Private Final Consumption Expenditure (PFCE)

Private Final Consumption Expenditure (PFCE)

Subject – Economy

Context – weakening growth in consumer demand impacted GDP growth

Concept –

• The GDP is calculated by capturing the expenditures of different components of the economy.
• It adds up the expenditure by private individuals (PFCE), by businesses investing money to ramp up production (Gross Fixed Capital Formation or GFCF), and all the spending by the government (Government Final Consumption Expenditure or GFCE).
• In India, the PFCE accounts for 55-56%of all national GDP in a year and is, quite obviously, the biggest driver of economic growth.
• Apart from this direct influence, it also indirectly influences the next biggest driver of GDP — the Gross Fixed Capital Formation (GFCF). This is a measure of the money spent by businesses when they make investments, and it accounts for33% of all GDP.
• It is crucial to understand the economic logic that links these two biggest drivers of economic growth, which together account for 88% to 89% of all GDP in India.
• If consumer demand slows down, it robs businesses of any incentive to boost productive capacities by making fresh investments. Just boosting investments—without regard for demand—will not make sense.
• The weighty role of private consumer demand in boosting the GDP makes it the most important factor determining India’s economic fortunes.
• The third driver of GDP is government spending (GFCE), and it accounts for 10%-11% of all GDP. It should typically be counter-cyclical. In other words, when the rest of the economy is doing well — consumers are demanding lots of goods and businesses are investing in new capacities to furnish such demand — the government should try to limit its spending in such a manner that it does not hurt (or “crowd out”) private sector firms from accessing credit and markets.
• But when consumer demand is weak, and firms are holding back (justifiably) from making fresh investments, the government should ramp up its spending to jump-start the economy and, hopefully, “crowd in” the private sector in the growth process.
• The fourth engine — net exports or the net effect of India’s demand for imports and the Rest of the World’s demand for our products (exports) — is quite small in India’s case.

How has consumer demand grown over the years?

• Given the overwhelmingly dominant role of private consumption demand in determining India’s economic growth in any year, it is instructive to look at how PFCE has grown in the recent past –

• The graph maps the last two GDP data series — one based on 2004-05 prices and the second based on 2011-12 prices.
• As can be seen, private consumption expenditure grew at an annual rate of 8.2% between 2004-05 (Financial Year 2005 or FY05) and 2011-12.
• Then, between FY12 and FY20 (that is, just before Covid hit India), its annual growth slowed down to 6.8%. In fact, if one further zooms into the years FY17 (after which India’s GDP growth rate started decelerating sharply) and FY20, the PFCE annual growth rate had slowed to 6.4%.
• Then came Covid-induced lockdowns in FY21 and they destroyed the already weakening demand. If we include FY21 as well, then the PFCE growth rate since FY12 falls to below 5% per annum.
• In FY22, the current financial year, the Indian economy is expected to register a recovery. Even if we assume that at the end of the current financial year, PFCE would grow at the same rate — 6.8% — that it had in the eight years before Covid, the FY12 to FY22 annual growth rate would barely rise above 5%.

Implications –

• The most important implication of weak consumer demand is that investments by corporations are unlikely to pick up in a hurry.
• They are expected to remain subdued for the coming year or two as indeed they were in the years preceding the pandemic despite historic cuts in corporate tax rates in 2019.
• A good measure of whether India has inadequate supply capacity or not is the rate of capacity utilisation. The data from repeated RBI’s OBICUS (Order Books, Inventories and Capacity Utilisation Survey) show how capacity utilisation has struggled to breach the 75% mark. Clearly, firms have been working far below their full capacity for several years now.