Moneycontrol Pro Panorama | The credit angle to a rural slowdown

If interest rates reverse course at some point, that could lower the exposure risk in case of a default.

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The state of interest rates is only of passing interest to investors in FMCG stocks as these companies boast of light balance-sheets with zero to little net debt. The business itself is famed for throwing up negative working capital, where the sum owed to debtors and tied up in inventory is much less than what the company owes to its creditors.

FMCG companies are famous for demanding that their distributors pay them in cash and only then will the goods leave the warehouse -- demand drafts from earlier years are now replaced by electronic payments. Meanwhile, the suppliers of raw materials have not been paid yet and may wait up to a month even to be paid. That’s money for jam for the company. Invest it in the money market or short-term debt market and earn returns, reflecting as other income in the books. Not surprisingly, the hike in interest rates has seen this income increase in recent quarters.

But this is not about their treasury management.

Dabur India’s conference call saw the management field questions on various aspects of its disappointing results. One of the main focus areas was on rural demand. While much of the concerns on rural demand were known, such as rural consumers getting hit harder by inflation, shrinkage of low unit price packs and as a result downtrading to cheaper or unbranded goods, one management comment added a new angle to this issue.

Dabur’s management said stockists were finding it difficult to recover payments in rural areas and were not filling up orders as a result. This refers to the model where companies do not have direct distribution in a rural location, but wholesalers buy goods from distributors/stockists and then sell them to retailers in these locations. While companies have direct distribution in rural areas and have been growing it, they still cover a relatively small portion of the total number of villages. The wholesale channel is useful to cover the ones that don’t have a critical mass for direct reach.

This model works on multiple legs of credit, with the consumer buying on credit, the shopkeeper buying on credit and if the wholesaler has a good standing then they will buy on credit too, but from the distributor/stockist. This chain has come under pressure in recent quarters, partly due to the market situation as consumer incomes are under pressure, but also due to higher interest rates. The steep increase in inflation also means that the same volume of goods costs much more to procure, leading to higher working capital costs and heightened risks across the distribution chain. Add to this the difficulty in recovering payments, and a well-oiled chain of credit fuelling purchases by rural consumers may have come unstuck. The recent spate of B2B distribution channels revising their business models may also be due to these reasons.

This situation may explain why Nestle India has been reporting consistently good results in rural India with its strategy of entering select markets with direct distribution. Since it has greater control over the channel, payment default risk is low and it can offer a good assortment of products. Of course, an unrelated tailwind is that although rural consumers are hard pressed, market research organisations cite a surprising increase in their purchases of impulse goods such as chips and chocolates. But that’s a different story.

Therefore, rural consumers may be switching or downtrading not just because of rising inflation and their stressed income situation, but also due to limited availability of products. Extend this to other goods purchased by a wide swathe of rural consumers and similar explanations may arise. But, for big ticket items, such as tractors or passenger vehicles or expensive consumer durables, these are typically bought by well-off rural consumers, and demand for these may be relatively unaffected as a result.

What’s the solution for FMCG companies? They can support their distribution channel by offering credit support at a lower cost, but with a backstop on payment defaults from the channel. A more expensive but long-term solution is to increase reach. But there are limitations to both these solutions.

The bigger answers are mostly in the macros. As inflation abates and if rural disposable income improves, then higher demand could give the channel more confidence to invest. If interest rates reverse course at some point, that too could lower the exposure risk in case of a default. A growing economy and an easing monetary policy situation is the combination that will work.

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Ravi Ananthanarayanan
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