The Hindu Business Line : Re-crowning the Indian consumer

Contrary to popular belief, the consumer has not been the king of the current boom. But he must become one to sustain it. With the right policies for more equitable income distribution, that is eminently feasible, says SUJAN HAJRA.

Middle- and high-income households with strong consumption demand are often assumed to be the catalysts of the growth story, but the reality is different.

Releasing upward revisions of India’s real growth over the last two years earlier this month and feeling just a tad disappointed at the CSO’s forecasts of a lower than nine per cent growth for the current year, the Finance Minister, Mr P. Chidambaram’s confidence in undiminished growth next year and beyond was as robust as ever. He is certainly not alone in his optimism. With current decadal average real GDP growth of 7 per cent and last four years’ average growth of 8.8 per cent as evidence, most observers feel that with some policy tinkering, India can sustain 8-10 per cent annual average growth rate in the long-term. Yet, a more detailed look at India’s current growth process makes such a buoyant outlook far from a self-evident prophesy.

The burgeoning ranks of middle- and high-income households with strong consumption demand are often assumed to be the catalyst of the growth story. The reality however, is different; the share of private final consumption in GDP declined from over 70 per cent in the early 1990s to 65 per cent a decade later and to below 59 per cent in 2006-07.

Moreover, while the gulf between real GDP and private consumption growth somewhat narrowed in the mid- and late-1990s, it widened after 2001-02. The main propellant for India’s take-off onto a high growth trajectory was investment.

Investment, the driving force

Over the last eight years, real GDP has averaged growth rates of 7 per cent, real private consumption 5.6 per cent while fixed investments have grown 12.6 per cent. Consequently, the share of fixed investment in GDP has increased sharply from 22 per cent in 2001-02 to 34 per cent in 2006-07.

Given the huge infrastructure gaps, the merits of increasing investment rates can hardly be questioned. Yet, there are reasons to argue that both economically and politically the sharp and generally widening gap between the growth in investment and private consumption is unlikely to be sustainable in the longer-run.

So long as rates of growth and share in GDP of consumption are higher than those of investment, ramping up the latter may not create generalised oversupply; between 1990 and 2002, in most years, that was the case. Since 2002-03, however, not only has the share of investment in GDP caught up with that of consumption but its growth rates have been significantly rising with those of consumption falling leading to a widening gap.

Managing the gap

Incremental capital output ratios suggest that India is currently going through a phase of significant productivity improvement. Trends of this sort deepen the large gap between private consumption and investment growth making it all the more problematic.

Of course, a sharp rise in government consumption or a marked increase in external demand could do the trick. But fiscal consolidation at the Central and State levels and the relatively low share of government consumption in GDP render it an unlikely substitute to relatively low private consumption. This makes strong growth in external demand the only possible mechanism to fill the large gap between investment and private consumption growth in the long run as has been done by China.

The contribution of external demand (net exports of goods and services) generally remained negative for India. The balance turned positive in recent years and the net external demand-to-GDP ratio is now hovering around 1-2 per cent. Balance of payments data, however, indicate that India continues to maintain a negative goods and services trade balance equivalent to 2-3 per cent of GDP.

China, on the other hand, has captured global demand in a major way, maintaining a trade balance equivalent to 5-6 per cent of GDP. China’s share in global exports jumped from 1 per cent in the early 1980s to about 7 per cent in more recent years. During the same period, India’s global export share rose from 0.6 per cent to about 1 per cent.

The services sector orientation of the Indian economy hinders India’s global demand in a way that China’s industry-oriented structure does not; services by nature are less amenable to international trade than industrial products.

Moreover, the absence of huge export-oriented foreign direct investment prevents India from emulating China’s successful export strategy. By cornering an increasing share of global demand, China has so far been able to avoid excess capacity creation in the face of high investment and low domestic consumption. It is unlikely that India will be able to achieve similar results.

The Gulf of poverty

A combination of high GDP and relatively low consumption growth is not just unsustainable; it is politically unacceptable. India has done well in poverty eradication since the 1990s and has registered impressive real per capita income growth over the same period.

The compounded annual growth in real per capita income, that was 4 per cent from the early 1990s, crept to 5 per cent in the later part of the decade and climbed to over 7 per cent in the last four years.

Yet, nearly one-fourth Indians still live below the official poverty line and a sizable number dwell just above it. Economic theory suggests that the marginal propensity to consume declines as income rises. For the economy as a whole, the falling share of private consumption in GDP noted above is, therefore, not surprising.

But the inverse relationship does not hold for income growth from very low levels; such an upward trend among the poor is unlikely to reverse their consumption propensity as unmet needs are converted into effective demand.

Trends in relevant data suggest that between the early 1990s and 2006-07, India’s average and marginal propensity to consume declined from about 80 per cent to 60 per cent and about 70 per cent to 50 per cent respectively. This 20 percentage point fall in propensity to consume in less than 20 years with a 4 per cent compounded annual growth rate (CAGR) in real per capita income, at the very least, is significant from a policy point of view, apart from the socio-political.

The pattern indicates overt concentration of the benefits of high economic growth in the higher income groups where the propensity to consume can decline sharply as income rises.

Sustaining high growth

Between 1999-2000 and 2006-07, the compound average growth rate (CAGR) of real private consumption in India has been 5.5 per cent. But the CAGR of food among its components has been just 2 per cent and that for rent, fuel and power 3.6 per cent.

On the other hand, during the same period, CAGR of private consumption on transport and communication stood at 10.8 per cent and for recreation, education and cultural services at 11 per cent. Private consumption on basic products is growing far slower than for other products.

The disproportionate concentration of the benefits of high GDP growth in favour of the economically better-off is likely to backlash on the overall reform process. A more even distribution of the benefits of high growth, on the other hand, is likely to stimulate demand for basic consumption goods.

Despite a sharp erosion of their share, basic goods still remain heavy weights of private consumption. For example, food alone still accounts for nearly 40 per cent of private consumption.

Therefore, a healthy growth in consumption of basic goods would also prop up overall private consumption which bodes well for a sustained high GDP growth.

(The author is Chief Economist, Anand Rathi Financial Services in Mumbai. The views expressed are his own.)