capital Formation meaningfully as these are not sufficient to offset the continuing weakness in private sector investment formation.
Two abnormal monsoons and a tilt in the terms of trade towards urban India from rural India have resulted in high levels of rural distress. Rural wage growth has declined from an annual average rate of 15% between FY09 and FY14 to only 5% over past two years. Correspondingly, nominal agriculture GDP growth has also decelerated from an average 14.7%% to 4.6% over the same time period. Rural distress has in our view been among the key determinants of India’s slowing growth in Private Final Consumption Expenditure.
Growth in private final consumption expenditure has decelerated from an average of 16% to 12% over past two years. The return of urban consumption has done the heavy lifting. Rural consumption growth—which had slowed sharply over past two years— should complement urban consumption growth, which has been the key driver of economic growth so far.
Big jump in allocations for rural economy in FY17 budget
A sharp increase of 94% in allocation for ministry of agriculture to an all time high appears to be the standout initiative by the government to shift focus to rural India, while allocation to Ministry of Rural Development has stayed at an impressive 4.4% of budgeted expenditure. In addition, there has been a clear thrust to rural infrastructure with allocation to the flagship rural road programme budgeted to rise 33%y-o-y from R142 bn to R190 bn—the highest allocation under this scheme since FY12. The government has also announced a 0.5% cess on taxable services for the welfare of farmers. A well implemented rural initiative will have a significant impact on rural consumption. There is a strong correlation (78%) between agri GDP growth and private final consumption expenditure suggesting a boost to rural economy should be beneficial for overall consumption in the economy. However, following the government’s shift, expectations of India’s crossover from consumption to investments will need to be recalibrated.
The monsoon does matter….even more in current year
While the renewed focus of the government towards rural India is positive, this initiative must be complemented with a normal monsoon, for the optimal benefits to be realised. India’s agri GDP growth has a strong, 71% correlation with the quantum of rainfall. According to the Australian Bureau of Meteorology, El Nino is expected to end by the second quarter of 2016. With a strong positive correlation between El Nino years and deficient rainfall, the moderating El Nino is good news and increases the likelihood of a normal monsoon this year.
It’s all about consumption
While we continue to stay positive on urban consumption plays we expect rural consumption to start rising strongly from September 2016. While the translation of the policy focus to corporate earnings of rural beneficiaries will take at least six months, we expect stocks to start reflecting this optimism. The first key catalyst for these beneficiaries may emerge when the monsoon forecast is released. Key beneficiaries from expected boost to rural consumption: Hero Motocorp, M&M, HUVR, ITC, Godrej Consumer, Shree Cement, Ultratech, Shriram Transport Finance, Jain Irrigation, Coromandel.
Key beneficiaries of urban consumption: Titan, Maruti, Whirlpool, Zee, Nestle.
Risk-reward may be turning favourable again, it is time to value hunt
While global risks have not yet dissipated, the stability in commodity and emerging market (EM) currencies illustrates that the risks are probably being better understood currently and risk reward is beginning to turn attractive. Stability in the Renminbi may lead other commodity dependent EMs to rally. While India may underperform the EM index briefly, the sharp selling by foreign institutional investors seen since January looks to be abating. Any signal that endorses that commodity markets have seen the bottom, will lead to a reversal in the near one way trend of foreign selling, seen since January, in India. Investors looking for value may look at banks, particularly SBI and ICICI Bank.