India Inc currently appears besieged on several counts. Investments haven’t taken off the way it was hoped; manufacturing activity is sluggish; meeting financial obligations hasn’t become any easier; and patchy monsoons throw doubts over agricultural growth.

So where, in all this gloom, is the light? In one word, consumption.

The Indian consumer looks set to spend more over the coming quarters, and thus push growth for a host of related sectors — from FMCG to cars to mobile operators. Within the broader scope of consumption, urban consumers, who have been a tired and wary lot so far, can consume more than their rural counterparts.

So, while the investment cycle will take at least a year or more to get into swing, household consumption can recover much faster. Playing the urban consumption theme, therefore, makes good sense for the next couple of years.

Stock market gains The knee-jerk reaction to the strong election victory in 2014 and an anticipation of revolutionary reforms by the new government sent prices of stocks in capital goods, industrials, and infrastructure soaring ahead of revenue and earnings growth. These sectors had been hit hard by the economic slowdown and were in need of an overhaul as well.

From the August 2013 low to when the new government presented its first Budget the following July, the Nifty index gained 37 per cent. In contrast, the BSE Capital Goods index galloped 111 per cent, with its PE multiple moving from 25 times to 37.2 times. The CNX Infrastructure index zoomed 61 per cent taking its PE multiple from 15.9 times to 24 times. The BSE Power index jumped 53 per cent.

Consumer companies, which had been the market favourites until that point, saw a far tamer performance. The CNX FMCG index, for example, rose just 11 per cent. The BSE Healthcare index rose 34 per cent. The index’s PE multiple dropped, in fact, from 26 times in August 2013 to 22.6 times the next July.

But while hopes were high, there hasn’t been a concrete improvement in the investment cycle and company order books are still unhealthy. According to industry experts, new capacities added until the 2012 slowdown have to first achieve a threshold utilisation before fresh expansion happens.

Nor does the private sector have the financial wherewithal to invest anew. Fresh investment needs to come from the government. Though the groundwork to do so is in place, actual government spending is yet to take off. Meanwhile, revenue for capital goods and construction companies shrank 3 per cent last fiscal. Aggregate sales for steel companies showed almost no growth. Net profits for infrastructure and power companies fell 10 per cent and 2 per cent, respectively.

Until the revival takes place, consumer companies will see better sales and profit growth than cyclical companies. Stock markets are therefore liable to revert to their former predilection for consumer-driven companies.

This trend is starting to take shape, with the BSE Healthcare index up 53 per cent in the past year. The FMCG basket is up 12 per cent. The auto and consumer durables indices on the BSE are up 21 and 29 per cent, respectively.

But other major cyclical indices — power, oil, metals, and infrastructure — have either declined or are up only slightly. So, what can drive consumption over the longer term?

Prices come down If there is one factor that makes consumers baulk and tuck away their purses, it’s inflation. And higher inflation translates into monetary tightening and higher interest rates which again stifle consumption. These factors are now gradually easing.

Inflation, measured by the consumer price index, came off its double-digit stretch by December 2013. Since August last year, inflation has remained below 6.5 per cent for the most part. The current inflation rate is also within the Reserve Bank of India’s 6 per cent target for January 2016. Assuming reasonable management on the food supply side, it can remain more or less at that level.

The wayward monsoon can affect production of kharif crops, such as rice, grains, and oilseeds. But currently, apart from paddy and ragi, minimum support prices for kharif food crops have not been hiked very significantly. The government has also indicated that it has enough buffer foodstock to tide over a drop in agricultural production.

Benign crude oil can also keep inflation under check. A CRISIL report estimated an additional savings of ₹300 billion for fiscal 2015-16 from savings in fuel costs. With the input cost scenario for FMCG staples, apparel and automobiles also turning cheaper, prices of several consumer products may not be hiked much, either.

Room to grow Lower inflation feeds into higher disposable incomes and a greater inclination to spend. This apart, in response to inflation heading south, the RBI cut rates this year by 75 basis points. Banks eventually followed suit with their own base rates; ICICI Bank, State Bank of India, and HDFC Bank have all cut their base rates by about 30 basis points since the start of the year, for example.

A lower base rate can reduce monthly loan payments for individuals, again increasing disposable incomes. Lower deposit rates can also act as an incentive to spend. Consumer confidence surveys conducted by the RBI, which assess consumers in metropolitan cities, indicate that consumers are buoyant about their spending over the long term.

The Future Expectations Index on economic conditions in the consumer confidence survey was up sharply in the March 2015 quarter; the index had been steady for two quarters before that. A good 78 per cent of the respondents also expected their future spending to rise over the long term. Corroborating a sustained intention to spend, Nielsen measures peg India’s consumer confidence at its highest level (in March 2015) since 2011, clocking a sixth consecutive quarter of rise.

An India Ratings & Research Report expects private final consumption expenditure, which accounted for 57 per cent of GDP for fiscal 2014-15, to drive growth in fiscal 2015-16. Growth in consumption expenditure is pegged at 8.2 per cent, a sharp rise from the 6.3 per cent it was last year.

The biggest potential driver in the long term could be the Seventh Pay Commission. The Pay Commission report is due to be released in October. The Sixth Pay Commission, whose report came out in March 2008 and involved retrospective payments from 2006, had resulted in a near-doubling of pay and allowances for Central Government employees alone.

Between 2007-08 and 2011-12, the outgo shot up from ₹74,647 crore to ₹166,792 crore, according to the 14{+t}{+h} Finance Commission report. While overall consumer spending is set to grow, urban consumption can bounce back and outpace the rural market.

Urban consumer to the fore For one thing, the deceleration in rural wage growth has already been happening; growth slowed to below 6 per cent by January 2015 from 16 per cent during April-October 2013, according to the RBI’s April 2015 monetary policy report. Growth in rural spending surpassed urban growth in 2009-10 with rising crop prices and higher non-farm labour wages through employment guarantee schemes, such as the MGNREGS. This is petering out now. Wages paid under the scheme dropped 9 per cent in 2015-16 over the year before, following up on a 2 per cent decline, according to government data.

Crop prices have been moderating over the past year-and-a-half too, affecting farm income growth. Rise in food grain prices in the WPI index, for example, has slowed to 5-6 per cent now from the 10 per cent-plus levels in 2012 and 2013. Prices of wheat have been flat for most of 2014. Cotton prices have been falling steadily for a year now.

With fiscal consolidation a priority, excessive spending on welfare schemes may be scaled back. Patchy monsoons and lower harvests, along with minimal MSP hikes could again dampen agricultural income. The heady growth in rural spending therefore may cool off. Preliminary signs of revival in urban spending are showing up in some pockets too, going by the numbers posted by listed companies. For example, sales at retail companies, which are mostly in Tier-I and Tier-II cities, grew 14 per cent in the March 2015 quarter, improving from 13 per cent the quarter before. Consumer durable players saw sales growth at 6 per cent in the March quarter, after being flat in the December 2014 quarter and 7-9 per cent in the quarters before that.

Hindustan Unilever improved growth in its personal care and packaged foods divisions, which depend on consumer discretionary spending, over the March 2015 quarter, compared to the earlier quarters. Food and skincare for Dabur India also improved sharply in the latest March quarter.

Sales of passenger cars, whose main demand driver is the urban market, had shrunk around 4 to 5 per cent in 2013-14. This bounced back to a growth of 5 per cent in 2014-15. Lower interest rates and higher disposable incomes can, therefore, cement this revival.

Playing the consumption card

So, given that urban consumption can pick up gradually over the next two years, how can you play this theme? Most stocks that operate in this space have already moved up. This was because revenue and profit growth for these companies were still better than firms in beleaguered sectors, such as steel or power. Despite high valuations, companies in the consumption space still hold strong growth potential. Lack of viable alternatives in the market is another reason why these companies are a good bet.

Smaller share of wallet

One way to play the consumer theme is to go for discretionary products that involve lower amounts and thus account for a smaller share of consumer wallets. Such spends will be among the initial beneficiaries of an upswing in consumer optimism. Among these are premium personal care products, packaged foods, or entertainment.

According to Nielsen reports, urban consumers are ready to spend on high-priced items, either in fancier variants or bulk packs for frequently used items. They are looking to both improve lifestyle and health in large cities as well as small towns.

On a strong wicket: Godrej Consumer Products, ITC, Dish TV, Eros, Idea Cellular, PVR

A step higher

The next rung of improved spending can take place in products or services that involve higher absolute amounts. These are more discretionary than, say, FMCG or entertainment. Over the longer term, spending on products such as branded apparel can rise. Prices of cotton and synthetics are down and are likely to remain so, resulting in minimal price hikes. Steady expansion by retailers is another positive.

On a strong wicket: Talwalkar Better Value Fitness, Speciality Restaurants, Bata India, Shoppers Stop, and V-Mart Retail

High-end purchases

On the other end of the spending spectrum are the high-value products, such as cars, white goods, and jewellery. With prices of gold and precious stones falling as well, demand could see an uptick. Cheaper financing can strengthen the revival in passenger cars.

On a strong wicket: PC Jeweller, Titan Industries, Maruti Suzuki, Tata Motors

Indirect plays

Then there are services that rely on consumer sentiment turning up, such as education, housing, or travel. Mutual funds built along the consumer theme often have banks, finance companies — as retail lending can improve — and pharmaceuticals as the heaviest sector weights.

On a strong wicket: MT Educare, Treehouse Education Accessories, Kansai Nerolac, Cox & Kings