Monday, December 19, 2011

>INDIA EQUITY STRATEGY: Rural growth - increasingly a mixed bag

India’s stellar rural growth is about the most consensus, verging on nearly unanimous, theme for investors in financial markets. Risks emanate precisely from this fact that rural growth is perceived as almost completely unaffected by the sharp slowdown in the rest of the economy. Early indicators and logical analysis of its drivers imply at least some caution in investments in the stock market.

Rural analysis – “mural” analysis
Plurality of rural India helps develop legends that make any report on the subject a captivating read right from the start. There are anywhere between 600,000 and 1 million villages in India with a combined population of over 700-million people. For anyone who starts by categorizing this continent-sized population as a single group, the first touch with the life in villages proves breath-taking, amid other things in its sheer diversity.

Less data, more pictures and anecdotes
It’s in the same unfathomable variety of rural India, the seeds of highly subjective and touchy-feely analysis are born. The reality is that there are extremely few real-time, objective data points on the economic life of rural Indians. All survey-based information on important parameters like land transactions, employment, wages or even expenditures on key consumables are generally available only sparsely and that too after long delays.

As a result, rural economy analysis has taken a highly pictorial form in the equity market industry in the last few years. A top-down discussion of the logical drivers of the rural economy are almost universally supplemented by the photos of well-paved roads, nicelybannered village shops or hard-working farmers with their gadgets or vehicles to prove the progress in the sector.

To be clear, photos replace charts in India’s rural economic discussions not just to make the reading more impressionable but mostly out of necessity of not having real-time data. The downside of the approach is obvious: a photo-based analysis is unlikely to show whether this diverse segment is growing at twice the speed in the previous period or a half. The long-term trends of better current state of affairs over the state many moons ago dominate the stories with little possible work on most recent trends and whether they are already in expectations or not.

As this report is not to introduce the sector or talk about its long-term trends or potential, but on marginal analysis – ie, whether growth in the periods ahead is likely to be lower or not – we will have to return to the traditional methods of available quantitative evidences and logical arguments.

Rural-only signals: some warning flags
All the above charts are for consumption across India and not just in rural provinces. The market is well aware of slowdown in the urban region which is likely the primary driver of most above series. The key question, of course, is whether there is any meaningful rural economic deceleration.

As we discussed above, there are extremely few real-time signals covering the vast rural economy. The two most encompassing, useful indicators are agricultural credit related data and tractor sales. Out of this, the former is definitely worrying. At below 8% YoY for the last two months, agricultural credit is growing at the lowest rates in over 15 years. More worryingly, there is a sharp increase in the sector’s non-performing assets with the largest State Bank of India.

Consumption is slowing – is it all urban?
It is true that India’s ongoing slowdown is led by the plunge in corporate investment cycle. That said, the associated impact from lack-of-supply caused inflation, high interest rates and reduced optimism have also begun to impact consumption. At around 6%, consumption growth is persisting close to the lowest levels seen in years. As the break-up of GDP growth also shows, all non-service related sectors (linked more to the rural economy) are decelerating sharply in recent quarters.

Main issue: investor expectations
Allow us to repeat one more time: for the vast and diverse rural India, the above evidences are scant and far from categorical in their conclusions. Painting a 700-million+ people segment with one boom or slowdown brush is simplistic in extreme even with best possible information. One can easily tell the rural tale even today with the same arguments that have been made repeatedly in the last five years to show that all is well. After all, there has been a great monsoon. Crop prices are still rising. Rural wages continue to benefit from government policies. And there are productivity increases. And even the most pessimists cannot claim that rural land prices, unlike urban property, are coming down.

The stock market conclusion is less ambivalent than the actual and potential rural growth trajectory because of the role played by lofty and unanimous expectations. We have created a basket of 15 stocks from the largest listed non-financial stocks that are generally considered a proxy on rural demand. As the following charts show, the basket has not only outperformed the benchmark handsomely in the last 18 months, the valuation premium too has expanded to the highest level in at least eight years.

To read the full report: EQUITY STRATEGY