Publication: The Economic Times Delhi; Date: Aug 7, 2011; Section: Cover Story; Page: 6

WHAT, ME WORRY? NOT YET

Headline economy numbers look troubling. But the ndian
consumer is still confident. That's the good news. For the
consumption story to continue, though, the investment climate must
change. So, shoppers need the sarkarto act
:: MaIini GoyaI, Soma Banerjee and Mishita Mehra



Something curious is happening at Maruti Suzuki. 2011 has been cruel on ndia's largest carmaker a crippling strike
followed by plunging sales (25% down in July) has left the company and auto analysts reaching out for their seat belts.
The company expects measly single-digit growth for the industry this year. At the same time, more and more people are
actually walking into showrooms to actually check out new cars, says Mayank Pareek, executive director (marketing),
Maruti Suzuki. "This signals two things sentiments are good and the intention to buy is intact but they are holding on to
the purchase for interest [rates] or other reasons, says Pareek. "The consumption story is powerful and intact. Long-term
bullishness remains.

Deep Kalra, CEO of Makemytrip.com, ndia's largest online travel portal, points out to the traveller numbers in the
holiday-segment of the company's business. n the past two years, the number has more than doubled to 4,50,000. This
season, Kashmir, says Kalra, had the best tourist season ever and there were no hotel rooms available for booking.
ndia's domestic aviation traffic grew by 14 % in June second only to Brazil (15.1%) globally. n Mumbai, the mood at
the Future Group, the country's largest modern retailer, is equally upbeat. Damodar Mall, the group customer director,
sees "growth coming in on the higher side.

Does this mean that Jyothi the working woman ndia's aam auratand the equivalent of the American Joe the plumber
is keeping the zipper on her purse open? s she continuing to spend on groceries and splurge on her shopping sprees
at the mall despite those 11 interest rate hikes by the central bank in the past 18 months? Will she buy that small car that
she has been planning to buy for over two years, later this year? Going by what Pareek and Kalra see in their business, it
looks like the great ndian consumer is not a spent force, despite many macroeconomic numbers losing their lustre.

The choices that she makes whether to splure or tighten those purse strings will be a large determinant of the
pace at which the ndian economy will grow.

%he Investment Story

So why are Jyothi's choices so important? As the folks in RB are busy combating inflation by repeated interest rate hikes,
the ndian economy's growth rate is under threat.

A few days after RB governor D Subbarao announced the latest rate increase, the Prime Minister's Economic Advisory
Council revised its growth outlook for the year down to 8.2% from 9%. Driving this weaker growth will be a 'significant
weakening' in investment, said the council. And it's not just investment. "One by one, all the growth engines appear to be
heading for a simultaneous slowdown, warn economists Chetan Ahya and Upasana Chachra of Morgan Stanley.

The investment story is revealing. nvestment grew at 8.6% in 2010-11, up from 7.3% a year earlier. nvestment growth
has been sluggish for the past nine months, with the last quarter of 2010-11 showing a mere 0.4% growth. But it
rebounded in the next quarter. "We have come off the peak in terms of new investment announcements. But, a lot is being
implemented and being completed. mplementation did slow down in 2009-10 but the pipeline is good and therefore the
investment story will continue for 2-3 years more, says Mahesh Vyas, head of the Centre for Monitoring the ndian
Economy.

But Vyas's optimism on investments is not shared by other experts. Vinayak Chatterjee, chairman of Feedback
Ventures and someone who works closely with infrastructure firms, says order books are weak. "My biggest concern is
don't see a good investment pipeline in the next three years, he says. "From ports to railways pick any sector, there is
just no action. Sentiments and confidence both are missing.

"Lending rates of 13.5-14% are currently at their highest in more than 12 years, suggesting that while the nas- cent
investment up cycle can continue, it is likely to be short lived, says Sonal Varma, ndia economist at Nomura, an
investment bank. That leaves consumption, which accounts for 58% of the GDP, as a major driver of growth. Moreover,
private consumption grew at 8.6% in 2010-11, compared with 7.3% in 2009-10.

%he Consumption Engine

Few see government consumption playing the role it did during the financial crisis of 2008. As Ahya and Chachara point
out, "the biggest driver to growth following the credit crisis was the spike in...government spending. Government
expenditure rose by 10.5% in 2008-09, and over 16% in 2009-10, and, through schemes such as MNREGA, transferred
substantial spending power to rural households. "However, this engine of growth is now slowing down rapidly, say the
Morgan Stanley economists. According to the latest GDP data, government expenditure rose by a little under 5% in 2010-
11. And with fiscal constraints, don't expect a helping hand from the babus in the finance ministry.

t is in this context that Jyothi's choices gain importance. Economists say that given the relentless hike in interest rates,
the main casualty have been the so-called 'interest-sensitive' sectors, where consumers usually assume debt to buy the
product; autos and real estate are the prime examples. Even consumer durables get affected. Annual growth in consumer
durables production for instance, has fallen from 13.9% in March to 5.2% in May.

The news from the automobile industry is predictably gloomy. Sales are tapering off, from an average growth of 30% in
December, to 1.6% in June. For many consumers, high interest rates are a double whammy because as high as 26% of
people who buy cars also have a home loan.

But at the same time, sectors like FMCG and pharma, where sales generally do not depend on interest rates, are still
going strong. "Overall growth in the FMCG sector is still robust. Higher prices in these sectors merely lead to consumers
switching from one product to another, says NCAER director Rajesh Shukla. "The impact may play out on quality terms;
so if the impact on demand is not visible in value terms, there may be an impact on the quantity and quality of products
consumed, he adds.

GoI Must Act

"We find not just the resilience in consumption but also continuation of the growth on the higher side, says Damodar Mall,
group customer director, Future Group, an organised retailer. His rationale is that if you are not going for bigticket buys
like cars and houses then you have more disposable money to do other things. He sees 15% growth in same store sales
(in supermarkets) in 2011-12 vis-a-vis last year.

But the future can be gloomier for the consumer. Arvind Singhal, chairman of Technopak Advisors, says he has begun
to see early signs of downtrading by consumers moving to cheaper options in the same basket.

nvestment and consumption have different response times. Abheek Barua of HDFC Bank points out that in 1997-98 an
investment cycle had peaked and then started going down. "t took about two years after that for consumption to flatten,
he says.

Underlying the short-term shifts in consumption and investment though, is a much bigger shift over the last 20 years
a shift that could have profound consequences for the nature of growth. n the early 90s, at the onset of reforms, spending
by private consumers contributed to 70% of GDP. By 2010-11, the share of private consumption had fallen to 58% a
surprising statistic for those who see the reform era as one of high private consumption by the middle class.

What picked up the slack? Not the government, whose expenditure as a share of GDP has remained more or less
constant at around 11-12%. Despite a record export growth, the share of trade in GDP is too small to have a substantial
impact on overall GDP growth, even less in the context of a weak global economy. The biggest shift has been towards
capital investment, whose share of GDP rose from around 20% in the early 90s to 32% now. nvestment is now a far more
critical component of the GDP engine than it was at the onset of reform. Private consumption is still the biggest
component of GDP of course, but it now accounts for less of the economy than it used to.

Here's the problem. Capital investment is far more volatile than consumption. n 2007-08, investment growth was 15%.
t slumped to 2.7% in 2008-09 as the global economic crisis took hold and bounced back up to 7.3% in 2009-10, due to a
combination of global economic recovery and government stimulus. n comparison, consumption growth slowed during
the crisis years, but its fall was much less. "Corporate investment is far more fickle and sensitive than consumer
sentiments are, says HDFC Bank's Barua. The increased importance of investment in overall GDP, and the wild swings
that it is subject to, has meant that GDP growth could become more volatile.

n such an environment, policy direction and stability becomes even more critical since that is what investment
decisions are based on. "The predominant headwind to investment is the ongoing governance crisis, says Varma in her
research note.

%he Consumer As Saviour

How much can the ndian consumer act as a buffer against a deeper slowdown? One doesn't have to go too far back in
time to see how consumption growth acted as the blue-pill equivalent for investment and GDP growth. Back in 2002-03,
consumption registered an uptick, growing by 3%. The next year, it grew by 6%. Since private consumption is on a huge
base, even a small growth like this meant a substantial expansion in the market, encouraging the corporate sector to
invest more. Companies soon began to add capacities. nvestment picked up by 2003-04 when it grew by 13.6%.
Between 2004-05 and 2007-08, investment grew at a steady clip of well over 14-15%.

The most important factor sustaining consumption today is the rapid rise in wages, especially in the rural sector. Within
rural ndia, wages in the agricultural sector has risen by 18.6% and that in the non-agriculture sector by 16.3% led by
higher MNREGA wages and higher land prices. "On a real basis, wages have seen a jump of 8.6% and 6.3% respectively
this is the largest percentage increase in real wages in the rural sector over the past 12 years says Subadha Rao, chief
economist at Yes Bank. Moreover, expected normal monsoons in 2011-12 would further support farm incomes and rural
consumption.

Even the organised sector job market is in good shape with double digit wage increase, Rao adds. For the organised
sector, HR consultancy firm Aon Hewitt projects a 12.9% rise in nominal salaries in 2011. "Wages have increased and
increased wages are being spent almost entirely on consumption says Shukla.

This is unlike the 2007-09 period. Then, rural wage growth after adjusting for inflation was negligible. "Wage growth
was slow in the recession years. The major difference is that unemployment is not an issue now and also the strong factor
sustaining consumption today lies in the rural side says Varma. Also, 2008-09 was a drought year which affected farm
incomes and consumption.

These positives could turn into negatives of course. f a slowdown really starts to bite, those salary hikes could go, and
hiring may come to a halt, forcing consumers to be more cautious. A weaker monsoon than expected could hurt rural
incomes.

The bottomline: yes, consumption is weaker, but there's still a lot of resilience left in the ndian consumer. But it's even
more critical than before that the government plays its role in kickstarting, and then sustaining investment.

Because income growth has outpaced infIation


Rural and urban incomes grew faster than inflation


Massive expansion in public works and public welfare plans aided demand


High demand kept investment coming in new and existing businesses high


nvestments sustained salary hikes and new jobs creation

But coming months couId dampen demand if


GDP/industrial growth goes down


Private/public investment slows or stalls


ncome growth and job creation flattens


Global economic uncertainty confounds investors


Government doesn't clear legislative logjam to improve sentiments