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Emerging Markets

India’s rural gamble

The chances of the Congress-led coalition returning to power with an easy majority are slim, despite its emphasis on the rural economy. But whoever clinches victory will face a burgeoning fiscal deficit that is already a drag on India’s growth

The chances of the Congress-led coalition returning to power with an easy majority are slim, despite its emphasis on the rural economy. But whoever clinches victory will face a burgeoning fiscal deficit that is already a drag on India’s growth.

Although economic data coming out of India continues to disappoint, with industrial production and export growth contracting, the rural economy – home to 700 million people or 70% of the country’s population – appears to be performing well. Indeed, robust domestic demand, driven in large part by a buoyant rural economy, has shielded India’s economy from the full extent of the global financial crisis.

The Congress-led coalition government is betting on the rural vote to help it return to power in the ongoing elections that conclude on May 13, 2009. Despite the fact that the Bharatiya Janata Party’s (BJP’s) “India Shining” slogan backfired spectacularly in the 2004 election, the Congress party is holding onto the belief that this time around its “Bharat Shining” campaign – a reference to India’s vast rural hinterland – will pay off. During its five-year term, the government’s policy emphasis has been on the rural economy and the “common man”. Even the recent fiscal stimulus packages have been skewed towards the farm sector and not recession-struck industries – a clear indication that politics is driving fiscal policy.

Partly as a result, the average expansion in agriculture GDP over the past four years has been twice that of the preceding four years. This growth has also become less volatile for reasons that include a declining dependence on farm income and a series of good monsoons that is expected to extend through this year as well.

Data on rural income growth are hard to come by, but a number of factors point to increased rural prosperity. Chief among them is the Congress-led government’s flagship programme, the National Rural Employment Guarantee Act (NREGA) – implemented in 2006 and broadened to cover the entire country in FY09 – that promises 100 days of work in a year to one member of every poor rural family. Other, arguably populist, measures to boost rural incomes are the Rs700 billion ($14 billion) farm loan waiver and increases of up to 40% in the minimum support, or floor, prices of cereals, such as rice and wheat, over the past two years.

The government’s push to build special economic zones during the recent economic growth boom also put money in the pockets of farmers as industrialists rushed to acquire land. An increase in non-farm employment in villages and small towns as companies seek to tap the purchasing power of rural consumers has also helped cushion to some extent volatility in agricultural growth. All these rural drivers bode well for overall domestic demand. Market strategy consultant Rama Bijapurkar and National Council for Advanced Economic Research (NCAER) senior fellow Rajesh Shukla, recently estimated that rural India accounts for 56% of India’s national income, 64% of spending and a third of total savings.

First signs of a growth revival

Improved rural prosperity combined with lower interest rates and the government’s focus on the infrastructure sector are providing some hope of an economic revival – or at least signs of a bottoming-out. Sales of cars and two-wheelers – an important indicator of consumer sentiment – have picked up after a difficult year in 2008. The green shoots of recovery are visible in sectors that are relatively protected from the global financial crisis, such as “fast moving consumer goods” companies, healthcare and telecom. In fact, companies in these sectors have seen much smaller erosion in their market capitalization during FY09.

There are some indications of a nascent revival in the steel, cement and agriculture sectors as well, with pricing power returning to producers. Although stocks of infrastructure-related companies have taken a hit due to the global liquidity crunch, government incompetence remains the key problem area in this sector, not demand. Strong recent bidding for state highway projects by some proactive state governments shows that investors are still interested in putting their money into well-structured projects.

The elusive rural vote

But it is far from clear whether the relatively buoyant rural economy will translate into votes for the Congress party and its allies. Current trends suggest that the outcome of the national polls will be as fragmented as the previous election in 2004 – if not more. The ruling coalition has to combat the strong anti-incumbency sentiment that has historically driven the Indian electorate. Five of the last six national governments have been voted out, while three of five state governments have faced a similar fate since 2004. Meanwhile, prospects of the major national opposition BJP are being constrained by a shortage of allies and a lack of opportunities for political growth.

On the economic front too, the Congress coalition faces significant risks. The broader economic slowdown may be negatively affecting the rural economy; there are anecdotal reports of reverse migration taking place as people return to their villages after having lost their jobs in urban areas in export-oriented sectors, such as gems and jewellery.

Perhaps more importantly, the continued increase in food prices could cost Congress votes in both urban and rural areas. The higher prices are driven in part by the Congress’s own initiatives to boost minimum

support prices and rural incomes. The government is hoping that anti-incumbent sentiment stoked by inflation will shift to state governments, and according to media reports there is some evidence that the strategy is working.

The Congress-led coalition has had to face inflation several times during its five-year tenure, resulting in losses in a few state elections, such as Punjab and Uttarakhand in early 2007 that were directly blamed on rising prices. While the headline wholesale price index inflation number is hovering around zero, inflation for primary articles has only recently started to ease after remaining in the low double-digits for much of 2008 and early 2009.

A better indicator of high food inflation is the consumer price index: all three components of CPI in India show persistently high inflation. Much of that is due to rising food prices: the weighting of food in the CPI for industrial workers is 47% and almost 70% in the inflation gauge for agricultural labourers. In comparison, the food products basket comprises about 15% of the WPI. High food prices particularly hurt those not engaged in farming: NCAER’s Shukla found that only half the people in rural areas directly earn their income from agriculture, down from 73% in the 1970s.

A divided house

As a result, the Congress’ bet on the rural sector may not pay off. The indications so far are that the parliament will remain divided, with none of the major coalition arrangements winning a clear majority.

As in 2004, there will be juggling around of coalition partners once the results are announced on May 16. For now, regional parties are keeping their options open and would prefer to form a third front in which neither the Congress nor the BJP are the dominant parties. However, such an arrangement would be chronically unstable due to infighting and destabilization by national parties.

A weak coalition government is a very likely prospect. The increasing regionalization of politics and the presence of multiple parties at the state and national level are making it harder for voters to ascribe the success or failure of policies. According to anecdotal reports, various parties in the political hotbed states, like Uttar Pradesh, woo voters by handing out money and material items, such as clothes, to entire villages. In return, families in the village usually divide up their vote between different political parties.

This sort of election-related spending, though, is yet another fiscal stimulus for the economy, especially in the rural areas. The Center for Media Studies (CMS) estimates total expenditure for the 2009 parliamentary elections at Rs.100 billion ($2 billion), more than double the Rs45 billion that was spent in the 2004 polls. Of the Rs.100 billion, CMS says at least a quarter of the spending is in the form of “unofficial money” used to purchase votes. Such cash flow in the economy is likely to increase consumer spending in the short term.

The bottom line is that the chances of the Congress-led coalition returning to power with an easy majority are slim, despite the emphasis it has placed on the rural economy. The increasing regionalization of India’s political system points to a divided parliament once again and possible instability if the verdict is even more fractured than in the past.

Challenges for the new government

No matter which arrangement of parties forms the next government, it will be hard-pressed to control the fiscal deficit and face the fact that the current slowdown is more than just a cyclical downturn, and growth is unlikely to return soon to the 8–9% levels of recent years. The current government has already blown its legislated target of keeping the budget deficit below 3%. Indian officials say that the extra spending is only a short-term crisis-related measure and they will quickly get back on track once the economy stabilizes.

However, those statements ignore the fact that the improvement in India’s fiscal position over the past three years was mainly due to buoyancy in tax revenues, which coincided with the spectacular 9% plus GDP growth. With the end of the bubble-related growth rate, the government will not be able to reduce its deficit without undertaking significant spending reforms, especially on below-the-line subsidies on oil, food and fertilizers.

The task of fiscal consolidation will be further complicated by the spending promises all the parties made during the elections. The Congress, for example, has promised to provide 25kg of rice or wheat per month at Rs3/kg ($0.06) to poor families. The main opposition BJP has gone even further, pledging to provide 35kg of rice or wheat per month at Rs2/kg.

Electoral promises do not always translate into government action, but given how the current set of policy-makers squandered the opportunity to implement expenditure reforms when the going was good, there is little hope for fiscal consolidation now. Although India will remain one of the world’s fastest expanding economies, with enough domestic drivers to turn in GDP growth numbers of around 6% by FY10, its fiscal deficit will constrain its growth potential and limit the scope for further economic and financial reforms.

Shumita Sharma Deveshwar is director of India Research at Trusted Sources

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