Really, consumer is queen


Indian Express, 16 December 2006


The latest data for industrial production in India shows that growth in consumer demand fell sharply in October. Production of consumer goods practically stagnated at a growth rate of barely 0.5 percent over October last year. The decline in consumer demand resulted in a sharp slowdown in industrial production in the country. It grew by merely 6.2 percent over October last year. Should the dependence of the India's industrial production on domestic consumer demand be a source of worry?

Comparisons are often made with China which invests 42 percent of its national income. It is suggested that India should also be saving more and consuming less. At 68 percent of Gross Domestic Production, household consumption in India is higher than in China at 38 percent, Europe at 58 percent and Japan at 55 percent. But as argued below, India's high domestic consumption demand is a source of strength, rather than a cause for worry. However, the high share of domestic consumer demand also means that India needs to re-think some important policy issues and cannot blindly copy from countries which rely more on foreign markets.

Let us look at the case of China. Chinese households consume less than half of what the country produces -- a mere 38 percent. The economy relies on export demand and investment as its engines of growth. The fortunes and fancies of American consumers determine China's GDP. Industrial production for exports is concentrated in a couple of special districts, cut off in many ways from the rest of the economy.

Indian households, in contrast, consume more than two-thirds -- 68 percent of what is produced in India. Demand comes from millions of people buying goods and services across the country. Production takes place all over the country. Indian companies are focussed on selling their products primarily to domestic consumers. Even foreign producers come to India, not to set up export units using cheap labour, but to sell their products to the Indian consumer.

Morevoer, the reason behind India's high domestic consumption is not that households in India do not save enough for their needs. At 22 percent of GDP households in India save more than Chinese households who save barely 16 percent of GDP. The difference in the levels of consumption lies in the fact that households in India own most of the country's productive assests, land and capital, and income from these assets accrues to these households who then spend or save it. In contrast, productive assets in China are held mainly by the government. The largest Chinese corporates are PSUs which are owned by the government, not widely held publicly owned companies. However, PSU profits do not flow back to the government, but are held back by them as retained savings. Savings of the corporate sector in India account for only 5 percent of GDP, while in China they are 20 percent of GDP. The bulk of household income in China comes from wages. In India profits flow back to households adding to their income.

Pushing down consumption, raising savings to increase investment and then exporting its products gave China a sharp rise in growth, but now this strategy is increasingly appearing to be non-sustainable. One of the problems with this strategy is that when the source of rising demand for the economy is exports, the exchange rate is of immense concern. Policymakers focus on keeping it at levels that encourage export growth. This is also the story of the Chinese yuan. Despite huge political pressure from the Americans, the Chinese have not really allowed the Yuan to appreciate adequately. Too much rests on it.

This brings us to the luxury India has. Given the strength that the economy derives from domestic consumption demand, we need not focus on export demand in the same way as China. At least, we need not keep our currency weak, or devote resources to special export zones at the cost of building better infrastructure for the rest of the country.

Yet, at the same time, the fact that the Indian growth story owes its strength to the domestic consumer also creates a different set of challenges. First, we cannot simply copy the policies of countries which rely on exports for growth. For example, before encouraging policies that weaken the rupee to encourage exports, we need to examine the impact this would have on domestic consumption. One of our concern should be that consumer demand can suffer when inflation rises. This means an increased focus on domestic prices. It implies monetary policy with a focus on domestic inflation. Instead of a weak rupee, consumer demand benefits when the rupee is strong and imports are cheap.

What does this imply for policy making in India in the immediate future?

In recent days, the US dollar has been witnessing pressure to depreciate against world currencies. There will likely be pressure on the rupee to appreciate too. India has two options. Either, it can intervene to prevent the rupee from getting stronger, as no doubt, China would do. Or, it can allow the rupee to appreciate. The latter would help curb inflation. First, the exchange rate pass through would mean lower prices for imports. Second, by not buying dollars, the RBI would not be injecting additional rupees into the system. Both consequences of the latter strategy would help bring domestic inflation under control. This would mean that the RBI can go easy on raising interest rates. Households will be better off as both inflation and interest rates would be lower.

In summary, the Indian consumer is India's big strength. But it is the responsibility of the Indian policy maker to nurture this strength. India needs to move away from the policies that countries like China with weak domestic demand follow in order to push exports and focus instead on policies that benefit the Indian consumer.


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