New rural index shows early signs of recovery from drought-driven slump

A slew of govt measures is driving sector's revival; however, demonetisation has worked as a speed bump

India’s rural growth appears to be picking up. It’s hard to overstate the importance of the rural economy -- its ups and downs determine broader growth and hold the key to political stability. Tracking rural activity though, is challenging given the dearth of data. The closest proxy --quarterly agricultural growth -- is released with a lag of two months. To fill this gap, Bloomberg Economics has created an India Rural Output Index -- a composite monthly gauge consisting of supply- and demand-side indicators that goes beyond agriculture to get a comprehensive view on the rural economy.

The latest signals are encouraging -- pointing to a turnaround from a drought-driven slump in 2014 and 2015 and shock from demonetisation in 2016. Normal rainfall in 2016 and 2017 helped revive activity, and the outlook for another year of good rains bodes well for 2018. In this note, we introduce the rural tracker in detail. 

Rural Tracker Shows Early Signs of Recovery

Nearly two-thirds of India’s population and 70 per cent of its workforce reside in rural areas, which accounts for nearly half the country’s output. A revival in rural activity would increase Prime Minister Narendra Modi’s chances of re-election next year. Modi aims to double farmers’ incomes over a seven-year period by 2022. That is proving to be tough, but it has put a spotlight on income gaps -- farmers’ incomes have languished at around one-third those of non-agricultural workers since the early 1980s.

Over the last few years and in the budget proposal for fiscal 2019, the government has put a greater focus on empowering farmers and rural households. Among the measures are free cooking gas cylinders, fast tracking the goal of connecting all villages to the electricity grid, agriculture marketing reforms, farm insurance subsidies, and higher support prices for agricultural produce. All of these bode well for the outlook of the rural economy.

Rural Tracker Correlates Well With Agriculture GDP

The chart above shows the rural tracker has a high correlation with agriculture GDP growth, varying between 0.6-0.8 over time. A recovery that started at the end of 2016 was interrupted by demonetisation, which dealt a blow to the largely cash-based informal economy. Rapid remonetization and a record harvest on normal rains in 2017 led to a revival.

Rural output growth and its components

The rural output index combines seven monthly activity indicators that track the health of the rural economy from the supply and the demand side. Three of the indicators focus on the agricultural economy, and four on the non-agricultural aspect of the rural economy.

Agriculture-focused components:

• Amount of rainfall: The Southern Oscillation Index, published by the Australian Weather Bureau, is the best proxy for tracking rainfall and consequently agriculture production in India. A sustained value of -7 or lower indicates a likely El-Nino event (drought in India), a sustained value of +7 or higher indicates a La-Nina event (surplus rainfall in India), and a reading in between indicates normal rainfall in India. The value is currently at -1.2, and the latest outlook issued by the bureau suggests normal rainfall during the 2018 monsoon season from June to September. The correlation with agriculture GDP varies over time in a range of 0.5 to 0.7.

Favorable Rainfall Revives the Rural Economy

• Agriculture trade balance: This variable uses detailed data on imports and exports, and aggregates the items under the agriculture and allied products group to compute the agricultural trade balance. During the drought years of 2014 and 2015, India’s import requirements increased, causing the trade balance to deteriorate. Record production over the last two years though, is boosting exports. The correlation between the agriculture trade balance and agriculture GDP varies in a range of 0.3-0.6.

Higher Agriculture Production Improves Trade Balance

• Tractor sales: Tractors are a key input in agriculture mechanization, and tractor sales serve as a proxy for investment on the demand side and capture retail trade services on the supply side. The correlation with agriculture GDP has increased from 0.3 over our historical sample (2005-2017) to about 0.7 over the last five years. Increasing mechanization in agriculture bodes well for productivity.

Rising Tractor Sales a Positive for Agriculture Productivity

Non-agriculture rural based components: 

• Real rural wage growth: This consumption proxy averages nominal rural wages for agricultural and non-agricultural occupations. This is deflated using inflation faced by rural labourers. Wage growth remained robust during demonetisation likely due to the good harvest increasing demand for labour. In the absence of demonetisation, wage growth could have been higher. Data on nominal wage growth is available with a lag of more than three months. For timeliness, we assume nominal wage growth remains unchanged from the last available value.

• Two-wheeler sales: This is another proxy for rural consumption. More than 50% of all two-wheeler sales are made in rural areas, according to industry sources. Sales were hit in the wake of demonetisation but have picked up in recent months.

Demonetisation - a speed bump for rural recovery

• Real change in currency held by public: This is the closest proxy available to capture transactions demand for money in rural areas given the high dependence on cash. With demonetisation rendering 86% of the currency in circulation invalid in November 2016, we mute the impact of this variable on the rural tracker until July 2017 to avoid wide fluctuations. Even so, evidence suggests that a shortage of currency over the period had a substantial negative effect on the informal rural economy that is not captured in our tracker.

• Government rural expenditure: Government rural expenditure is constructed as the sum of central government expenditure made through key rural ministries -- the Ministry of Rural Development, Ministry of Agriculture and the Ministry of Tribal Affairs. As it tends to be lumpy, year-on-year growth tends to be highly volatile. The data available since April 2012 show a slowdown following demonetisation, and more recently a rising trend.

Government Expenditure Picking Up Again Post demonetisation