India: rural wages surge --- to support consumption but pressure food inflation:: JPMorgan

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��

India: rural wages surge --- to support consumption but pressure food inflation

Recently available data indicates that nominal wage inflation in rural India has accelerated sharply post-NREGA, and is currently running at over 20 % on a year-on-year basis This has translated into a sharp rise in rural real wages which are growing at more than 13 % oya in 2011 Sharp and sustained real wage growth is likely to keep rural consumption buoyant and provide a key support for GDP growth in FY12, allaying fears that growth will slip below 7% this fiscal However, the sustained increase in rural real wages is also likely pressuring food inflation through higher food demand and increased unit labour costs at the farm gate With real wages accelerating sharply in 2011, food inflation is likely to stay structurally high and unlikely to abate much from current 8-10 % levels   Analysis by anecdote   There has been a growing consensus that the advent of the National Rural Employment Guarantee Act (NREGA) has been responsible for pushing up all rural wages. Strong rural wage growth, in turn, has been presumed to underpin strong rural consumption over the last few years. But increased rural consumption and changed consumption habits – in the case of food, in particular – has also pressured food inflation as supply has been unable to meet the growing demand.   While this chain of events is broadly accepted by policymakers and market participants alike, the problem is that it has so far been largely predicated on anecdotal information. In the absence of a comprehensive time-series of rural wage data thus far, there has been much hand-wringing on the extent to which rural wages have actually risen and how pervasive this phenomenon really is.   As a result, key questions have remained unanswered, thus far. Was the NREGA effect a one time increase in wages or has wage inflation continued to sustain? Would strong rural wage growth be able to sustain in a slowing economy? As a consequence, is rural consumption -- and food inflation – posed to moderate in any significant way?   Rural wage data shows a seismic shift, post-NREGA   A comprehensive time series of rural wage data – both agricultural and non-agricultural – put together by the Ministry of Statistics and Program Implementation has recently become available and is able to provide key insights into many of these questions.   There are several conclusions one can quickly draw. First, the advent of NREGA has resulted in a significant structural break in rural wage inflation. The numbers are truly striking. Between 1999 and 2005, pre NREGA, nominal wages in the rural economy grew at an average annual rate of 2.7% oya. Post NREGA, average wage inflation almost quadrupled to 9.7 % oya between 2006 and 2009.   What’s more, wage inflation continues to accelerate. Between January 2010 and May 2011 (the last date for which this data is available) annual nominal wage growth averaged almost 20% (18.8 % oya). But even these averages are misleading, because nominal wages have shown a sharp and secular acceleration over the last 18 months, with wage inflation reaching almost 22 % by May of 2011. While the increase in wages in 2011 is, in part, likely a result of NREGA wages being indexed, a sharp acceleration of wages was evident through most of 2010 – even before indexation was announced or came into effect. As a result, indexation in 2011 has simply exacerbated this phenomenon.       What’s more, this phenomenon is pervasive. It is not limited to just a particular gender or a particular sector of the rural economy. Since January 2010, for example, agricultural wage inflation has averaged 20.2 % oya while non-agricultural rural wage inflation has averaged 16.7 % oya. Wage growth for men in the agricultural sector has averaged 19.7 % oya while that for women has averaged 20.8% oya.           But it’s not just NREGA   The advent of NREGA in 2006 has clearly been the key catalyst in driving up nominal wages in the rural economy. By becoming the reservation wage in districts where public work programs exists, NREGA has, by all accounts, exerted upward pressure on all rural wages. Furthermore, as NREGA has increasingly proliferated through the country in the years since 2006, the average national rural wage has likely increased commensurately, explaining why rural wage inflation has sustained in the years after 2006.   However, the fact that annual nominal wage growth continues to be close to 20% in 2010 – several years after the NREGA was instituted and before NREGA wages were indexed – suggests that wage inflation is not being influenced by NREGA alone. Instead, a rural infrastructure thrust over the last few years, higher minimum support prices year after year, and increased “urbanization” of the rural economy have likely driven up the demand for rural labour and also contributed to the sharp wage inflation   Too much of a good thing: wage inflation pressures food inflation   The dramatic increase real rural wages and incomes (more about real wages below) is a clear manifestation that the benefits of economic growth over the last several years have filtered into the rural economy and that growth is becoming more inclusive as a result.   However, there have also been several unintended, and undesirable, consequences on account of this dynamic. As alluded to above, the rise in rural wages and incomes have likely contributed to the structural increase in food inflation over the last few years. This has happened through two channels:   First, rising nominal (and real) rural wages and incomes have resulted in increased food demand by rural families. With supply relatively inelastic, this increased demand for food has pressured food inflation.   Second, as discussed above, the rise in rural wages likely reflects the presence of an NREGA reservation wage more than it does commensurate increases in productivity. As a result, unit labour costs have likely risen in the rural economy and increased input costs at the farm-gate. In turn, farmers have been compensated with higher minimum support prices for key crops – which has contributed to keeping food inflation high. Rising rural wages have therefore contributed, both directly and indirectly, to keeping food inflation high.   As an aside, rising real wages in the rural economy have also resulted in reduced migration to urban areas, putting upward pressures on urban wages – and therefore input costs more generally – in key sectors that compete for unskilled, rural labour.       With wage inflation accelerating sharply over the last year, it is no surprise that food inflation continues to hover close to the 10% mark – even higher than the 8% “new normal” observed between 2006 and early 2009 – despite two successive normal monsoons and record harvests over the last 18 months. Given the continued strength of real wage inflation, it is unlikely that food inflation will abate significantly from the 8-10 % levels.   With food inflation largely out of the purview of what monetary policy can directly impact, the central bank will have to ensure that core inflation moderates commensurately more to keep the headline rate in its desired range.     An institutionalized wage-price spiral   As if the pressure from rural wages to food prices was not enough, the desire to index NREGA wages to inflation has effectively institutionalized the wage-price in the rural economy. Higher food inflation will now automatically translate into high nominal wage inflation which, through the channels mentioned above, will come back to pressure food inflation, resulting in the vicious wage-price cycle currently being played out.         Strong real wage growth to keep rural consumption buoyant   With agricultural and rural CPI inflation (which have a very large weight of food and beverages) also accelerating along the time that nominal rural wages began to rise, it is legitimate to wonder if sharp nominal wage inflation translated into commensurate growth of real wages over the last few years – since this is ultimately what matters in driving food demand and consumption, more generally.   As it turns out, the trajectory of real wages mimics that of nominal wages, particularly since 2010. Real wages were essentially flat (annual average growth of 0.1 %) between 1999 and 2005. Post NREGA, real wages growth averaged 2% oya between 2006 and 2009, suggesting that the impact of rising nominal wages was offset by the food inflation that existed as a result. However, post January 2010 real wage growth has been on a sharp and secular ascent rising to about 10 % oya by December 2010 and accelerating further to 14% by May 2011. Indexation of NREGA wages was meant to preserve the real value of NREGA – and therefore rural – wages. Far from merely being preserved, real wages have surged month after month for the last 18 months.         Given the high marginal propensity to consume out of income by rural households, the sharp growth of real wages and incomes likely boosted consumption (particularly consumer non-durables) over the last few quarters, and is likely to provide a key support for consumption and growth going forward. (We will soon be putting out a more detailed analysis on the likely drivers and outcomes for GDP growth this fiscal). For example, the sharp growth of real wages over the last year ties in well with the pick-up in consumer non-durable production since the beginning of 2011.       In sum, in an environment where export growth is likely to moderate significantly, and there are no signs that the investment cycle will pick-up meaningfully before the current macroeconomic uncertainty resolves, buoyant consumption growth – underpinned by buoyant wage growth – is likely to provide a key support for GDP growth this fiscal and ensure that growth does not slip below 7% for FY12 (JP Morgan Forecast: 7.6 %) as is feared in some quarters.