The sudden drop in growth rates for multiple consumer focused companies for the Mar 19 quarter has come as a shock for investors and analysts alike. Yet the reasons for this slowdown were neither unknown nor difficult to understand, which were: a) rural distress and b) NBFC liquidity crisis.

Several companies in the consumer non-durables space have reported that depressed growth in rural income has led to a lower demand in Q4 FY19. HUL reported a 7 percent volume growth in the March quarter–the lowest in six quarters–largely due to a moderation in demand from rural area. “The macroeconomic data is also showing that rural demand has moderated,” Sanjiv Mehta, Chairman and Managing Director, HUL said. Dabur Ltd said “earnings were hit by rural distress and demand slowdown which affected volumes in food and juices category. Growth was slightly lower than the previous quarter due to prolonged winter season and a general slowdown in demand due to agrarian distress and liquidity crunch.” The chairperson of Godrej Consumer said: “We delivered a relatively weak performance in the fourth quarter of the fiscal year 2019. Our India business remained soft on account of a general slowdown in staples consumption and the adverse impact of the delayed summer on our portfolio”.

India’s fast moving consumer goods (FMCG) industry is likely to grow at a slower pace at 11-12% in 2019, almost 2% lower than that in 2018, says a report by Nielsen. The industry is also expected to grow at 12-13% during the April to June quarter of the calender year 2019, according to Nielsen. “While slight drop is witnessed in urban growth, there is a significant softening of growth trends in rural which is dampening the overall FMCG industry growth from third quarter of 2018 to first quarter of 2019. Historically, rural has grown 3-5% points faster than urban and the recent slowdown in rural growth has brought the growth closer to the urban growth.

Now let us turn to consumer durables:

Passenger car industry grew just 3 per cent in 18-19, the lowest in the past 5 years. Car buyers’ sentiment has tanked in urban markets in past 3 quarters. Maruti, which sells one out of every two cars sold in the country has reported an 8 per cent drop in urban sales in Q4, preceded by -1 per cent in Q3 and -3 per cent in Q2. Rural car sales are still in the positive, but slowed to just 2 per cent in Q4 against 15 per cent in Q3. CMIE’s consumer durables index for December, 2018 was at its lowest in the past 4 quarters.

Bajaj Electricals’ Shekhar Bajaj said: “As a company, we are not finding much of a slowdown. Our growth has been anything 22-23% in consumer durable. The consumer durables space — that is appliances and fans – has grown even faster.”

As per Asian Paints “The Automotive coatings JV (PPG-AP) growth was impacted as a result of the slowdown in the Auto OEM segment”. Voltas’ revenue from the Unitary Cooling Products for Comfort and Commercial Use segment in Q4 FY19 was down 6.28 per cent YoY to Rs 997.57 crore as against Rs 1,064.49 crore.

Disbursements at Shriram Transport Finance declined by 21% YoY as the new vehicle loan book growth continued to shrink on slowdown in activity and uncertainty around elections. The company had to adjust disbursements affected by tight liquidity and the weakening demand in commercial vehicle segment.

That rural distress is a root cause for slowdown in consumer non-durables as well as durables is evident from the statements made by diverse companies. But what is also clear is the optimism shown by most companies, and Nielsen, saying that the demand should pick up post-election and the Apr-Jun quarter should see better numbers. However, assessing trends in rural income is something that is best left to experts who are far better equipped to analyse this. But it should be noted that this rural distress has come in the wake of record mop up of grains and cereals under MSP and loan write offs in several states. These actions were expected to infuse liquidity in rural areas and drive demand. Apparently this has not happened.

Coming to the second cause for the slowdown viz. NBFC led liquidity crisis, there is a slew of data available that can be looked into to get corroboration of the slowdown.

In order to do that, we need to go back to 21 September 2018 when in a single day, Dewan Housing Finance Ltd shares tanked 44%. The panic started when rumours started doing the rounds that DHFL may have defaulted on one of its debt payments. The reason for this rumour:  DSP Mutual Fund had sold short term DHFL paper at a significant discount. Dealers with domestic banks said the fund house sold DHFL’s 1-year commercial paper, due to mature in June next year, at a yield of around 11 percent.

This sparked concerns about DHFL’s ability to raise money from the market at a feasible rate. For one, DSP was finding it quite challenging to find takers for the instrument, even at 11 percent. If a fund house is forced to sell 1-year commercial paper at 11 percent, it is apparent that no one is willing to buy it. As a result, investors’ outlook on DHFL’s stock weakened and they started selling its shares in panic, pulling it down by over 55 percent intraday.

DSP MF’s exposure to IL&FS papers led it to dump DHFL to generate liquidity. In essence, IL&FS crisis was the cause for DHFL downfall, although it had no direct dealings with IL&FS. What was the IL&FS crisis? While at core the IL&FS crisis is a story of corporate manipulations, accounting shenanigans, and outright frauds, the outward problem was an asset-liability mismatch. IL&FS, beginning life as a project finance company, eventually entered project execution business. Its source of funds was mainly institutional finance and bank borrowings. Project loans are typically long-duration exposures, while an Indian bank’s corpus of funds has an average maturity of no more than three years today.

This mismatch between the source and the utilisation of bank funds is fraught with serious liquidity risks and towards August end, IL&FS tripped up and defaulted on payments to SIDBI. This immediately led to a turmoil in the debt funds as several funds had exposure to IL&FS group of companies. There was a chain reaction in other NBFCs as well as the fount of funds started to shrink.

The Finance Ministry, in a note sent on Sept. 30 to the Ministry of Corporate Affairs underscored how IL&FS group’s high debt and exposure to its commercial paper in the debt market threatened to impact the financial sector.

The infrastructure conglomerate had a high leverage ratio of 13 times as the borrowing of about Rs 91,000 crore was on the base of equity and reserves of just Rs 6,950 crore, the note said. “The cascading impact of the default by the IL&FS group on the financial sector would be quite substantial as evidenced from the partial default of some of the companies in September 2018,” according to the note.

In the aftermath of the IL&FS crisis, there were huge bursts of outflows from debt funds every time a negative news item appeared. During Sept 18, there was net outflow of Rs 244,522 crores, which was repeated in December when there was a net outflow of Rs 152,307 crores. Overall from Sept 18 to Mar 19, there was a net outflow of Rs 255,000 crores form debt funds, more particularly from liquid funds.

The liquid funds were the main source of funding for various categories of NBFCs which raised funds from MFs through short term maturity commercial papers. While on the one hand, the MFs sought to cut back on subscribing to CPs on account of rising net redemptions, on the other hand the NBFCs preferred to conserve their resources for repayment of CPs. Both these factors combined to a slowdown in lending by the NBFCs. Loss of credibility and higher risk perception by lenders also led to higher cost of funds for several NBFCs. These too added to the slowdown in loan disbursements.

The cumulative impact of these events beginning September 2018 led to a severe slowdown in lending and off-take of consumer durables (including automobiles). As per Bloomberg Quint, data reported by NBFC firms as part of third quarter earnings showed either a decline in the loan growth or, in some case, an actual drop in lending. The performance differed widely based on individual groups and ability to raise funds from the bond market at a reasonable cost.

As per a report in ET, “some NBFCs cut back a bit on disbursement targets for FY19 year as funding dried up.  Growth could be down 200-500 basis points for an industry that was thriving due to a lending slowdown by banks”. Aadhar Housing said “we reduced loan disbursement to 20% of normal to avoid defaulting as we fear that shorter-term papers which are to mature in the next couple of months may not be rolled over.” Disbursements of DHFL during the December 2018 quarter shrunk to just Rs 510 crore, a fall of over 95%. Mahindra Finance saw YoY disbursement growth of 9% in fourth quarter as compared to 30% in previous quarters.

The crisis is not yet past and will require a huge inflow of cash and confidence to overcome the downturn. The new government that comes in will have its task cut out to inject liquidity, restore confidence and revive demand to bring back the growth. Any delay in applying the balm will lead to a funk that may be difficult to cure. Fortunately, the concerned ministries seem to be aware of the looming crisis and have made the right noises in that direction. The crisis of confidence in NBFCs may be easy to resolve, given timely and adequate liquidity. But the issue of rural distress is a much longer duration malady and will take more than a good monsoon and loan write offs to resolve.