The falling consumption story

India’s consumption slowdown threatens to drag the economy down with it — and, in fact, that’s already happening.

Household consumption spending, or private final consumption expenditure, posted a modest growth rate of just 4 per cent in 2012-13, after growing by 7.9 per cent in 2011-12. With manufacturing on the decline, corporate investments stagnant and exports sluggish, can India afford a consumption slowdown?

What is causing the slump in household consumption demand? Is it high inflation, interest rate or fall in GDP growth rate? How will consumption slowdown affect different sectors of the economy? How bright are the prospects of revival of household consumption in 2013-14?

Growth driver

With roughly 57 per cent share in India’s GDP, household consumption spending has been the major driver of economic growth until 2011-12, growing at about 7- 8 per cent each year ( see chart ).

Consumer spending kept growing even in the post-crisis period (2007-08 to 2011-12) because of a surge in discretionary spending supported by low interest rates, increased government spending (post the implementation of 6th Pay Commission recommendations) and rising rural income, because of government transfers, increase in non-farm employment and improving terms of trade for farm produce. However, over the last few quarters, it has started to decline with serious implications for economic growth.

The size and growth of household consumption in any economy depends upon a number of factors, including growth of disposable income, demographic profile of the population, extent of urbanisation, access to credit and interest rate sensitivity of consumption. Inflation is also an important determinant, as it affects real purchasing power.

Since 2011-12, GDP growth rate has moderated. However, inflation (measured by WPI and CPI, though of late, WPI has started to decline) has remained very high. This reduced the real purchasing power of the households. To fight inflation, the RBI has kept interest rates high. The result is slowing household spending.

Sluggish household spending drags down business activity. But businesses are also hit by supply-side factors, such as low-cost imports in a high inflation scenario, and rupee fluctuation.

These further slow down growth and with it consumption expenditure. Are we entering a downward spiral of consumption and business activity pulling each other down, aided by inflation and external factors?

Competitiveness affected

Moderation of consumption demand does not affect all sectors of the economy equally. Spending on non-durable goods accounts for only a small proportion of household income. Hence, such items possess relatively less elastic demand — change in income/price/interest rate does not affect their demand much.

However, high interest rate affects demand for consumer durables, that is, electronics, home appliances and automobiles (more than two-third of the vehicles bought are credit-financed), and housing, as they account for a substantial proportion of household income. Besides, in the slump period, margins of businesses come under severe pressure, as buyers tend to bargain hard or postpone purchases until the sale season starts.

One of the effects of ongoing global economic downturn, sticky inflation and moderating consumption demand is increased competition from imported goods made in low-cost countries such as Bangladesh and China.

Thus, the actual shrinkage of market for domestic businesses is more than what can be explained by overall reduction in household spending. This fact is not well reflected in macroeconomic data. Vulnerable businesses, especially those from SMEs with not much pricing power, will take a bigger hit from such imports.

Rupee behaviour

The sharp decline of rupee may provide some protection to domestic businesses, for example textile and clothing.

However, given the reality of import parity pricing, the increase in rupee cost of inputs (synthetic fibre or yarn that are linked to crude price), whether domestically sourced or imported, will eat away most of the gains arising out of rupee depreciation. Further, currency depreciation affects net importing sectors such as automobiles, consumer electronics, copper smelting, edible oil refining, fertiliser and petroleum products because of the rise in rupee cost of imported inputs.

Ideally, rupee depreciation should improve export competitiveness of domestic businesses. However, the actual gain in export competitiveness depends on the real exchange rate (and not nominal exchange rate) that, in turn, depends on the change in nominal exchange rate and inflation differential in domestic as well as export markets. Besides, simultaneous decline of currencies of all emerging markets has reduced the actual gain in India’s export competitiveness arising out of falling rupee.

Prospect for revival

An 8 per cent growth in household consumption is unlikely to return in 2013-14; however, a mild recovery may be expected depending on what policy actions the government takes to restore GDP growth to its potential level — sub-7 per cent.

Given the slowdown in China and other net commodity importing countries like India, falling international price of commodities and better monsoon will help contain inflation. However, where the rupee is headed will also be a determinant, given the inelastic nature of India’s import demand.

The continuing rupee crisis may keep the RBI’s hands tied on rate cut. This will dampen the prospect of rate-sensitive sectors such as consumer durables — automobiles, in particular, and housing.

Given the backward and forward linkages of these sectors with other sectors of the economy, it may further depress India’s GDP growth when exports are not picking up and corporate investment is down. Car sales fell by 6.7 per cent to 1.9 million units in 2012-13. Going forward, rising fuel prices because of decline in rupee and hike in interest rates (to save the rupee) will only make it difficult for auto sector.

Silver lining

Consumption demand is also about consumer sentiment. Most people believe that the current economic environment (within and outside India) will continue to remain bleak. The way our policymakers are dealing with macroeconomic mess does not exude much confidence.

This pessimism will impede growth of consumption demand in the next few quarters. Impending political uncertainty may make it worse.

The ‘silver lining’, however, remains rural spending, that is expected to remain robust in the run-up to the general election, and the somewhat better performance of the farm sector. Another source of mild optimism is the upcoming festive season that can push up the demand for a variety of consumer goods.

Discount offerings by retailers may induce sections of consumers to buy more. New product offerings and consumer categories may help sales in a non-conducive macroeconomic environment. Above all, to protect operating margins, businesses will have to resort to cost-cutting measures.

(Ritesh Kumar Singh is Group Economist of a corporate house. Prerna Sharma is a research analyst of a global financial services firm. The views are personal.)

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