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Thematic Research: India Strategy - Rural Consumption; Growth levers for next 2-3 years look promising

We reiterate our thesis of sustainable rural consumption growth over next two to three years. Factors that support our view are 1) fortified government rural spend, 2) better targeting of government expenditure, and 3) decoupling of crop production from monsoons (which should facilitate higher crop output in FY19) and 4) recent MSP hike which will support price realization for farmers, though with a lag. Key areas where government expenditure/policies support rural consumption include a) Increase in rurally oriented expenditure by state and central governments at 16% CAGR over FY14-19BE as against 13% CAGR rise in total expenditure, b) Rising share of state government expenditure from 54% in FY14 to 65% in FY19BE, c) Increase in share of rural and social ministries’ expenditure within the Central Government from 9.1% in FY16 to 11.9% in FY18, d) focused government spends (MNREGA, PMAY-G, NRLM, etc) with higher allocation to poorer states to support the economically weaker class, e) extension of Direct Benefit Transfer (DBT) to most government schemes (money to be directly transferred to beneficiary account), f) farm loan waivers. Moreover, sowing for Kharif crop (key factor for FY19E crop output) remains robust, despite an overall weak monsoon (we have seen decoupling of crop output and monsoon in last 2-3 years and the trend seems to continue). Consequently, we expect rural-oriented companies to post robust volume growth supported by a) strong base effect caused by demonetization and GST disturbances (over last two years) b) higher and focused government rural spend, and c) superior crop output and prices. Dabur, Hero Motocorp, Maruti, Mahindra & Mahindra, HUVR are our top picks. This is in line with what we have been reiterating earlier in our last note on

Government expenditure targeting has been efficient in recent years: Government expenditure/ policies tend to provide additional support to rural income, though with a lag. Overall, government expenditure targeting has been more efficient in recent years with poorer states getting higher allocation with higher execution rates under government schemes (earlier states with better execution track record, which also happened to be states with relatively lower poverty rates, were preferred for higher allocation of resources). Key things that we observed - a) relatively higher number of persondays worth of jobs under MNREGA are being created in poorer states (81% of job days created in poorer states FY19YTD against 69% in FY15) b) higher fund allocation under MNREGA targeted towards poorer states, c) higher housing expenditure allocation under rural housing scheme (PMAY-G) is targeted to towards poorer states, d) PMAY-G execution rate has been relatively higher in poorer states (95% of houses completed over FY17-19 were from poorer states against 84% in FY16), e) DBT ensures money directly in hands of beneficiaries (total Rs4.4 trn transferred to beneficiaries since inception of scheme). The government has been focusing on reaching a wider population to uplift broader spending power.

State governments pitching in more: While the overall combined expenditure of states and central governments targeted at rural-oriented sectors has seen robust 16% CAGR over FY14-19BE, the share of states in overall expenditure has risen from 53% in FY14 to 66% in FY18. Moreover, the share of rural/social- focused ministries in central government expenditure too has risen from 9.1% in FY15 to 11.9% in FY18, which continues in FY19. This confirms government policy and focus continuity on rural segments.

Decoupling of monsoon vs Agricultural produce: Sowing progress primarily determines the output of crops, as monsoon progress has been decoupled from crop output over last 2-3 years (3% CAGR in crop produce, FY15-18, with on an average 10% deficient monsoon and poor spatial distribution). Increase in irrigated area has historically supported a good crop annually, despite weak monsoon. A robust sowing progress despite a weak monsoon points to better farm and irrigation practices, in our view. However, the reason behind decoupling remains open to interpretation, given the lack of latest data.

Quantity of crop produced determines income growth more than pricing, as MSP percolation mechanism is weak: As majority of Indian farmers remain small and marginal (~80%), they have relatively lower negotiating power. Moreover, lack of storage facilities and limited agriculture market infrastructure impact pricing equation, making the percolation mechanism of MSP hikes weak. Our analysis revels insignificant impact of MSP hike on real price realization growth of a crop in a given year (though MSP hike tends to impact with a lag).

Volume growth of most rural-oriented companies/sectors is associated with agri and allied GVA growth: Volume growth of rural-oriented sectors/companies exhibit close co-movement with Agri-GVA (as ~70% of India’s rural population depends on agriculture, according to FAO). While tractor volume growth (income facilitators) moves in line with Agri-GVA growth, consumption (follows income) follows Agri-GVA growth with a 3-5 quarter lag exhibiting sustainable growth.

Overall rural consumption score card looks healthy: Thus, we believe the rural consumption scorecard looks healthy and majority indicators point towards rural consumption