Immediate sharp upturn seems unlikely; rate cuts and rural-oriented govt spending will help
The investment slowdown is undeniably one of the major challenges that India faces today. While the focus on investment is right, one cannot ignore an equally dramatic decline in private consumption growth. India?s household consumption spending, at 57% of GDP, is almost two times greater than investment demand. Private consumption was also the major driver of economic growth till 2011-12. Even the global financial crisis did not have a major impact on Indian private household consumption. Its real growth fell only marginally to 7.2% during the peak of the crisis in 2008-09 and swiftly regained its pre-crisis growth of 8% per year over the next three years. Come 2012-13, however, private household consumption growth halved to a 12-year low of 4.1%. Why? What are the prospects of its revival in 2013-14?
Income is an important driver of household consumption demand. Rising income and perceptions about its sustenance make higher consumption possible. In such a scenario, discretionary spending by households on goods and services rises. This happened during 2004-05 to 2007-08 when real household consumption grew at 8% per annum, led by a surge in discretionary spending on automobiles, household appliances, furniture and furnishings and clothing. Households were also eating out (consumption spending on hotels and restaurants) and spending more on entertainment than ever before.
The global financial crisis in 2008-09 did punctuate this consumption boom, but only mildly, and temporarily. GDP growth fell to 6.7% during the fiscal but private consumption expenditure growth dipped to only 7.2%. The sharp cut in interest rates, increased spending by the government and rise in public sector wages buffered private consumption in 2008-09. Although household expenditure on eating out contracted, spending on transport and communication and furniture furnishing and appliances maintained the pre-crisis momentum. Uncertainties about the future, on the domestic as well as international front, and the prospects of unemployment did not deter consumers much. They treated the impact of the crisis as a transient phenomenon. Consumer confidence was soon boosted by the swift revival of GDP growth to 8.6% and 9.3% in 2009-10 and 2010-11, respectively.
In no time, household spending growth revived to 8% per year during 2009-10 to 2011-12 as the positive effects of interest rate cuts and increased government spending on rural welfare and the hike in salary and wages of government employees played out. Some part of the increase in income levels in the post-crisis boom was durable in nature. Public sector employees account for almost 60% of total employment in the organised sector. The central government?s Pay Commission not only raised regular incomes of government employees but also provided lump-sum arrears to government employees. This bolstered purchases of consumer durables goods (automobiles) and even semi-durables like clothing, which grew at a faster pace than during 2004-08. Household spending on hotels and restaurants too gradually picked up. Despite the fall in GDP growth to 6.2% in 2011-12, real household consumption continued to grow at 8%, with hotels and restaurants and transport and communication growing at 20% and 10%, respectively. A strong increase in rural incomes, led by rising non-farm employment opportunities, boosted rural consumption as well. Rural spending outpaced urban consumption in the two years up to 2011-12, for the first time in nearly 25 years.
This suggests that, till 2011-12, the consumer did not expect his/her permanent income to be dented. But this expectation was belied and 2012-13 came as a rude shock. The sharp slowdown in private consumption highlights the severity of the current slowdown compared to 2008-09 as well as the lack of policy buffers. Fiscal policy turned restrictive in 2012-13. The fiscal deficit was contained at 5.1% with a 4% cut in central government expenditure. Due to persistently high inflation, the Reserve Bank of India?s (RBI) policy rates continue to be 2.5% point higher as compared to 2009 despite lower GDP growth.
The minute details of the current slip in consumption are difficult to comprehend as the disaggregated data has not yet been published. But the pull-back in discretionary spending?automobiles, eating out and durable purchases?is expected to be the primary reason for the sharp fall in household consumption spending. Sales of cars and utility vehicles fell by 7.5% during first 11 months of 2012-13; other durable goods, too, have fared poorly.
An immediate sharp upturn in consumption from the current low levels seems unlikely, but a mild recovery may be in sight. Some reduction in interest rates will aid consumption growth. With wholesale inflation falling below the 6% mark, there is some room for RBI to cut rates to support growth. Rural-oriented government spending in a pre-election year is expected to keep demand in rural areas buoyant. Deals and discounts by retailers will also induce the consumers to loosen their purse strings. The heydays of sustained real private consumption growth of over 8% may not return any time soon, at least not in 2013-14. For that to happen, not only the current growth rate will have to be lifted to the potential (which many believe is at sub-7% currently), but the potential too will have to go up. A tall order indeed, at this juncture.
Dharmakirti Joshi is chief economist, CRISIL. Anuj Agarwal is economic analyst, CRISIL