The Indian economy has been stress tested for the past year and a half, and we are now exhaling a collective but cautious sigh of relief. Yes, the economy has slowed down but we are still hanging in there at a 6.5+% growth, which is much better than what it was in 2000-2003. Also there do not appear to be any major cracks in the edifice of the global economic powerhouse that we are in the process of building. One must admit though that there is some merit to the often made argument that we have not been hit any less than everyone else, since the percentage decline in our GDP growth has been as severe as the economies in the world which have contracted. Hence, our slowdown is equivalent to their recession.

However, we have had no collapse of institutions, and what’s more, consumer demand is up and about, although still a bit sluggish. The good news is that foreigners haven’t deserted us, and inflows after taking out the FIIs and adding the NRIs remain good, and the stock market has bounced back and not wiped out anybody’s future life. As a wag said last year, the only ones who really had a bad Diwali were the CNBC channel watching stock market aficionados in Mumbai. But even they have no cause to complain – in fact, many have made far more money than they lost, by buying at the bottom and riding the wave of recovery.

It is also a huge relief to know that our job losses were not as bad as people originally thought they might be. 1.3 million job losses (out of a labour force of 500 million) is the estimate so far, mostly in export sectors like textiles and gems and jewellery. As of February 09, the official figures were that only half a million had lost their jobs. And now that there is an uptick in exports, presumably the damage is under control.

Someone recently told me that different societies handle downturns differently. In Japan, everyone takes a proportionate haircut. In America, there are clear losers and winners. Presumably in India, because most of our workers are in the informal economy, we end up following the Japanese model, by default rather than design, of course! How we respond to economic hardships is certainly a debate worth having in our society. The hiring and firing of America and ruthless shutting down of businesses only to restart them in good times might not be our holy grail, given how bereft most of India is of any form of social security.

What has been the mood and behaviour of corporate India through all this? A foreign businessman who was visiting India earlier this year said that whenever he met Indian businessmen in a group, they would say business is really bad and the recession was on in full swing. Individually, however, they would admit that things were not too bad, that while they had seen far better days, but no, the bottom was not falling out of the market or their business.

An Economic Times report of October 2009 quoting a CMIE study said that, ‘Despite the slowdown in the global economy and the bad monsoon, corporate India is likely to clock 22.8% growth in net profit in 2009-10 because of the improvement in margins due to a fall in input costs… Corporate sales growth [however] will average at a meager 4.1% in 2009-10. At the same time, profit after tax (PAT) will rise by a robust 22.8%.’

‘From 35% in the first-half of 2008-09, its sales growth slumped to 12.1% and 0.1% in December 2008 and March 2009 quarters, respectively… However, the corporate houses managed to protect their profits from the impact of the global liquidity crisis as PAT rose by 16% in the March 2009 quarter and the growth further accelerated to 19.9% in the June 2009 quarter.’

From the ringside view I have of Indian business confidence, both as a market strategy consultant and as a board member, I notice an interesting mind game cycle that Indian companies go through. Like the stock broker, they are either bullish or bearish on consumer demand, creating larger swings in revenue growths than warranted. When they are bearish on it, they focus on growing the bottom line through cost cutting and operational efficiency improvement, and more or less give up on growing the top line.

They act as if the top line of their business is dependant on the performance of a third party called ‘the market’ which is out there, and they can only aspire to their natural share of it. They do not even consider the possibility that market growth is the result of the sum total of all companies’ efforts to grow their individual top lines through strategic and tactical efforts to persuade the consumer to buy. Often even companies who control over 60% of the market in their category will state that their top line fell because the market did not grow, when in fact it was their non-performance that depressed market growth!

When they are bullish on consumer demand, they unfreeze and invest and push very hard to attract consumers and grow the market by converting non-users–new products, new geographies, new features, innovative and hard-hitting marketing communication, new distribution channels and so on. Even when input costs go up a lot and margins come under pressure, they often go to the other extreme and hold prices, betting that lower margins will be more than amply compensated by higher volumes and an increase in market share to boot.

They push consumer credit, rather imprudently, to push consumption of their products down to income levels where they should not really be going. When they turn bearish, they start unwinding all these, and end up depressing top line growth even more than normal. However, in the bearish phase, they do go to war on the flab they accumulated in the bullish phase, and emerge even more ready to play the bullish game when the time comes.

2000-2003 was a bearish phase for corporate India, when corporate bottom lines grew but not their top line, and companies got lean, mean and fit. Then came the golden years of 2003-2008, and we were back to top line growth (at all costs). That did drive profit growth, but made companies flabbier. Now, its back to focusing on profit growth through cost-cutting and extracting efficiencies, and the corporate results are testimony to that. A senior executive who worked for a company that was excellent at growing bottom line without top line growth once wryly commented on how ‘cutting costs to the bone’, if not done carefully, could end up ‘cutting costs into the bone!’

As of today, large corporate India is sitting on enough capacity that it built, assuming that the environment, both global and local, of the boom years of 2003-08 will continue. However, it is still going ahead with investment plans that were anyway in the pipeline, partly downsizing for the new world, wherever possible. On new investment opportunities, it is cherry-picking.

If there’s a deal or an expansion of opportunity, global or local, relating to any aspect of the business which looks attractive, it is being snapped up, surely and swiftly. Large corporate India’s mood and conduct can best be described as pragmatic optimism and the pacing of a marathon runner. SMEs which are the bulwark of India business, however, are not in such great shape. Many of their business models are not so robust, and a combination of a slowing top line, higher receivables and inability to access loans has left many of them sick.

Consumer India’s spending behaviour is not a cause for serious concern. It is a bit like large corporate India’s investment behaviour–going ahead with whatever was part of an earlier plan, but delaying the timings a bit to manage the cash flows (buying the flat or the car that was booked), buying new things that absolutely have to be bought like replacing a busted new TV set, and doing the automatic upgrading that is part of every replacement purchase. However, consumers are not buying the first car or the second home, if it has not moved from the desire to the planning stage, before the downturn. While food prices are higher, they are a smaller proportion of middle and upper India’s household budget and non-food price inflation is pretty low. Poor consumer India, however, is suffering, in particular, from food price inflation and a bad monsoon, even as it laps up cheaper telephone rates, and Chinese goods that are freely available at very low prices.

If one were to paint a broad brush picture of what we are seeing in consumer India, everyone is consuming as and when they can, and good deals encourage them to. However, unlike in the recent past, we see a more thoughtful ‘should I/do we need to’ consumption as compared to the ‘why not, may as well’ consumption. This rewards some companies with better value propositions than others. In the FMCG sector the market leader had almost flat sales while the second had a 65% quarter on last year’s quarter sales growth, with profit going gang busters. In two wheelers, the market leader’s revenue increased 27% while the second increased just 14%.

It could appear from this view that a ‘do nothing, wait and watch’ approach would be quite alright, assuming that around seven per cent GDP growth is what we will achieve, which will gradually accelerate back up to higher levels. However, this cannot be taken for granted because we do have problems looming that could further moderate our already moderated economic behaviour-a high fiscal deficit, soaring inflation, continued government spending, worrying agricultural performance, and an already cautiously spending consumer left alone by cautiously investing companies and cautious banks who seem to believe that abstinence is the best form of prevention.

Some worry that removing subsidies to better balance the budget will depress consumption and hence economic growth and the entire engine may go into economic seizure – pretty much the same argument that is being advanced in support of corporate debt restructuring. The pyrrhic victory of riding the recent storm would be that when the world starts to recover, all our domestic problems catch up with us and we start to feel sick. An export linked India will do better at that time, but is not big and powerful enough to be the engine that powers the rest of the economy.

We need to take a call on what we should do next. There is a strident school yelling that all we have to do is to make money more easily available and much cheaper, so that more companies can expand more and more consumers can borrow more and spend more and all this will get us back to the golden growth rates and rise in per capita income of 2003-08. They also believe that easy money will not go into unproductive uses and create an asset bubble. Another school, which I subscribe to, says that throwing money at the problem won’t fix it.

The ‘make money cheaper an all will be well’ argument assumes that companies and customers have plans and are starved for cash to implement them, or that if money was cheaper and plentiful, it will lead them to make fresh plans. However, this is not about two macro forces talking to each other, but about real people making real decisions, with a logic that needs to be listened to.

Large companies are not starved for cash in order to execute their plans. Nor will they create more plans merely because money is going cheap and thank God for that. Further, they already have access to fairly cheap money overseas, as also options to raise money from sources other than banks, as analysts have been pointing out. Mid-size companies too have learnt to play the ‘get money’ game well, often to the peril of banks, and also have higher order survival skills. The better ones are the darlings of the private equity business in any case especially the unlisted ones.

The SME sector probably has cause to complain about getting asphyxiated for lack of money, and that sector is far more critical to the health of the Indian economy than the large corporates. However, even if money were cheaper, there is still no guarantee that they would have access to it, because banks don’t like them as much as they like large corporates. Credit rating agencies do tell you that there are several SMEs that are credit worthy but not being lent to, though it is unclear who tracks this data. Anecdotally, however, it is obvious that many SMEs do not have robust business models. Their business moves are based on a herd mentality and as long as the tide is rising, they get by and do modestly well. What they need is not cheaper money but more business monitoring and mentoring, and who better than banks to do this? Some of them are winners but some of them are not. As my friend Jayanth Verma of IIM Ahmedabad is fond of saying, many of these are weak and should be allowed to die because it is periodic bush fires that keep the forest healthy. And newer ones are mushrooming all the time in any case. Banks, however, must be forced to follow more progressive risk assessment processes so that they don’t throw babies out with the bathwater by being ‘lazy’ or extra safe.

As for consumers they are telling those who bother to listen that they will not be tempted by cheap money to take more EMI pain at this time, merely because it comes cheap. Makes sense! Data on absorption of housing inventory shows that except for Pune and Bombay where the number is 62% or so, in other cities it is between 30 and 40%. It is also true that today it is cheaper to rent than to buy – the seller is holding out but needs to generate some money on his asset. The speculator on housing and the stock market punter shouldn’t have access to cheaper loans in any case, it is aam janata that drives the sort of consumption that motors the economy.

Instead of pushing the economy to perform beyond its capability, perhaps we should take a look at what a realistic growth ‘entitlement’ should be for an economy such as ours – one which is characterized by a consumer base of lots of modest income people served by a large number of SMEs and micro-suppliers that are collectively far bigger than large corporates. To use an analogy from business, companies are always told that first you have to earn the right to grow by having all the basics in place to grow sustainably, and only then should you grow.

In their case, the right to grow is about having the right set of businesses, the right consumer propositions, a clear source of advantage or competence that makes the case for why they should survive and, of course, great operational efficiency. Bribing consumers and buying consumption growth, and disconnecting investments by companies from consumer demand and connecting them to stock market valuations only ends up winning us the short term battle and losing the long term plot. It may buy today’s growth but could well weaken tomorrow’s economy.

We need to understand the reality of our consumer economy and work towards strengthening it so that it is a robust growth engine that grows on fundamentals, not on stimulus; and grows not because of unsustainable strategies adopted by suppliers – either by pricing so low that it makes everyone unprofitable, as in the case of the telecom industry today, or by offering credit that will eventually make banks take the hit. You cannot square a circle and extract more demand than the income-affordability realities of a consumer base.

The fact is that the income growth of our consumer base is insufficient to sustain large growth in every product and service category. Consumers have too many things to buy and not enough money. So it is the survival of the fittest category and company. The compelling story even for FDI into India is that even if lacklustre in terms of returns today, it is worth it for companies to come and invest in building robust growth engines for all their business divisions, which will ride the India growth story almost on ‘auto pilot’. It is not today that sells the FDI. It is the fact that India is a de-risked ‘guaranteed to happen’ growth story; it’s the second biggest game in the world (after China) and entry tickets are still going cheap.

We need to separate the truth from the jingoism and examine whether it was luck, economic prescience or a super robust economy that made us successfully hang in there the last one year. Was the growth of the golden years of 2003-08 the ‘entitlement’ of our economy or was it ‘flogged’ and extracted and borrowed from the future growth? My assessment is that more than entitlement, favourable circumstances had a lot to do with it. The tight money policy towards the middle of 2008 was perhaps tighter than warranted (some say it would have choked off growth had the crisis not hit, so it’s a random act of providence!). The saviour of rural demand holding out was partly an act of God and partly an act of government for reasons other than economic prescience (writing off loans and clearing the slate for fresh consumer credit to flow, NREGA money due to an impending election) and partly due to a one time jump in road connectivity.

For a consumption driven economy, our consumer base isn’t all that it is cracked up to be. Between 2000 and 2003, we performed poorly. And it’s not as if there was a fundamental improvement in the quality of our consumer base to cause the sparkle of the next five years. The events that drove 2004-08 performance were good monsoons, good global economy, a stock market boom fuelled by FII and high animal spirits which drove the rich India (both urban and rural); and as enumerated earlier, a star burst of one time events that stimulated the poor, rural economy up (the best ever monsoons road connectivity jump, loan write-offs, NREGA etc). All the stars were aligned and it got as good as it could. We were actually quite lucky that the global meltdown came when it did and interrupted our bullishness party, or else we would have discovered very many more people swimming naked when the tide would finally have gone out.

The bullishness (animal spirits?) of the supply side in the latter part of the 2003-08 period was because we believed that we had broken through the 6%+ growth barrier and were firmly in the 8%+ range, and had created an unstoppable growth engine that would head towards 10% GDP growth. Driven by consumer spending this, in turn, attracted company investments, both domestic and FDI, and huge inflows of money into the stock market, making a lot of Indians even richer. Companies played the valuation game and borrowed to fund expansion which would improve valuation but would not take a chance on sufficiency of consumer demand – instead of the other way round!

The modern retail sector valuations have been a lot like the dotcom ones. Twice the revenue multiple for an under 5% net margin, and in early stage valuations, even a 1 % net margin. The only difference between the two was that while many dotcoms had neither a proven revenue nor a profit model, retail companies here had a revenue model, even if they didn’t have a profit model! The media valuations also defied logic, as did the housing and the power. As we know, when everyone is playing the valuation game, and when new businesses are being built to be sold asap that is unsustainable.

Young educated people with good jobs who started working in the boom period and had never seen a downturn or a slowdown, are now saddled with high EMIs and low bonuses. Fortunately for us, this generation also has parents who are pretty well off and offer a safety net. Banks were infected by the same mood and lent far more easily than they should have – and when the trouble began, they discovered the virtues of risk management, both with consumers and with companies, especially the SME sector which is the mainstream and the mainstay of business India.

We definitely have not built a growth autobahn on which we were speeding along in a well engineered vehicle. We have at best been rattling along on a rough and ready, state of the art in parts highway in a sturdy jugaadu, coasting along on its momentum and powered by our collective confidence in it, de-risked by the law of large numbers of many mini-demand segments and mini-economies, each with their own triggers and turn-offs. Once such a contraption slows down, it is not easy to get it back to its earlier speed; but it isn’t easy for it to crash and self-destruct either.

While private final consumption expenditure and per capita income has grown nominally in double digits every year in the golden years, and even as we count up the increase in mobile phones and television sets and two wheelers, the consumer base remains very fragile, and hence the consumption economy is being built on shifting sand. Only a tiny fraction of Indian consumers have regular salaries, leave alone jobs in the organized sector. Most don’t have a social safety net either. Most pay more than they should for education, and for loans from which they fund consumption. A health emergency usually destroys their financial (and consumption) rhythm. A family of four people working in Mumbai can earn Rs 15000-20,000 a month serving those who can earn a lot more with their time saved; but will live in a one room 200 sq feet or less servants quarter in Mumbai and when ejected from there at any time, suffer huge income losses.

Most consumers are self-employed, and not out of choice — the great Indian dream is still to have a regular and well paying job. Only 37% of urban Indian households and 11% of rural Indian households have a chief wage earner who earns a regular salary/wage. Only in the top twenty cities is the salaried percentage close to half. In reality, most consumers are financially vulnerable. A quarter of them have loans outstanding, and in case of a major drop in income, feel that they do not have savings to sustain themselves even for a year. What makes them spend is a financial (mis)optimism that something somehow will work out. (Source: NCAER, ‘How India earns, spends and saves’.) We don’t have enough jobs being created either, and many people will perforce have to become self-employed, and we do not have a support system for micro-entrepreneurs.

We need to learn a lot more about our consumption economy. Unfortunately, we don’t have enough sophisticated data sources that are timely and which examine what’s happening at the level of people who power it. Because our consumer base is getting more and more heterogeneous, sample sizes need to be larger and it has to be the government’s business to fund it.

Consumer India is a hydra-headed monster (or a many splendored beast if you prefer), and often begs the question: Which India and whose India are we talking about? It is true that if the stock market went down to zero, it would still not affect half of consumer demand because the top 20% of India, by income (45 million households, approximately), account for about 40% of consumption expenditure, and the stock market and mutual funds serve a maximum of 30 million investors. Assuming one investor per household, this will not even be the top 20% of Indian households.

The companies that serve India’s entire consumer base are equally heterogeneous — Indian and non-Indian multinationals, as well as micro-enterprises, importers from China and the rest of Asia who sell on the pavement as well as modern trade and so on. Many of these are not on any known radar and so we don’t really have a good picture of what’s going on out there to be able to say we know it all exactly. Perhaps it is this heterogeneous nature of the consumer base that de-risks India’s consumption economy.

We have a 110 million strong country that has a slightly better per capita income than Brazil, a 330 million strong country that is slightly poorer than Indonesia, and we have a 650 million large country that is as rich – or poor – as Bangladesh. We have the ability to build global scale domestic businesses and yet most of our consumer base hasn’t even started its consumption journey in earnest. The task on hand is to build the engines of growth and fix the fundamental quality of our consumer base, relying on a strategy with which businesses can tap into a collectively rich but individually poor heterogeneous consumer base like no other in the world. The debate isn’t about the cost of money or the level of subsidy that will help us hit a high number of GDP growth today. It’s about improving the health of the goose that lays the golden eggs.