The Indian consumer is showing signs of fatigue. The indications are evident in what consumer goods companies are reporting as well as from hard data in the national income accounts. Household consumer spending grew at half the pace of the overall economy in the financial year that ended in March. This has wide implications.
Several economists have in recent weeks pointed out that companies are unlikely to buy machinery to increase capacity in their existing factories or build new factories at greenfield sites till they are sure of robust demand for their products in the years ahead, either from India or foreign consumers. A recovery in the corporate investment cycle right now depends on better visibility of consumer demand in the future.
Here is a stylised version of what happened to the purchasing power of consumers in recent years. India entered the pandemic with the economy losing momentum over seven quarters in a row. The pandemic hit the economic activity of households in very different ways, but the economy as a whole saw a sharp increase in the forced savings plus precautionary savings of households.
In other words, households saved more either because they had few opportunities during the strict lockdowns or living in the penumbra of uncertainty made them wary of spending.
India saw a splendid recovery in consumer spending after the pandemic ended. One reason was that the stock of excess savings that households had built up during the lockdowns provided a significant financial buffer. This buffer, combined with the regular inflow of income as well as the psychological relief from the return of normal patterns of life, spurred a burst of revenge spending.
Recent data released by the Reserve Bank of India shows that most of the stock of excess savings has been spent down by households. A lot now depends on the flow of income to support consumer spending, especially at a time when households have taken on more debt in their balance sheets, though much of it could be to buy homes.
The upshot: inertial income growth is a drag on consumer spending in India. Recent data from official surveys of the labour market as well as the state of unorganized enterprises shows that the past seven years have not been good for households in the lower deciles of the income pyramid, after being hit by multiple shocks.
One view in the immediate aftermath of the pandemic was that Indian consumer spending is anyway driven by the top two deciles, which are still doing relatively well. This sanguine view did not take into account the fact that there are feedback loops—the inability of a poor households to buy a bar of soap or a motorcycle will eventually hurt the incomes of those in higher parts of the income pyramid.
Three policy issues deserve to be highlighted in this context, spanning an immediate response to structural solutions over a longer time horizon. The immediate question is what the new government should do in the upcoming Union budget as a response to the slowdown in consumer spending.
The higher dividend from the Indian central bank as well as buoyant direct tax revenues provide the government with some extra fiscal headroom compared to what was assumed in the pre-election interim budget.
The question is whether the government should use the extra revenue to stimulate consumption or announce a fiscal deficit target that is lower than the glide path announced after the pandemic, by around 0.2 percentage points of gross domestic product (GDP). The case for sticking to a fiscal deficit of 5.1% is quite strong right now, so that domestic demand can get a small dose of stimulus either through more spending or a cut in the effective rates of income tax.
However, given the fact that India needs to reduce its fiscal deficit through this decade, the stimulus that can be provided by fiscal policy will be limited, and perhaps just enough to deal with the cyclical component of the downturn in consumer spending.
That brings us to the second issue —the so-called ‘home market’ problem that was a hot topic of debate among Indian economists in the 1970s. Underlying it are issues ranging from a lack of adequate quality jobs to anaemic growth in real wages.
One way to break out of the home market problem is to sell more to international consumers, which is what so many countries east of our borders did over the past few decades. The answer then includes trade policy rather than just a fiscal stimulus.
The deepest structural issue is what economists describe as the ‘functional distribution of labour,’ or how national income is distributed between capital and labour. This is not easy data to estimate, especially in a country such as ours with a large household sector in which separating capital income from labour income is a statistical challenge.
But the very fact that profits have grown faster than the underlying nominal GDP while labour incomes have not suggests a shift in the functional distribution of income. This column has earlier commented on the economic recovery that was led by profits rather than wages, and the macroeconomic implications of such a shift.
The capital intensity of Indian manufacturing as well as the sectoral preferences of the production-linked incentive scheme need to be seen against this backdrop.
The Indian economy has a lot going for it. The slowdown in consumer spending could be a transient problem, but it is just as likely that it’s an advance signal of deeper structural issues that deserve more policy attention beyond the annual budget.
