Motilal Oswal Financial Services

COPE

Initial signs of rural sector bottoming out…

…but sharp urban weakness to keep consumption growth subdued



17 December 2019

The Economy Observer



Real rural wages declined 1.5% YoY in 1HFY20, marking its first decline in 13 years. However, the reality for the rural

sector is not as grim as these numbers suggest as almost the entire decline in real wages can be attributed to higher

inflation. Nominal wage growth was 4.5% in 1HFY20, same as that in FY19.

In contrast to the broad economic dynamics, higher inflation is benevolent to the farmer community, as it is a reflection

of the higher prices fetched for their output. Not only retail food prices, but wholesale food prices have also increased

at 6-year highest pace in the first eight months of FY20.

Moreover, while farm output prices (at wholesale level) have increased sharply at 7.3% in Apr-Nov’19, farm input prices

have declined slightly in FY20, implying better profitability for the farm sector this year after two years (FY18 and FY19)

of declining margins.

Interestingly, the central government’s spending on the rural sector has increased ~21% YoY in the first seven months of

FY20 (Apr-Oct’19), marking the fastest growth in 11 years. It was >13% of total spending, the highest in eight years.

Combining the above mentioned facts with unusually strong water reservoir levels and pick-up in rabi crop sowing

activity, there are sufficient initial signs pointing toward the rural sector bottoming out. Nevertheless, even if the rural

sector picks up in some time, total consumption growth may continue to remain subdued as the urban sector has

weakened sharply in FY20 and is not showing any signs of abatement.

Real rural wages have contracted in 1HFY20…:

Accordingly to the monthly data

released by India’s Labor Bureau, real rural wages contracted 1.5% YoY in 1HFY20

(Apr-Sep’19), marking its first and worst decline in 13 years. The decline also marks a

sharp reversal

(Exhibit 1)

when compared to the decent growth of ~2.5% in the

corresponding period a year ago.

The entire decline in real

rural wages was on account

of higher rural inflation

since nominal rural wage

growth in 1HFY20 was the

same as that in 1HFY19.

…entirely because of higher inflation:

Nevertheless, we believe that the headline

numbers have much to hide – not devils, but angels (or silver linings) – from the

agricultural sector’s perspective. Almost the entire decline in real rural wages was

on account of higher rural inflation

(Exhibit 2).

Nominal rural wages increased 4.5%

YoY in 1HFY20, same as that in 1HFY19. While the nominal wage growth is not very

strong, it suggests that the deterioration reflected in real terms is more statistical.

Exhibit 2:

…but nominal wage growth remains similar

(% YoY)

18.7 19.2 17.6

3.1

1.8 1.9 1.2

3.0 2.4

10.0

(1.5)

8.3

10.2

11.5

6.9

Nominal rural wages

CPI-RL

Exhibit 1:

Real rural wages have declined sharply in 1HFY20…

(% YoY)

Real rural wages

10.1

7.8

6.8

14.9

8.7

6.4

4.6

4.5

4.6

2.2

6.0

0.2

(1.5)

(1.2)

(2.6)

0.9 0.2 1.2

5.5

4.2

5.3

2.3

Adjusted by CPI for rural laborers (RL)

*Apr-Sept’19

Source: Labor Bureau, RBI, CEIC, MOFSL

Nikhil Gupta – Research Analyst

(Nikhil.Gupta@MotilalOswal.com); +91 22 6129 1555

Yaswi Agarwal

– Research Analyst

(Yaswi.Agarwal@motilaloswal.com); +91 22 7193 4196

Investors are advised to refer through important disclosures made at the last page of the Research Report.

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Higher inflation good for farmers…:

In contrast to our usual perception, higher

inflation is good news for the rural sector, especially farmers as it implies higher

realization for their output. A simple analysis shows that (nominal) rural wages and

rural inflation share a very strong and positive correlation of ~70%, measured over

the past two decades

(Exhibit 3).

After crumbling from double-digits between FY09

and FY14 to 17-year low of ~2% in FY18 and FY19, rural inflation increased to 6% YoY

in 1HFY20. Thus, we believe that it may be just a matter of time before nominal

wage growth also starts to follow higher inflation and move higher.

Food prices are increasing at a much faster pace compared to the past many years.

Not only at the retail level, but food prices at the wholesale level too are growing

much faster

(Exhibit 4).

Retail food prices (measured by CPI: Food at all-India level)

grew 10% YoY last month, at least partly supported by record decline of 2.6% a year

ago. More importantly, from the farmer’s viewpoint, however, food prices of

primary articles at the wholesale level grew even faster at 11.1% YoY last month,

marking the highest growth in almost six years. Consequently, food prices at the

wholesale level grew 8% YoY in the first seven months of FY20 (Apr-Nov’19), as

against a decline of ~1% in the corresponding period a year ago.

Exhibit 3:

Rural wages share a high positive correlation with

rural inflation…

FY19

1HFY20

Exhibit 4:

…and at wholesale level, food prices have grown

steeply in FY20

(% YoY)

9.9

13.8

WPI: Primary food articles

y = 1.3522x - 0.1621

R² = 0.6904

FY10

5.9

1.8

8.0

5.3

2.0

(0.9)

FY13

FY14

FY15

FY16

FY17

FY18

FY19

FY20

CPI-RL inflation (% YoY)

CPI for rural laborers (CPI-RL)

April-November period for all years

Source: Office of the Economic Adviser (OEA), CEIC, MOFSL

During the first eight

months of FY20, while farm

output prices grew 7.3%

YoY, marking the highest

pace in six years, farm input

prices declined 0.4% during

the corresponding period.

…and more so, when input costs are declining:

What makes it even sweeter for the

farmer community is the fact that farm output prices have increased at a time when

farm input prices have declined

(Exhibit 5-6).

Based on the five inputs (namely, high

speed diesel, electricity, fertilizers, pesticides and agricultural machinery &

implements), farm input prices declined 2.3% YoY last month, marking the third

successive contraction. In contrast, farm output prices (based on primary food and

non-food articles) grew at 6-year high of 9.4% YoY in Nov’19. During the first eight

months of FY20, while farm output prices grew 7.3% YoY, marking the highest pace

in six years, farm input prices declined 0.4% during the corresponding period

(Exhibit

5 on the next page).

This is in sharp contrast to the happenings of the past two years (FY18 and FY19).

While farm output prices grew marginally in FY18 and contracted in FY19, farm input

inflation was as high as 3% and ~8%, respectively, implying declining margins for the

farmers.

17 December 2019

The ‘terms of trade’ turned

significantly negative for

the agricultural sector in

FY18 and FY19, which has

reversed in FY20.

In other words, the ‘terms of trade’ turned significantly negative for the agricultural

sector in FY18 and FY19, which has reversed in FY20. This reversal in situation from

declining margins to improved profitability is certainly highly welcomed by the

farmers section in the rural society.

Exhibit 6:

…led by a combination of rising farm output

prices and declining farm input prices

7.3

Farm output WPI

Farm inputs WPI

Exhibit 5:

‘Terms of trade’ for the agricultural sector has

improved in FY20…

(% YoY)

10.2

7.2

12.4

Farm output WPI

Farm inputs WPI

6.5

4.1

1.7

5.1

1.1

(0.7)

3.1

7.7

(1.9)

(0.2)

The Worst Phase

for farmers

(0.4)

(10)

(% YoY)

FY20*

(20)

May-13 Jun-14

Jul-15

Aug-16

Sep-17

Oct-18

Nov-19

FY13

FY14

FY15

(12.2)

FY16 FY17

FY18

FY19

* April-November 2019

Source: OEA, CEIC, MOFSL

Rural spending by the

central government grew at

11-year high of 20.8% YoY

in FY20.

Rural spending by the central government rises sharply…:

It is a well-known and

established fact that the government has an instrumental role to play as far as the

rural sector is concerned. Consequently, it is important to note that rural spending

by the central government (including Ministry of Agriculture and Farmer’s Welfare,

Department of Fertilizers, Drinking Water and Sanitation, Ministry of Panchayati Raj

& Ministry of Rural Development) grew 20.8% YoY in the first seven months of FY20,

marking the highest growth in the past 11 years

(Exhibit 7).

Consequently, the share

of rural spending in the center’s total spending rose sharply from 11.3% in FY19 to

the 8-year high of 13.3% in FY20

(Exhibit 8).

Unfortunately, we don’t have

corresponding data from the state governments.

Exhibit 8:

…taking the share of rural spending to over 13%

of total spending in FY20 (Apr-Oct’19)

18.1

Rural spending (% of total spending)

14.5 14.9

5.1

11.8

Exhibit 7:

Center’s rural spending has risen sharply in the first

seven months of FY20…

(% YoY)

20.1

5.8

7.6

1.7

(1.9)

(7.3)

Rural spending

17.1

14.1

20.8

13.4

11.4 10.9 11.0

10.4

11.0 11.6 11.3

13.3

(8.3)

FY08

* April-October 2019

FY10

FY12

FY14

FY16

FY18

FY20*

Source: CGA, CEIC, MOFSL

…and unusually high water reservoir levels look promising for rabi season:

Finally,

the water reservoir level in the week ending 12

Dec’19 was at an unusually high

level of ~84% – 54.4% YoY higher and as against the 10-year average of 65.4%

(Exhibit 9).

During the past five years, by mid-December, the water level is ~50-63%

of the total live storage in the country. However, the late monsoons have increased

reservoir levels to unprecedented levels. At 83.8%, not only is this the highest since

17 December 2019

At 83.8%, reservoir level is

not only the highest since

2001, but it is also much

higher than the previous

high of ~75% in 2006.

the time we have data available (2001), but is also much higher than the previous

high of ~75% in 2006.

Not surprisingly then, the area sown under rabi season till 12

Dec’19 was ~5%

higher than a year ago, marking the best growth in the past seven years after two

consecutive declines

(Exhibit 10).

Exhibit 10:

…helping rabi area sown to pick up in FY20

(% YoY)

4.9

Rabi area sown till mid-December

4.9

5.1

Exhibit 9:

Water reservoir levels are unusually strong…

(% of live

storage)

74.4

67.7

62.8

50.9

62.3

59.6

Water reservoir levels

83.8

57.0

(4.9)

2013

2014

(4.0)

(2.4)

(7.8)

2011 2012 2013 2014 2015 2016 2017 2018 2019

Till mid-December of each year

2015

2016

2017

2018

2019

Source: Department of Agriculture, IMD, MOFSL

Sufficient initial signs point

out that the rural sector

may have bottomed out.

Conclusion – Sufficient initial signs point toward the bottoming out of the rural

sector; sharp urban weakness may keep consumption growth subdued

Overall, while the sharp contraction in headline real rural wages presents a worrying

trend, adding to one more dismal data point amid the sea of such reporting, details

convey a totally different picture – an optimistic one. Although the narrative of

weakening rural sector confirms with weak consumption data, there are sufficient

initial signs pointing out that the rural sector may have bottomed out. If conditions

such as higher inflation, favorable terms of trade, supportive fiscal spending and

high water reservoir levels persist for some more time, agricultural sector will soon

start growing faster.

Does this mean that consumption slowdown will also reverse with better

agricultural sector? Not necessarily. Although one tends to think of rural sector

whenever we talk of general consumption growth in the nation, it is important to

note that the recent moderation in consumption growth can be attributed more to

the urban sector. Almost all leading indicators – salary and wages, production of

consumer durable goods, airline passenger traffic, house prices, etc. – discussed in

the

earlier

report, have weakened sharply in FY20. This implies that urban

consumption has decelerated to post among the slowest growth in at least the past

fifteen years. Therefore, even if the rural sector picks up in some time, total

consumption growth may continue to remain subdued as the urban sector has

weakened and is not showing any signs of abatement.

Even if the rural sector picks

up in some time, total

consumption growth may

continue to remain

subdued as the urban

sector has weakened and is

not showing any signs of

abatement.

17 December 2019

Explanation of Investment Rating

Investment Rating

BUY

SELL

NEUTRAL

UNDER REVIEW

NOT RATED

*In

case the recommendation given by the Research Analyst is inconsistent with the investment rating legend for a continuous period of 30 days, the Research Analyst shall within following 30

days take appropriate measures to make the recommendation consistent with the investment rating legend.

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through Motilal Oswal Private Equity Investment Advisors Pvt. Ltd which is a group company of MOFSL. Research & Advisory services is backed by proper research. Please read the Risk

Disclosure Document prescribed by the Stock Exchanges carefully before investing. There is no assurance or guarantee of the returns. Investment in securities market is subject to market risk,

read all the related documents carefully before investing. Details of Compliance Officer: Name: Neeraj Agarwal, Email ID: na@motilaloswal.com, Contact No.:022-71881085.

* MOFSL has been amalgamated with Motilal Oswal Financial Services Limited (MOFSL) w.e.f August 21, 2018 pursuant to order dated July 30, 2018 issued by Hon'ble National Company

Law Tribunal, Mumbai Bench.

17 December 2019