IIFL Rural India Q1 2010

Rural India
Country roars
National Rural Consumption Guarantee Act
1Q2010
Rural India
Did you know?

Governments rural employment spending Rural infrastructure
Government spend on rural programmes
has grown at 45% annually during the last two years. spending is towards employment schemes, NREGA (National Rural Employment Guarantee Act) being the largest of them.
Based on 2001 census, 78m of the 134m
About 35% of the governments rural
rural households were without electricity. Under the rural electrification programme started in 2006, the government is spending US$1bn per year, to provide electricity to 3m rural households per year. So far, 9.4m households have been provided electricity under this programme. (rural population forms 73% of total population) remains unconnected by roads, a proportion down from 25% as of 2000. 16m ha under irrigation, a significant acceleration from less than 10m ha targeted to be added during each of the prior three Plan periods.
Wastage under NREGAat 2040%is
perhaps the lowest among the governments rural schemes. For perspective, wastage under PDS, a bigger scheme, is over 73% as per the governments own estimates. have NREGA job cards. India currently NREGA.
Almost 17% of Indias rural population
More than 70% of all rural households Almost a third of all rural households in
secure wages under
The XI Five-Year Plans target is to bring
Only 14% of households employed under

NREGA receive the full stipulated 100 days of employment. NREGA scheme is unskilled workers. towards wages of Rural consumption
Seventy percent of all payout under the NREGA incentivises local governments to
Aggregate rural consumption expenditure

in India is ~30% more than aggregate urban consumption expenditure.
find work under the scheme, by placing the entire burden of the unemployment allowance payout on the state government, while the centre bears 75% of the payout towards skilled wages and 100% of payout towards unskilled wages. paid only into bank accounts of individual workers. This will bring ever more villagers into the banking system.
During 1999-2007, rural spending on non Rural penetration of motorcycles, at 10%,

is significantly lower penetration at 30%. than
food items grew at 2.5x that of food spend. urban
Wages under the NREGA scheme can be
Rural penetration of toothpastes and

shampoos is only 42% respectively, in rural India. and 37%,
Direct transfer of funds to recipients bank

accounts has kept siphoning of funds much lower than it would have been otherwise.
Fifty-six percent of Bharti Airtels and
Vodafones net mobile subscriber additions, and 40% of Idea Cellulars revenues are from rural areas.
Rural India
Rural factoids
Figure 1: NREGA accounts for a third of all govt spending on rural schemes
Bharat Nirman National Rural Health Mission 1,400 1,200 1,000 800 600 400 200 0 FY08 FY09 FY10
Source: Government Budget documents, IIFL Research
Figure 2: NREGA spend has been focussed on irrigation

(% share of spending under NREGA) 100 80 60 40 20 0 2006-07 2007-08 2008-09
Source: NREGA website, IIFL Research
NREGA AIBP (Irrigation)
Land development & others Irrigation & w ater conservation Rural connectivity
(Rs bn)
Figure 3: Rise in labour wages and urbanisation has led to higher mechanisation
Yield (LHS) 5 (tonnes/ha) 4 3 2 1 0 1998-99 2000-01 2002-03 2004-05 2006-07 No. of tractors purchased (RHS) 350,000 300,000
Figure 4: Rural penetration is still low across consumption categories

Rural penetration 100% 80% 77% 57% 42% 40% 20% 0% Toothpaste Shampoo Hair oil Laundry Telecom
Source: Census of India, IIFL Research
Urban penetration 93% 90% 80% 67%
100%
250,000 200,000 150,000 100,000 50,000 0
60%
37% 18%
Source: Department of Agriculture, Mahindra & Mahindra, IIFL Research
Figure 5: Rural population offers a potentially huge market opportunity

Low income 180,000 (no. of. Households - '000) 150,000 120,000 90,000 60,000 30,000 0 Rural 198990 Rural 200102 Rural 2009- Urban (200910E 10E) Middle income High income
Figure 6: YoY growth in MSP has accelerated since 2002 at an unprecedented rate
Wheat Paddy 40% 30% 20% 10% 0% -10% 2003-04 2004-05 2005-06 2006-07 2007-08 Gram Soyabean Mustardseed
Source: NCAER, IIFL Research
Source: Census of India, IIFL Research
Rural India
Racing across the countryside

Our visits to a number of states over a period of 12 weeks across the length and breadth of the country revealed the diversity in infrastructure, sources of income and standards of living across Indias rural populace. For our visits, we chose states that met one of the following three conditions: 1) runaway success in NREGA implementation, to directly assess the schemes contribution to income growth; 2) large contribution to Indias agricultural output, to evaluate how severe the impact of rainfall deficiency might be on farm income; and 3) languishing in implementation of most rural reforms, to assess if these states have any scope for improvement in the medium term.
We visited 18 districts across seven states in a 12-week period
Source: IIFL Research
Rural India
Executive summary
G V Giri gvgiri@iiflcap.com (91 22) 4646 4676 Sangeetha Saranathan sangeetha@iiflcap.com (91 22) 4646 4644 Arnab Mitra arnab.mitra@iiflcap.com (91 22) 4646 4661 Jatin Chawla jatin.chawla@iiflcap.com (91 22) 4646 4654
Corroborative evidence from our visits to villages in seven Indian states and our meetings with the rural development minister, Dr C P Joshi, make us optimistic on rural consumption growth. Government spend on the rural sector is already significant at US$27bn (FY10ii), and will almost double in the next three years, with emphasis on employment generation (NREGA) and infrastructure upgradation. Growth in farm incomes is accelerating, thanks to rising productivity, better prices, reducing cyclicality, and improving infrastructure, especially road and mobile connectivity. Growth in rural consumption spend is set to accelerate. This theme will play out over a number of years, and for longerterm investors in consumption-linked sectors, returns from earnings compounding will likely be substantial. Rural Employment Guarantee: the powerful change agent The UPA governments flagship scheme, NREGA, which assures every rural household employment for a minimum of 100 days a year, is leading to an increase in rural wages, greater income visibility, and decline in rural unemploymentthereby ushering in much desired social change. Spend on NREGA, which currently covers 30% of rural households, is set to jump to ~US$8bn in FY10 (vs US$1.9bn in FY07), and is likely to almost treble from here by FY13. The government is also investing heavily in upgrading road and education infrastructure. Cumulative government spend on rural schemes will almost double in three years from the current US$27bn. Efficacy of this spend will also improve as true inclusive growth is enabled by the governments unique ID programme. Rising farm incomes: another forceful accelerant Indias agrarian sector is on course for much faster income growth than at any time in the past. Productivity is rising on account of a number of factors, especially improved mechanisation and increasing power availability, a factor crucial for irrigation. Tractor sales, for example, have grown at 10% annually in the past five years, vs 3.4% annually in the previous ten. Yield growth acceleration and rise in prices of soft commodities has ushered in buoyancy in incomes. Infrastructure quality is improving, albeit slowly, with a rising share of irrigated land, and better road and mobile connectivity. Dependence on monsoons, while still high, is gradually waning despite the highest rainfall deficiency in almost three decades, FY10 would still end with a 3% increase in farm incomes. Consumption growth: can only get better The US$200bn annual consumption expenditure of 152m rural households will accelerate, powered by rising farm and non-farm incomes. We estimate that the increased government expenditure in itself can potentially raise consumption growth by 15-20% from the current levels, over the next 3-4 years. Greater visibility and stability in incomes from employment guarantee will act as a further psychological boost to rural consumption. With rural consumption set to cross the tipping point, all consumption proxiesespecially FMCG and autoswill see growth rates in coming years trending much higher than in the recent past. Our preferred large-cap proxies on this theme are Mahindra & Mahindra, Hero Honda, Bajaj Auto, ITC, and Hindustan Unilever.
Rural India
Stocks to play the rural consumption tune

Figure 7: Plays on the rural consumption theme
Company Consumption ITC* Hindustan Lever* Nestle India* Asian Paints United Spirits Dabur* Godrej Consumer Marico* Titan Britannia Inds.* Emami* Kansai Nerolac ITC IN HUVR IN NEST IN APNT IN UNSP IN DABUR IN GCPL IN MRCO IN TTAN IN BRIT IN HMN IN KNPL IN 254 265 2,550 1,796 1,380 165 274 104 1,429 1,688 499 1,060 20,550 12,444 5,287 3,703 3,501 3,102 1,826 1,368 1,364 867 773 614 29.5 23.5 43.7 43.3 NA 36.5 40.1 31.3 38.7 19.9 35.9 27.8 23.7 25.6 34.2 27.3 42.3 29.0 26.2 24.8 30.6 18.6 26.3 19.4 20.2 22.0 28.3 24.0 27.9 23.8 22.1 20.0 24.8 15.4 19.2 16.7 19.6 4.4 17.4 19.8 26.9 30.5 39.6 13.1 20.5 12.2 6.2 16.8 15.5 4.2 14.0 17.2 18.6 22.7 23.4 9.9 18.7 12.0 2.7 11.0 13.2 3.4 11.6 15.4 14.8 18.5 19.9 7.9 15.5 9.4 2.0 9.5 Bloomberg code Price (Rs) Market cap (US$ m) FY09 PE FY10 FY11 EV/EBITDA** FY09 FY10 FY11
Autos Maruti Suzuki* Hero Honda* Bajaj Auto* TVS Motors MSIL IN HH IN BJAUT IN TVSL IN 1,568 1,725 1,749 71 9,742 7,406 5,442 362 38.3 26.5 34.9 NM 17.2 15.7 14.5 24.8 14.8 14.3 13.1 15.0 30.0 16.0 20.0 56.1 12.0 9.7 8.4 11.7 9.5 8.3 7.2 9.7
Telecom Bharti* Idea* BHARTI IN IDEA IN 328 58 26,758 3,897 15.0 21.0 14.7 30.4 15.8 55.0 7.9 9.8 7.7 10.7 7.5 9.1
Farm equipment Mahindra & Mahindra* Kirloskar Engines Greaves Cotton Escorts MM IN KKOE IN GRV IN ESC IN 1,116 161 287 132 6,717 672 301 299 25.6 27.0 31.5 37.2 16.7 NA 16.4 26.8 16.3 NA 13.0 22.8 17.9 NA 13.3 9.9 11.4 NA 9.0 NA 10.7 NA 7.0 NA
Farm inputs United Phosp.* Tata Chemicals Jain Irrigation* Monsanto Rallis India Advanta India UNTP IN TTCH IN JI IN MCHM IN RALI IN ADV IN 177 320 855 1,665 955 555 1,667 1,617 1,389 309 266 201 13.6 11.6 47.6 19.5 17.8 18.5 15.6 12.9 24.1 21.6 13.6 21.1 13.8 11.2 19.3 17.9 10.3 14.4 8.5 7.6 8.7 NA 9.5 11.4 7.8 7.7 7.4 NA 8.2 10.6 7.6 7.1 6.5 NA 6.6 8.8
Banks State Bank of India (Cons) SBIN IN Punjab National Bank PNB IN 2,291 926 31,413 6,302 12.5 9.4 12.7 7.9 10.7 6.7 2.0 2.2 1.7 1.8 1.6 1.5
Source: IIFL Research. * Refers to IIFL estimates; the rest of them are based on Bloomberg consensus estimates. ** For banks, the last three columns are P/BV multiples. Prices as at close of business on 4 January 2010.
Rural India
Rural India to see sustained govt support

In our opinion, the thumping success of the UPA government in the 2009 general elections was in no small measure due to rural schemes such as NREGA, PMGSY (rural roads) and SSA (free education). We estimate that cumulative government spending on these rural schemes will increase by 2.7x between FY07 and FY10 to US$27bn, and then further increase by US$23bn to reach US$50bn in FY13. NREGA would be the largest contributor to this jump, going from ~US$8bn in FY10 to US$21bn in FY13. This increase would be driven by more even implementation across states (currently, just five states account for 65% of the spend).
Significant acceleration seen in govts rural spend

Government spend on rural programmes has grown at 45% annually in the last two yearsunderlining the importance the government places on rural India
Government spending on rural programmes has registered a CAGR of 45% in the last two years (FY07-09), as shown below. In calculating the total rural spend, we have assumed that 50% of the PDS spend is aimed at rural areasa reasonable assumption, as PDS is designed to provide heavily subsidised food grains to below poverty line (BPL) families, the bulk of whom live in rural areas.
Figure 8: Central Govt Budgetpriority areas are employment, roads, education
(US$ bn) Rural Employment (including NREGA) Other rural schemes Roads and bridges (PMGSY ) Education (MDM and SSA ) PDS (taken at 50% focussed on rural) Total Growth
4 2 3 1
FY05 1.4 1.1 0.5 1.3 2.5 6.8
FY06 2.5 1.2 0.8 2.1 2.5 9.1 35.1%
FY07 2.7 1.3 1.1 3.2 2.6 10.9 19.8%
FY08 3.0 1.7 2.3 4.2 3.4 14.6 33.5%
FY09 7.8 2.7 3.2 4.5 4.6 22.9 57.0%
How is rural India defined? Per the census, urban areas must meet all the following criteria: (a) places that fall within the administrative limits of municipal corporation, municipality, cantonment board; (b) places with population greater than 5,000; (c) places where at least 75% of the male population is not engaged in agriculture and allied activities; and (d) places with population density of at least 400 per sq km. All other places are rural.
Source: Govt of India Budget documents, IIFL Research. Rural spend on PDS taken at 50% of actual spend; for instance, the actual in FY09 was US$9.2bn. NREGA actual expenditure taken from NREGA site (includes wages and material, central and state expenditures).
Figure 9: Agriculture and rural infrastructure have seen significant improvement

Particulars Agricultural GDP Agricultural capital formation Total capital formation Agricultural exports growth Total exports growth Road connectivity at the end of the period Rural literacy levels Growth in prices of agricultural commodities CAGR FY94-2004 2.8% 6.6% 8.8% 11.5% 15.4% <40% 45% (in 1991) 2.5-4% CAGR CAGR FY04-08 3.5% 9.9% 16.4% 20.2% 21.5% ~70% 59% (in 2001) 10-15% CAGR
Source: Department of Agriculture, Planning Commission, NCAER, IIFL Research
The bulk of the incremental expenditure by the central government, especially in FY09, is focussed on providing rural employment. The key scheme under this is the National Rural Employment Guarantee (NREGA) scheme.
1 PMGSY: Pradhan Mantri Gram Sadak Yojna (Prime Ministers Rural Roads Programme). 2 MDM: Mid-day Meal (government scheme to provide mid-day meal to school children, thus providing an incentive for parents to send their children to school). 3 SSA: Sarv Shiksha Abhiyan is a programme to ensure free and compulsory education to children aged 6-14 years. 4 PDS: Public Distribution System is a government scheme to provide heavily subsidised food grains to the poor.
Rural India
What is NREGA?
The National Rural Employment Guarantee Act (NREGA) gives every rural household a right to 100 days of guaranteed employment from the government. Figure 10: Afforestation work under NREGA
How is it different from a typical government welfare scheme? Demand-based, not allocation-based: Most government schemes are allocationbased, whereas NREGA is demand-based. People have a right to 100 days of employment per household, and allocation in the scheme has to be increased if higher demand for work comes through. Unemployment allowance to incentivise states to generate work: Unemployment allowance ensures that work is available, as states have to bear the entire unemployment allowance. All payments through bank accounts: Money to be paid directly into the workers accounts in banks or post offices. This will ensure that there is a clear trail of money. All documentsjob cards, muster rolls, etcare open for audit.
Key highlights All adult rural citizens are guaranteed 100 days work: NREGA is applicable to any adult member of a rural household, irrespective of his current income. The only requirement is that the person should be a local of the village (this includes those who may have migrated to work in cities). There is an entitlement of 100 persondays of employment per household. Household is the unit: A household means a nuclear familyfather, mother, children and any substantial dependents. Household could also mean a single-member family. Minimum wages, unemployment allowance, timely payment: Wages are to be paid as per the Minimum Wages Act in each state, but cannot be below Rs100 per day. Unemployment allowance has to be paid to those who qualify but cannot be provided work. Money must be paid to workers within one week, and not beyond 15 days in any case. Employment near place of stay: Employment to be provided within 5km of the workers village; if the work is farther beyond, an extra 10% to be paid. Minimum wage-to-material ratio prescribed: A 60:40 wage-to-material ratio has to be maintained in NREGA. Theoretical maximum annual spend on wages + material is US$350/HH: The maximum payout on wages is Rs100/day for 100 days per household per year. Additionally, a minimum 60:40 wages-to-material ratio has to be maintained. Hence, the total annual expenditure by the government can be US$350/HH, out of which US$215/HH can be in direct wages and the rest in material.
Funding for NREGA: Central and State government share The key cost elements for NREGA are wages for unskilled and skilled labour, material costs and unemployment allowance in case no work is allotted to people willing to work. Central government funding: 100% of unskilled labour; 75% of skilled labour; 75% of material; 0% of unemployment allowance. State government funding: 0% of unskilled labour; 25% of skilled labour; 25% of material; 100% of unemployment allowance.
How has the scheme fared? Phase I: NREGA was launched to cover 200 districts in FY07. An allocation of Rs112bn was made, and the expense was Rs88bn. Phase II: NREGA was expanded from 200 districts to 330 districts in FY08. An allocation of Rs120bn was made, and the expense was Rs159bn. Phase III: NREGA was rolled out to all 596 districts in FY09. Allocation was Rs160bn and expense was Rs272bn.
Figure 11: NREGA job cardabout 70% of all rural households have job cards
Rural India
Q&A with C P Joshi, Minister for Rural Development

rainfall, and large rivers, but lags in a big way in productivity, owing to poor irrigation and water harvesting infrastructure. This will significantly help improvement of agricultural productivity in future. Execution of NREGA has not been uniform. While states like Rajasthan have seen very good execution, others like Bihar are lagging behind. Yes, the execution has been very different across states. The 45m households that have been given employment under NREGA are predominantly from the states of Rajasthan, Madhya Pradesh, and Andhra Pradesh. Almost two thirds of the Rs400bn allocation for NREGA is being spent in just four or five states. Large states like Bihar, UP, West Bengal, Jharkhand and Orissa, which have the highest population of poor people in rural India, are lagging behind in NREGA. It is here that we need to really ramp up.
NREGA, which is arguably one of the largest employment benefits schemes worldwide, currently employs 45m householdsabout 30% of the rural households in Indiaat an estimated spend of ~US$8bn for FY10. Of these, only 14% of rural households have fully realised the promised benefits of 100 days of employment, a number which Dr C P Joshi, Minister for Rural Development, aims to raise to 4550% in the next few years. NREGA has been the most talked-about scheme of your government and has added to rural prosperity. Do you think the programme can be sustained for long in its current form? As of now, NREGA is largely augmenting incomes and purchasing power in rural India, but not adding significantly to productivity assets. However, to sustain NREGAs success, we have to focus on productivity gains. Also, people employed under NREGA today are largely illiterate and completely unskilled. We need to gradually upgrade these people to semi-skilled and then skilled to improve the nature of work. Also, we need to give employment to the educated youth in rural areas under NREGA. Hence, we are in the process of revamping NREGA to make it sustainable for the long term. How do you propose to improve NREGA in terms of productivity gains from the work? A large part of agricultural land in rural India is rainfed and not irrigated. This results in high dependence on monsoons, and we see a big impact on production when the monsoon fails, like it did this year. Earlier, NREGA did not include irrigation and water harvesting on private land as eligible for payouts under the scheme. We have now allowed work on private land of small and marginal farmers. The government is thinking of expanding the scope of NREGA to allow irrigation and water harvesting work on private land of large farmers as well. The overwhelming majority of agricultural land in India is held by large farmers. Thus, we can see large gains in irrigation and water harvesting in rural India through NREGA. For instance, take Bihar, which has very fertile land, good
Almost 2/3rd of the Rs400bn allocation for NREGA is being spent in 4-5 states. Large states like Bihar, UP, West Bengal, Jharkhand and Orrisa, which have the highest population of poor people in rural India, are lagging behind in NREGA.
So, what steps are being taken to improve NREGA in these large states? We are working on it. I am in discussion with the state governments on this matter. We have identified specific districts where we need to focus on first. I am hopeful that once we allow NREGA on private land of all farmers, more work will be available and hence employment under NREGA will improve in these states also.
Rural India
How do you propose to give work to educated youth under NREGA? We are planning a Rajiv Gandhi Seva Kendra in every village panchayat. These centres will have computers and Internet connectivity. We will be able to provide employment to educated youth in these centres to do various kinds of jobs on computers. How big can NREGA become in five years time? According to available data on NREGA, 70% of rural households have job cards, but only 45% have availed of any employment, and only 14% of these 45m have availed of the full 100 days of employment guaranteed under NREGA. Thus, we have a long way to go. As we discussed, large parts of North and East India are lagging in NREGA employment. I believe at least 45-50% of households should be able to avail the full 100 days employment under NREGA in a few years time compared to 14% now.
number of rural youth. Currently, Rs230bn on bank credit is made available to rural skilled manpower for starting their own work. However, this amount remains mostly unutilised, as there has been no major effort to impart vocational skills to rural youth. What about rural infrastructure? What are your plans to improve rural roads? My ministry is running the PMGSY (Pradhan Mantri Gram Sadak Yojna). Under this scheme, we are now connecting all villages with population of 500 or more with roads. We will soon connect all villages with population of 250 or more. We have allocated Rs500bn to this programme.
Currently, only 14% of those employed under NREGA have received 100 days employment; we want to increase this to 45-50% in the next few years.
You spoke of skill upgradation of the poor in rural India. How do you plan to achieve this? We are embarking on a major skill upgradation programme in rural India that will drive long-term productivity. Over 30% school students in rural India drop out of school before completing their 10th class exams. We are setting up institutes to train these students in specific vocational skills such as electrical repairs, plumbing, and carpentry. Today, every village has electrical borewells, electrical white goods, motorcycles and furniture, which need regular repair and maintenance. Thus, these trained youth will get employed in the rural areas itself. To begin with, each of the 621 districts is getting one such institute with central government funding. We will expand the number of institutes in future to cater to a very large What is your vision for rural India? I believe rural India will see a huge change in times to come. Our focus is on strengthening the grassroots. Almost a quarter million panchayats in India are struggling to meet basic needsdrinking water, roads, good schools, hospitals. The poor people in rural India have potential, but opportunities are limited. We are striving to give them opportunity, which should make them a lot more resourceful. I am very happy to see that a young leader like Rahul Gandhi has rural India as his topmost priority. Here is a young leader who is experiencing rural India himself and then looking for solutions. I am very hopeful that the positive change in rural India will continue for a long time.
Rural India
NREGA progressing at a brisk pace

NREGA spend by the government has grown at 75% annually during FY0709, and by 31% YoY in 1HFY10
Figure 12: Spending rising steadilyNREGA is a pet project of the government

9 8 7 6 5 4 3 2 1 0 2006-07 2007-08 2008-09 2009-10 (till Nov) 1.9 3.4 5.8 4.9 (US$ bn) 8.0
Figure 13: Wage payouts have risen by 11% annually over FY07-10ii
Actual w ages paid per person per day (Rs) 100 90 80 70 70 60 50 FY07 FY08 FY09 FY10ii (till Nov)
96 87 79
NREGA has focused substantially on remunerating unskilled labour70% of all payouts go towards these
Figure 14: Most of NREGA expense goes toward unskilled labourers wages
Break-up of NREGA expense Semi-skilled wages 2%
Un-skilled wages 70%
Raw materials 25%
Others 3%
10
Rural India Figure 15: Over 70% rural households have NREGA job cards
Households provided employment (LHS) 60 (m) 45 80% 60% 30 40% 15 20% 0% 2006-07 2007-08 2008-09 2009-10 (till Nov) % of rural HHs issued jobcards (RHS) 100%
Figure 16: there is still huge scope to increase days of employment per HH
Average no. of days per HH pa 120 100 80 60 40 20 0 2006-07
Guaranteed min no. of days per HH pa
43
42
48
2007-08
2008-09
Figure 17: So far, NREGA penetration has been highly uneven

State FY08 (US$ m) Rajasthan Andhra Pradesh Uttar Pradesh Tamil Nadu Madhya Pradesh Karnataka Bihar West Bengal Jharkhand Chhattisgarh Assam Gujarat Orissa Maharashtra Kerala Uttarakhand Punjab Haryana Others TOTAL 314.3 443.4 403.9 109.9 615.3 80.4 224.0 213.7 226.1 298.3 116.8 17.4 123.8 40.2 17.7 20.4 6.4 11.1 121.2 3,404.2 % YoY 113 206 143 241 55 -17 48 155 49 110 -7 -5 -21 8 199 97 20 46 151 77 FY09 (US$ m) 1,311.6 630.6 759.3 213.6 756.4 76.1 280.1 200.1 285.5 305.2 202.9 41.7 144.3 76.9 47.8 28.9 15.4 23.4 398.2 5,798.0 % YoY 317 42 88 94 23 -5 25 -6 26 2 74 139 17 91 169 42 141 110 229 70 Apr-Oct 2009 % YoY (US$ m) (over Apr-Oct) 867.1 16 565.3 504.6 250.9 234.1 226.2 198.4 176.5 175.4 156.6 107.3 73.7 66.5 46.5 30.0 27.9 13.0 11.2 251.2 3,982.2 41 76 75 -48 706 31 86 11 -18 20 307 12 -1 87 201 259 25 83 31 30 % of rural households receiving employment under NREGA 68 40 13 36 23 24 18 24 24 26 28 16 9 4 9 22 4 3
Source: Govt of India, NREGA Website; IIFL Research. *Penetration is defined as the % of rural HHs employed under NREGA.
11
Rural India
NREGA: field visits reveal challenges as well as upsides

NREGA seems responsible for 25% jump in labour rates: NREGA is perceived to have caused a ~25% rise in labour rates YoY across the board in every state we visited. This is despite the payout under NREGA usually being at least 1015% less than the stipulated Rs100/day/ HH. Apart from leakages, the reasons also include payouts being prescribed as a function of work accomplished, and sub-optimal deployment of labour in such work. NREGA activity slows down during the busy monsoon months as farm activity picks up; nevertheless, various farmers associations have made representations to the government to restrict NREGA activity during the harvesting window, to help keep labour rates under control. Improvements possible in awareness, implementation: Seventy-three percent of rural households (HHs) in India have NREGA job cards; but of these, only 45% are receiving employment under the programme. Awareness levels are abysmal in the poorest states, Uttar Pradesh (UP) and Bihar. For instance, in UP, we found that only BPL families are considered eligible for NREGA, whereas the Act allows all rural families to participate. Also, people are not aware that they are entitled to 100 days of employment, though they know about the scheme in general. Most people are also unaware that there is an unemployment allowance if employment is not provided. Next, awareness of what qualifies as NREGA work is poor and inconsistent, both on the part of rural poor, as well as government officials administering the scheme. Finally, farmers are generally unaware that routine agricultural work can be classified under NREGA and the farmer and farm labourers can get additional compensation for little additional work. Figure 18: Efforts for increasing awareness in Rajasthan have yielded handsome results NREGA likely to have a skill-building orientation in future: In most villages we visited, the BDOs (Block Development Officers) waxed eloquent about NREGA. But villagers often derisively described NREGA work as digging up earth and filling it back up. NREGA does not seem to be creating relevant assets (roads, bridges, etc), as by definition, activities managed by contractors are given lowest priority under NREGA (for curbing leakages). One result of this is that skilled labour is largely absent in NREGA work. In our meetings with government officials, we understood that this is being actively considered by the government and is likely to be among the changes to NREGA in FY11. Significant rural income upsides possible, provided the right hands steer the wheel: In our analysis, NREGA can potentially increase rural households income by 2025%. The key factor in the process is the local Development Officer. Whether the DO is enthusiastic, apathetic or corrupt, determines whether NREGA is successful, sluggish, or full of leaks. Government officials we spoke to were fully aware of leakages. In Rajasthan and Karnataka, anecdotal evidence pointed to 20%, but in Bihar, a very formal leakage mechanism has been instituted, yielding 40%. The more zealous among the DOs were of the opinion that a measured approach to plugging leakages would be appropriate than a crackdown. An example is the current stipulation that workers be paid by cheque, not cash. Well-intended as this condition is, it has made the payment cycle longer. Gradually, the government may permit contractors to participate in NREGA work while ensuring that leakages dont get out of hand. This will raise the skill levels in the programme. NREGA a far bigger success than PDS (Public Distribution system): That NREGA has been spectacularly successful becomes evident when one looks at the Public Distribution System (PDS). PDS seeks to ensure availability of essential commodities like wheat, rice, sugar and kerosene to the poorest in the society (BPL families) at affordable prices. India has persisted with the scheme for over 50 years, and PDS perhaps occupies pole position in terms of wastageonly an estimated 27% of the US$11bn in food subsidies reaches the intended beneficiaries. In the states we visited, especially Uttar Pradesh, BPL was a coveted status, especially as it would bring PDS benefits in its wake. The truly poor people were bitter and cynical about whether PDS would ever bring them any succour.
12
Rural India
The NREGA goose can lay a few more golden eggs

We estimate that NREGA spend will increase by ~2.5x in the next three years to US$21bn. Our estimate is based on the following factors. 1) Significant headroom left in penetration and per-day payout
There is significant scope to ramp up the scheme, through an increase in awareness, penetration growth, and rise in share of households deriving 100% benefits
Current payout is US$50 per employed HH, 1/7th of permitted maximum: Average income accruing from NREGA is currently US$50 annually per rural household, as against the governments target of US$350 per household (including spend on labour and material). This gap is due to: a) low penetration (only ~30% of rural households receive employment under NREGA); b) low payout per day (Rs87/day vs the stipulated Rs100/day); and c) fewer days of employment (48 days per annum vs the stipulated 100 days). Only 14% of households getting employment under NREGA were provided 100 days of employment: Firstly, NREGA has reached only ~30% of the rural population in India (45m HHs out of 152m rural HHs were employed under the scheme). Within these, only 6.5m households (14% of those who were employed under NREGA) were provided the stipulated 100 days employment in FY09. Thus, annual days of employment per employed HH averaged just 48, vs the stipulated 100 days. As such, there is considerable potential for improvement, through an increase in penetration (3x from current levels) and number of days of employment (2x from current levels). Average payout per day was Rs87, against the mandated Rs100: The total wage payout for FY09 was US$4bn, which translates to a per-day wage payout of Rs87/day vs the stipulated Rs100 per day. Upsides here are unlikely to be huge, since the payout relates to work done, and the work groups are usually overstaffed, thus reducing the per-capita payout. That said, we reckon that the current per-day payout of Rs87 will climb at least to match inflation. 2) Government focus on laggard states will increase NREGA spending The governments commitment to the scheme is already evident, as states that have been laggards during the initial phases of the schemes rollout have witnessed significant acceleration in their rollout plan during the past year.
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Rural India Figure 19: In FY10, states that lagged in NREGA penetration have led growth
180.0 FY09 spend per HH (US$ m) Leader states 120.0 600% 400% 60.0 Leader states Laggard states 200% 0% 800% Apr 09 - Oct 09 YoY grow th Laggard states
Jharkhand
Karnataka
Andhra Pradesh
Rajasthan
Gujarat
Punjab
Jharkhand
Karnataka
Andhra Pradesh
Rajasthan
Source: NREGA Website; IIFL Research
Poor level of awareness and interpretation in the laggard states likely to be ironed out by the government over time, resulting in spending increase on NREGA
During our visits, we found several instances of subjectivity in the interpretation of NREGA guidelines by administrative officers. For instance, in DK district of Karnataka, we were told that NREGA benefits are available to all rural families, and that NREGA support can be used to back regular agricultural development activity such as water harvesting. On the contrary, in Uttar Pradesh, we were told that NREGA is only for BPL (below poverty line) families, and that tractors cannot be used in NREGA work. Such arbitrary and inconsistent interpretations of the schemes scope are more prevalent in NREGA laggard states, and are likely to be acted upon by the government. 3) Expanding NREGA beyond small farmerscreating longterm irrigation assets: We believe NREGA has the potential to create farm assets of greater relevance such as tanks, reservoirs and water-harvesting facilities assets that will promote irrigation and reduce dependence on monsoons and hence curb volatility. Currently, the scheme is limited mainly to small farmers. We understand from conversations with agriculturists that only one third of the total land under cultivation in India is owned by small farmers. Once NREGA-backed facility upgradation begins to include larger farmers too (with suitable design amendments to ensure that the gains reach the needy poor), the farm sectors exposure to the volatility of monsoons could be tempered. The government is thinking precisely on these lines (see interview of Dr C P Joshi, Minister for Rural Development). Hence, the scheme will likely expand rapidly to increase its practical utility and progress beyond the Keynesian circumference of digging up roads and filling them back in, which is the instant recall villagers often have when asked about NREGA work. 4) Emphasising skill-building for labourers, implying that the average payout per day can rise: Currently, the programme de-prioritises contracted work to minimise leakages; this, we suspect, keeps high-skilled labour away from NREGA. As per the Ministry of Labour and Employment, of the 12.8m annual addition to Indias labour pool of ~410m, only 3.1m are skilled, presenting NREGA with a huge opportunity to influence skill-building. The government is likely to change the design of the programme suitably (this also finds mention in the policy document of the Ministry of Labour).
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Both rural development and labour ministries are emphasising the convergence between NREGA and skill building
Gujarat
Punjab
Rural India
NREGA spend will reach US$21bn by FY13

Increase in penetration: We assume an increase in NREGA penetration from the current 45m families to 79m families. This is based on the reasoning that the government will bring down the vast gap in penetration between Rajasthan (76% of rural HHs) and the remaining states. Indeed, from our conversation with Dr Joshi, we learn that he is aiming for precisely thisto establish greater uniformity in NREGA benefits for different states. Currently, the rest of the country is languishing at 26%, and we assume this will rise to 50%, thus reaching 79m HHs including Rajasthan. Increase in amount of work days per household: In FY09, NREGA work averaged just 48 days per HH, as against the stipulated 100 days per year per HH. Only 6.5m HHs (14% of those employed under NREGA) got the full 100 days of employment, a proportion that Dr Joshi aims to raise to 45-50%. Our assumptions are in line with Dr Joshis target; as such, we estimate average days of employment per HH will increase to 66. Increase in payout per day @10% annually: Finally, assuming an annual increase of 10% between FY09 and FY13, per-day compensation (inclusive of spend on material) will rise from Rs127 in FY09 to Rs186 by FY13. We reckon that 10% YoY growth is achievable, given that actual wage payout grew at 11.6% annually during FY07-09. To summarise, our assumptions for FY13 are: increase in HHs getting employment from 45m to 79m; increase in proportion of employed HHs getting the full 100 days to 50% from the current; and inclusive of materials, increase in daily payout @10% pa.
NREGA spend will increase 2.5x between FY10 and FY13 driven by accelerated penetration and a 10% annual rise in payout rate
Figure 20: Assuming 50% of HHs get full employment, and wages rise in line with inflation, NREGA spend should reach US$21bn in FY13
Item HHs (m) Days per HH Number of days (m) Daily payout inclusive of material cost (Rs) Aggregate spend (US$ m)
Source: IIFL Research; US$/INR = 47.0 for both years.
FY09A 45 48 2,147 127 5,798
FY13ii 79 66 5,250 186 20,758
Thus, we see that NREGA spend can increase by US$13bn over estimated FY10 levels to US$21bn.
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Rural India
Unique ID: inclusive growth must start with identity

Nandan Nilekani left Infosys, a company he cofounded, to give an identity to every Indian, literally. As Chairman of the Unique Identification Authority of India (UIDAI)which aims to provide a unique identification number for all residents of Indiahe holds the status of a Cabinet minister. Excerpts of a chat with Nandan: What is the biggest challenge in this? The most obvious one is the technology build-up. Nowhere in the world is there a database of over a billion with bio-metrics. The largest bio-metric database is maybe ~120 million. This is 10x of anything else in the world. Moreover, we are providing online authentication, which is not done anywhere else. This will be cutting-edge technology. But more than size, the challenge is in eliminating duplicate numbers. There is no established database in the country that can serve the purpose of a unique ID. Then parallel processing capabilitylet us assume that a few years from now, there are 400 million records in this UID system. Every new entryand there will be millionshas to be compared with all the 400 million records, a massive task. Nextcoordination and logistics. Within the next few years, one billion people, including children, have to come to some enrolment point and give their fingerprints, face picture and possibly an iris scan. Can you explain the strategic significance of this project from a rural inclusion perspective? In our society, a small minority have benefited from economic reforms because they have had access to certain fundamental needs, like health, education, infrastructure, water, and jobs. But the majority does not have that access. A stable society cannot be created with such unequal access. Giving an identity is a significant part of that access. Of course, you need good roads, food and health centres, but giving access is crucially important. When everybody gets a unique number, access to such fundamental needs will improve. For instance, this number would facilitate the opening of bank accounts or telephone connections, by helping in customer verification. Customers have to fill the know your customer (KYC) form. We can help in reducing the KYC cost. Our aim is to enable authentication based on fingerprints within five seconds. How would the Unique Identity numbers be assigned? Everybody gets a random number. Mostly, the numbers would be 16-digit (12 plus 4) Once a person has a UID number, their basic identity linked to their biometrics is established. We are only going to store your name, date of birth, sex, address, photo, fingerprints, your UID number and maybe one or two details. You will continue to have all your existing documents such as PAN card. Additionally, you will have this UID number, which will be common across the board, including your PAN card, passport, and ration card. Lastly, this touches every government department, every central ministry, state governments, panchayats, and every municipality. A few hundred government agencies must play by one set of rules. These are massive challenges. In terms of time schedule what is the plan? We aim to issue the first set of numbers in 12-18 months. How have you staffed this project? I have got very good response from around the world. We are creating a very unique organisation, which is partly staffed by people from the system, like IAS officers. Then we have a whole set of teams who have come from outside, like people in technology, law, marketing, and civil service. We have to blend these two groups together. If the government changes will the project continue? The UID initiative has got widespread support. I have met chief ministers from the non-Congress parties who have requested me to do the needful right now. UID is improving the quality of public spending and giving benefits to the poor. Why would anyone oppose it?
In our view, efficacy of all government spend in the rural sector will improve, as the UID programme enables true inclusive growth and reduces leakages.
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Rural India
PDS: an instructive study in contrast

With over 70% wastage, the Public Distribution System has not quite delivered
That NREGA has been spectacularly successful is evident from a comparison with the Public Distribution System (PDS). PDS seeks to ensure availability of essential commodities like wheat, rice, sugar, and kerosene to the poorest in the society (BPL families) at affordable prices and is supported by a network of around half a million fair price shops (FPS), which reaches more than 160m households in India, supposedly the largest distribution network of its kind in the world5. India has persisted with the scheme for over 50 years, despite the fact that the scheme perhaps occupies pole position in terms of wastageonly an estimated 27% of the US$9.2bn in food subsidies reaches the intended beneficiaries.
Distribution a joint centre-state responsibility: PDS is operated under the joint responsibility of the central and the state governments. The central government, through FCI (Food Corporation of India), has assumed the responsibility for procurement, storage, transportation, and bulk allocation of food grains to the State governments. Other than FCI, the central government has also entrusted the responsibility of foodgrain procurement to 11 states, which procure on behalf of the central government. The operational responsibility, including allocation within a state, identification of families below the poverty line, issue of ration cards, and supervision of the functioning of Fair Price Shops (FPS), rests with the state governments.
PDS suffers from wastage of an estimated 73%, owing to poor supply chain (36%), diversion (22%), and other inefficiencies (15%): Benefits of PDS have not translated into the desired results. A recent study (2005) conducted by Planning Commission of India highlights the shortcomings of the PDS programme. The study reveals that:
A poorly designed system of checks and balances has left the system susceptible to widespread fraud
about 58% of the subsidised food grains released from the Centres pool do not reach the intended BPL families, largely because of corruption; of the above 58%, around 36% of the total food-grains released are lost because of leakages in the supply chain and another 22% is lost because of diversion to non-BPL category (APL); and inefficiencies in cost and other aspects of the PDS result in only 27 paise of every rupee spent by the government reaching the poor.
In our visits to rural India, especially in Bihar and Uttar Pradesh, we noticed that PDS had resulted in the BPL card becoming a coveted prize, the lure being the PDS benefits to which BPL families are entitled.
5 Arvind Virmani and P V Rajeev (2001-02) in a discussion paper Excess Food Stocks, PDS and Procurement Policy
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Rural India Figure 21: Despite wastages, food security schemes spend has been on the rise
1.2% Food Subsidy as % GDP
Despite such blatant misuse, government spend under the scheme has continued to grow
1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 1980 1985 1990 1995 2000 2005 2010
Source: Government of India budget documents; IIFL Research
Figure 22: States with >50% leakagesBihar occupies pole position, again
State Off - take by states 2003-04 (Kg/BPL family/p.a) 138.1 364.2 480.8 285.2 Off - take by Food grains not identified BPL reaching the poor Families (Kg/BPL households family/p.a) (Kg/BPL family/p.a) 12.2 125.9 38.3 139.9 92.7 326.0 340.9 192.4 % Reaching
Bihar Punjab Karnataka UP All India Average
8.9% 10.5% 29.1% 32.5% 27.0%
Source: Planning Commission (Government of India), IIFL Research
Specifically, in Biharwithout doubt the state with the highest levels of wastage and corruptionleakages under PDS are 91.1%, whereas the most pessimistic estimates of NREGA leakages stood at 40%.
Figure 23: Rural families queue up to receive their quota of subsidised food
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Rural India
Rural education: a major focus area

The major schemes are: (a) Sarva Shiksha Abhiyan (SSA; Education for all) and (b) Mid-day Meal Scheme, which is designed to provide free midday meals to children studying in government schools. These two schemes have a budgetary outlay of US$2.8bn and US$1.7bn respectively for FY10. SSAfree education to almost 200m children: Launched in 2002, SSA is the governments main programme to make free and compulsory education for children in the 614 age group a fundamental right. It aims to cover almost 200m children, by setting up new schools and strengthening existing ones, as well as ensuring adequate and properly trained teaching faculty. SSA provides for free text books for backward classes, besides emphasising computer education. SSA has achieved creation of more than 185,000 new schools, 700,000 new classrooms, annual training to almost 4m teachersno mean feat. Furthermore, it has achieved school enrolment level of 96% of eligible students in the target age group, and 81% of primary students move to upper-primary grades. But a lot still remains to be done 46% of students drop out because of financial or other difficulties before grade VIII. About 35% of schools have a pupil-teacher ratio of more than 40:1which means less than two teachers per section in primary schools or less than one teacher per section in upper primary schools. Only 17% of all schools (including almost 1m government schools) have computers.
185,000 schools set up (total government schools number 0.95m) since 2002, but only 17% have computers
Figure 24: Achievements of the SSA include free text books to 66m children
Item Cumulative targets including 2007-08 275,585 1.134 216,237 812,738 18.567 69.1 Achievement (up to 30 September 2007) 186,985 0.81 170,320 713,179 8.828 66.4 % cumulative achievement 77.8% 71.4% 78.8% 87.8% 44.3% 96.1%
Opening of new schools Teachers appointed (m) Construction of school buildings Construction of additional classrooms Enrolment in EGS/AIE* centres (m) No. of children receiving free textbooks (m) Functional academic resource centres: Block level Cluster level
6,413 71,381
6,385 68,137
99.9% 95%
Source: Government of India, IIFL Research. * Education Guarantee Scheme / Alternate and Innovative Education
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Rural India
Mid-day Meal Scheme reaches out to 120m children: Launched in 1995, the programme aims to provide daily meals to children. It covers all children studying in government, local body and government-aided primary and upper primary schools and the Employment Guarantee schemes/Alternative and Innovative Employment Education centres of all areas across the country. Nutritional standards of mid-day meals at upper primary stage have been fixed at a minimum of 700 calories and 20 grams of protein, through 150 grams of food grains (rice/wheat) per child per school day. The programme is projected to benefit almost 120m children in 0.95m government-run and government-aided schools.
Children in Hardoi, UPpoorly ventilated classrooms not a problem
Free meals not the only reason for attendance going up: In the states we visited, we got a mixed picture of the success of this scheme. In a few villages in Bihar, we were given to understand that the only reason for poor families sending children to school was to avail of the mid-day meal, and that thinly stretched teachers were so preoccupied with preparation of safe meals that they could scarcely do justice to their main job of teaching. In an equally backward area of Uttar Pradesh, on the other hand, we saw children exhibiting remarkable interest, studying under trees to escape a hot sun and poorly ventilated classrooms. There was evidence on the ground in several states we visited that the government is investing purposefully in rural literacy.
Source: IIFL Primary Research
Road connectivity: the backbone

PMGSY: Pradhan Mantri Gram Sadak Yojana (Prime Ministers Rural Roads Programme) improving connectivity of rural habitations providing alternative work for landless labourers
To address the problem of rural road connectivity, the government launched the PMGSY in December 2000. The key objective was to provide connectivity through good all-weather roads to all unconnected habitations with population of more than 500 persons. The programme was divided into two phases, with the first phase connecting habitations with population of 1,000 and above, and the second phase connecting those with population of 500-1,000. Direct evidence of road construction and completion on the lives of villagers
The roads programme has led to an increase in wages of non-farm labourers and ensured better farm realisations
Landless labourers earned substantially higher per-day wages in road-building work (at times up to Rs400/day) than farm wages (average wage of Rs100/day) Small farmers were able to sell cash crops (potatoes and other vegetables) directly into nearby markets, thanks to improved road connectivity. This improved yield on their land, coupled with elimination of middlemen, has in effect more than doubled the effective sale price. Large farmers deployed their tractors in road-building (payback period for tractor loans only from road-building use was five years) Cumulatively, 56% of the sanctioned funds of ~US$20bn have been used.
20
Rural India
We estimate that ~17% of Indias rural population (rural population forms 73% of total population) remains unconnected, a proportion down from 25% as of 2000. Along with connectivity, the quality of roads has improved, thanks to extensive upgradation.
% population connected 35.0% 39.3% 52.5% 56.9% 67.7% 70.9% 75.4% 78.1% 82.0% 94.7% 94.7% 97.6% 97.7% 98.6% 99.0% 99.7% 99.8% 76.5% % habitations connected 37.0% 41.2% 42.6% 33.2% 53.2% 51.2% 47.4% 66.6% 79.0% 84.9% 91.2% 89.6% 98.5% 96.5% 94.8% 99.9% 99.6% 69.2%
Figure 25: PMGSY programme is attempting to even the disparities out

State Assam West Bengal MP Bihar Jharkhand Orissa Chattisgarh UP Rajasthan Gujarat Kerala Maharashtra Tamil Nadu Punjab AP Karnataka Haryana All India
Figure 26: Progress on PMGSYwe are on the road
but by no means at the end of it
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Rural India
Rural Electrification: power to the masses

RGGVY (Rajiv Gandhi Grameen Vidyutikaran Yojana Rural Electrification Mission)
Over 9.5 million households have been electrified since 2006
Based on 2001 Census, 78m of 134m HHs in India then had no electricity. Under the Rural Electrification programme started in 2006, the government is spending US$1bn per year to provide electricity to 3m rural HHs per year. So far, 9.4m HHs have been provided with electricity under this programme. Rural Electrification (RE) is viewed to be critical for accelerating rural development. Provision of electricity is essential to cater to the requirements of agriculture and other important activities, including small and medium industries, khadi and village industries, cold chains, health care, education, and information technology. The RGGVY Policy aims at: provision of access to electricity to all households by year 2009; high-quality and reliable power supply at reasonable rates; and minimum lifeline consumption of one unit per household per day as a merit good by year 2012.
Rural Electrification Corporation Limited (RECL IN), a PSU, is the nodal agency, facilitating loan financing as well as coordinating with state governments and state utilities. The Ministry of Power defines an electrified village as one that has: a) basic infrastructure such as distribution transformer and distribution lines in the inhabited locality as well as a minimum of one dalit basti/hamlet where it exists; electricity available in schools, panchayat office, health centres, dispensaries, community centres, etc; at least 10% of the total number of households in the village with electricity.
b) c)
Figure 27: Majority of the HHs in rural India remain unelectrified

Item A B C D E F G H Total villages in India per 2001 Census Un-Electrified villages per 2001 Census Total rural HHs per 2001 Census (m) Unelectrified HHs per 2001 Census (m) Cumulative HHs electrified in scheme as of March 2009 Targeted HHs to be electrified in 2009-10 Cumulative funding by Govt (US$ bn) FY10 budgeted estimates (US$ bn) Amt 638,000 119,750 134 78 9.4 3.0 3.6 1.0
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Rural India
All taken, government to increase rural spend by US$23bn from FY10 to FY13
US$13bn increase in FY1013 period plus a non-NREGA government spend increasing at 15% annually
We assume that non-NREGA rural spend will grow from US$20bn in FY10 to US$30bn in FY13 (15% CAGR). This is much lower than the four-year CAGR of ~30% over FY05-09. Together with the additional spend of ~US$13bn on NREGA, the cumulative increment in government spending in the rural economy would amount to US$23bn by FY13.
Figure 28: Incremental rural-focussed government spending between FY10 and FY13 should be US$23bn
(all figures in US$ bn) NREGA Other Rural (@ 15% CAGR) Total FY10ii 7.3 19.6 26.9 FY13ii 20.8 29.8 50.5 Incremental w.r.t FY10 13.5 10.2 23.6
which should translate to US$19bn consumption boost

Rural savings rate assumed at 20%, compared to national average of 30% of personal income
Personal income in India has averaged ~80% of GDP over the past four years (FY05-08), while household savings have averaged ~24% of GDP over the same period. This translates into a household savings rate of ~30% of personal income, implying that on average, for Rs100 of income, individuals and households end up spending (consumption) Rs70 and saving Rs30. The NSSO surveys clearly state that estimating rural savings rate is difficult; in the absence of hard data, we assume conservatively that rural savings will at least be 20%, lower than the average savings rate, and hence the total consumption spend from the above US$23bn would be ~US$19bn. Note that this does not include ripple effects of other schemes such as rural electrification, which can have a significant consumptionboosting impact.
Will this hurt the fisc?

Focus on disinvestment and lower spend on other government schemes should keep Indias finances intact for FY11
With government finances under considerable stress, it is natural to be sceptical about prospects of substantial increases in government spending. An increase of US$23bn over three years would amount to ~0.7% of GDP annually. In our view, the current government is likely to manage the fiscal deficit targets for FY11 along with this increased spending on the key rural schemes. Some of the large items that can contribute to the reduction in fiscal deficit for FY11 are as follows. 1. FY11 would not have large expenditures such as farm loan waiver and Pay Commission arrears: The FY11 budget would be free of some large expenditure items, among them farm loan waiver and VI Pay Commission arrears. The government expenditure would be lower by ~Rs300bn on this count, cutting the deficit by 0.5% of GDP. 2. Revenue buoyancy from indirect tax rate increases: The cut in indirect tax rates introduced in the budget for 2008, as part of the fiscal stimulus package, is likely to see a partial rollback. We estimate this would improve revenues by Rs300bn and bring down fiscal deficit by ~0.5% of GDP.
23
Rural India
3. Increased disinvestment proceeds: Increased visibility on disinvestment as a revenue source will further reduce the strain on government finances. We estimate the central government could raise ~0.4% of GDP by way of revenue from disinvestment annually over the next 2-3 years. 4. 3G auctions likely to add to government receipts: The government is likely to net Rs300bn from 3G auctions, which would be knock off deficit to the extent of ~0.5% of GDP. 5. Corporate tax collections likely to rise: With most companies seeing a strong pick-up in business, the government would see a good pick-up in corporate tax collections. All things considered, the government should comfortably be able to maintain the rural spending momentum.
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Rural India
Farm incomes: lower volatility, better prices

Inclusive growth is gathering steam. Growth in rural incomes has not only become more resilient, but also accelerated, driven by: a) increase in mechanisation in farms; b) improvement in power availability, which has increased utilisation levels of the irrigation infrastructure; and c) enhancement of rural infrastructure, mainly roads, which has supported 1.7% annual growth in yields over FY04-09up from 1.4% annually during FY1999-2004. The change in regulations to allow direct sale of farm produce has reduced the share of intermediaries. Additionally, the governments thrust on ensuring remunerative prices for farmers has led to an unprecedented increase in prices of soft commodities (8.7% CAGR for foodgrains during the UPA governments tenure vs 5.2% CAGR during the previous five years). Further, NREGA will drive: a) greater mechanisation owing to labour price increase; and b) an increase in irrigation levels, especially on private lands. Improved power availability will further reduce monsoonrelated volatility.
Structural drivers afoot

Rise in farm incomes and greater affordability has increased affordability of mechanised farm equipment
Yield increase driven by greater mechanisation Whereas the Green Revolution of the 1970s drove yield increases mainly through improvement in the quality of seeds and nutrients, the years since 2005 have witnessed a spurt in mechanisation in farming. After languishing for more than a decade, tractor volume growth picked up from 3.4% annually during 1995-05 to 10% annually during 2005-10. The rise in farm incomes during this period (supported by prices) and a steady spell of monsoons increased the affordability of high-value farm equipment (the price of an entrylevel tractor is roughly equal to about two years of revenues, or 5-7 years savings for small farmers).
Figure 29: Tractor penetration increased 12x since the Green Revolution
12 Tractor/'000' ha 10 8 6 4 2 0 1972-73 1980-81 1990-91 2000-01 2006-07
Source: Mahindra & Mahindra, IIFL Research
25
Rural India Figure 30: Farm output growth accelerated since 2001; yield growth steady
6% Yield grow th CAGR 5% 4% 3% 2% 1% 0% 1981-86 -1%
Source: Department of Agriculture, IIFL Research
Acreage grow th CAGR
1986-91
1991-96
1996-2001
2001-08
Irrigation penetration has witnessed a massive rampup in recent years
Momentum for irrigation penetration has more tailwinds Although Indian agriculture remains highly dependent on seasonal rainfall (monsoon), focus on improving agriculture infrastructure including irrigation and warehousing, has increased significantly during the tenure of the UPA government. Whereas it took over 30 years to bring 15% of the cropland under the irrigation infrastructure (1985-2000), and the next 5% has taken less than seven years.
Figure 31: Less than 50% of crop land in India is irrigated
45 (%) 40 35 30 25 20 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Net irrigated land
The XI Five-Year Plans target is to bring 16m ha under irrigation (including major, medium and minor irrigation works), a significant acceleration from less than 10m ha targeted to be added during each of the prior three Plan periods. This will also be the highest increase in irrigation potential since the VII Plan Period, when ~11m ha was brought under irrigation.
26
Rural India Figure 32: The XI Plan targets adding 2x the area under irrigation vs prior Plans
20 Incremental area under irrigation across plans (mn ha) 16 12 8 4 0 I II III IV V VI VII VIII IX X XI
Source: Planning Commission, IIFL Research
Given NREGAs focus on irrigation, we expect a further catalyst to increase the penetration of irrigation over the next few years
NREGA is also likely to act as a tailwind to the increase in irrigation infrastructure, as the scheme plans to encompass activities such as irrigation infrastructure creation on private lands (as against the Five Year Plan targets of creation of canals/reservoirs on public property). Even under the existing scheme, irrigation has remained a major focus area (accounting for >60% of all activities undertaken under NREGA).
Figure 33: Irrigation, which is a focus under NREGA, will gain momentum
Rural connectivity 100 80 60 40 20 0 2006-07
Irrigation & w ater conservation
Land development & others
(% share of spending under NREGA)
2007-08
2008-09
Pricing growth to offset volume weakness in farm income In addition to the UPA governments thrust on increasing spending on rural employment and infrastructure development, the focus on increasing farm income also ranks high in the governments priorities. As compared to the 5.2% annualised growth during FY972003 in food-grain MSP, prices have been raised at 8.7% annually during 2003-2009. Other categories including oilseeds and pulses have also witnessed 2-3ppts increases in growth during the past five years.
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Rural India Figure 34: MSP hikes in all major soft commodities have accelerated by 2-3ppts
12.0% 1997-2003 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Foodgrains Oilseeds Pulses 2003-09
Figure 35: Market prices of grains and oilseeds have risen by 50-100% in five yrs
Political compulsions and the need to maintain acreage for food grains are strong reasons for expecting MSP to continue increasing
225 (Rebased to 100 at Nov 04) 200 175 150 125 100 75 Nov-04 Soyabean (yellow ) Sugar Rice (lr-8) Wheat (Dara)
Jul-05
Mar-06
Nov-06
Jul-07
Mar-08
Nov-08
Aug-09
Figure 36: Market prices of commercial crops have rallied by >50% in just a year
200 180 160 140 120 100 80 60 40 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Jan-09 Aug-09
Rebased to 100 (Aug 2004)
Sugar
Cotton
Minimum support price (MSP) for key crops has become a politically sensitive issue in India. Given that the UPA government enjoyed the rich political dividends of MSP hikes (being voted back to power with a wide margin), we believe that political reasons will continue to drive an elevated level of pricing growth (through MSP hikes) during the next four years (ie, the remaining term of the current government).
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Rural India
Few cost heads have spiked in recent yearsexcept labour and powerso farms profitability has seen a steady increase
Costs increase lower than price rise, thanks to subsidy Farmers key cost heads are seeds, fertilisers, agro-chemicals, labour, power and transportation costs. Farm costs have remained mostly stable, excluding labour and power, owing mainly to government intervention in the form of subsidies. Labour prices have seen a significant increase: Labour cost (which account for 30-40% of costs) has witnessed an increase in most stateslabour-deficient states such as Punjab and Haryana have witnessed a very high (20-30% YoY) spike in costs. NREGA has resulted in an overall increase in labour wage rates across the country. We believe that cost increases on account of labour wages (driven by NREGA) will continue to be a headwind, as NREGA ramps up further. Fertiliser prices largely stable for the past five years: Spend on fertilisers, which is the second-largest cost head (1020% of total costs) are fully supported by subsidies, and cost to farmers has remained stable in the last five years (up a modest 3-5% YoY). We expect these costs to see similar low growth rates going ahead. Seeds have seen no major price increases: Seeds, which account for ~10% of farmers total costs, are not directly supported by government intervention. However, most farmers in India depend on seeds developed and distributed by the state agricultural universities. The private sectors share of farmers seed usage is low (except in cotton, in which GM seeds are allowed). Hence, seed costs have remained stable, as these costs are indirectly subsidised through government support to state agricultural universities. Agrochemicals prices declined in 2009, in line with global prices: Agrochemicals (which account for 5-15% of farmers total costs), unlike fertilisers, are not covered by government subsidies. Prices of these are fully linked to global chemical prices. Farmers have benefited from a steep decline in agrochemical costs during 2009, since international prices of chemicals have corrected by 40-90% YoY. Power costs increased during FY09 as power deficiency in some states forced high usage of diesel for pump sets: The usage of power in farming increases significantly when monsoons fail, as there is need to pump ground water for irrigation. However, power-related costs will remain a more sporadic influence on inflation, depending on the monsoons. Barring such a deficiency in rainfall, we do not foresee any material cost pressure on account of power in most parts of the country. Power supply, a critical input, should improve further Availability of power has picked up somewhat during the past couple of years, and we estimate it will see a significant ramp-up in capacity by 2012. Our energy analyst estimates that 45,000MW of additional generation can happen by then, and a further 100,000MW by 2017. Availability of power will remain a key trigger for increasing yields as well as acreage.
29
Rural India Figure 37: Power capacity to register at 8% annually

220 (GW) 200 180 163 160 143 140 120 100 FY08 FY09 FY10 FY11 FY12 FY13
Source: Government documents, IIFL Research
211 Pow er capacity 186 198
148
Power availability insulates farmers from impact of poor monsoons, by enabling easy usage of ground water
Why is power critical in farming? Historically, Indian farmers have suffered from power deficiency. Less than 50% of Indias population gets electricity. In this population, power supply deficit is 12.6%, according to the Central Electricity Authority. Indian farmers are eligible for free power (on paper), though with such a steep power deficit, they are typically last on the priority list. In our visits, we found that in Punjab and Haryana, power is available for almost eight hours per day, with the result that farmers were better insulated against bad monsoons. On the contrary in Bihar (8% of Indias population but 1.5% of the power supply), we found that small farmers are a sorry lot. For an average realisation of ~Rs7,000/acre, farmers would normally need to invest ~Rs5,000 per acre on seeds, fertilisers and labour, thus managing a surplus of Rs2,000/acre. However, inability to access power has resulted in an additional cost of Rs5,000/acre for using diesel to pump water from borewells, converting the surplus into a deficit of Rs3,000/acre.
Figure 38: Though power deficit is high in states strong in agriculture, some of them (mainly Punjab, Tamil Nadu) have made agriculture a priority sector for power
Power supply / demand for Apr-Oct 2009 Haryana Punjab Rajasthan Uttar Pradesh Gujarat Madhya Pradesh Maharashtra Andhra Pradesh Karnataka Kerala Tamil Nadu Bihar West Bengal Others All India
Source: Central Electricity Authority, IIFL Research
Demand ( MW ) 6,133 9,786 6,487 10,856 10,406 6,766 18,981 11,325 7,196 3,045 10,158 2,249 5,381 7,512 116,281
Supply ( MW ) 5,678 7,407 5,500 8,563 9,515 5,970 14,292 10,294 6,352 2,852 9,675 1,495 5,349 8,667 101,609
Deficit % 7.4% 24.3% 15.2% 21.1% 8.6% 11.8% 24.7% 9.1% 11.7% 6.3% 4.8% 33.5% 0.6% -15.4% 12.6%
30
Rural India
Cold storageswe need a lot more
Cold storages are primarily used to store fruits and vegetables, meat and marine products, floriculture, etc. The business model of cold storage owners is based on charging rentals for the facility. Rentals at the cold storage we visited were Rs130/quintal per season for 50 quintals or more. The cold storage had a capacity of 60,000 quintals with loading in March (when the summer starts) and unloading in October (cold storage is not required in the winter months). Given the power shortage, cold storages have to rely on generators, which increases their costs and final rates to customers. There is only one cold storage facility in the whole of Bhojpur districtgrossly inadequate for the region. Considering that the output per acre is around 100 quintals per acre and typically in every village we visited, land under cultivation would typically be 600 acres or more (translating to an output of 60,000 quintals), available cold storage capacity seems grossly inadequate for even a village, let alone an entire district. According to a study by Assocham, about 30-40% of agricultural produce goes waste every year.
Figure 39: There is a huge shortfall of cold storages in India
31
Rural India
Is dependence on monsoon fading?

With monsoon rainfall in India in 2009 being the most deficient in decades, the key issue is whether rural incomeswhich are highly levered to agricultureare sustainable. Rainfall during the monsoon season (JulySeptember) was 23% below the long-term average (LTA), which makes this years deficiency the highest since 1973. Rainfall deficiency was high this year in most parts of North and Central India. The worst affected area is North-western India, where rainfall was 36% lower than the long-period average. Parts of South India and Western India have seen normal rainfall. Figure 40: This monsoon has been the worst in over 35 years, North-western India has seen the highest rainfall deficiency
(%) 20 10 0 (10) (20) (30) Southw est monsoon - All India average (deviation from long term average) 120% 100% Northw est has had the w orst 80% 60% 40% 20% 0% 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Northw est India Central India South Peninsula Northeast India Rainfall as a % of long term average
Source: Indian Meteorological Department, IIFL Research
Yet, rainfall may not play truant as it has during the past Despite such a significant decline in rainfall, we do not anticipate a material weakness in rural incomes (and consequently consumption spending), on account of two factors: (a) Pick-up in monsoons towards end of the season Two key aspects that can positively affect the rabi crop are reservoir levels and the late rainfall in September. Reservoir levels recovered considerably in September and October, and are now only 5% below the 10-year average for the country. This would mean normal irrigation in reservoir water-dependent areas during the rabi season. Rainfall in the first half of October was also very good, with most areas recording more than 20% excess rainfall in the duration. Figure 41: Reservoir levels this year have inched close to that of 10-yr avg levels after the spell of rains towards the end of the kharif season
120 100 80 60 40 20 1-Oct-09 8-Oct-09 10-Sep-09 17-Sep-09 13-Aug-09 20-Aug-09 27-Aug-09 24-Sep-09 15-Oct-09 2-Jul-09 9-Jul-09 16-Jul-09 23-Jul-09 30-Jul-09 6-Aug-09 3-Sep-09 0 This year Water stock in reservoirs (BCM) Last year 10-year average
Source: IMD, IIFL Research
32
Rural India History also supports strong rabi output pattern despite weakness in kharif. Over the past 30 years, there have been over 10 occasions when there was considerable divergence between growth in the rabi and kharif crops without any significant base effect. Though the causes for such divergence would be different in each year, the data does show that the rabi crop can be reasonably good even in a bad kharif year, given the aforementioned factors. Figure 42: Kharif and rabi output trends do not necessarily mirror each other
15% 10% 5% 0% -5% -10% -15% -20% 1978-79 1982-83 1985-86 1987-88 1990-91 1991-92 1993-94 1994-95 1998-99 2002-03 2004-05
35.6% 26.4% 4.9% 4.4% 8.4% 37.9% 18.0% 100%
Kharif production grow th
Rabi production grow th
-25%
Source: Department of agriculture, IIFL Research
(b) Rainfall deficiency was in areas with strong irrigation & power availability The North-west regions which witnessed the highest deficiency this year saw almost NIL impact on its output during this kharif season, as irrigation penetration (>80%) and a strong political willpower to ensure uninterrupted power supply during the peak sowing seasons ensured stable acreage and yields. For instance, Punjab and Haryana are estimated to have witnessed a 4%YoY growth in paddy output this year, vis--vis a 20%+ YoY decline in paddy in other parts of India. Farm incomes should still grow 3% YoY, supported by prices We estimate that total crop output (excluding sugarcane) will decline by 8% YoY during 2009-10 (based on the governments first advance estimates for kharif crop, and our assumption that most rabi crops will decline by 2% YoY, while paddy grown during the rabi season will decline by 5% YoY, given its water-intensity). Based on current mandi-level prices, despite the 8% decline in agri output that we estimate for this year, a much larger 11% YoY increase in prices will offset the volume weakness - thus supporting an overall 3% YoY increase in farm incomes. Figure 43: -8%YoY volume growth to be offset by +11%YoY pricing growth
Volume (YoY) Pricing (YoY) Income (YoY) Total foodgrains Cereals Coarse cereals Pulses Total oilseeds Total horticultural crops Others Total prodn (excl sugarcane)
Weightage
-10% -10% -15% -4% -10% -5% -7% -8%
18% 15% 25% 25% 5% 8% 10% 11%
6% 4% 7% 20% -6% 3% 2% 3%
33
Rural India
Government schemes can boost rural consumption CAGR by ~175bps

The US$200bn annual consumption expenditure of 152m rural households will accelerate, powered by rising farm and non-farm incomes. We estimate that the increased government expenditure in itself can potentially raise consumption growth by 15-20% from the current levels, over the next 3-4 years. Greater visibility and stability in incomes from employment guarantee will act as a further psychological boost to rural consumption. With rural consumption set to cross the tipping point, all consumption proxiesespecially FMCG and autoswill see growth rates in coming years trending much higher than in the recent past. What is MPCE? MPCE stands for Monthly Per Capita Expenditure. The number is estimated by the NSSO on the basis of a large on-theground survey over rural and urban India. The last survey was carried out for the period 2006-07, and involved a sample of 33,146 rural households and 30,583 urban households.
Rural consumption: substantial, and accelerating

By our estimates, at US$200bn (FY10ii), the annual rural consumption expenditure is 30% more than urban consumption expenditure in India.
Figure 44: We estimate rural consumption in 2010 to be ~US$200bn
Item Rural population (m, FY07) Rural MPCE (Rs, FY07) Rural annual consumption (US$ bn) FY05-FY07 rural MPCE CAGR% Rural population (FY09) Est rural consumption (US$ bn, FY09) Incremental NREGA spend in FY09 All-India rural consumption FY09 Rural consumption FY10ii (assuming 10% growth over FY09) Value 800 695 142 11.5% 818 180 3.5 183.9 202.3
Source: Government of India, IIFL Research. Population data taken from Census 2001. MPCE data taken from NSSO. NREGA spend taken from NREGA website.
Despite the apparent poverty in rural India, rural consumption expenditure outstrips total urban consumption expenditure in India
Figure 45: Rural consumption expenditure is higher than urban

300 (Indexed to FY02: rural consumption = 100) Rural Consumption 200 Urban Consumption
100
0 FY02 FY03 FY04 FY05 FY06 FY07 FY14
Source: NSSO, Census of India, IIFL Research
The potential number of people in the consuming class (defined as households with annual income >US$1000) in rural India is ~2x the size of urban India (121m HHs in rural India vs 65m in urban India above the given threshold levels).
34
Rural India Figure 46: Consuming HHs in rural India 2x the number in urban India
(no. of. Households - '000) 180,000 150,000 120,000 90,000 60,000 30,000 0 Rural 1989-90
Source: NCAER, IIFL Research
Consuming class (>Rs45000 per household p.a) Low income (<Rs45000 per household p.a)
Rural 2001-02
Rural 2009-10E
Urban (2009-10E)
Rural consumption growth has overtaken urban growth Rural consumption spending has witnessed a significant acceleration in growth over the past 2-3 years, with rural MPCE growth overtaking urban MPCE growth for the first time during 2005-07. The shift in the trajectory of growth in rural consumption expenditure is evident when it is compared with the consumption spending growth since the mid-1980s, when rural MPCE invariably growth lagged urban MPCE growth.
Figure 47: Growth in rural MPCE has outpaced that in urban MPCE for the first time in over two decades
Rural MPCE (LHS) 12% 10% 8% 6% 4% 2% 0% FY88-94
Source: NSSO, IIFL Research
Urban MPCE (LHS)
Gap (RHS) 2.0%
(% CAGR)
(Urban-Rural grow th rate) 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% FY94-2000 FY00-05 FY05-07
Diversification of income sources will act as a psychological boost to rural consumers, who were otherwise prey to the vagaries of rainfall
Improved income visibility to spur rural consumption In combination with the declining influence of monsoons, the governments rural spending programmes should improve both the level and visibility of disposable income for the rural populace. Landless labourers are getting alternate employment opportunities under NREGA. NREGA incomes will shield farmers from monsoon related volatility. Small farmers are benefiting from improved rural road connectivity and getting better prices for their produce. The concomitant improvement in personal disposable income visibility will act as a psychological boost to the consumption behaviour of rural people. This morphing of psychological mindset will increasingly play a critical role in translating increased incomes into increased consumption spending.
35
Rural India Figure 48: NREGA will rise from the current measly 5.6% of rural PCE
Rajasthan leads the way in NREGA implementation State Rajasthan Andhra Pradesh Madhya Pradesh Karnataka Tamil Nadu Assam Uttar Pradesh Bihar West Bengal Orissa Gujarat Maharashtra Kerala Haryana Punjab MPCE 767.4 727.1 514.9 624.3 728.8 721.3 653.2 541.3 629.8 458.6 796.6 776.1 1,250.3 1,012.7 1,198.1 Per-capita NREGA spend 147.8 59.3 38.9 44.4 40.8 31.5 28.0 20.4 20.5 12.2 15.3 5.2 7.7 5.6 5.6 NREGA % 19.3% 8.2% 7.6% 7.1% 5.6% 4.4% 4.3% 3.8% 3.3% 2.7% 1.9% 0.7% 0.6% 0.5% 0.5%
Source: IIFL Research. MPCE data taken from 2007, the last year for which available; monthly NREGA spend taken for period April to Oct 2009.
Understanding consumption psychology of a labourer Figure 49: Dharmendra Prasad, who makes Rs1,500 a month, bought a second-hand mobile phone worth Rs3,000
Dharmendra typically gets work for 10-15 days per month at an average rate of Rs100/day, up from Rs70-80/day a year ago. He is part of a 14-member family, in which four members are earning members (two have been working in factories in Kolkata for the last seven years, and the other two are labourers). Both the labourer brothers have NREGA job cards. They are both happy with NREGA, which they say has resulted in an increase in wages. They were otherwise not getting enough work, as farm work was low during the year because of the poor monsoon. In spite of earning only ~Rs1,500/month, he had spent Rs3,000 on buying a second-hand Nokia phone (pictured above). While he spent Rs150-200/month on his mobile phone, he did not spend any money on purchasing toothpastes (instead, he used a datun, or tree bark).
36
Rural India
Rural consumption growth to accelerate by ~175bps

Rural consumption spending is indeed poised to take off. Merely considering the first derivative impact of the incremental government spending (US$23bn over the next three years) should accelerate rural consumption by 175bps. This is based on the following building blocks: Rural savings rate being 20% (significantly less than the national average of 30%). Only the impact of government spending in excess of the historical rural consumption CAGR of 11% being considered for estimating consumption acceleration.
Figure 50: Additional rural spend will add ~175bps to consumption growth rate
All fig in US$ bn Estimated FY09 rural consumption Incremental government rural spend Projected incremental Govt rural spend at PFCE growth rate Excess spend over PFC growth rate Consumption impact @80% Rural consumption (Est FY10) Annualised acceleration of rural PCE (bps)
Amount 183.9 23.6 9.9 13.8 11.0 202.3 178
Non-food consumption substantially higher

Available consumption headroom much higher in the relatively underpenetrated non-food categories
acceleration
will
be
Growth in rural consumption spending will not be uniform across categories. Food items, which comprise over 50% of rural MPCE, will grow slower, while non-food items would see faster growth. This is because of the low penetration and consumption levels of most nonfood categories at present, leaving large scope for an increase. During FY99-07, rural MPCE grew at an estimated 4.6% annually and food spending growth lagged at 2.8% annually, while non-food grew at 6.8% annually.
Figure 51: Non-food spend has grown at ~2.5x food spend in rural areas; consumer goods grew 1.8x of rural MPCE growth
During FY99-07, spending on food lagged at 2.8% CAGR vs. non-food spending which grew at 6.8%
14% 12% 10% 8% 6% 4% 2% MPCE 0% Consumer goods Consumer services Fuel Education Non-food Clothing, footwear Medical Food Rural consumption grow th (1999-07 CAGR)
37
Rural India
While it is hard to estimate the exact split of consumption spending on each category, it is safe to assume that spending on non-food items, which constitute ~48% of total consumption spending, will grow significantly faster than overall consumption spending. In the past eight years, categories such as consumer goods have grown at 1.8x the pace of total rural consumption growth.
Figure 52: Food formed over 50% of the rural MPCE in 2006-07
MPCE contribution 2006-07 (Rural India) 7% Food Fuel & Light Clothing, Footwear Education Services Medical FMCG Others 3%
5% 8%
8% 7% 10%
52%
FMCG, automobiles would be key beneficiaries

Theres substantial scope to increase penetration of autos and FMCG goods in rural areas
We believe the acceleration in growth of rural MPCE will be most beneficial to the FMCG and automobile sectors in India. These sectors already derive substantial portions of their sales from rural areas, but have considerable scope to increase rural penetration, which lags behind penetration in urban areas. FMCG: direct beneficiary for income growth at the bottom of the pyramid The strength in sales of consumer goods in rural India as reflected in the MPCE data is also reflected in the 13% annualised growth over the last three years in the FMCG sectors revenues from rural India. This has been a key driver for the acceleration in the FMCG markets overall growth over 2007-09 to 15-20%, from much slower growth in prior years.
Figure 53: FMCG value growth in rural India grew at 13% annually over 2005-08
FMCG market grow th in rural India 20% 16.2% 16% 12.2% 12% 8% 4% 0.6% 0% 2005 2006 2007 2008
Source: Industry data, IIFL Research
10.4%
38
Rural India
Within consumer goods, penetration gaps are the highest in personal-care categories
Personal-care categories will see the biggest boost to growth as penetration gaps narrow The increase in incomes at the bottom of the pyramid will directly benefit these categories, as penetration gaps with reference to urban India are still very large in them. Penetration gaps exist, as many rural consumers are unable to afford even small-ticket items such as shampoos and toothpastes, given their stretched spending on food itself. As rural prosperity increases, we see a narrowing of the penetration gaps in these categories, similar to that in soaps and detergents, which currently have similar penetration for urban and rural areas.
Figure 54: Personal-care categories will see the highest impact from rural prosperity, as the gap in rural and urban penetration will narrow
Rural penetration 100% 80% 60% 42% 40% 20% 0% Toothpaste Shampoo Hair oil Skin Cream Mosquito repellants 37% 18% 77% 67% 57% 59% 80% Urban penetration
32% 18%
In the past four years, these categories have benefited significantly from rising rural MPCE. Within FMCG, the growth in these personal care categories like toothpaste, hair oil and shampoos was the highest, at a CAGR of 13-20%. Penetration in categories such as toothpaste has clearly seen an inflection point, and will rise sharply from here.
Toothpastes, hair oils and shampoos poised for sharp growth in penetration rates
Figure 55: Sales growth in rural India has been the strongest in personal-care goods
Rural CAGR (2005-09) 25% 20.0% 20% 15% 10% 5% 0% Toothpaste
13.7%
15.1%
Hair oil
Shampoo
39
Rural India Figure 56: Toothpaste penetration has seen an inflection in the past four years
60% Toothpaste penetration (India) 54% 55% 50% 50% 44% 45% 45% 44% 44% 46% 51% 57%
40% 2000 2001 2002 2003 2004 2005 2006 2007 2008
Autos: volume growth will surprise positively Given the poor state of urban transport, a two-wheeler is almost a necessity in most parts of India; it is not a discretionary purchase, unlike a car. Thus, although bike penetration in India has risen significantly in the last few years, it is still a long way from peaking. Currently, only 29.5% Indian households own a two-wheeler.
Figure 57: Domestic two-wheeler volumes have grown at an annualised rate of over 15% CAGR in the last 25 years
10.0 (m units) 8.0 6.0 4.0 2.0 0.0 Domestic tw o w heeler volumes 50% 40% 30% 20% 10% 0% -10% FY10ii FY84 FY86 FY88 FY90 FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY94 FY96 -20% An aberration given the w ithdraw al of financing by banks FY10ii 29.8 26.7 28.0 FY98 FY00 FY02 FY04 FY06 FY08 YoY grow th in motorcycle volumes
Source: CMIE, SIAM, IIFL Research
Ample scope for increase in penetrationalmost 70% of Indian households and 90% Indians still have no personal transport vehicle
Figure 58: Ample scope for improvement in penetration

35.0 (%) 30.0 25.3 25.0 20.1 20.0 15.0 15.0 10.0 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10ii
Tw o w heeler penetration per household
23.4 21.7 17.2 18.5
15.7
16.4
40
Rural India
Given that two-wheelers are usually driven by young people, the addressable market for these vehicles would be the population in the 16-45 age group. Even in this age bracket, two-wheeler penetration in India is only 10%, as against over 50% in South-east Asian countries like Malaysia and Thailand. In developed countries, penetration of two-wheelers is lower, because most people use cars.
Figure 59: Indias penetration is far lower than South-East Asian countries
70 60 50 40 30 20 10 Germany France Iran India Japan Indonesia Malaysia Thailand China Italy Vietnam Brazil Spain 0 Argentina 64 53 45 45 29 27 25 19 16 12 12 11 11 10 7 UK 7 Russia (% of population ow ning tw o-w heelers)
6 Phillippines
5 Turkey
5 US
2 Mexico
Source: CRISIL, IIFL Research CRISIL has calculated penetration on population with age between 16 and 45 years
Motorcycles account for 80% share of two-wheelers in India; demographics and infrastructure will continue to drive growth
Motorcycles a key beneficiary of rural prosperity Almost ~80% of two-wheelers sold in India are motorcycles. In the last few years, gearless scooters have been increasingly popular because they can easily be ridden by women as well as men, but these vehicles sell mainly in cities and towns. For the foreseeable future, motorcycles will continue to dominate two-wheeler sales in rural India, given the condition of roads, higher fuel efficiency of motorcycles, and cultural issues against women driving motorised vehicles. Indias overall motorcycle penetration is close to 18%. Motorcycle penetration in rural India stands at only 10.1%significantly lower than the ~30% penetration levels in urban areas. Thus, there is significant catching-up to do.
Figure 60: Whilst volumes in rural India have grown faster than urban India, penetration rates are still significantly lower than in the rest of the country; we reckon contribution of volumes from rural India could double in the next 10 years
(%) Motorcycle penetration per household (2008) 16.1 Rural 100% 80% Top 7 metros Over 1m cities 0.1 - 1m cities Tow ns Rural areas 0 10.1 0% 10 20 30 40 FY84 FY89 FY94 FY99 FY04 FY08 28.4 22.9 36.8 33.3 60% 40% 20% Contribution to motorcycle sales Tow ns 0.1 - 1m cities Over 1m cities
All India
Source: CMIE, SIAM, IIFL Research
Rural Indias contribution to overall volumes has been rising in the last five years. In FY10, we expect motorcycle volumes to increase
41
Rural India
by over 20%, in spite of a slowdown in demand from urban India. We reckon contribution of volumes from rural India has risen to ~40% in the current year, from 35% about five years ago. We reckon this proportion can rise as high as 60% in the next few years, given that 70% of all households in India live in rural areas, when penetration of motorcycles is considerably lower than in urban India. We reckon that penetration in rural India would go to 20% in the next five years, with rural India contributing more than 50% of the volumes. Whilst industry volumes grew by 12% annually during FY02-08, motorcycle purchases by farmers rose much faster, at 24% annually in this period, on the back of strong growth in farm incomes.
Motorcycle purchases by farmers grew at 24% annually during FY02-08
Figure 61: Strong growth in farm incomes has spurred motorcycle sales by farmers
Contribution by farmers to motorcycle volumes 14% 13% 12% 11% 10.5% 10% 9% 8% 7% 6% FY02 FY03 FY04 FY05 FY06 FY07 FY08
Source: CRISIL, IIFL Research
13.5%
12.0% 10.8%
12.1%
12.2%
7.4%
Increased labour rates brighten tractor industrys prospects The tractor industrys volumes have grown at an average annual rate of 5.7% in the last 25 years. In the last 10 years, however, the industrys volumes have slowed to a CAGR of 1.1%, in spite of the robust growth in farm incomes. The trend has changed in FY10; we expect the tractor industry to end FY10 with volume growth of over 15% and sustain at least a double-digit CAGR over the next few years, as structural drivers for its growth are in place. NREGA and urbanisation have led to labour becoming expensive and scarce, increasing the need for mechanisation. This, along with easy availability of finance will power rapid growth (>10%) in industry volumes between FY10-FY14.
Figure 62: Tractor industry volumes have grown by 5.7% annually over the last 25 years
350 300 250 200 150 100 50 FY84 FY86 FY88 FY90 FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 0 ('000 units) Tractor industry volumes
Source: CRISIL, IIFL Research
42
Rural India Figure 63: Tractor sales have registered a modest 5.4% CAGR in 20 years; we expect the next decade to be much better
12% Tractor volumes CAGR 10% 8% 6% 4% 2% 0% 1981-1991 1991-2001 2001-2010*
Source: IIFL Research. *9-yr CAGR for 2001-2010; 10-year CAGR for the other two periods
10.0%
8.6%
5.4%
Despite the strong acceleration in tractor volumes, penetration in India is still low10 per 1,000 ha
Penetration is significantly lower than global average India still has only ten tractors per 1,000 hectares of land. On a perperson basis, less than 10% of Indias farmers own tractors and less than 25% currently use tractors. Tractor unit sales have registered at 9% CAGR in the last five years, and we expect robust growth to continue for the next few years.
Tractors: construction demand offsets impact of poor monsoon
Stone-crushing was a big business in one of the villages we visited on our trip to Bihar; the village headman there owned five tractors, all employed in transporting stones. A tractor yielded him about Rs1,000/day in revenues, which, given his costs of Rs100/day for driver, Rs250-350/day for labour and Rs350/day for diesel (10 litres daily) gave him a clear profit of Rs200-300/day. Thus, he could make a profit of ~Rs75,000/year from one tractor one-fifth of the cost of the tractortranslating into a payback period of five years. In fact, he said he had paid back his tractor loans in three years. This instance supports the theory that tractor volumes are a lot less dependent on monsoon now than earlier. In fact, our interaction with industry sources indicates that in some states, among them Bihar, Uttar Pradesh, and Andhra Pradesh, construction demand forms 60% of total tractor demand.
Figure 64: Tractor in use for road construction
43
Rural India Key takeaways from our meeting with head of M&Ms farm equipment business Further upward revision in FY10 tractor volume guidance to >15% YoY: There has been no significant impact of the poor monsoon; YTD, tractor industrys unit sales have grown 22% YoY. Going forward, given the lower base; management expects volume growth to remain strong and has revised its FY10 growth estimate for the industrys tractor sales from 8-10% to >15%. Tractor volumes medium-term growth boosted by shortage of labour: NREGA and urbanisation have led to labour becoming expensive and scarce, leading to higher mechanisation. On account of NREGA, tractor industry growth can reach 10% YoY for the next three years (2-3% higher than it would be otherwise). Easy liquidity has led to higher cash purchases: MSPs were raised 11% in FY08 and 30% in FY09 (compared to the average annual increase of 1.5% in the five previous years). Further, with Kisaan Credit Card, farmers have access to a loan of Rs200,000 at 7% interest. As a result, currently ~25% of vehicles are sold on cash, vs only 10% in FY06. Increasing focus on other farm equipment: Tractors account for ~90% of the Indian farm equipment industrys sales. Going forward, demand for other equipment is also likely to see a significant increase. With the PTL acquisition, M&M has a harvester business as well (more than 50% growth this year). Going forward, it plans to enter more agri-allied businesses (GM seeds, fertilisers, etc).
44
Rural India
Can telecom be the dark horse?
The Indian telecom story has largely been urban-focussed, and the recent entry of more operators into the playing field has made the sector hyper-competitive, sparking intense tariff wars. The sector has got de-rated in anticipation of eroding earnings, but what is often forgotten is that the intensification in competition is currently restricted to urban markets. In the rural markets, it is a different story, though tariffs are falling there too. The main difference is that rural India demands bigger investments in telecom due to lower subscriber density, and not all telcos have shown the stomach for this. Among the big firms, the lions share of rural subscriber additions has in recent times been cornered by Bharti Airtel, Vodafone and Idea Cellular.
56% of Bharti Airtels net mobile subscriber additions are from rural areas
Figure 65: Bharti, Vodafone and Idea have been leaders in adding rural subscribersall these major operators have seen >50% additions coming from rural subscribers, while players such as RCOM and Tata see additions mainly from the urban areas
Millions Rural subs in Mar 09 29.5 15.1 20.4 19.1 17.2 2.7 5.6 0.0 109.7 Rural subs in Jun 09 33.8 16.4 24.8 19.4 19.8 2.9 8.8 0.1 126.0 Rural subs additions 4.3 1.2 4.4 0.3 2.6 0.3 3.2 0.1 16.2 Total subscriber additions 8.4 7.0 7.7 2.2 4.1 2.0 3.3 0.6 35.3 Rural as % of additions 50.4% 17.7% 57.6% 11.7% 62.9% 13.5% 96.1% 10.5% 46.1%
Bharti Reliance Vodafone BSNL Idea Tata Aircel Shyam Total
Source: TRAI, IIFL Research
We estimate that for the industry, in the next few years, rural revenues will start matching urban revenues. Bharti and Idea are the firms with maximum thrust in rural areas among the major listed firms. In a capex-heavy industry like telecom, continuing investment in rural India will be the key determinant of tomorrows rural winners and with its strong cash flows and balance sheet Bharti is the horse to back.
40% of Idea Cellulars revenues are from rural areas, a very high proportion compared to the rest of the industry
Figure 66: The rural urban divide is extremely stark in telecom, and once the current tariff wars blow out, rural focussed firms will do well. Bharti leads here.
Rural penetration 100% 80% 60% 42% 40% 20% 0% Toothpaste Shampoo Hair oil Laundry Telecom
Source: IIFL Research; Urban telecom penetration is technically >130%, but we force it to 100% to reflect the artificial nature (multiple SIM phenomenon) of the high urban penetration.
Urban penetration 90% 93%
100%
77% 67% 57% 37%
80%
18%
45
Rural India
Q&A with Akhil Gupta: rural markets the next major wave in telecom
Akhil Gupta is the Deputy Group CEO and MD, Bharti Enterprises, a long-time board member of Bharti Airtel, and the Chairman of Indus Towers, the largest passive telecom infrastructure company in India. IIFL met Akhil What is the potential for telecom in rural markets? Huge. In rural India, frequently, farmers realised just a fraction of the market price for their yield, and middlemen took the rest. But with a phone, instead of getting cheated, the farmer is now able to immediately get the correct price information on the phone and benefit. There are many more such examples. With improved connectivity and increased income, rural people will become more active consumers. Bharti has invested heavily in rural areas, and now, last month, 56% of Bhartis mobile net adds came from rural areas, and this is climbing. In fact the rural consumption expenditure is higher than urbanbut in telecom, not more than 20-25% of the revenue comes from rural. Yes. Rural consumption is higher because their rural peoples income is small therefore their saving low and expenditure high. But while currently the rural revenue proportion is very low, it will start matching urban revenues in a few years. But rural operations are more expensive, especially in energy There are several ways of cutting this that we are working on. In rural areas, electricity supply is pathetic. However, in the next 3-4 years as new power capacity is added the cost will reduce as the dependence on the much costlier DG (diesel generator) decreases. The second is that the sharing of the passive infrastructure will increase the DG utilisation and reduce costs. Thirdly we are experimenting with alternate energy, solar technology, biofuel, etc. What are the prospects in VAS (value-added services)? The big areas on VAS will be m-banking, mcommerce and money transfer, all of which have major rural orientation. The only way of reaching the 85% of our population that is un-banked is virtual banking, and only through mobiles, a massive opportunity. If you look at the M-commerce, we have just about 250,000 credit card outlets because the POS (point of sale) machines are expensive. But, mobile phones can be a far more cost effective and secure alternative, enabling inclusion of the masses. Money transfer is the third big opportunity, again done by very expensive means today, which mobile technology can significantly improve upon.
46
Rural India
Racing across the countryside

Our visits to 18 districts across seven states over a 12-week period revealed the diversity in infrastructure, sources of income and standards of living across Indias rural populace. Also, the variation in the monsoon deficiency across states added further to the diversity of income impact during this kharif season. Key observations during our various state visits include: a) states with very high monsoon deficiency (of >35%) but with good irrigation facilities were almost completely unaffected by the rainfall shortage (kharif output estimated to have grown 2-5% YoY), while even marginal shortage in rainfall has left the infrastructure-poor states badly affected (kharif output estimated to have declined by >10%YoY in the rest of the country); b) while the NREGA programme has been a success all over India, siphoning of funds continues to be lower in traditionally well-governed states; and c) almost all states have witnessed diversification in rural incomes away from farms, thus contributing to stability in rural incomes despite rainfall failure. For our visits, we chose states that met one of the following three conditions: 1) runaway success in NREGA implementation, to directly assess the schemes contribution to income growth; 2) large contribution to Indias agricultural output, to evaluate how severe the impact of rainfall deficiency might be on farm income; and 3) languishing in implementation of most rural reforms, to assess if these states have any scope for improvement in the medium term.
Figure 67: We visited 18 districts across the length and breadth of the country
Siphoning of NREGA funds continues to be low in traditionally well-governed statesit was reported at ~20% in TN and Rajasthan, vs >40% in Bihar and UP
47
Rural India
Rajasthan
20-23 August 2009 Jaipur, Tonk and Kota districts
Grim reapers
Our trip to the rural parts of the North-western state of Rajasthan was a sobering experience. The visit was during the latter half of August, during which time the steep deficiency in monsoon rainfall had left villagers in very dire straits. Furthermore, outlook on the rabi crop was also quite bleak back then.
We visited the main agricultural regions and districts that have implemented NREGA successfully
Bundi Jaipu Kota Tonk
While Rajasthan has historically been a very poor state, thus likely not a very large driver of the consumption boom during the past few yeas, we chose to visit the state since it has been one of the forerunners in implementation of NREGA since the programmes launch in 2006. We wanted to evaluate if the significantly large expenditure that the government has incurred towards NREGA in this state will make a meaningful dent in the outlook for rural Rajasthan. We also met NGOs and banks involved in implementing many of the governments rural schemes in these areas. Kharif yields to decline by 20-50% YoY: In the Northern and Eastern parts of Rajasthan, yields of kharif crops (mainly bajra, jowar, groundnut grown here) could drop by over 50% YoY if rainfall fails. Most of the bajra crop we saw had already started to yellow (ideally, it should have yellowed in 6-8 weeks from the time we visited). The Southern parts, despite being well-irrigated (thanks to water from the Chambal river and the Gandhi Sagar dam), have faced severe water supply crunches: most of the reservoirs were running at 30-50% of the full reservoir levels (that is less than half the levels witnessed the previous year). In this region, yields are expected to be slightly better than in the northern parts, and are likely to decline by up to 20% YoY.
Figure 68: Most villagers upset over the fact that they get paid less than Rs100/man-day of work
Mumbai
Demographics of the state visited Population: 56m (~11m HHs) HHs employed under NREGA: 6m Arable land irrigated: 20%
48
Rural India Figure 69: Rajasthan is one the largest states for implementation of NREGA; rainfall has been 27% below normal this season and could impact incomes of >30% of rural HHs
49
Rural India
Capital invested will need to be written off: Farmers have invested ~Rs8,000 per acre on seeds, fertilisers, etc, and these costs will have to be substantially written-off if yields do not improve. Most of the farm input costs have not increased much YoY, seeds are procured from government universities, and fertiliser prices are controlled by the government. On the other hand, the cost of power has surged: one farmer we spoke to said hed spent Rs1,500 on pumping water from borewells over the past three monthsup from Rs900 in the same period last year. Should yields decline by 50% YoY, these farmers will incur a net loss of ~Rs4,000 per acre.
Figure 70: Afforestation projects under NREGA implemented in groups of 5
Whereas the kharif crop has been badly hit, prospects for the rabi crop look brighter, with late rainfall
Hope for rabi exists; poor rains spell disaster: While there was no hope for rabi, at the time we visited, the subsequent improvement in rainfall activity has provided some succour to the rabi crop. For this region, rabi is the main income earning season (they earn income of Rs40,000-50,000 per household from the rabi crop each year, as against <Rs5,000 from the kharif crop). The main rabi crops grown here are mustard seeds and wheat, prices of which are already up 20-30% YoY currently. Agricultural incomes to decline steeply: In sum, agricultural incomes will decline steeply (from Rs50,000 per household last year to less than Rs5,000 this year).
Figure 71: NREGA job card indicates that the total payout received by a HH during an entire year was <Rs3,000
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Rural India
Strong progress on NREGA

Awareness high, but NREGA viewed as easy money work:
All villagers we met knew about the minimum wage per day and stipulated number of days of work per HH (100 days pa). We saw plenty of large posters about the NREGA programme on many walls in the village we visited. There was a detailed flowchart in the government offices in the taluka/panchayat headquarters about the programme. Both bureaucrats and villagers we met view this as easy money. Forty percent of the rural HHs in Rajasthan received the entire 100 days of employment pa during the past year. Bureaucrats see little reason to believe that a larger proportion of rural HHs would receive all 100 days of employment. NREGA contributing ~10% of HH income; payments delayed: Implementation of NREGA in a drought year can at best offer an income of Rs3,000-8,000 per household, while agricultural income loss would be Rs40,000-50,000 per household. NREGA wages are actually received within 30-60 days of completion of work (as against 15 days stipulated by the government) are known to create bogus accounts for people and withdraw funds from these accounts. These sarpanches are also known to routinely over-invoice value of materials used in projects. An NGO supervising NREGA implementation in villages in this state pegged the leakage at 20-30%. state is implemented in the off season (that is, May-July and November-January), when agricultural work is minimal. Agricultural wages have not been affected, since there is no competing NREGA activity during the peak sowing season. Many nearby factories had also been shut down recently, hence the demand-supply balance was heavily in favour of land-owners, not labourers. NREGA work for infrastructure: Most of the activities undertaken under NREGA are oriented toward infrastructure creation (irrigation, roads, etc). However, the quality of materials used in creation of these assets is quite poor, thus restricting their potential useful life to 2-3 years.
NREGA programme well highlighted in each village
20-30% leakage happening: Some powerful gram sarpanches
Little impact on labour rates: Most of the NREGA work in this
Figure 72: More than 40% of the households in Rajasthan have been given 100 days of employmentmuch better than in other states in the country
HHs provided job card (m) HHs provided employment (m) % of HHs provided employment Person-days (m) Average number of days per HH % HHs completed 100 days
2006-07 1.37 0.18 13.0% 6.6 37 53.8%
2007-08 3.22 1.27 39.4% 62 49 41.5%
2008-09 8.46 6.44 76.1% 383 59 40.8%
2009-10 (till Oct) 9.15 4.65 50.8% 202.7 44 6.4%
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Rural India
Karnataka
25-28 September 2009 Kodagu, DK, Chamrajnagar districts
NREGA holds promise

Our visit to parts of rural Karnataka (a state that has had normal to excess rainfall) during September 2009 suggested that farmers fortunes had taken a hit on account of monsoon deficiency. Small farmers were buffeted by deficient monsoons (50% drop YoY in eastern parts, producing sugarcane, banana and paddy) on one hand and excessive rainfall (50% above requirements in western Karnataka in the areas we visited, producing mainly coffee) on the other hand. Over the medium term, however, enthusiastic government officials implementing NREGA give us reason to look beyond the monsoons effect. Karnataka: Farmers income badly hit, mainly because of uneven distribution of rainfall and higher labour rates: We visited rural Karnataka (Chamrajanagar, Kodagu and DK districts). On the whole, Karnataka has had normal rainfall, though there are parts of eastern Karnataka--where the main crops are sugarcane, banana, paddy and turmericthat rainfall has been lower 50% YoY and has crippled yields. A 20-30% YoY price hike has provided relief. In western parts (where the biggest crop is coffee), there has been excessive rainfall (110 inches in parts of Kodagu, as opposed to the requirement of 70 inches), leading to severe wastage. In either case, the common woe has been sharply reduced net income. Labour rates are uniformly up 25% YoY.
Figure 73: NREGA has caused an increase in labour rates in Karnataka Demographics of the state Population: 53m Employment provided under NREGA: 0.65m HHs % arable land irrigated: 27% BPL population: 17% (national average 27%)
Strong medium-term outlook for durables and FMCG, telecom; near term wobbles for tractors: During a phase of sharply reduced rainfall, increased mechanisation (tractors) is not uppermost in the minds of farmers. Among prominent FMCG brands finding mention in our meetings were Colgate and Mysore Sandal, and our impression was that there would be no scale-down of spending on these items or on telephony, as they did not form a material portion of household spending. However, NREGA-driven allround increase in income bodes well for durables and rural twowheeler sales.
52
Rural India Figure 74: Uneven distribution of rainfall has resulted in severe deficits in some areas (eastern parts, affecting sugarcane, banana) and excess in others (western parts, affecting coffee)
53
Rural India
Eastern Karnataka: decline in rainfall but rise in prices

Main crops in this region are sugarcane, paddy, coconut, banana,
and turmeric. A 50% average YoY drop in monsoon has been partly compensated by a 20-30% increase in prices (average across the sample). Among the villages we visited was Udiagala, in Chamrajnagar district. Profile of a small farmerannual revenue Rs200,000: Sixty percent of the countrys farmers have land of less than 5 acres, and Karnataka seems no different. The typical farmer we met owns two acres of land, with main produce being coconut, which sells 20,000 pieces pa for Rs4/piece, thus yielding Rs80,000 pa in revenue. Income from supplementary cropsRs50,000 from sale of milk (from four cows, which help him with tilling as well), and Rs50,000 from sale of another crop (banana / turmeric) takes the total revenue to Rs200,000 pa YoY price increase has been significantfor coconuts, the previous years price was Rs3/piece. But overall revenue was down ~20% on account of yield drop caused by deficient rainfall. Labour in short supplyNREGA driving rates up: Labour costs are the biggest portion of costs for a farmer. At three labourers a day for 365 days (at typically Rs100/day), labour forms 60% of the costs. Fertilisers cost 10% of revenue and taking tractors on hire (@Rs400/hr) costs an additional 5%. Labour rates are considered to have gone up by 25% YoY. Farmers attribute this partly to NREGAlabourers prefer to send multiple family members for NREGA work, earn their 100 days of employment as quickly as possible and return only when NREGA is done, unless they are paid more by the farmer. So a good labourer stands to earn Rs35,000 pa and supplement that by sending at least Rs8,000 through NREGA. Surplus usually Rs25,000/acre: Hence, the farmers surplus is usually no more than Rs50,000 ie Rs25,000 per acre. Some farmers operated on the model of hiring out farm land in bigger (10-acre) chunks, and their retention is similar at Rs25,000/acre.
Labour rates have risen by 25% YoY, thanks partly to NREGA
Figure 75: Mechanisation not a priority in bleak times
54
Rural India
Western Karnataka: excessive farmers smell the coffee
rainfall
makes
Coffee dominates, with prices ruling firm: Kodagu districtwe visited Madikeri Talukis dominated by coffee plantations (approximately 300,000 acres). Each acre is capable of revenue of Rs100,000 (70% coming from coffee at the rate of Rs2,000/bag). The harvesting is mainly in the JanuaryMarch period. Prices are determined by international supply from Vietnam, Brazil, etc, and are currently ruling at Rs2,000/bag, but for the last few years had been at a crippling Rs400/bag. There is no government support on prices, and plantation farmers seem an unhappy lot. Excessive rainfall has crushed yields: The coffee belt has seen excessive rainfall, of 100+ inches in the last two years, whereas only 70 inches are needed. Yield has been adversely impacted, because of excessive moisture preventing drying, premature dropping, mist making it difficult to pick fallen fruit, etc. Yield has fallen by up to 65%+ in these areas. Farmers have made up by growing supplementary crop such as banana.
Figure 76: Plantation labour well looked after, and prospering
Such is the labour shortage that semi-permanent labour at times needs to be imported from 150km away
Source: IIFL Research. House, water and electricity supply provided by plantation owner to the permanent labourer; without these perks, the labourer might quit
Labour costs have been high: Labour rates are set by the Coffee Board and are currently Rs112/day. Farmers hire semi-permanent as well as permanent labour. Permanent labourers need to be given accommodation, separate water lines, medical aid, etc. Such is the labour shortage that semi-permanent labour at times needs to be imported from 150km away. Plantation owners in these parts complain that labour is getting harder to find as the younger generation is increasingly favouring white collar jobs instead of picking coffee seeds from the ground manually (this is the only form of harvesting). Labourers are enjoying cumulative pay of Rs150/day for 250+ days a year, as opposed to the Rs60-80 they may earn through NREGA, for only 100 days.
55
Rural India
NREGA - awareness rising, leakages low, massive jump in disbursements (~8x YoY so far in FY10)
Disbursements under NREGA in Karnataka had risen eight-fold YoY up to October 2009
Awareness has surged in the recent past (15x jump in
registered HH in six months): In our visits to Chamrajanagar, Dakshin Kannad (DK) and Kodagu districts, we discovered that most farmers are aware only of the problems that NREGA has caused them (in terms of increased labour rates), and have not thought about using NREGA for community development to benefit themselves. Further, awareness in terms of their right to earn income, earn through getting NREGA reimbursement for material, etc, seems to be almost completely absent. In March, the DK district had ~4,000 households registered, out of an estimated 180,000 HHs in this district. The registered HH count had increased to 6,000 by May, 31,000 as of August, and 66,000 as of November. Several NGOs are involved in spreading the message that NREGA can benefit farmers as well as labourers.
Potentially, a 40% boost to
HH incomes: Officials administering the programme are encouraging community development work to be done by farmers and farm labourers (building tanks, bunds, small dams, etc). In other words, relatively little additional work on a net basis could result in a significant income boost for farmers; we estimate that for small farmers, this can potentially be 30-40%. in labour rates: In all the villages we visited, a common problem cited was the ~25% YoY increase in daily labour rates, which some farmers attributed to NREGA (farm labourers choosing NREGA work over farm work). Officials administering NREGA acknowledge that leakages are rife, but point out that the problem is being tackled. Local NGOs put the leakage at 20% or less.
Tank bund being under NREGA
constructed
Labour shortages exacerbated by NREGA; 25% y-o-y jump
Corruption seems quite lowleakages less than 20%:
Figure 77: Very few households achieved their full quota

2006-07 Number of households issued job cards (m) Number of households provided employment (m) % of HHs provided employment Total number of person-days (m) Average number of days per HH % of households completing 100 days
2007-08 1.52 0.55 36.1% 19.78 36 4.2%
2008-09 3.42 0.90 26.2% 28.76 32 5.4%
0.80 0.55 68.5% 22.20 41 12.8%
2009-10 (till Aug) 4.96 1.77 35.7% 87.07 49.2 8.2%
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Rural India
Bihar
20-25 October 2009 Vaishali, Gaya districts
Caught in a time warp

Our trip to rural parts of the southern and central parts of Bihar was an eye-opener. We visited the central and southern regions of Bihar to understand the impact of a poor monsoon on agriculture and the effectiveness of some of the recent government schemes. One of the key reasons to choose Bihar to visit was that it has been one of the laggards in implementation of NREGA since the programmes launch in 2006. We also met district officers involved in implementing many of the governments rural schemes in these areas. We understood why Bihar is so notorious for corruptiona large part of most Government project funds is embezzled with impunity by officials at various levels. Facilities have improved, but still a lot needs to be done to provide even basic services to people: All is not bleakall the villages that we visited had seen an improvement in availability of electricity in the last five years. Condition of roads too has improved significantlymost villages we visited had hard roads (bitumen), thanks to state government initiatives. There was plenty of evidence of road construction under the Pradhan Mantri Gram Sadak Yogna (PMGSY). PMGSY was launched in December 2000 to improve rural road connectivity by providing good all-weather roads to all unconnected habitations with a population of more than 500 people.
Figure 78: Road connectivity has improved significantly in the last few years Demographics of the state Population: 82m HHs provided employment under NREGA: 4m (2008) Arable land irrigated: 30%
Facilities for basic education too have improved in the last five years. We were given an example of a one-room, two-teacher school being upgraded to a five-room, ten-teacher school. The villagers though were not too fond of the Mid-Day Meal Scheme (the scheme involves provision of lunch free of cost to school children on all working days), as according to them the teachers were more worried about food poisoning in the food being served rather than teaching the children.
57
Rural India Figure 79: Bihar is one of the most corrupt states in the country; a big laggard in NREGA implementation
58
Rural India
Figure 80: The village post officea sign of the facilities, or lack thereof
In one remote village, the post office was a decrepit structure with a table, three chairs, and no one to man the officeand thus practically useless to the village. Pensioners have to struggle past the corruption and lethargy of officials to get their dues, and that too after the disbursing officials have taken their cut.
Figure 81: A disabled pensioner telling us how he has to pay 10% of his Rs200/month pension to the postmaster to receive the amount from him even after three trips
There is widespread embezzlement of funds in all government projects, by village headmen and government officials alike
First-hand account of the corruption in the state: During our visit, we got a first-hand account of why Bihar is so notoriously famous for corruption. According to the villagers we spoke to, government officials at every levelstarting from the Post Master to the District Collectorextracted a bribe for every task done by them. There is widespread embezzlement of funds in all government projects, by village headmen and government officials alike. For instance, for the NREGA scheme, we were given specific percentages charged by government officials at each level. The charges range from 2% at the lowest level and go up to 40%and this is only up to the level of block development officer who knows how much is taken away by higher-ranking officials.
59
Rural India
Kharif yields to decline by 20-30% YoY: Yields of kharif crops (mainly paddy) could drop by 20-30% YoY. Most of the crop we saw had already started to yellow. Northern parts of Bihar have been hit by floods in the last two years, caused by the release of dammed water in Nepal, with whom Bihar shares a border. In this region, yields are expected to be better than last year, as this year they have not been hit by floods.
Figure 82: Retail store in Bihar
Power and labour costs have moved up sharply this year, causing a drop in farm profits
Grim reaping seasonpower costs up on low rainfall and labour costs up on account of NREGA: Most of the farm input costs have not increased much YoY, seeds are procured from government universities, and fertiliser prices are controlled by the government. Farmers need to invest ~Rs2,000 per acre on seeds and fertilisers. However, power costs have surged: one farmer we spoke to said the poor rainfall had forced him to spend Rs5,000/acre on pumping water from borewells over the past three months. Labour costs too have moved up sharply since the implementation of NREGA. At a wage of Rs100 per day per labourer and assuming that ten labourers are used for three days for sowing, reaping and cleaning, this cost would amount to Rs3,000/acre. Per five acres under cultivation (this is the average land holding size), a farmer can grow 15 quintals of paddy (can be sold at Rs300 per quintal), 25 quintals of wheat (Rs1000/quintal) and 15 quintals of potatoes (Rs300 / quintal) in a year. This totals up to Rs34,000, equivalent to Rs7,000/acre approximately. Thus, given the current cost structure, the farmer will end up with a deficit of Rs3,000/acre instead of a surplus of Rs3,000/acreunless prices move up substantially.
60
Rural India
Bihar: leakages guaranteed, not employment

NREGA
means guaranteed income to corrupt intermediaries: There is no doubt that the people in power (bureaucrats, village headmen, other intermediaries) have decided that the NREGA system is meant to guarantee steady returns to themselves, whether or not it guarantees employment to poor people. Those who are most in need of NREGA money are painfully aware that the guarantee in NREGA is only in theory. Payment cycle painfully long in NREGA: A typical NREGA worker would spend three days in NREGA work, and would then have to chase government officials for 7-8 days for compensation. By comparison, farm labour provides daily cash to the labourer, and at the same rate or better. In several cases, labourers gave up chasing NREGA money due to them altogether. Labour costs have risen by 40% YoY: NREGA was cited as one of the reasons for labour rates going up from Rs70/day to Rs102. This number of Rs102 was cited consistently in several places, for both NREGA and daily farm wages, further establishing the link. The state of Bihar is the main source for supply of labour to other states such as Karnataka, so it was surprising that here too rates had moved up. Work under NREGA included canal-building, digging bore-wells and other agricultural development work. Leakages 35-40%, and not a cause for consternation: According to a number of villagers we spoke to, 35-40% of the NREGA money is embezzled by corrupt officials at various levels. These percentages seem to be fairly standard across the villages visited by us, and cause no consternation or surprise. However, after the government changed the NREGA payments from cash to cheque, the cut has become smaller, and corrupt officials have reacted by delaying payments.
How much? 5.0% 3.0% 5.0% 5.0% 2.0% 3.0% 5.0% 2.0% 5.0% 35.0%
Village post office an important funds disbursement medium for NREGA wears a deserted look
Figure 83: Who is guaranteed NREGA money?

Leakages from NREGA payouts* BDO (Block Development Officer) DDC (Deputy District Collector) Panchayat Head Engineer Cashier Assistant Engineer Programme Officer Official who draws estimates Others including village headman Total
Source: IIFL Primary Research. *This is indicative of villages we visited and may not be true for the entire state
Figure 84: Awareness not translating to income

2006-07 No. of households issued job card (m) No. of households provided employment (m) % of HHs provided employment Total no. of person-days (m) Average number of days per HH % of households completing 100 days
2007-08 7.25 0.01 0.17% 0.15 12.06 0.09%
2008-09 8.58 0.74 8.62% 15.29 20.66 0.85%
0.00 0.00 70.54% 0.00 16.05 0.00%
2009-10 (till Oct) 8.58 0.11 1.33% 2.40 21.07 0.70%
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Rural India
Uttar Pradesh
1-3 November 2009 Hardoi, Rampur, Jyotibai Rao Patil districts
Income diversification in the countryside
Our visit to central Uttar Pradesh (UP), Indias largest state, strengthens our view that rural income is more robust than perceived. The visit was after the sudden downpour in rainfall towards the end of the kharif season, thus bolstering the prospects of the agrarian economy in India. Weaker monsoon rainfall this year has adversely affected kharif crop (the effect was partly compensated by 15%+ price increases), but the Rabi (winter) crop is expected to remain normal. Rural auto dealers look capable of shrugging off weak monsoons. Further, diversification of rural household income is compensating for ineffective penetration of government schemes such as those under NREGA (National Rural Employment Guarantee Act) and Antodaya Anna Yojana. Sugarcane crop has declined over the years despite rising Minimum Support Price (MSP), as the cane mafia denies small farmers the benefit of MSP, causing a shift away from sugarcane. Cane growers not benefiting from MSP The area of our visit is primarily a sugarcane belt. Small and marginal farmers (with land up to 3 hectares) do not realise market price / MSP for their produce. This is primarily due to corruption prevalent in sugarcane mills procurement system. In Hardoi, one of the districts we visited, the Cane Society hands out indents to farmers for supply of sugarcane to crushing mills. The Cane Societies are generally controlled by large farmers, who issue themselves indents in excess of their own capacity to produce, and source the deficit from small farmers. Small farmers, thus denied opportunity to directly supply to the crushers, are thus forced to sell at odd times, to the large farmers.
Figure 85: Small farmers getting caned cannot realise MSPs on their produce because of the cane mafia Demographics of the state Population: 190m HHs employed under NREGA: 4m (2008) Arable land irrigated: 65%
62
Rural India
The labour market is generally weak around October, so small farmers like to bunch their production for this time, but large farmers exploit these conditions better, by manipulating supply schedules to mills. These factors have led to disenchantment among small sugarcane farmers. During our visit, we came across a few farmers who said they are moving away from growing sugarcane to other cash crops, citing corruption in the procurement system.
Figure 86: The situation in Indias most populous state seems to be improving in spite of poor implementation of Government schemes
63
Rural India
Surprisingly good quality of roads: Road building has been surprisingly strong, with good-quality motorable bitumen roads connecting several small villages along the way.
Figure 87: Surprisingly good quality motorable roads
Mid-day meal scheme has helped increase school attendance
Mid-day meal schemenot the only driver for school education: Mid-day meal scheme is a central-government-assisted programme whose objective is to reduce malnutrition and increase school attendance among the poor. From our conversation with villagers, we understood that mid-day meal schemes were working pretty well by and large (though sometimes students get no meals under the scheme for several days, owing to disruptions in grain supply). Contrary to our perception, there is no material drop in attendance on days when meals are not available, according to the school teacher in Ali Nagar Jamri village.
Figure 88: Thrust on primary education seems to be bearing fruit
64
Rural India Figure 89: despite inadequate infrastructure (no lighting / ventilation)
Antyodaya Anna Yojana (AAY) and PDScontrolled by powerful middlemen: This scheme is aimed at providing food security to the poorest of the poor, through the existing Public Distribution System (PDS). Under the scheme, each family is provided 35kg of food grains per month, at subsidised rates (rice at Rs3/kg and wheat at Rs2/kg). The scheme is meant to cover 10 million poorest families from a total of 65.2 million BPL families. We understood from our visits that a large proportion of the intended beneficiaries remain untouched by the scheme. For example, in the village of Ajitpur, which is inhabited by 2,870 families, only 57 families are designated BPL. Villagers also said it is very difficult for them to obtain BPL ration cards. According to the village Pradhan, 60% of the families in the village are below poverty line. This story was repeated in other villages as well.
PDS is beset with leakages engineered by powerful middlemen, thus denying the true BPL families their rightful due
As if this were not enough, the PDS is beset with leakages engineered by powerful middlemen, who corner the BPL entitlements and sell to traders at market prices, thus denying the true BPL families their due. As an example, a ration card holder is entitled to receive 5 litres of kerosene every month. However, they get only 23 litres once in six monthsand that, if they were lucky to be in the BPL list in the first place.
Non-farm income streams are resilient

Zari work an example of stabilising influence on rural income Villages in Rampur district are engaged in handicraft activity. Zari work (gold/silver threading of fabric) is another key occupation besides farming. In the village of Ajitpur (the village we visited), approximately 1,000 out of a total of 2,870 families were engaged in zari work. Zari work is available across the year and fetches wages of Rs100 a day (more for higher skill levels). Normally, more than one person in each family is involved in zari work.
65
Rural India Figure 90: Zari industry is big in villages in Rampur; work at Rs100/day is available across the year
Daily labour rate in the busy season is ~Rs200 and one can earn up to ~Rs400 a day doing multiple shifts
Construction also bolsters non-farm labour income Villagers can get the equivalent of six months work in neighbouring urban areas every year. Typical employment is in mandis (market), construction sites, etc. Daily labour rate in the busy season is ~Rs200 and one can earn up to ~Rs400 a day doing multiple shifts. One of the village pradhans said that farmers with small land holdings (less than 2 acres) concentrate more on labour work than farming.
Figure 91: Labourers can earn up to Rs400 a day
Weak monsoon during sowing and excess monsoon pre-harvest The key kharif crop in the central region of UP is sugarcane, followed by paddy during kharif season and wheat in the rabi season. The parts we visited have received ~30% below average rainfall. Adding to the woe of below-average rainfall was untimely rainfall in the first week of October. Kharif yield of sugarcane is likely to be lower by 10-15%. At the time of our visit, it was early to judge the impact of excess pre-harvest monsoon on the paddy crop. However, some of the farmers told us that losses to paddy crop could be severe. Rabi crop expected to remain normal After 30% deficiency in monsoon rainfall, concerns on its impact on rabi crop were escalating. However, the late monsoon witnessed in the past week will result in increasing ground water table levels. For rabi, the key source of irrigation is ground water. During rabi season, the primary crop is wheat. Rabi crop accounts for approximately 35% of farm income. Sugarcane price increase will offset impact of lower yield The impact of lower yield will be partly offset by higher selling prices. State advised prices for sugarcane and paddy have been increased to Rs165/tonne (up 22%) and Rs1030/tonne (up 14%). Sugar prices in India have increased from Rs15/kg to Rs33/kg over
66
Rural India
the past 16 months. Farmers in the villages we visited expect to sell sugarcane this year at above Rs200/tonne.
Figure 92: Auto dealers have had a great festive season; the only worry seems to be supply of vehicles
67
Rural India
NREGA: Inconsistent interpretation
Only BPL families can apply? NREGA implementation
languishes in UP. In Ajitpur village, we were told that as per their understanding only BPL (below poverty line) families can apply of work under NREGAthough in reality, NREGA is applicable to any adult member of a rural household, irrespective of income status. The only requirement is that the person should be a local of the village (this includes those who may have migrated to work in cities). Incorrect interpretation of permissible work under NREGA: Another misunderstanding is with respect to scope of work covered under the scheme. For example, according to a village pradhan (head man), a pucca (motorable) road can be constructed only if kacha (mud) road of the same length is also constructed. That tractors cannot be used to bring mud for building mud roads was another twist invented by the Development Officer.
Tank bund being under NREGA constructed
Such inconsistencies in interpretation seem to have resulted in low level of interest in NREGA in these villages. In Ajitpur, only 50 people benefited from NREGA and got employmentfor less than 50 days, as against the 100 days guarantee under the scheme. In another village, Asha, employment under the scheme was equally abysmal, at less than 150 in the village of 7,500 inhabitants. Farmers complaining about higher labour cost: NREGA is squarely blamed for the 25% YoY increase in farm labour rates.
Figure 93: Misinterpretation casts a shadow on NREGA implementation
Figure 94: Very few households achieved their full quota

2006-07 No. of households issued jobcard (m) No. of households provided employment (m) % of HHs provided employment Total no. of person-days (m) Average number of days per HH % of households completing 100 days
2007-08 1.52 0.55 36.1% 19.78 36 4.2%
0.80 0.55 68.5% 22.20 41 12.8%
2008-09 2009-10 (till Nov) 4.96 3.42 0.90 26.2% 28.76 32 5.4% 1.77 35.7% 87.07 49.2 8.2%
68
Rural India
Punjab and Haryana

10-12 November 2009 Ludhiana, Fategarh, Kurukshetra, Panipat districts
No blip
Our trips to rural areas in Punjab and Haryana highlighted the resilience in rural consumption trends in areas where irrigation infrastructure and government intervention have nullified the impact of one of the poorest monsoons in the most deficient areas.
We visited the main agricultural belts of India where rainfall deficiency this year was the highest
We visited the eastern parts of Punjab, and northern and central regions of Haryana. All the areas we visited are well-irrigated. Together, these two states account for 20% of Indias paddy output during the kharif (summer crop) season. We chose to visit these two states mainly because we wanted to evaluate the impact of a poor monsoon on agricultural income. Monsoon rainfall in north-west India this year was 35% below average. We also wanted to understand the role government programmes such as NREGA play in a relatively rich state with strong agricultural output. Kharif crop unaffectedirrigation mitigated rain risk Farmers in Punjab and Haryana seem to be much better off than their counterparts in other regions we have visited, particularly northern and western India. All the farmers we met had maintained acreage sown YoY and none of them expected any material change in yields. The main kharif crop grown in this area is paddy. Despite deficiency in rainfall (36% in Punjab and 38% in Haryanaamong the highest in India), farmers sounded very upbeat. Most of them had access to irrigation canals/reservoirs as well as power supply for at least eight hours a day to pump water to their fields throughout the kharif season (paddy fields need to be immersed in water throughout the growing period). This is impressive, given that Punjab and Haryana have among the highest rates of power deficiency in India. Farmers were equally upbeat with respect to their expectations for rabi crop. Punjab and Haryana have published their estimate of paddy output during the current kharif season which indicates a 4% YoY rise in output, a strong contrast to the ~22% YoY decline in paddy output expected from the rest of India.
Figure 95: Farmers in Khamanon (Punjab) growing potato after paddy harvest
Demographics of the two states Population: 45m (~10m HHs) Arable land irrigated: 80% Contribution of agriculture to GDP: ~55% HHs provided employment under BREGA: 0.3m (200809)
69
Rural India Figure 96: Punjab and Haryana are among the most important agricultural regions in India, account for ~20% of paddy and 33% of the countrys wheat output; rainfall has been 36-38% below normal this season, yet irrigation infrastructure is expected to leave rural incomes largely unaffected
70
Rural India
Rabi expected to be stable: None of the farmers we met expected any change in acreage sowing for wheat (the main rabi crop in these regions). Additionally, many parts of the states we drove through, had a third crop (potato mainly) planted between the kharif harvest and the rabi sowingindicating no dearth of irrigation/water availability for the ensuing season.
Figure 97: Farmer in Punjab, preparing for rabi season sowing
Incomes and cost remain stable: Overall, farmers in these states earn incomes (net of costs) of ~Rs20,000/ha from paddy harvest during kharif, ~Rs7,000/ha from sale of potato and Rs30,000/ha from sale of wheat. While input costs have remained mostly stable, availability of fertilisers has improved this year (thanks to improved supply of chemicals in the international market). Most farmers seem satisfied with the quality and quantity of seeds they receive every year from local agricultural universities, their only source of seeds. Two-wheeler dealers indicate improvement in financing We met two-wheeler dealers in both states. All the dealers said sales volumes were up 20-30% YoY this yearthough Hero Honda dealers did say festive season sales were weaker than expected, mainly because of supply constraints caused by vendors strikes in and around Gurgaon. Dealers said there was little weakness in demand. However, amongst the dealers we met, those with predominantly semi-urban customers indicated greater demand strength than those with mainly rural customers. Availability of loans has also improved YoY. One dealer we met said the proportion of loan-financed vehicles had risen from zero last year to over 40% this year. While private sector banks have increased their share YoY, cooperative and PSU banks continue to be the main sources for credit for two-wheelers. Dealers said most buyers of two-wheelers (bikes mainly) are youngsters in the 1822 age group. Stability in incomes over the past five years, availability of credit in lean years (such as this, when monsoons have been deficient) in addition to the urgent need of the target segment, have kept demand relatively robust.
Stability in income and easy availability of credit has driven 20-25% increase in motorcycle volumes
71
Rural India
Contraction in replacement period of tractors has driven strong sales growth in the past two years
Tractor dealers indicate strong market for replacement demand Tractors sold in these two states are used mainly for agricultural purposes. Dealers said there has been a contraction in the replacement period for tractors (from 10 years earlier to 3-5 years now). This has supported growth in demand for tractors during the past couple of years. Also, a large proportion of their customers buy tractors on cash (~80% for the dealers we met). An improvement in the credit environment is likely to further propel demand for tractors.
Figure 98: Tractor dealer at Kurukshetra has had a good season
Additionally, a shift in demand towards higher-power tractors (from <20HP to >40HP) has supported an increase in the value of tractors sold. While the size of farm holding has actually gone down over the years (a function of families land-holding declining over generations as the land gets split), tractor dealers said the rise in demand for higher-power tractors is mainly due to the status factor.
Figure 99: Punjab farmers have a clear preference for larger tractors (>40HP)
FMCG dealers indicate strong growth despite price hikes FMCG wholesalers and distributors we met said there has been no slowdown in the high growth rates seen in the past 12 months. The early onset of winter in north India also seems to have spurred demand for winter-care products such as creams and lotions.
72
Rural India
Wholesalers felt that price hikes taken by most companies have not dampened purchasing. On the negative side, they indicated that the number of new launches has increased in the recent past, and this has made it difficult for them to manage old and new products from the same brand.
Figure 100: Dabur sub-dealer in Kurukshetra has 60% sales to rural areas
No slowdown in high growth in sales of FMCG goods seen in the past 12 months
Figure 101: Wholesaler in Panipat has seen no slackening of demand
High land prices add further to economic prosperity Farm land prices in Punjab and Haryana have risen significantly in the past 3-4 years. Price for an acre of land now ranges from Rs2 million to Rs10 million. Most dealers pointed out that this high valuation has added a feeling of economic security to consumers, who are less worried about temporary blips in income. Farm labourers incomes have increased by 50-100% Farm labourers daily wages have increased from Rs70-100 a few years ago to Rs150-200 now. Most farmers also said there has been a significant drop in labour arrivals from states like Bihar and Uttar Pradesh, as wages in those states have also become attractive. Besides, NREGA is providing income for unskilled labour in those states. Thus, the differential gain for labourers from Bihar and Uttar
73
Rural India
Pradesh to come and work in Punjab has come down. Higher wages have enabled farm labourers to own gadgets like mobile phones.
Figure 102: Harvested paddy laid out in a grain mandi in Haryana
NREGA: little reason to seek employment guarantee
Agriculture offers sufficient employment: Most villagers in
NREGA has had little effect on farmers in Punjab & Haryana, except that labour availability has declined
the states of Punjab and Haryana are either land-owners or are well employed in farms. Even in a year with steep monsoon deficiency (~37% this year), farmers were sufficiently employed, thanks to the irrigation infrastructure, so there was little demand for alternative employment. Additionally, thanks to the soils fertility and infrastructure availability, agriculture provides employment throughout the year: farmers here sow both kharif and rabi crops, and in some cases even a third crop in the interim. Punjab also has the lowest poverty rate in India (as of 1999-2000 estimate) at ~6%, which could explain the low demand for employment under NREGA. Awareness low: As against our observations in other states, very few people we met had even heard of NREGA. There were very few boards on display highlighting the features of the scheme. Most of the gram panchayat heads or senior villagers were involved more in issues relating to production and trade of soft commodities, than in identifying projects under NREGA. Success of NREGA elsewhere pinches Punjab and Haryana; farm mechanisation to rise: While the states of Punjab & Haryana themselves were little affected directly by emoluments paid under the scheme, the farmers/land-owners indicated that labour availability (traditionally from the states of Bihar and UP) had gone down. Migration from these states during the cropsowing season has been on the decline for a couple of years as labourers in these states have found opportunities closer home. As a result, wage rates in the states have almost doubled in the past two years (from Rs70-100/day a couple of years ago to Rs150-200/day now). This has also increased demand for mechanisationa trend that is likely to continue.
74
Rural India Figure 103: NREGA implementation is very poor in Punjab and Haryana
% NREGA penetration 0.35 (% of rural HHs) 0.30 0.25 0.20 0.15 0.10 0.05 0.00 Punjab Haryana India (days p.a/HH) 60 50 40 30 20 10 0 Avg days p.a per HH (RHS) 70
Source: Government of India, IIFL Research
Figure 104: Very little initiative towards enrolment in NREGA

Number of households issued job cards (m) Number of households provided employment (m) % of HHs provided employment Total number of person-days (m) Average number of days per HH % of households completing 100 days
2006-07 0.10 0.00 0.07% 0.00 34 4.00%
2007-08 0.20 0.01 4.3% 0.27 31 2.62%
2008-09 2009-10 (till Nov) 0.95 0.95 0.14 15.% 4.64 32 4.14% 0.11 11.3% 2.85 27 2.24%
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Rural India
Tamil Nadu
25-28 October 2009 Kanchipuram, Tiruvallur, Chidambaram districts
Price rise takes care
Our visits to Tamil Nadu indicated the support farmers have derived from the growth in pricing for soft commodities, coupled with the stability in incomes derived from diversification of incomes. While volume of agricultural output could be slightly lower YoY, the strong increase in prices for kharif crops (mainly paddy) in the South will support a 5-10% YoY growth in farm incomes. Additionally, share of income from livestock has gone up from 5% to ~10% prices for which have remained fairly stable.
Agricultural production is likely to decline very modestly by <5%
Demographics of the state Population: 66m (14m HHs) HHs provided employment under NREGA: 3.3m (2008) Arable land irrigated: 50%
YoY given that this region witnessed no deficiency in rainfall through the monsoons season (deficiency during the peak sowing season was higher at ~10%, which caused a decline in acreage sown; subsequent recovery in monsoons has protected yields, thus leading to <5% YoY decline in production). Over the past decade, the rural populace has diversified their incomes sources availability of alternatives sources of income from new industrial projects has increased given the governments thrust towards attracting manufacturing set-ups in the state. Additionally, Tamil Nadu has witnessed a sprouting of BPOs in the rural areas (we met young graduates in the Cuddalore district who are trained to operate local-language call centres). In the rural districts we visited, the local population indicated that at least 20% of all labour derives income from non-farm sources (mainly through employment in manufacturing and services companies). Livestock farming has gained popularity, especially with the rise in demand for meat based food over the past decade. Prices for poultry chicken in India has remained stable rising ~3% YoY during the past year. Livestock, while somewhat adversely impacted by an adverse monsoon (due to lower availability of fodder), farmers in this state indicated that the increase in rainfall post-Sep has supported stable fodder availability for their livestock.
Figure 105: India poultry prices have remained stable during the past 2 yrs
India w holesale price index for poultry chicken 110 (Index rebased to 2001) 100 90 80 70 60 Jan-05 Jul-05 Jan-06 Jul-06
Source: CSO, IIFL Research
Jan-07 Jul-07 Jan-08
Jul-08 Jan-09 Jul-09
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Rural India Figure 106: Non-farm sources of rural income have increased in importance
77
Rural India
NREGA: untimely employment leads to wage spiral
Awareness high: Awareness about the scheme and the

minimum wages to be paid under the scheme was quite high. The local governments have been very active during the past 12 months in communicating features of the scheme, thus increasing interest in the programme (which was otherwise very low during the past two years). Labour rates have spiralled: Thanks to NREGA implementation, many villagers have been offered wages during the peak sowing season and harvest season, causing a hike in labour rates for land owners. Although farm owners tend to pay daily (as against a lag of 30-60 days in the case of NREGA), villagers here seem to prefer the easy work supported by employment under NREGA. As a result, labour costs for farming have gone up from ~Rs100/day a couple of years ago to Rs140160/day.
Figure 107: NREGA has recently picked up in the state

Number of households issued jobcard (m) Number of households provided employment (m) % of HHs provided employment Total number of person-days (m) Average number of days per HH % of households completing 100 days
2007-08 0.1 0.0 0% NM NM NM
2008-09 5.9 0.3 4.6% 7.7 29 2.8%
2009-10 (till Nov) 5.9 2.8 47.0% 76.5 28 0.0%
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Rural India Appendix: How NREGA works
Workers can withdraw money from bank accounts Rural household Application for jobs Issue job cards, allot work, open bank accounts Bank Send details of payments
Gram Panchayat (GP) Application for jobs made to the GP Job cards to be issued by GP within 15 days after verification Projects for the village would be recommended by the GP GP to execute at least 50% of projects Allotment of works to workers done by GP Preparing and maintaining of all records GP should open the accounts of all workers free of cost Submit plan of works May send back works plan if found not feasible
Intermediate Panchayat (IP) Consolidates planned works at the block level Recommends works for the block level, like interconnected roads
Submit plan of works
Check feasibility of plans, release muster rolls, issue wage slips
Program Officer (Block level government implementation officer) Issues muster rolls for payment of wages, with name of worker, days worked and amount paid. Should have the thumb impression/sign of the worker Issue wage slips to every worker Payment of unemployment allowance Scrutinize planned works for technical feasibility and give approval Disposal of complaints, grievance redressal Report plans and payments Release funds, monitor works
District Program Coordinator (District level government officer) Release and utilization of funds for NREGA at the district level Consolidation of all block plans Monitoring of works being carried out
Source: NREGA guidelines document
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Rural India
Key to our recommendation structure BUY - Absolute - Stock expected to give a positive return of over 20% over a 1-year horizon. SELL - Absolute - Stock expected to fall by more than 10% over a 1-year horizon. In addition, Add and Reduce recommendations are based on expected returns relative to a hurdle rate. Investment horizon for Add and Reduce recommendations is up to a year. We assume the current hurdle rate at 10%, this being the average return on a debt instrument available for investment. Add - Stock expected to give a return of 0-10% over the hurdle rate, ie a positive return of 10%+. Reduce - Stock expected to return less than the hurdle rate, ie return of less than 10%. Published in 2010. India Infoline Ltd 2010 This report is for the personal information of the authorised recipient and is not for public distribution. This should not be reproduced or redistributed to any other person or in any form. This report is for the general information of the clients of IIFL, a division of India Infoline, and should not be construed as an offer or solicitation of an offer to buy/sell any securities. MICA (P) 024/11/2009. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, so far as it relates to current and historical information, but do not guarantee its accuracy or completeness. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. India Infoline or any persons connected with it do not accept any liability arising from the use of this document. The recipients of this material should rely on their own judgment and take their own professional advice before acting on this information. India Infoline or any of its connected persons including its directors or subsidiaries or associates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained, views and opinions expressed in this publication. India Infoline and/or its affiliate companies may deal in the securities mentioned herein as a broker or for any other transaction as a Market Maker, Investment Advisor, etc. to the issuer company or its connected persons. India Infoline generally prohibits its analysts from having financial interest in the securities of any of the companies that the analysts cover. In addition, the company prohibits analysts from conducting F&O transactions or holding any shares for a period of less than 30 days.
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Rural India

Did you know?

Government spend on rural programmes

Based on 2001 census, 78m of the 134m

About 35% of the governments rural

Wastage under NREGAat 2040%is

Almost 17% of Indias rural population

The XI Five-Year Plans target is to bring

Only 14% of households employed under

Aggregate rural consumption expenditure

During 1999-2007, rural spending on non Rural penetration of motorcycles, at 10%,

food items grew at 2.5x that of food spend. urban

Wages under the NREGA scheme can be

Rural penetration of toothpastes and

Direct transfer of funds to recipients bank

Fifty-six percent of Bharti Airtels and

Figure 2: NREGA spend has been focussed on irrigation

NREGA AIBP (Irrigation)

Figure 4: Rural penetration is still low across consumption categories

Urban penetration 93% 90% 80% 67%

250,000 200,000 150,000 100,000 50,000 0

Source: Department of Agriculture, Mahindra & Mahindra, IIFL Research

Figure 5: Rural population offers a potentially huge market opportunity

Source: NCAER, IIFL Research

Source: Census of India, IIFL Research

Racing across the countryside

Source: IIFL Research

Stocks to play the rural consumption tune

Rural India to see sustained govt support

Significant acceleration seen in govts rural spend

FY05 1.4 1.1 0.5 1.3 2.5 6.8

FY06 2.5 1.2 0.8 2.1 2.5 9.1 35.1%

FY07 2.7 1.3 1.1 3.2 2.6 10.9 19.8%

FY08 3.0 1.7 2.3 4.2 3.4 14.6 33.5%

FY09 7.8 2.7 3.2 4.5 4.6 22.9 57.0%

Figure 9: Agriculture and rural infrastructure have seen significant improvement

Source: Department of Agriculture, Planning Commission, NCAER, IIFL Research

Source: IIFL Research

Source: IIFL Research

Q&A with C P Joshi, Minister for Rural Development

NREGA progressing at a brisk pace

Figure 12: Spending rising steadilyNREGA is a pet project of the government

Source: NREGA website, IIFL Research

Un-skilled wages 70%

Raw materials 25%

Source: NREGA website, IIFL Research

Guaranteed min no. of days per HH pa

Figure 17: So far, NREGA penetration has been highly uneven

NREGA: field visits reveal challenges as well as upsides

The NREGA goose can lay a few more golden eggs

Source: NREGA Website; IIFL Research

NREGA spend will reach US$21bn by FY13

FY09A 45 48 2,147 127 5,798

FY13ii 79 66 5,250 186 20,758

Unique ID: inclusive growth must start with identity

PDS: an instructive study in contrast

Bihar Punjab Karnataka UP All India Average

8.9% 10.5% 29.1% 32.5% 27.0%

Source: Planning Commission (Government of India), IIFL Research

Source: IIFL Research

Rural education: a major focus area

Source: IIFL Primary Research

Road connectivity: the backbone