Dwindling Consumer Confidence

Adit JainWhen an economy begins to slacken, it is common for people to hastily blame their government. This is rather simplistic. Economies move in cycles and whilst governments and central banks can nudge things one way or another, longer-term growth requires structural adjustments. Governments, though, have the ability to create a feel good factor that motivates consumer spending, for instance through lower taxes; and central banks through lower interest rates. But ultimately growth is a consequence of new investment and demand. Governments can play a role in both areas but cannot flap a magic wand.

There is no single solution to fixing the current state of affairs. Longer term reforms must be complemented with short term feel good measures.

The current slowdown is due to a combination of a few factors. First, rural incomes have been stagnant for the past few years. According to a report by the Reserve Bank of India, rural earnings soared by 15-17% pa between 2007 and 2013 and consequently, so did consumption. Thereafter, through to 2017-18, earnings slumped to around 6% pa with a resulting shock to a range of products, including consumer goods and farm equipment. Although inflation also fell during this period the drop in wages was far higher. Second, urban incomes failed to keep pace with their previous growth, largely an outcome of an absence of sizeable investments in manufacturing – new capacities create new jobs and consequently a new set of consumers. Whilst urban consumption has been climbing over the past three years, so has the quantum of consumer imports, mainly from China. For instance, 60% of India’s electronic imports come from China. Therefore, the marginal rise in demand has not really helped Indian manufacturers. The Indian corporate sector, refraining from investments in their own country, preferred manufacturing commitments in offshore locations. Whilst the growth in services, such as retail and logistics, created a tangible number of new jobs, most of these complemented a rise in consumer goods and electronics imports. For instance, electronic imports have jumped by about 16% pa in the last two years, capital goods by ~17% pa, toys 15% pa; apparel 35% pa and fertilisers by 27%.

Equity markets need to be buoyant, as they are a source of capital for business enterprise. They also generate private consumption through the ‘wealth effect’.

Third, the shrinking of retail credit influenced the purchase of products that cost more than Rs 15,000. Banks and NBFCs that provide such loans are themselves in dire straits. In the wake of the IL&FS crisis, the balance sheets of NBFCs came under scrutiny with fewer lines of credit from traditional lenders such as mutual funds and banks. Dodgy loan exposures amongst NBFCs aggregate to Rs 2 trillion or thereabouts. Commercial banks, themselves, need to fix their balance sheets and this requires unaffordable sums for recapitalisation. Finally, urban consumption complements a feel-good factor. When stock markets are buoyant people feel happy about their notional wealth. On the other hand when markets deflate, they become cautious. Stock values have collapsed by more than Rs 10 trillion over the past few weeks, providing a setback to retail spending. The sectors most likely to be impacted would be tourism, automobiles, consumer durables and really anything that is considered discretionary.

The issue now is how does one fix this? Regrettably, there is no plain solution. As a start, the government needs to continue with its infrastructure spending that in turn would sustain longer term growth. In the short term though, a combination of tax incentives would be handy. These could cover both personal income taxes – to persuade consumption – as well as corporation tax to inspire new investments. Currently, the effective tax rate on businesses is around 48% or even higher, when dividend distribution levies and further taxes on individual shareholders on dividend incomes are included. Equity markets need to be buoyant, as they are a source of capital for business enterprise. They also generate private consumption through the ‘wealth effect’, which affects the bulk of India’s middle-classes. This can’t be all that hard to fix.

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Adit Jain, Editor