India Insight:Slowing rural wages–positive for inflation but pulling down growth

Event

Rural wage growth slumped to 3.6%YoY in Feb-15 from the recent high of17%YoY CAGR (compound annual growth rate) registered during the fiveyears ending 2013. This is a key economic indicator to track as ruralpopulation still accounts for the bulk of India’s total population (69% as perlatest census data) and has an important bearing on both the inflation andconsumption outlook.

Why is rural consumption slowing?

The slowdown in rural income levels and hence demand over the past fewmonths seems to be driven by:

a) Sharp cut in government spending especially in the last six months ofFY15 to meet the fiscal deficit targets. Indeed, the employment generated (interms of million person days) under the Mahatma Gandhi rural employeeguarantee scheme (MGNREGS), the key flagship socialist programme of theprevious UPA government, declined by 25%YoY in FY15 with most of themoderation seen from Aug-14 onwards.

b) Measured increase in minimum support prices (MSPs) by thegovernment: The average hike in MSPs for agricultural crops was only~2.4%YoY in FY15, the lowest in 8 years.

c) Adverse terms of trade for the agricultural sector: Considering India is anet agricultural & allied products exporter, falling global commodity pricesand a stronger rupee have hurt exports. At the same time, the poor rainfalltrend in 2014 (12% below normal) also impacted agricultural cropproduction.

Our channel checks have revealed that many farmers have also now begun toopt for mechanization to reduce their dependence on contractual labour owing torising wage bills. While this will improve productivity of the agriculture sector inthe medium term, it will create lesser employment opportunities in the short termfor the landless labourers that earlier used to get absorbed under various socialwelfare programmes and construction projects of the government.

Outlook - rural wages likely to get some support in therange of 6-8%YoY over the coming months

We believe slowing rural demand is one of the key reasons for the sharpdeceleration in CPI inflation (headline and core) seen over the past fewmonths. While this has helped reduce the macro stability risks and facilitatedlowering of key policy rates by the central bank, the sluggish trend in ruralincome levels has now started to have an adverse impact on overall growth.

We believe that rural wages will get a support in the range of 6-8%YoY overthe next 6-9 months as government spending picks up pace. At the sametime, the government’s efforts towards increasing infrastructure spending andimproving the productivity dynamics of various social welfare programmes willalso help support rural income levels without fuelling inflation. We think ahigher minimum support price (MSP) increase for agricultural crops could notbe ruled out in the case of deficient rainfall this year.