Economy & Finance

Consumption is driving

The classical economic theory believed that economic growth could be achieved mainly by savings and investment. In the last century, Lord Keynes came with the theory that demand and consumption can trigger and sustain economic growth. Now, the world is convinced that investment, savings and consumption are substantially interdependent and one may trigger the other.

The current economic turnaround has started with the Iraq war. The war driven demand in the Western economies lead by US drove the world out of the recession. Thereafter came the great demand from China, which gobbled raw materials as well as intermediate products at a very high speed. This has lead to further increase in demand all over the globe and especially in developing countries like India and Brazil. The phenomenon of growth of demand is still driving up the world economies.

Demand is essential for production of goods and services. Consumption creates demand. Unless there is an expectation for demand, an enterprise will not produce. Globally, the production efforts are directly related to the consumption lead demand. In the last few years, the benefit of globalised capitalism has percolated, more than ever before. Certain part of the population, which was economically not well placed earlier, is a major beneficiary of the globalisation. This transformation has happened more in the developing countries. A large middle class has emerged which has a lot of consumption appetite as well as the purchasing power.

I believe that though the current economic boom is part of trade cycle mechanism; the drivers this time are very strong. In last few years, substantial economic development has happened in the BRIC countries as well as other developing Asian and South American countries. Though rich have become richer, and probably disproportionately richer, still the less rich have better economic prosperity. It has generated a consumption boom. Rich becoming super rich does not generate great consumption demand but creation of larger middle class fuels a lot of consumption as such class has substantial non-satiated demand. They start craving for goods, which they could not afford earlier. Further, the penetration of credit and credit cards have made a lot of difference to the economics of the globe. With substantial increase in personal loans and consumer credit, now major population of the world can buy goods and services based on anticipated income. Such a facility has given enormous boost to consumption in the last decade, specially in the developing countries. Due to the high consumer demand, the demand for capital goods has increased substantially in the last few years. Due to this growth, the economies of the major technology and capital goods suppliers regions such as US, Europe and Japan are smiling.

The world has always tried to keep a regional economic equilibrium based on the natural resources, human resources and capital availability. Various countries have traditionally developed their import and export baskets of commodities and services. Based on the resources, the basket is developed. The recent boom in consumer demand has changed equilibrium of the baskets of various countries for better. It has resulted in strong economic growth all over the globe and has developed more resources with people to buy more and consume more. The world is going through a great time; and we hope and pray that the party may last long.

If the global data is surveyed, it will be noticed that in the developed countries, a smaller part of per capita income is used for primary consumption related to food and clothing as compared to the under developed or developing countries. The business margins on production of food and clothing are probably the least unless the producer is producing specialty products. The recent economic growth has increased per capita income in many developed countries, which has in turn increased consumption needs. It has changed the consumption pattern and inclination is created towards more sophisticated goods and services. This has reduced the percentage of expenditure on traditional food and clothing and has increased the percentage of luxury goods. The recent growth in demand of such goods and services has resulted in production of specialty goods catering to the sophisticated needs of the affluent consumers. Such shift has in turn generated more profits for manufacturers as well as service providers. The profits have resulted in payment of more taxes, which has lead to increase in spending and investments by states. The profits have increased investment in private sector, which have further increased the production, consumption and profits. As of today it is win-win for all, all over the globe.

The risk now is of over heating. High growth can create heat in an economy, which can increase inflation rate as well as bubble the asset values. In the process, the economic equilibrium can become vulnerable and can cause sudden downfall. This is called as hard landing for an economy. Hard landing is generally accompanied by lots of unforeseen financial losses and losses of jobs, which can hamper the sentiment and wellness of the society.
Most of the finance ministries and central banks over the world are concerned and cautious about economic over heating. Recent cooling effort by the Central Bank of China is a part of the exercise of controlling excessive growth rate, which can make the economy vulnerable. After enjoying high growth for a last few years, the efforts of Reserve Bank of India are tilting toward avoidance of overheating of the economy. The measures such as interest and repo rate hikes as well as market operations indicate that RBI is not keen in accelerating the economic growth rate beyond a point especially if it is causing high inflation. Such efforts may not necessarily bring immediate effects but fortunately for India, the actions of RBI have aided reduction of inflation rate and have slowed down the growth of lending. Indian economy should grow well during the year 2007-08. The economic growth of around 9% and inflation under 4% may be ideal situation.

Indian stock markets are booming and Sensex has scaled a new high. It has now crossed the level of 15,000 and has further growth potential. The corporate results for the quarter ended June 2007 as well as quarter ended September 2007 will throw better light on the direction of Indian economy as well as stock market. We will have to closely monitor the impact of rupee appreciation on Indian exports and imports. As of now good progress of monsoon and lowered inflation has a positive impact on the economy as well as the stock market. The directions are positive but whether the markets have already discounted the future, is the question. I am positive on the economic direction as well as stock market for the short as well as medium term. Investors in stock should stay put in stocks and small additions may be made on regular basis. Nonetheless, the markets are not cheap.

The interest rates in India are likely to remain stable and may not be increased in immediate future. At the same time, major reduction in the rates is not expected. The rates of interest are good especially considering that the Indian currency is appreciating as of now. The investors should remain invested in deposits and debt products. Even a part of the current savings may be invested in deposits.

I currently advise staying away from investments in diamonds and precious stones but it is a good time to buy jewellery for personal user.