Macroeconomics and Business Environment Term Paper

Private Final Consumption Expenditure in India During the period of 2004-05 to 2010-11

Submitted to: Dr R.K.Ojha

Date submitted: 8 January, 2013

Group code:

Group members: Rohit Pal Rohit Rastogi Sanjana Agarwal Vatsal Sharma

[JL12PGDM126] [JL12PGDM127] [JL12PGDM132] [JL12PGDM173]

Acknowledgement
Perseverance, Inspiration and motivation have always played a key role in the success of any venture. So hereby, it is our pleasure to record thanks and gratitude to the people involved. Firstly, we thank Dr. R.K.Ojha, for his continuous support in this term project. He was always there to listen and to give advice. He showed us different ways to approach a situation suited to our term project and the need to be persistent to accomplish any goal. Without his encouragement and constant guidance we would have been unable to finish the project. He was always there to meet and talk about any query. Last, but not the least, we would like to thank all our group members who supported us throughout the project.

Table of Contents
Summary.....................................................................................................................................1 Conceptual background of the topic ............................................................................................2 Review implications of data and literature ...................................................................................5 Business implications of analysis and findings ............................................................................8 Conclusion and Recommendations ............................................................................................10 Appendices ...............................................................................................................................11 Private Final Consumption Expenditure during the period of 2004-05 to 2010-11..................11 Graph showing upward moving PFCE of the stipulated periods: ............................................12 Bibliography .............................................................................................................................13

Summary
The Private Final Consumption Expenditure (PFCE) is defined as the expenditure incurred on final consumption of goods and services by the resident households and non-profit institutions serving households (NPISH), i.e. the amount of the money spent on food and non food items. It is measured on monthly basis and it is the second most important macro variable used in macroeconomics analysis. It is also the most important factor in determining the level of economic activities in an economy. It is therefore the most important variable in income determination models. The Consumption function is C = a + bY where bY = induced consumption and a= autonomous consumption. However, there are two methods to estimate PFCE that is Market Surplus Ratio (MSR) and Inter-Industry Consumption (IIC). 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 has increased phenomenally over the past two decades- services now form about 25% of rural and 38% of urban consumption expenditure. The biggest beneficiaries of changing consumption patterns have been the durable goods sector and the services sector. Within the PFCE, the major items of expenditure are food, beverages and tobacco with a share of 20.9 per cent, transport and communication with a share of 9.9 per cent, gross rent, fuel and power, with a share of 8.6 per cent, miscellaneous good & services, with a share of 8.4 pe r cent and clothing and footwear with a share of 3.7 per cent. Indian households are increasingly spending more money on education, and for a majority of households today, children's education is one of the key motivations for saving. Estimates from National Sample Survey Office (NSSO) data reveal that even though food has been a priority in the consumption basket of Indian households, its share has been declining. On the other hand, the share of many non-food items is on the rise: in particular, education, along with health, durable goods, consumer services and conveyance. Household budget share of education increased and education has witnessed one of the fastest growth rates among different expenditure heads of Indian households.

Conceptual background of the topic

Consumption Function: A consumption function is a functional statement of relationship between the consumption expenditure and its determinants. The most common form of consumption function is expressed as: C = a + bY Where C = Aggregate Consumption expenditure Y = Total disposable income a = Intercept a is a positive constant. It denotes the level of consumption at zero level of income. The consumption at zero level of income is called autonomous consumption. b = b is a positive constant; it represents the slope of a linear consumption function. bY = is induced consumption Private Final Consumption Expenditure: The Private Final Consumption Expenditure (PFCE) is defined as the expenditure incurred on final consumption of goods and services by the resident households and non-profit institutions serving households (NPISH). The National Accounts Statistics (NAS) compiles the estimates of Private Final Consumption Expenditure (PFCE) following the commodity flow approach. It implies working of commodity balances relating to various items of consumption, taking into account 1. Production 2. Intermediate consumption in agriculture, manufacturing and other industries 3. Net imports 4. Change in stock 5. Consumption on government account and 6. Gross Fixed Capital Formation (GFCF) Private Final Consumption Expenditure (PFCE) can be obtained as: Final Consumption expenditure of households in domestic market; (+) Direct purchases abroad by resident households; (-)Direct purchases in the domestic market by non-resident households = Final consumption expenditure of households (+) Final consumption expenditure of private non-profit institutions serving households; = Private final consumption expenditure How to Estimate Private Final Consumption Expenditure : For food Items: For food items, PFCE is estimated at two stages.

The quantity retained by the producers for their own consumption is evaluated at producer's prices and; Marketed part is evaluated at retail prices.

For Manufacturing items : The value of output is adjusted for excise duty and trade and transport margin (TTM). The TTM'S are separately estimated for various commodities/commodity groups on the basis of price data at various levels; i.e., producers', wholesale, retail etc. Import duty is also added to the value of imports. For Services: The estimates of final consumption expenditure is derived from the total output (as measured by the gross earnings) of the agencies providing these services to the consumers after netting out the expenditure by the private enterprises and public sector on these services during the year. The sum of all the commodity-wise estimates of value gives the aggregate estimate of PFCE, which in fact represents the value of goods and services consumed by the households and Nonprofit Institution Serving Household (NPISH). PFCE Estimates: PFCE are worked out on the basis of large number of Rates and Ratios. Two important issues are 1. Market Surplus Ratio (MSR) 2. Inter-Industry Consumption (IIC) 1. Market Surplus Ratio: The Private Final Consumption Expenditure estimates for most of the food items are worked out using two different prices. Quantity Retained by the Producer (QRP) is estimated at ex-farm prices and the quantity purchased from the market is evaluated at retail prices. The market prices are generally higher than the ex-farm price. In order to obtain quantity retained by the producer, seed/feed and marketed supply is deducted from the total production. The marketed supply is worked out on the basis of MSR, which are available from DES, Ministry of Agriculture. The information on MSR is available with a lag of approximately 2 years. As per the present methodology of estimation of Private Final Consumption Expenditure, it is an implicit assumption that MSR would remain fixed at the base year level. Perhaps it may not be the real situation as farmers would retain certain minimum quantity for their own use and sell the remaining quantity in the market. The quantity retained by the producer depends on its requirement and only the surplus is sold in the market. The fluctuations in the production will not affect much the quantity retained but it does influence the marketed supply. This assumption of fixed MSR may give a distorted picture of the PFCE estimates. Since MSR is available with a time lag of 2/3 years and actual MSR cannot be used, an alternative approach has been attempted to first estimate QRP and estimate marketed supply as residual. For this purpose the QRP has been estimated based on the per capita QRP and the projected population. The QRP for a year is divided by the rural population (used as proxy for producers of food grains) to obtain average per capita QRP. For the subsequent years, the per capita QRP is multiplied by the projected rural population to get the QRP.

2. Inter-Industry Consumption: The quantity supplied in the market is distributed in different components of use namely interindustry consumption, consumption by government and imports & exports, capital formation (change in stock) and private final consumption. For obtaining PFCE, the expenditure incurred by industries as intermediate consumption and all final consumption (including imports and exports) are deducted from the total availability. The inter-industry consumption is being computed only for some items and this too is based on very old data on inter-industry consumption ratios. It fails to capture the existing pattern of interindustry consumption of these items. For example, amount of pulses, fruits and vegetables, vanaspati and meat, egg and fish etc. used as inputs in other industries including hotels and restaurants, which has grown fast in recent years, is not properly accounted for in the present methodology of estimation of PFCE.

Review implications of data and literature

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 countrys 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. The shift between the proportions of food and non-food categories observed is known as Engels 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. To analyze how consumers spent the surplus left over after food expenses, we look at annual estimates of PFCE. In the last decade, household expenditure on clothing, footwear, furniture and appliances, and transport and communications has increased substantially. 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 cell phones). 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 jewelry, 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. 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 has increased phenomenally over the past two decades- services now form about 25% of rural and 38% of urban consumption expenditure. 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. 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. Indias economic output is primarily driven by pr ivate 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. 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. 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. The proportion of expenditure allocated to food declined by 20% in rural areas and 16% in urban areas. The share of Private Final Consumption Expenditure (PFCE) in the domestic market in GDP at current market prices is estimated at 58.0 per cent in 2009-10 as against 58.5 per cent during the year 2008-09. Within the PFCE, the major items of expenditure are food, beverages and tobacco with a share of 20.9 per cent, transport and communication with a share of 9.9 per cent, gross rent, fuel and power, with a share of 8.6 per cent, miscellaneous good & services, with a share of 8.4 per cent and clothing and footwear with a share of 3.7 per cent. Indian households are increasingly spending more money on education, and for a majority of households today, children's education is one of the key motivations for saving. Estimates from National Sample Survey Office (NSSO) data reveal that even though food has been a priority in the consumption basket of Indian households, its share has been declining. On the other hand, the share of many non-food items is on the rise: in particular, education, along with health, durable goods, consumer services and conveyance. Household budget share of education increased and education has witnessed one of the fastest growth rates among different expenditure heads of Indian households. While the overall consumer market has grown at 14.5% per annum in nominal terms over the last 5-6 years, spending on education rose by 21% per annum. And, it is not just the same people who are spending more on their children's education. The growth rate of private final consumption expenditure has been fairly consistent even when the economys growth rate has fluctuated somewhat. As against an overall growth of private final consumption expenditure that was in the range of 7.1-9.2 per cent during the period 2005-6 to 2010-11, the rates of growth of the consumption groups food, beverages, and tobacco and gross rent, fuel ,and power have generally been lower. On the other hand, the growth rates of items like furniture and furnishing, transport and communications, and miscellaneous goods and services have generally been higher. As a result, the composition of private final consumption expenditure in terms of shares underwent changes. As per the QE released by the CSO, gross domestic savings as a ratio of GDP at current market prices (savings rate) declined from 33.8 per cent in 2009-10 to 32.3 per cent in 2010-11. This

decline is accounted for by a reduction in private savings, primarily household savings in financial assets, and somewhat by a reduction in corporate savings. Public savings on the other hand registered an increase, thanks to fiscal consolidation. The reduction in the financial savings rate of households could be partly attributable to inflationary tendencies in the economy during the period that resulted in higher growth of private final consumption expenditure than of personal disposable income and partly to a reduction in real interest rate. The revisions indicate that the global crisis in 2008-9 was mainly reflected in negative growth in gross capital formation, with the slowdown in private final consumption expenditure being modest. More importantly, post-crisis growth in gross fixed capital formation has been lukewarm. The growth in real terms of consumption expenditure, gross fixed capital formation, exports and imports respectively works out to 6.0 per cent, 5.6 per cent, 14.3 per cent, and 17.5 per cent for the year 2011-12. The growth in these indicators in 2010-11 was 8.1 per cent, 7.5 per cent, 22.7 per cent, and 15.6 per cent respectively. The rate of growth of private final consumption expenditure in real terms has been fairly consistent and did not decline significantly even when the growth rate was relatively lower, partly due to the inherent nature of private consumption that does not fluctuate as much as other demand-side components and partly on account of inflationary tendencies, which tend to reduce savings (on account of reduction in real interest rates) rather than affecting the consumption level in the economy.

Business implications of analysis and findings

At sectoral level, growth is estimated to be 2.5 per cent for 2011-12 for agriculture and allied sectors, a little lower than expected. However, this has to be seen in light of the high growth of 7 per cent achieved in 2010-11. Growth in the services sector is likely to be 9.4 per cent in 2011-12 as against 9.3 per cent in 2010-11. Thus, it is primarily the dip in growth in industry to 3.9 per cent in 2011-12 that has led to the slowdown in real gross domestic product a part of the reason for the slowdown lies in global factors, particularly the crisis in the euro zone area and nearrecessionary conditions prevailing in Europe; sluggish growth in many other industrialized countries, like the USA; stagnation in Japan; and hardening international prices of crude oil, which always has a large effect on India. Domestic factors, namely the tightening of monetary policy, in particular raising the repo rate in order to control inflation and inflationary expectations, resulted in some slowing down of investment and growth, particularly in the industrial sector. Since monetary policy operates largely through demand compression in the short run, the expectation is that this policy will in fact bolster long-run growth. The 2008-9 downturns came to India when the countrys fiscal balances were robust. Hence, there was ample scope for fiscal and monetary stimulus. As in most parts of the world, this second slowdown is coming so quickly on the heels of the previous one that the latitude that we have in terms of fiscal and monetary policy is much more limited. Evidently, there is need to be innovative. The biggest beneficiaries of changing consumption patterns have been the durable goods sector and the services sector. Transport & communication: The Indian government, through the Ministry of Surface Transport (MOST), announced incentives and tax holidays in its efforts to invite and encourage private sector in road infrastructure. Because, by nature, private sector responds to short term returns, infrastructure investments having long gestation periods are unattractive to private investors. However, while the private roads that operate on a commercial basis will be confined to high-density corridors, the rural roads will still be the responsibility of the government. If development has to be spread evenly, much greater attention needs to be paid to roads, which are outside national highways. The number of vehicles on our roads is expected to double in another five years. Investments go heavily into production and manufacturing of vehicles, and lack in infrastructure to support this growing demand. Food and beverage: The biggest expected challenges in the coming months include the ability to recognize and respond to customer needs and trends, responding to market, competition, and managing the volatility of the price of raw materials. The sector as a whole is still challenged by decreased consumer confidence, including limited ability to gain access to capital and increased government regulations. Fuel rent power: The recent power shortages, which are a reflection of deeper infrastructure issues, is one more motivation for ratings agencies to lower Indias credit rating. ratings agency Standard and Poors cut its outlook on Indias long-term credit rating of BBB-, the lowest investment grade rating, to negative from stable, citing its large fiscal deficit and expectations of only modest

progress on reforms. Rival Moody's, meanwhile, has maintained its stable outlook on India's current Baa3 rating one notch above junk territory. Byrne of Moodys said that if India doesnt deal with the situation correctly, it would have negat ive credit implications. One example of this would be introducing stop gap measures, such as costly fuel imports to deal with the power shortfall, which would widen the countrys deficit, he said. We continuously highlight this as a credit challenge. If its not dealt with correctly and it worsens the fiscal situation and balance of payments situation, then it would have negative credit implications, he said. Clothing and footwear: The clothing industry is apparently undergoing a state of deepening crisis and will be in a fight for survival over past few years and for the next year and a half.21 The industrys woes are blamed on three factors, largely; The lack of an industrial policy from the DTI over the past 10 -15 years. With lots of uncertainty manufacturers are reluctant to invest in upgrading their machinery A surge in imports (from China in particular). Industry complains that the quotas imposed, whilst welcomed, were too little, too late and that government took too long to respond. A perception within government and the public that industry is calling for protection from foreign competitiveness due to poor productivity and inefficiency, point to Chinas manipulation of its currency and suspect labor practices in respect of human rights. The footwear industry is much smaller than clothing or textiles but, after being decimated by Chinese imports over the years, it has shown growth over the last two years. 22 In response to import liberalization, footwear manufacturers chose to focus on the top end of the market (with support from the retail sector - they claim). This strategy is also recommended for smaller players. The footwear industry is much smaller than clothing or textiles but, after being decimated by Chinese imports over the years, it has shown growth over the last two years. 22 In response to import liberalization, footwear manufacturers chose to focus on the top end of the market (with support from the retail sector - they claim). This strategy is also recommended for smaller players. Medical care and health: Expenditure on health by the Government continues to be low. It is not viewed as an investment but rather as a dead loss. States under financial constraints cut expenditure on health Growth in national income by itself is not enough, if the benefits do not manifest themselves in the form of more food, better access to health and education: Amartyo K Sen Poor facilities even in large Government institutions compared to corporate hospitals Lack of funds, poor management, political and bureaucratic interference, lack of leadership in medical community.

Conclusion and Recommendations

The trend of Private final consumption expenditure shows that there is upward sloping curve implying increase in expenditure year on year basis irrespective to business cycles that country faced during the given stipulated time span. 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 ofte n used to measure a countrys 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. The value of output is adjusted for excise duty and trade and transport margin (TTM). The TTM'S are separately estimated for various commodities/commodity groups on the basis of price data at various levels; i.e., producers', wholesale, retail etc. Import duty is also added to the value of imports .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. And as of todays scenario it has been observed that people are spending more money into education services. Thus, there is almost constant growth in PCFE i.e. between 7-9 percent, however the sectoral trend is quite volatile.

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Appendices

Private Final Consumption Expenditure during the period of 2004-05 to 2010-11

Food and Beverage 769500 817829 845898 900100 929881 932764 990831 Furniture & Services 65174 75039 87865 101991 114412 124371 140563 % Change ----6.28 3.43 6.4 3.3 0.31 6.22 % Change ----15.13 17.09 16.07 12.17 8.7 13.01 % Change ----10.96 8.42 9.79 6.79 3.99 5.55 Clothing and Footwear 127829 153075 188784 198263 208101 239131 247650 Health Care Services 95560 103925 113008 118077 126204 137407 147851 Gross Rent Fuel & Power 266434 276400 286844 300441 311109 327947 344075 Transport & Communication 371800 393365 429003 463077 498914 558872 628644 % Change ----3.74 3.77 4.74 3.55 5.41 4.91 % Change ----5.8 9.05 7.94 7.73 12.01 12.48 % Change ----8.53 8.65 9.2 7.12 7.37 8.23

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

% Change ----19.74 23.32 5.02 4.96 14.91 3.56

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

% Change ----8.75 8.73 4.48 6.88 8.87 7.6

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 Source:

Education 57213 63488 68839 75583 80717 83941 88607 CSO

Miscellaneous % Change 172082 ----206731 20.13 250447 21.14 322154 28.63 387145 20.17 447868 15.68 498826 11.37

PFCE 1925592 2089852 2270688 2479686 2656483 2852301 3087047

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Graph showing upward moving PFCE of the stipulated periods:

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Private Final Consumption Expenditure 1925592 2089852 2270688 2479686 2656483 2852301 3087047

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Bibliography
Following websites are referred: http://mospi.nic.in/mospi_new/admin/publication.aspx http://research.stlouisfed.org/fred2/series/INDPFCEQDSMEI http://ciel.co.in/blog.php?blog_view=122&mpage= http://www.stats.gov.lc/na_main/concept.htm http://www.britannica.com/EBchecked/topic/134598/consumption-function

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Group code: Selected topic: Private Final Consumption Expenditure in India during the period of 2004-05 to 2010-11 Contribution Matrix

S.NO. 1 2 3 4

Name of student Rohit Pal Rohit Rastogi Sanjana Agarwal Vatsal Sharma

Enrolment no. JL12PGDM126 JL12PGDM127 JL12PGDM132 JL12PGDM173

% contribution 28 28 20 24

Signature of the student

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