Perception is a key growth driver

How much is the Indian economy likely to grow by? This remains a moot question, especially in the wake of the recently released GDP estimates. A perusal of the RBI’s recently released Forward Looking Surveys may provide an important lens into what we can expect in the near future. In particular, three of these surveys, focussing on consumer confidence, business expectations and the demand conditions in the manufacturing sector, merit attention.

The main drivers of growth in an economy are domestic consumption and investment. With India being largely a consumption-driven economy, consumption spending must grow to drive overall growth. Consumer spending depends to a large extent on growth in disposable incomes. However, an important factor, which is often overlooked is consumer confidence regarding the general economic situation captured in consumers’ perceptions and expectations.

Negative perceptions lead to negative consumer sentiments, which are likely to halt consumer spending — a major lever for growth in India, accounting for 56 per cent of GDP. An index of such perceptions is the Consumer Confidence Index (CCI), which may indicate either consumer pessimism (if less than 100) or optimism (if above 100) regarding the general economic situation, price levels, consumers’ own incomes, employment and spending. Thus, such an index indicates consumers’ attitude to consume less or vice-versa.

The RBI’s survey of consumer confidence is fairly broad-based, covering 13 major cities and comprising 5,347 responses on households’ perceptions and expectations on the general economic situation, the employment scenario, the overall price situation and their own income and spending.

The latest RBI survey indicates that the current CCI (at 96.7) continues to remain below 100, even two years after the disruptions to the economy through demonetisation, and later through the imposition of the Goods and Services Tax (GST). This indicates the persistence of a pessimistic situation, despite a small (2.8 points) increase in the index between November and December 2018.

Consumers, however, expect the future to be rosier. Interestingly though, their expectations regarding future spending one year hence, seems to have deteriorated between November 2018 and December 2018. Also, despite the Consumer Price Index being at a low of 2.19 per cent in December 2018, consumers’ expectations regarding the price situation one year hence remained negative.

Investment determinants

Another important growth driver is investment expenditure, especially in the manufacturing sector. The rate hikes/cuts by the RBI have dominated public discussion in the last few quarters, especially since the RBI adopted a policy stance of calibrated tightening since October 2018. In doing so, it effectively ruled out any further possibilities of rate cuts in the near future, leading to government unease.

However, what is lost sight of is that the investment function is only partly dependent on interest rates. Investments are as much driven by business sentiments as by the rate of interest.

The business sentiments in India are reflected in two indices — the Business Assessment Index (BAI) and the Business Expectations Index (BEI). Values of these indices can range between zero and 200, with values less than 100 indicating contraction and those above 100 indicating expansion.

The business sentiments, as assessed from responses of 1,267 companies, appear to be positive, with both BAI and BEI above 100. However, the current situation seems to have deteriorated between Q3 2017-18 and Q3 2018-19, from 109.8 to 107.1, while the business expectations seem to have only marginally increased in the same period from 115 to 116.2.

More importantly, a majority of the companies surveyed expected ‘no change’ in multiple business health indicators for Q4 2018-19, including production, order book, capacity utilisation, employment outlook, overall financial situation, cost of finance and raw materials, profits and the overall business situation. In the absence of expectations regarding significant increases in, among others, production and order book, business units, especially in the small and medium sector, may not invest in capacity.

The demand for the manufacturing sector is an equally important metric to trace in the Indian context. A back-of-the-envelope calculation indicates that while capacity utilisation in manufacturing has increased in the last quarter, it was much lower during 2014-2018, at 73.1, than the average figure in the period 2010-2014, at 76.2. New orders have actually fallen in Q2 2018-19. It is clear that the demand for the manufacturing sector is not quite as high, despite the government’s well-intentioned ‘Make in India’ programme.

What is clear, therefore, is: Perception drives reality. If consumers and businesses expect ‘no change’ or ‘de-growth’, the promised growth will remain a chimera. History is replete with examples, such as the US recessions of the early 1990s or even 2000 which were caused by a dip in consumer confidence and business sentiments, respectively. These are leading indicators of future developments in an economy. Reading these signs better and paying heed to people’s expectations would be important for the government to get its game right going forward.

The writer is Professor of Economics at SP Jain Institute of Management & Research, Mumbai. The views are personal.

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