The Great Indian Consumption Conundrum

It is a well-known fact that in the last five years, the Indian economy has slowed down considerably. GDP growth between FY13-FY18 has averaged 7% (under the new series) which pales in comparison to the 9% average growth (under the old series) registered during FY04-FY11. Also well-known is that the slowdown has been brought about by a marked decline in domestic capex activity as well as stagnant exports. After gaining market share by over 1.5% during the last decade, India’s total exports as a % of global trade has plateaued at 2% for the last many years (Chart 1). However, more noteworthy, is the unusually large decline in capex activity which the economy has experienced in recent years. Thus, while Gross Fixed Capital Formation (GFCF) grew at roughly 2x the rate of GDP growth between FY04-FY11, its growth has now fallen much below GDP growth in the last few years.

                                          Chart 1: India’s share in world trade has stagnated

With two major engines of the economy moving in slow-motion, needless to say, private consumption has been the sole driver of economic activity in the current decade. In fact, what is striking, is that the share of private consumption in GDP has declined in every single decade, since independence, except the current (Chart 2). There is no doubt that consumption has provided the much-needed lifeline to the economy at a time when other engines have failed to fire. Generally, in an economic recovery, first consumption picks-up which in turn leads to better capacity utilizations and consequently leads to pick-up in capex activity. Therefore, consumption led growth is not bad per se. However, in India’s case, while consumption has undoubtedly supported growth, it has also resulted in the emergence of certain structural imbalances. These structural imbalances if not addressed can have serious implications for the long-term growth potential of the economy and can turn the “Great Indian Consumption Story” from a boon to bane.  

Chart 2: Rising Private Consumption (% of GDP)

These imbalances have manifested itself in mainly two forms:

• Consuming more of what is not domestically produced: India’s consumption profile seems to be increasingly misaligned with its production profile. A testimony to this is the continuous  rise in India’s non-oil non-gold trade deficit in the last few years (Chart 3). It has always been convenient to blame oil and gold imports for India’s external vulnerabilities. However, beyond the oil curse, what is being ignored is the steady deterioration in the composition of India’s import basket.  In fact, electronic goods appear to have become the new gold with electronic imports more than doubling since the start of 2010. While a weak commodity cycle has masked India’s external vulnerabilities in the last few years, underlying trade balance has continued to worsen. As the support of benign commodity prices wane, the economy could become increasingly susceptible to an external shock.
• Declining household savings rate: In most emerging economies, out of the three stakeholders, savings by the household sector tends to the be the largest and the least volatile component of the overall savings rate. While corporate and government savings fluctuate with the business cycle, household savings are generally determined by more structural factors like demographics. In India, household savings rate has been on a rising trend ever since data is available (from 1950s onwards). It is only since 2010 that this trend appears to have broken with household savings rate declining continuously (Chart 4). A possible explanation is that in the absence of any significant income growth in the last 5 years, households have increasingly started to substitute savings with consumption. Moreover, higher consumption can be supported not only by withdrawal of savings but also higher debt. This too appears to be happening with household debt in India rising recently (albeit from very low levels). 

 Chart 3: India's worsening non-oil non-gold trade balance

Chart 4: Declining Household Savings (% of GDP)

What are the implications of the above?

For the last many years, discussions of India’s growth have centred on one simple question: how soon will the economy revert to 8-10 percent growth? The question is at times posed as if such a reversion is a fait accompli, a phenomenon just waiting to occur. Perhaps it is even just around the corner, given all the structural reforms the government has implemented in recent years.

However, history suggests that no economy has been able to achieve consistently high economic growth without accompanied by rising savings rate. The economic success of many East Asian economies is a case in point. Experience of these economies show that during the phase of good demographics, household savings rose sharply. This in turn led to higher investments and propelled these economies into a higher growth trajectory (Chart 5). On the other hand, in many LATAM economies (Brazil, Argentina, etc.) despite favourable demographics, household savings rate remained stagnant with households substituting savings with consumption. Not surprisingly, this led to creation of several macro imbalances (high interest rates, high inflation, high CAD) with the economies falling into what is known as a “low-income trap”.  

                  Chart 5: In China, savings & investments grew during phase of good demographics

                                             Chart 6: This did not happen in case of Brazil

India is at the cusp of realizing its own demographic dividend. It therefore becomes imperative to exploit this phase of good demographics optimally to prevent the economy from going the "LATAM way". However, household led current account imbalances which result from declining household savings rate are difficult to tame. Also, it is not ideal to solve it by stifling the consumption engine through contractionary policies. This is because such policies (be it fiscal or tighter monetary conditions) tend to have a greater adverse impact on capex activity rather than making any significant dent on consumption trend. Instead what is required is a supply side response, i.e aligning the country's production profile with its consumption profile. “Make in India” cannot remain a mere slogan. “Make in India by Indians for Indians" is the urgent need of the hour. For this, a collective effort by all stakeholders including the RBI and the Government is needed. A clear vision and execution strategy to achieve the right growth mix cannot be compromised for any other objective.