New Delhi: Government numbers show Indians are buying more products such as televisions and refrigerators (popularly termed consumer durables), and economists have theories ranging from the so-called wealth effect to the impact of a populist employment scheme that has put more money in the hands of the rural poor.
There is one small problem: The consumer durables industry claims the first three months of fiscal 2008-09, the period ended June, have been “sluggish” as inflation and interest rates rose.
The seeming disconnect between the numbers and the logic behind them, on the one side, and the actual performance of the industry, on the other, could mean one of three things: that the data is flawed; that the volume of consumer durables in trade channels has increased significantly without translating into any rise in sales, with manufacturers probably preparing for a coming spike in demand; or that consumer durable makers are facing the same kind of problems other producers are—higher raw material costs, tighter consumer credit—and are equating these with “sluggishness” in the market while, in reality, demand and sales have risen.
First, the data.
Even as overall industrial activity in June, as represented by the Index of Industrial Production, or IIP, recorded a slowdown in growth year-on-year, consumer goods output soared. According to D.K. Joshi, principal economist and director at rating agency Crisil Ltd, IIP’s consumer goods index can be used as a proxy for consumption of merchandise such as television sets.
Changes in IIP represent changes in the volume of production and not value, keeping out the immediate impact of inflation on the level of industrial activity.
Economists claim this is happening because people are spending more out of a perception that they are wealthier, an impression bolstered by tax breaks and rural job creation.
“On account of the fiscal stimulus such as income-tax benefits, there is a sudden boost in income which has led to a real wealth effect,” says an economist at India’s finance ministry who doesn’t wish to be named. “The income boost through the NREGS has added to it.”
NREGS is short for the National Rural Employment Guarantee Scheme that promises at least 100 days of work a year to one person in a rural family.
The last Union budget tried to boost disposable incomes by offering tax benefits. This was followed by the promise of a pay hike to Union government employees. These two factors jointly created a wealth effect, the finance ministry economist says.
Wealth effect is a term used by economists to refer to an increase in spending that comes along with a real or perceived increase in income.
Pronab Sen, chief statistician of India, who oversees data collection on IIP, says the tax benefits and expected salary increase in the wake of the Sixth Pay Commission report created a wealth effect that was reflected in the production of consumer goods in the first quarter.
“Almost all increase seen in consumer durables has accompanied (expectations on) pay commission recommendations,” Sen says. The cabinet this month rewarded five million government employees with an average pay hike of 21%, going beyond the recommendations of the commission that had submitted its report in March.
The production of consumer durables increased by 3.8% in the first quarter of 2008-09 compared with a contraction of 0.7% a year ago.
An underestimate or a mistake?
The consumption of durables as represented by the index is likely to be an underestimate, says Crisil’s Joshi. For instance, the index, which uses 1993-94 as the base year, includes typewriters but not personal computers. Therefore, spending on computers isn’t captured by the index.
The composition of IIP’s consumer durables index can present a “distorted” picture of the underlying level of activity, according to Suresh Khanna, general secretary of Consumer Electronics and Appliances Manufacturers Association who added that the numbers do not reflect reality. “In the first three months (of 2008-09), generally, the market has been sluggish.”
The difference between Khanna’s take on the market and IIP data, if it is accurate, could be on account of the dated consumer goods basket in the index. For instance, some important products such as DVD players and set-top boxes do not figure in this basket, Khanna says. Split air conditioners, which outsell window air conditioners, also aren’t represented.
The economic basis
A rise in disposable income on account of tax giveaways “in the first year would be treated as a windfall”, Sen says. The windfall is likely to show up in the purchase of durables. From the second year on, the increase in disposable income is likely to show up in consumption of so-called non-durables such as alcohol and personal care products, he says.
There is a consensus among economists that NREGS has increased purchasing power of a section of the rural population. However, not everyone agrees with the finance ministry economist’s view that it could have had a positive effect on the production of consumer non-durable production in the first quarter of the current year. “I would hesitate to stick my neck out,” Sen says on the impact NREGS has had on the level of consumer non-durable output.
According to him, NREGS has had an impact on the price levels in districts where it has been rolled out. Companies that operate directly in rural markets say they are insulated from factors such as hardening interest rates that are expected to slow overall growth.
“The current blip in the economic sentiment has not impacted rural consumers. The rural demand has been quite robust despite the rising inflation and interest rates,” Sudhanshu Vats, vice-president for home care products at Hindustan Unilever Ltd, says, without attributing any reason for this. “The rural sentiment is intact and since rural markets contribute around 50% to our turnover, we have had it good so far.”
A long-term trend
The level of consumer goods production over a longer period showed that it has fluctuated between 8.2% and 9% in three consecutive fiscal first quarters. Other sectors such as capital goods have seen wider fluctuations. The overall industrial production growth fluctuated between 5.2% and 10.3% during the same period.
According to Crisil’s Joshi, the consumption pattern today is an outcome of a long-term trend rather than temporary developments. “Transition to a higher income is what is driving consumption. Income dynamics become strong when growth dynamics are strong.”
The economy has grown at an average rate of 7.3% in the eight years since the beginning of this century. At this average growth, the economy’s size doubles every decade. “It (growth rate) will keep the overall consumption story going,” Joshi says.
While economic growth provides a boost to income levels, consumption is also being driven by a younger population that is earning. “Consumption will be supported by two critical factors: Income dynamics and a huge young population that is consumption-driven,” Joshi says. Younger earners tend to be more inclined to consume, Joshi adds.
Currently, a majority of India’s population—62.9%—is in the working age group. According to the government’s Economic Survey 2007-08, the working age population will increase to 68.4% by 2026.
Such underlying factors will drive long-term consumption even if there is a temporary slowdown in consumption growth on account of economic policy such as the current monetary stance which aims to make borrowing more expensive to cool overall demand, Joshi says.