Will recovery in consumer demand hold?

Households still might not have spent down the entire stock of excess financial savings accumulated from April to September 2020. Photo: Mint
Households still might not have spent down the entire stock of excess financial savings accumulated from April to September 2020. Photo: Mint


  • A lower share of output for wages, persistent inflation and a whittling down of covid-time excess financial savings are the risks.

A lot of the recent discussion on the Indian economy has pivoted from the domestic economic recovery towards concerns about the external balance. As an energy importer, India has been hit by a negative terms-of-trade shock over the past year. India is likely to end this year with a current account deficit of $120 billion, which is mirrored in the fact that domestic savings are lagging domestic investment by around 3.3% of gross domestic product (GDP). The widening trade imbalance also means that local demand for consumer goods, machinery, intermediate goods, energy and services is spilling over into the international market, especially as the Indian economy expands at a faster rate than most of its peers.

Before covid and after
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Before covid and after

It is unlikely that capital inflows from the rest of the world will be enough to cover this wide external gap, especially when global financial conditions are being tightened. The professional forecasters polled by the Reserve Bank of India (RBI) estimate in the latest survey conducted in September that India will have a balance of payments deficit of $57 billion during the ongoing fiscal year. The rupee has naturally weakened against the US dollar in response to this foreign exchange funding gap, despite heavy intervention by India’s central bank to support the currency.

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This is a good time to take a closer look at the three drivers of domestic demand: households, companies and the government. These three groups also share the national income pie in terms of wages, profits and taxes respectively. This column had earlier flagged on two separate occasions (December 2020 and June 2021) that early signs were indicating how India’s economic recovery from the pandemic was being led by profits rather than wages. There is now even more reason to believe so. The distributional nature of the recovery has profound implications for the way forward. A bit of further explanation is perhaps warranted.

One way to assess what is happening is by examining the trend in wages, profits and taxes as a percentage of the economy. It is well known that corporate profits as well as tax collections have done well in recent quarters. On the other hand, the labour market has been recovering very slowly. Simple arithmetic suggests that the share of wages in national income must have come down since corporate profits as well as government taxes have been growing faster than the underlying economy in nominal terms.

There is nothing sacrosanct about a recovery led by either wages or profits. A lot depends on the macroeconomic situation at any point of time. Here is a simple way to think about the situation. A rising share of wages in national income can boost production when companies have excess capacity because of weak consumer demand; but it can be inflationary when there is no excess capacity to meet higher demand.

There is a similar argument to be made about a rising share of profits in national income. Its utility is contextual. A higher share of profits can boost economic activity if companies use their net income to expand capacity in their factories by buying new machines; however, companies will prefer to use their net income to either save money or pay off old debts when there is no compelling reason to buy new machines because of excess capacity or business uncertainty.

Households spend out of current income, or by dipping into their accumulated savings in instruments ranging from bank deposits to mutual funds, or by borrowing from the financial system. Recent data released by RBI on the quarterly net financial savings of households shows that these savings are normalizing after a sharp spike during covid-related lockdowns, when we were forced to save because everything around us was shut.

However, there is reason to believe that Indian households have still not spent down the entire stock of excess financial savings that were accumulated between from April to September 2020. Has Indian consumer demand been steady despite weak labour market conditions because households have been spending down these accumulated savings? Shayan Ghosh reported in this newspaper on 28 September that the gross financial savings of Indian households have dropped to the lowest level in five years “as people drew on their savings to indulge in a post-pandemic spending spree" (see bar chart on savings).

This year’s festive season has started off well, but companies, policymakers and analysts have to be alert to the possibility that a lower share of wages in national income, persistent inflation and a gradual whittling down of the excess financial savings accumulated during covid lockdowns can lead to weaker consumer demand in the coming quarters. In that case, the role of capital spending by both the government as well as companies in supporting aggregate domestic demand will grow in importance. The government has done a good job in its spending on infrastructure, despite fiscal constraints from higher food and fertilizer subsidies. A long-overdue revival in the private sector investment cycle, however, is still unsure.

The Indian economy had barely crossed its pre-pandemic level by the first quarter of this fiscal year (see second chart). A sustained recovery requires a robust increase in capital spending by the private sector, which has till now been more focused on deleveraging rather than expanding capacity.

Niranjan Rajadhyaksha is CEO and senior fellow at Artha India Research Advisors, and a member of the academic advisory board of the Meghnad Desai Academy of Economics.


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