Column: Addressing the consumption crunch

Written by Siddhartha Roy | Updated: Jan 3 2014, 15:07pm hrs
The consumption growth story seems to have swung from being one of all round exuberance to one of despondency over the last two years. Yet the basic themes propelling itburgeoning middle class, rural growth based on higher agricultural prices and wage escalation due to the MGNREGA, urbanisation and aspirations of a young populationseem to have remained unchanged. To this mix, one should also add the low penetration and low intensity in most categories of consumer goods. Per capita income in current prices rising by more than two times between FY06 and FY12 took business expectations and consumer aspirations to an elevated level. During this period private consumption expenditure was growing at 15.2% in current prices. However, the emergence of strong headwinds in the last two years has forced businesses and policymakers to whittle down the projections of consumption growth made earlier.

So far as private consumption expenditure is concerned, empirical studies in the Indian context would indicate that post-reforms, between 1991-92 and FY05, the growth trend was 4.96% in constant prices. However, there has been a sharp jump since then, and it touched 8.23% in constant prices between FY06 to FY12. Interestingly, private consumption expenditure did not go down in the meltdown period (2008 to 2011) as it had the support of a loose fiscal policy in terms of tax cuts, additional spending and subsidies. However, since 2012, the scenario has started changing with the growth rate down to about 4%.

The question that arises is: What is happening to the variables behind private consumption expenditure Our empirical estimation indicates that the key drivers that have a positive impact are consumption in the previous period, which provides some kind of a benchmark lifestyle to the consumer, and disposable income of the current period; in the long run, one unit increase in income leads to 0.65 unit increase in private consumption. On the other hand, increase in interest rate affects consumption negatively. The previous periods consumption habit provides some kind of a buffer, even when disposable income growth is inadequate and interest rates are high. This is valid for both food and non-food consumer expenditure. Another interesting aspect since 1992-93 has been a steady decline in the tariff rates of imported consumption items. Importers often leverage the advantage of a free trade agreement (FTA) which creates an inverted duty structure for domestic manufacturers. On other occasions, domestic industry has to confront imports from China which are covertly subsidised by lower capital and utility charges and undervalued currency. Consequently, we find that the relative inflation and exchange rate have significant inverse relationship with growth of domestic consumer goods sector. Interestingly, if Indian currency strengthens, the markets will be flooded with imported consumer goodsthe vice-versa is likely to happen if the currency weakens. Without economies of scale and technological upgradation, it will be difficult for the Indian consumer goods industry to remain competitive.

A study of the wealth effect on consumption captured through increase in the BSE index did not indicate a significant relationship. This may be because the stock market during Q1FY07 and Q1FY13 did show several spurts but no steady trend. It can be suggested that the wealth effect, though positive, had a fleeting impact on consumption. No permanent change in consumption was visible.

The next question to arise is what conclusions would one draw if one examines the consumption expenditure data for rural and urban sectors separately. It is advisable to consider NSS data for the purpose. Based on the 68th round data , it appears that 53% of household consumption expenditure is in rural areas and 47% is in urban areas. Interestingly, the ratio of average urban and rural average per capita monthly expenditure is 1.87 by uniform reference period method. However, there is wide variation across states. Amongst urban areas, Bihar has the lowest per capita consumption expenditure at R1,507. The four states with the highest MPCE are Haryana (R3,817), Kerala (R3,408), Maharashtra (R3,189) and Karnataka (R3,026). Similarly, rural prosperity gets reflected in Kerala (R2,669), Punjab (R2,345) and Haryana (R2,176). Another interesting finding across the period 1993-94 to 2011-12 that has attracted attention is the decline in the share of food expenditure. In other words, rural discretionary expenditure (defined as total monthly per capita expenditure minus food expenditure including paan, tobacco and intoxicants as well as fuel and light) is growing at 11% per annum and urban discretionary expenditure at 12%. The combined discretionary expenditure at the all-India level would be projected to grow at 11.4% per annum. The growth based on NAS also shows a similar trend (12.6% total, 11% per capita).

The items included in the discretionary expenditure include clothing and footwear, durable goods, and miscellaneous goods and services. It is interesting to note that the share of both education and medical care in total expenditure has increased between FY05 and FY12. This may also indicate that the states inability to provide these services has forced individual households to access them from the market. The share of entertainment in rural India has doubled between FY05 and FY12. The share of conveyance has gone up from 3.8% to 4.8% in rural areas and from 6.5% to 7.5% in urban areas. Increasing the road network has enabled higher public and private transportation. Another area which is marked by a significant rise is urban rentits share has gone up from 5.6% to 7%. This, coupled with the housing shortage story , suggests low-cost urban housing, particularly for the middle- and lower-expenditure classes, should be made a priority.

Another striking observation of the FY12 household expenditure survey is that the average consumption expenditure of the top 5% is 8.6 times that of the the bottom 5% and three times the average expenditure in rural India. In urban India, expenditure of the the top 5% is 14.6 times that of the bottom 5% and 3.9 times the average. Other than food and fuel, the market is largely concentrated at the top. In fact, the top-most decile (top 10%) constitutes more than 30% of the market in most categories. Now, the question is where are these people located and how can they be approached. This is the key research question for marketers. Undoubtedly, there will be category-wise concentration of demandlittle fertiliser will be sold in metros just as few stilettos would sell in rural India.

The long-term consumption growth-trend projection in the economy continues to be positive; however, in the near-term, businesses may have to face strong headwinds. First, rising food and fuel prices will leave lesser money in the household budget for discretionary expenditure. Second, rising cost of consumer credit has started affecting demand for automobiles and housing. Third, the economic slowdown is affecting recruitment and job creation, which, in turn, affects consumption.

Given this scenario, it appears that there is no catch-all solution to the current problem of tepid growth in consumer goods and services. Recognising this, most of the marketing companies are focusing on growing segments, selected locations and specific channels. There is an increasing realisation that discounts are not going to move the markets in the long run; all they will do is drag down the bottomline. On a positive note, the results of some of the key companies operating in the premium and luxury segments of branded textiles, FMCG, white goods, and automobiles suggest that there is no down-trading across the board.

Looking ahead, another positive trend is the expectation of a good kharif harvestthis, along with the rural spending by government before the election and consequent leakages, should contribute to growth in demand. Finally, it needs to be kept in mind that nothing has changed fundamentally on the demand side. India continues to be a market with low penetration level and low usage intensity in most of the categories and hence markets are bound to grow in the long run. However, this growth cannot be leveraged unless domestic industry becomes competitive. Too much focus on opening up the consumer goods sector, particularly through FTAs and RTAs, before putting in place a roadmap for building up domestic competitiveness will negatively affect current account and industrial growth.

The author is economic advisor to the Tata Group. Views are personal.