How can India’s consumption growth be revived?

Tax relief is an obvious option. The net tax burden on Indian households has surged in recent years. Personal income taxes, combined with net indirect taxes (indirect taxes minus government subsidies), now exceed 20% of private consumption spending, the highest level on record. However, the design of any tax relief will be crucial. An indirect tax cut may be more effective than a direct tax cut for several reasons. 

A personal income tax cut would benefit only a small fraction of the population, as the vast majority do not pay income tax. Also, tinkering with the direct tax rate makes sense only when there is confidence over the medium-term fiscal sustainability. Aggregate direct tax collections have slowed unexpectedly, and reversing an income tax cut later, if needed for the sake of fiscal health, will be politically difficult.

The savings from a personal income tax cut are also unlikely to translate one-for-one into increased consumption. Household balance sheets are already quite leveraged because of a recent spike in personal loans, and savings have diminished due to the post-pandemic spending boom. In short, for the economically better-off cohort that can benefit from income tax relief, the willingness to spend on non-essential items may remain subdued. Such cautious consumer behaviour is already visible in rising net household financial savings.

In contrast, indirect tax relief benefits the population universally and equitably. For instance, a fuel-price cut would supplement household disposable incomes directly and indirectly. It would rapidly ease transport inflation, and lower input costs would gradually make their way to other goods and services, easing non-transport inflation. Even if output price inflation does not fall much, a fuel-price cut can still marginally improve business profitability, which is currently under stress.  

Importantly, a fuel-price cut can also ease food prices, which have become a thorny economic policy issue. A key factor behind elevated food prices is abnormally high retail food trade margins in the post-pandemic economy. Domestic fuel costs have a tight correlation with retail food trade margins, as transport is a key component of the retail price mark-up for food and agricultural commodities.

In a similar vein, another option is to cut the cooking gas price further. Though the government has lowered the LPG cylinder price by 300 rupees since early 2023, it remains 20% above the pre-pandemic level, which is expensive for poorer and rural households. ‘Fuel and light’ inflation has been persistently higher in rural than in urban areas, as rural demand and prices for alternative and unregulated cooking fuels (such as charcoal and coal) have shot up due to the reduced affordability of LPG cylinders. Lower rural cooking fuel costs would support disposable incomes and strengthen the rural demand recovery. For every unit increase in their respective incomes, rural households tend to consume more than their urban counterparts.

A fuel- or LPG-price cut also makes economic sense. Global oil prices have fallen 38% from their peak of $120 per barrel in mid-2022, yet domestic fuel costs have eased only 10% and LPG costs by 24%. With domestic demand slowing, now might be an attractive time to pass on the fiscal savings from lower global oil prices to the private sector. 

That said, the challenge remains in funding consumption stimulus while reducing the fiscal deficit. In an uncertain world, there is no room for fiscal adventurism, especially with a high fiscal deficit and public debt in the backdrop. Re-evaluating spending strategies might be beneficial. For example, setting a realistic capex target for 2025-26. In recent years, actual capex has fallen short of the budgeted figure, and large capex plans risk execution delays. 

The bottom line is that any fiscal stimulus should not focus exclusively on boosting demand but must tackle inflation as well. A countercyclical step must also not be mistaken for a panacea, as any tax or subsidy relief is essentially a transfer of limited resources from the government to households. Sustainably strong consumption growth requires solid job creation and income growth as the foundation. To achieve this, ramping up ongoing reforms and pursuing tougher ones may be necessary. Boosting human capital, simplifying labour laws, attracting foreign direct investment, and driving domestic business investment must remain in focus.

Dhiraj Nim is economist at ANZ Banking Group