Posted by: Deepa Vasudevan on Mon, Jul 30th, 2012
The India Consumption Story: Roti, Kapda and Cellphones
India’s economic output is primarily driven by private consumption demand. In other words, expenditure incurred by people on food, clothing, rent, utility charges, education, vacations and all other activities that support living- these collectively add up to almost 60% of Gross Domestic Product1. Despite the 2008 crisis, private consumption continued to grow steadily at 7-8% until 2010-11. This helped to set-off the negative impact of a slowdown in investment and government spending on GDP (Pic 1).
Pic 1: Growth Rates of consumption and Investment
However, y-o-y growth in quarterly Private Final Consumption Expenditure (PFCE) slipped to 5-6% levels in 2011-12. There are concerns that households may react to persistent inflation and declining incomes by cutting back on non-essential expenditure. The less-than-normal monsoon-though its impact is not fully certain yet- may further curtail rural incomes and spending capacity. For manufacturers of FMCG goods- some of whom derive half their revenues from rural markets- this may signal a lower earnings outlook. There is much discussion in the financial press and among analysts about the end of the Indian consumption story.
To understand the impact of declining consumption on growth, it is useful to examine past consumption trends. Two facts emerge from this analysis.
- Across India, the proportion of food expenditure in total expenditure has reduced over the last two decades. Correspondingly, the share of non-food items has gone up.
The National Sample Survey Organization (NSSO) conducts household expenditure surveys periodically; the results provide an excellent ground view of actual consumption patterns in cities and villages. Table 1 gives a snapshot of the composition of consumption expenditure from the five most recent large-sample surveys conducted by NSSO. Between 1987 and 2011, the proportion of expenditure allocated to food declined by 20% in rural areas and 16% in urban areas. Sometime in the mid-nineties, the share of food expenses dropped to below 50% in urban India. This shift had not occurred in rural areas until 2009-10.
Table 1: Composition of Consumer Expenditure (%)
Source: NSS KI(66/1.0) Key indicators of Household Consumer Expenditurein India, 2009-10.
The shift between the proportions of food and non-food categories observed in Table 1 is known as Engel’s Law. The Law states that as incomes grow, households spend proportionally lower amounts on food. The poorest households spend almost their entire incomes on food. With higher earnings, there is more money left over for clothing, education, or other non-food expenses.
The underlying principle of Engel’s Law can be extended to countries. As economies develop and become wealthier, the share of food expenditure in total domestic private consumption declines. This trend is so well entrenched that the ratio of food expenditure to the total is often used to measure a country’s standard of living and progress in poverty reduction. By this count, living standards of Indians have improved significantly in the last two decades.
- The biggest beneficiaries of changing consumption patterns have been the durable goods sector and the services sector.
To analyse how consumers spent the surplus left over after food expenses, we look at annual estimates of PFCE2. In the last decade, household expenditure on clothing, footwear, furniture and appliances, and transport and communications has increased substantially (Pic 2). The biggest beneficiaries of rising non-food expenditure have been the services sector. Communications expenditure jumped from 1.5% of total PFCE in 2000-01 to 4.7% in 2010-11 (mainly due to the boom in ownership and use of cellphones). The share of miscellaneous services doubled to 16% in the same period. This is a category that includes personal care products (beauty, sanitary, tailoring, cable TV), some personal goods such as jewellery, watches, leather bags, cosmetics and other services such as banking, life insurance, legal and business services. Indian households have spent the last ten years improving their life style in many ways!
Pic 2: Trends in Private Final Consmption Expenditure (at constant prices)
Unless inflation remains at very high levels or the economic slowdown worsens, it is reasonable to assume that essential consumption items- the roti, kapda and makan troika- will not be affected by a decline in household spending. Therefore the most vulnerable sectors are likely to be consumer durables, high-end automobiles, mobile services, entertainment options including travel and personal services. In terms of domestic consumption, that could be anything between 10-20% of PFCE!
Rising consumption creates incentives for greater private investment, which in turn spurs employment, growth, incomes and more consuming power. This is a virtuous cycle that works especially well for India, where half the population is aged between 15-64 years and is potentially a good consumer. Declining consumption can reverse this cycle and reduce overall living standards.
As households reduced the share of food expenditure, the surplus is usually spent on goods and services that enhance quality of life. In both rural and urban India, households are spending more on buying durable consumer goods. The consumption of services (shown under the head miscellaneous goods and services in table 1) has increased phenomenally over the past two decades- services now form about 25% of rural and 38% of urban consumption expenditure.
Table 2 gives a break-up of non-food items consumed and their share of expenditure as estimated during the survey period in 2009-10. Items on which expenses are higher than 5% of the total for rural or urban consumers are highlighted. These include the use of electricity and energy for household consumption, transport and conveyance, rent (note the steep disparity between rural and urban rental costs), purchase and repair of durable goods, and other consumer services. The last includes personal services such as expenses on servants, laundry, beauty care, tailoring, priests, legal services, telephone charges.
Table 2: Breakup of Non-food Expenses by Item
Source: NSS KI(66/1.0) Key Indicators of Household Consumer Expenditure in India, 2009-10.
Clearly, India is a good consumption story. And even as early as 2009-10, rural consumption demand was rapidly catching up with urban demand. Consumption demand has been the most reliable contributor to growth: that is why signs that it may be slowing down are worrying for policy makers and manufacturers. The government cannot help either: its fiscal constraints prevent it from offering substantial farm loan waivers or announcing additional rural spending programs.
1 In 2011-12, break up of GDP by expenditures was as follows: private consumption- 57.9%, government consumption- 11.2%, investment- 32%, exports- 25.2%, imports- minus 32.6%. Source: CSO.
2 NSSO survey data show similar results, but the NSSO large sample survey is conducted once in 5 years. Annual trends can be seen from PFCE data.
krishna murari agrawal on Thu, Aug 2nd, 2012 7:47:21 pm
the actual data for whole of india.which is stunning to note.the data relating to cigarate and gutuka is also increased in percentage term which is not reflected in actual,i think so.otherwise the first summary of this kind in india
CIEL Website Administrator Administrator on Thu, Aug 2nd, 2012 3:05:53 pm
You are absolutely right. NREGS has increased rural incomes, and created some supply side issues for food inflation. The impact of dollar depreciation on overseas travel will be clearly observed when PFCE data is updated, probably before end of 2012.
CIEL Website Administrator Administrator on Thu, Aug 2nd, 2012 3:02:54 pm
Thanks for bringing this up. I would like to clarify that in table 2- the ratio of fuel/light expenditure to total expenditure is higher for rural areas as compared to urban. This means that rural residents spend a higher proportion of their monthly expenditure on paying for fuel and light as compared to urban residents. If we examine the data in more detail, it appears that they spend mostly on wood chips and diesel and very little on electricity. Rural incomes are so low that fuel forms a larger part of their expenses. Probably the same explanation works for toilet articles. As for data, it is survey based, so only as good as the responses of the people surveyed!
I P BHARTI on Wed, Aug 1st, 2012 3:59:53 pm
Excellent analysis.. However,don't you think that the private consumption demand especially for food and non food articles in the rural area has increased with the govt. sponsored schemes like NREGS? This too might be the reason for increase in food inflation besides supply constraint.. One more reason for demand decrease could be the $ appreciation by over20% leading to less of overseas travel etc.
kamal gandhi on Wed, Aug 1st, 2012 10:04:51 am
Very useful article, the data given in table-2 is very interesting. It is to be noted that the fuel and light consumption is more in rural area then in urban and same in the case of toilet articles.
I have a doubt on this data because the practical situation is something different.