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Can private consumption be India's growth engine?

Dharmakirti Joshi and Gunjan Gulati | December 15, 2003

The falling cost of credit has triggered a boom in the retail finance market. Population demographics support an increase in private consumption.

Households are transiting from low income to high-income categories. The prices of consumer goods have either come down or stayed low.

Does this imply that a consumption boom is in the offing and that private consumption will become a key trigger of economic growth? Many analysts are quite gung-ho on the role of private consumption in shaping the future growth trajectory in India.

An analysis of National Accounts data up to 2001-02, however, provides a somewhat cautionary backdrop to these very optimistic projections.

In the context of the role of consumption vis--vis other drivers of growth in the economy, it would be useful to examine the behaviour of the components of GDP from the aggregate demand side.

The table "GDP growth trends" compares the growth performance of the Indian economy from the demand and the supply side in the 1980s and 1990s.

On the average, private consumption has improved its growth performance in the 1990s vis--vis the 1980s but its growth stayed below the rate of growth of government consumption. The growth patterns, however, change once we focus on the trends in the 1990s.

For the 1990s, we focus on the two phases: the high growth phase (1993-94 to 1996-97) and slowdown (1997-98 to 2001-02).

Viewed from the production side, all the three sectors -- agriculture, industry and services -- witnessed deceleration in the slowdown phase vis--vis the high growth phase. The demand components of GDP, however, show differential growth patterns.

The growth in overall consumption expenditure declined marginally from 6 to 5.8 per cent between the high growth phase and the slowdown.

Within consumption expenditure, while the Government Final Consumption Expenditure notched up its growth from 4.5 per cent a year to 8.4 per cent, Private Final Consumption Expenditure growth slid from 6.2 per cent to 5.3 per cent.

Both exports and imports boomed during the high growth phase. The slowdown, however, saw a slackening in the growth of imports but sustenance of export growth rates.

External demand has, therefore, been a key contributor to GDP growth in the slowdown phase. With the growth of gross domestic capital formation falling from 10.6 per cent in the high growth phase to 5.3 per cent in the slowdown phase, the slowdown in investment activity contributed significantly to the overall growth slowdown.

The National Accounts provide disaggregated data for 37 consumption categories. Although the overall PFCE is available for 2001-02, the disaggregate data is available only up to 2000-01.

The highest growth (less than 10 per cent per annum) took place in those PFCE categories that have a relatively low weight.

In the high growth phase, 14 PFCE categories with a weight of 20.1 per cent in the overall PFCE grew at more than 10 per cent a year.

In the slowdown phase, only 11 PFCE categories with a weight of 17.8 per cent registered over 10 per cent annual growth.

Thus, the high growth in PFCE was restricted to a few sectors to begin with and has become more concentrated in the recent years.

The nine PFCE segments that were able to maintain their high growth performance include communication, refrigerators, washing machines and so on, hotels and restaurants, beverages, LPG, coffee and tea.

The number of PFCE categories that registered growth between 5 to 10 per cent a year increased from 12 to 14 between the high and the low growth phase but their weight in aggregate PFCE fell from 33.6 per cent to 29.4 per cent in the corresponding period.

Purchase of transport services, electricity, education, sugar and gur, spices, potato and tubers, oil and oilseeds are the key consumption categories that continued to grow at 5 to 10 per cent a year throughout the post 1993-94 period.

The PFCE categories that transited from zero to 5 per cent growth category to 5 to 10 per cent growth category include footwear and glassware, tableware and utensils.

Cereals and bread, fruits and vegetables and pulses (with a combined weight of 24 per cent in total PFCE) moved from zero to 5 per cent growth category to negative growth category between the high and the low growth phases.

This resulted in an increase in the share of consumption categories witnessing negative growth from 2.3 per cent in the high growth phase to 26.8 per cent during the slowdown.

The growth resilience in some consumer categories and growth deceleration in others is a consequence of a number of factors.

The negative growth in cereals and bread, tobacco, pulses and fruits and vegetables reflects the change in consumer preferences away from these items.

However, within food items, a shift has taken place from cereals, pulses and so on to beverages, coffee, tea and other processed foods that have higher income elasticity.

Two conclusions can be drawn from the above analysis. One, on the positive side, a low-share, high-growth combination bodes well for sustained growth, because of the low levels of current penetration.

On the negative side, the sheer bulk of the slow-growing segments will keep the role of private consumption as an engine of growth somewhat restrained.

In contrast to PFCE, GFCE notched up its growth in the slowdown phase. Within GFCE, both salary and wages and purchases of goods and services witnessed a sharp rise in growth.

Despite a favourable shift in dependency ratios, rising income levels, growing middle-class, falling prices and a kick from the rise in salaries and wages of government employees, the growth in private final consumption expenditure fell from 6.2 to 5.3 per cent between 1994 to 1997 and 1998 to 2002.

Within the overall PFCE, some consumption categories like white goods, beverages, transport equipment, communication witnessed double-digit growth rates and maintained their growth resilience from 1993-94 onwards.

However, the overall growth in PFCE slid because some categories with high weight, particularly cereals, pulses and so on witnessed a decline in consumption expenditure.

A sharp pick-up in GFCE in the past six years indicates that government consumption has played a key role in propping up the overall GDP.

While factors such as access to cheap credit, favourable demographics, low prices and attitudinal changes will keep the consumption ticking in some categories, a boost from government consumption should not be expected. The impact of rise in salaries and wages has already petered off.

Against this backdrop, the role of aggregate private consumption as a key growth driver needs to be carefully thought.

Despite a significant notch up in their growth rates together with other factors such as lower prices, both India and China, in the past few years have witnessed a declining share of PFCE in the overall GDP.

In the Chinese case, investment and net exports have clearly dominated the process, while in India, it appears that government spending and exports have provided the momentum.

Even with the growth buoyancy in the high-growth consumption categories continuing into the future, the overall PFCE growth in the next five years is unlikely to exceed the overall GDP growth.

From the perspective of consumption spending, the reason for this is that the fastest growing items of consumption have such a small share of the basket that it will take quite some time before their contribution to growth picks up.

These products will become true drivers of growth only when their share becomes significant and their penetration reaches saturation point.

Dharmakirti Joshi is a senior economist and Gunjan Gulati is a trainee economist at the Centre for Economic Research, Crisil

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