There are two misunderstandings and false assumptions that are running amok in India. First one believes that U.S. exports and dealings only have 2% impact upon Gross Domestic Product (GDP) of India. The second one believes that Indian economy is a domestic consumption based economy so tariffs and non-trade barriers by U.S. and other countries would have nil effect upon Indian GDP. Both these assumptions and beliefs are wrong and super dangerous to pursue and accept.

GDP is the value added in the production of all goods and services in a year by an economy. It has four components, i.e. (a) Private Consumption, (b) Private Investment, (c) Government Expenditure, and (d) Trade Surplus. Economic growth driven by consumption is not only slower than investment-led growth, but it also aggravates inequalities. The growth of jobs, incomes, and consumption has remained depressed for many Indians, and they have been left behind. In fact, 100 crore Indians are begging for 5 kg ration and India is behind Pakistan, Nepal, Bangladesh, etc in World Hunger Index.

India’s economic growth over the last decade has been driven mainly by expanding domestic consumption expenditures. In 2023, consumption as a share of GDP was 60.3% in India compared to 39.1% in China. The dominance of consumption in India’s GDP structure is mainly due to the weaknesses of the other components of aggregate demand in the country. The shares of investment and government consumption expenditure are relatively low. India also has a trade deficit, with its import of goods and services being larger than its exports, reducing domestic demand.

China’s investment rates have been significantly higher than India’s from the 1970s onward. In 2023, these rates were 41.3% and 30.8%, respectively, for China and India

Despite India’s relying solely upon domestic consumption for 60% of its GDP, it has started waning out. Domestic consumption in India is declining due to several factors, including stagnant wage growth, rising inflation, changing consumer behavior, broader economic challenges, and increased uncertainty about future income, which leads consumers to cut back on spending. Additionally, urban households are prioritising savings over expenditures, further impacting overall consumption levels.

Let us discuss these issues in more details.

(a) Inflation: Rising inflation has significantly impacted consumer purchasing power, particularly among lower-income groups. While high-income households have driven discretionary spending, inflation has led to a shift in spending habits, with consumers prioritising essential goods over discretionary items. This has resulted in a decline in private consumption, which dropped from 58.1% of GDP in FY22 to 55.8% in FY24.

(b) Stagnant Income Growth: Wage growth has remained flat, limiting disposable income for many consumers.

(c) Changing Consumption Patterns: Over the past decade, there has been a noticeable shift in how consumers allocate their budgets. Many consumers are now spending more on electronics and gadgets, often at the expense of essential goods like food. This trend has been exacerbated by the economic pressures faced by households, leading to a decline in demand for high-margin items such as packaged foods and personal care products.Consumers are also opting for cheaper products and services to manage their expenses, indicating a shift in spending habits.

(d) Economic Slowdown: The Indian economy has been experiencing a slowdown, with GDP growth rates declining from 8.2% in 2023-24 to an estimated 5.4% in the second quarter of 2024. This slowdown has been attributed to weaknesses in demand, particularly in private consumption and fixed capital formation. The decline in automobile sales and FMCG revenues further illustrates the weakening consumer demand.

(e) Long-term Structural Issues: The decline in domestic consumption is not a new phenomenon but rather a continuation of long-standing issues within the Indian economy. The failure to create a robust home market, coupled with a large informal workforce and volatile income, has contributed to a chronic consumption demand crunch. This has been evident in the declining growth rates of consumption in both rural and urban areas.

(f) Consumer Confidence: The overall consumer sentiment has become increasingly cautious, reflecting a deeper, lasting change in spending behavior. As consumers face economic uncertainty, they are more likely to cut back on spending, further contributing to the decline in domestic consumption.

(g) Increased Savings: Many urban consumers are prioritising savings over spending due to economic uncertainty.

(h) Urban vs. Rural Dynamics: Urban areas, which significantly contribute to consumption, are experiencing a slowdown in spending as residents face income challenges. While urban consumption is faltering, some rural sectors are showing growth, but overall urban demand remains critical for economic health.

(i) Low Private Investment: Despite high corporate profits, private sector investment has dipped, affecting job creation and consumer confidence.

(j) Global Uncertainties: Economic uncertainties and competition from imports have made companies cautious about expanding their operations.

So households are spending less as they cut back on expenses after a post-pandemic boom, leading to a cyclical slowdown in consumption and declining consumer confidence. Real wage growth for urban Indians has remained stagnant, falling below the 10-year average, which curtails spending capacity, particularly as headline and food inflation remain high. High inflation, especially in food prices which have averaged above 8% due to weather-related issues, erodes purchasing power, forcing households to prioritise essential spending over discretionary goods and services. A pullback in government spending, an important economic driver in recent years, has further dampened demand across the economy. Increased household debt incurred during the pandemic and rising interest rates for personal loans are contributing to households focusing on saving more and servicing their loans, rather than spending. Despite high corporate profitability, companies are not investing to expand capacity or create new demand because of the current lack of sufficient overall consumer demand, creating a “vicious cycle” of low investment and consumption. While rural demand shows some recovery, urban demand remains particularly muted, impacting sectors like fast-moving consumer goods (FMCG).

The decline in domestic consumption in India is a multifaceted issue driven by economic pressures, changing consumer behavior, and long-term structural challenges. The combination of inflation, stagnant wages, changing consumer behavior, and hesitancy in corporate investment is leading to a decline in domestic consumption in India. This trend poses challenges for economic growth, as consumer spending is a major driver of the economy. Addressing these issues will require targeted government interventions and policies aimed at boosting consumer confidence and stabilising income growth. But too much reliance upon domestic consumption to leverage and boost Indian GDP and economy is a sure recipe for disaster and India is already heading in this direction says Praveen Dalal.