India’s real GDP growth is provisionally estimated at 8.2 per cent in 2023-24 by the National Account Statistics (NAS), revealing an upward movement from the growth rate of 7 per cent in FY 2022-23. While exhibiting the highest growth among all the major economies of the world, the annual growth numbers need to be construed as a result of the 8-plus per cent growth rate in the first three quarters, and a 7.8 per cent in the last quarter.

This growth was enabled by significant expansion of the manufacturing and construction sectors, in tandem with a consistent performance of the services sector. However, the demand side or the expenditure approach to accounting reveals a lot about a shift in the structure of India’s growth force. This is more so because econometric analysis conducted by the authors reveals that from 1991 India encountered a consumption-driven growth phenomenon. The data in the Chart also suggests that growth in private final consumption expenditure (PFCE) and GDP growth have moved in tandem with each other from 2012-13 till 2022-23 with consumption constituting more than 55.5 per cent of the GDP. However, as the Chart suggests, in 2023-24 the co-movement has snapped.

Contrary to consumption driving the Indian growth story, in 2023-24, private final consumption expenditure grew at only around 4 per cent against the 8.2 per cent GDP growth. Interestingly, gross fixed capital formation or investment grew by almost 9 per cent — emerging as the prime mover of the Indian growth story last year. The origin of this shift can be located in the data for the last two quarters. There is at least a temporary decoupling of consumption and GDP, with investment picking up pace and acquiring a greater share of domestic output.

The departure

Interestingly, East Asian Tiger economies, as well as China, experienced a steady shift from consumption-driven growth during their heyday. South Korea witnessed a decline in the consumption share in its GDP from around 85 per cent in the 1960s to 45 per cent recently. During the same period, both South Korea and China witnessed a concomitant doubling of their investment share. Thus, critical forces are at play in India, that can determine the future trajectory and pace of economic growth.

The shift away from consumption-driven growth does not occur in a macroeconomic vacuum — there are gradual systemic shifts that influence and nudge this transformation. This can be explained best by looking at the economy as a collection of homogeneous households. As a household moves to a higher income level, its propensity to consume out of an extra rupee in income declines. In other words, a richer household might choose to spend only ₹10 out of an ₹100 increase in income, while a poorer household will tend to spend ₹50. On an aggregate level, when an economy gets richer, its tendency to spend or consume declines.

Given a steady level of government expenditure and current account, this should translate into higher investment at the macro level. In addition to the national income accounting identity, there are behavioural forces that trigger this shift.

As households consume less as a proportion of their income, they generate higher share of savings — this might be in the form of financial or physical savings. The presence of credit markets channels these savings into investment which becomes the driving force of economic growth.

Impact on growth

As such, Indian macroeconomy needs to possess a diversity of growth drivers, and cannot rely on private consumption as its lone long-term growth enabler. Consumption-driven growth is not going to be sustained over time, since rising incomes will spur savings, and reduce consumption share of the GDP. The World Inequality Database reveals that while India’s income inequality has plateaued over the last five years, wealth disparity has surged, with the top 1 per cent creating more assets out of their incremental income. This implies that the lower- and middle-income groups are more likely to spend additional income, fuelling economic growth through the consumption channel, unlike their wealthier counterparts.

While the “rich getting richer” undermines the aim of short-term consumption-led growth, consumption as a growth driver tends to peter out in a mature economy, and eventually takes a back-seat once per capita income reaches higher levels. This has been the case with China, Japan, South Korea, and also the EU.

Thus, the government’s emphasis on high capital expenditure is appropriately timed and can help in creating enabling business conditions for both domestic investment and FDI. However, the influx of funds will need to be complemented by a pro-market policy environment — the absence of which will hinder the returns on investment and lead to underutilisation of capital.

While investment in terms of gross capital formation has led to last year’s growth, India cannot afford to do away with its organic advantage of consumption-led growth that can be driven by the biggest consumers of the economy — the youth.

Today’s India enjoys a unique demographic dividend with more than 55 per cent of the population below the age of 30. Therefore, fiscal measures to increase disposable incomes among the youth are important for India.

As such, China is also on a spurt with fiscal measures to promote consumption-led growth. Rather, the Indian economy is at that stage where both forces of consumption and investment need to work together to promote an over 8 per cent growth rate over the next decade.

Ghosh is Director, and Bardhan is Research Assistant, Observer Research Foundation