Moneycontrol Pro Panorama | What is hurting India’s rural demand story?

There are strong reasons to believe that the jump in rural demand of late has been largely triggered by increased borrowing.

Dear Reader, 

On October 29, in his post results conference interaction with media, Maruti Suzuki India Chairman R C Bhargava sounded a bit worried over the decline in sales of models in the sub-Rs 10 lakh car market. Bhargava cited stagnant income levels, volatile fuel prices and surging price points of entry-level models as reasons leading to a dip in volumes of compact cars such as Alto, S-Presso, WagonR and the like.

This comment came a few days after new monetary policy committee member Nagesh Kumar strongly pitched for a rate cut arguing that demand in the economy has taken a hit. Kumar said the RBI’s Enterprise Surveys showed the demand conditions in manufacturing and the job landscape have moderated across major sectors.

Some of us would also remember Nestle India Chairman and Managing Director Suresh Narayanan’s recent post-earnings commentary where he said the FMCG sector is facing sluggish demand with the growth in F&B declining to 1.5-2 percent as against double digits some quarters ago. This decline is due to a combination of factors, including food inflation, Narayanan said.

On the two-wheeler segment too, the trend shows a grim picture. Recently, Bajaj Auto cut its growth outlook for two-wheeler sales in India to a modest 5 percent after a slower-than-expected festival season and despite offering steep discounts. Two-wheeler sales are generally considered as a better indicator for rural demand.

So, let’s say there is a consensus among the companies about a demand moderation in the economy. Now the critical question is, why is this happening?

As my colleague Manas Chakravarty pointed out in his article, there are strong reasons to believe that the jump in rural demand of late has been largely triggered by increased borrowing by the rural customers from banks, microfinance institutions and other non-banking financial companies (NBFCs).

Why did this happen? There are three key reasons I can think of:

One, the primary reason is banks’ obligation to fulfil the priority sector lending requirements under the present RBI rules. Under this, banks have to lend 40 percent of their adjusted net credit to economically weaker sections such as microloan borrowers, agriculture and women borrowers etc.

To meet this obligation, banks often push too much credit to microlending firms which create a flood of money in the rural ecosystem where these firms primarily operate.

Second, the penchant for lenders for unsecured personal loans too has played a critical role in ballooning the rural demand in the past few years. Unsecured personal loans are mouthwatering instruments for lenders due to high margins. But these loans are often disbursed without assessing the credit worthiness of the borrowers and without any documentation.

Third, NBFC-MFIs have been competing hard in the same geographies—particularly in states like Andhra Pradesh—to grow their books. There are cases where a single borrower has as many as 12 loans from different lenders and 3-4 lenders operating in the same area—all suggesting a toxic concentration of credit.

Such easy money flow over the past few years has resulted in borrower overleveraging and over indebtedness. This pushed the rural demand as consumers used borrowed funds to purchase consumption items.

But the story is changing, for sure.

The Reserve Bank of India (RBI), wiser from the past crisis episodes, has acted early this time. It has clamped down on unsecured personal loans by upping the risk weight of such loans. Most recently, the RBI also cracked down on two NBFC-MFIs citing material supervisory concerns linked to high interest rates and poor assessment of household income while giving loans.

I feel these actions may not be enough this time as borrowers begin to push back against lenders pushing too much credit to their pockets. The RBI may have to do a lot more going for a wider clampdown to avoid a repeat of 2010 crisis. The earnings of NBFC-MFIs suggest that the cookie is crumbling already.

A combination of the above factors will squeeze the money flow to consumers in the days ahead and will thus curtail demand. This will reflect across all industry segments linked to rural consumption in the quarters ahead.

Investing insights from our research team

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 Dinesh Unnikrishnan Moneycontrol Pro