Problem Isn't Consumer Demand

Financial Express - December 10, 2008

The primary problem at this juncture is not the lack of consumer demand, but the lack of funds desperately needed by companies to stay afloat on a week to week basis. This, if not addressed soon, will cause corporate collapses, leading to job losses and business associates collapsing, leading to more job losses, and a shattered faith in the economy.

Typical stories around us today are of companies that have over leveraged themselves and expanded aggressively in the past few years; and who have, until recently, diverted cash flows to fund even more aggressive expansion. The implicit assumption they made was that further equity and/or debt would be available on call; the question was never about its availability, but only about its price.

Part of the reason for the aggressive expansion was the valuation payoff that several of them, especially not-yet-listed companies, assumed that they would get. Part of the problem today is a high burn rate because of a high cost structure built up over the past few years. The philosophy was that growing quickly and aggressively was going to be far better for overall financial health and competitive advantage than being careful with the costs.

Then the banks suddenly turned the lending tap off or reduced the flood into a trickle. Several companies are strapped for working capital. Several of them have had suppliers turn off the credit taps, have their buyers defaulting on payment because they in turn are strapped for cash; and that's how the cycle is worsening.

We all know of situations where owners have pledged their shares and borrowed against them to finance business expansion-only to find that the valuations have crashed and the banks are hounding them for further collateral. Also in this age of asset light businesses, especially service businesses, banks are even more conservative since there isn't much collateral for them to base their lending on. Right now, it isn't bank collapses that we should be watching out for. Banks seem to be safe and reasonably flushed with cash. Company collapses are what we should worry about, far more.

Stimulating consumer demand through incentives and subsidies won't solve the problem of companies not having enough cash to service this demand. The drop in company sales is not always an indicator of evaporating consumer demand. It could also be an indicator of a malfunctioning company. And we need to make the clear distinction between the chicken and the egg.

Consumer demand is about people needing or wanting to buy and being able to afford to indulge their wants and needs. Consumer desires never fade, but their income does. So far, we have not seen an alarming drop in consumer income across the board, despite announcements of job cuts. This is in part because much of Consumer India does not have a job that someone can cut. They have a livelihood that will disappear if corporates in the sector in which they are employed, collapse.

Consumers who work in some sectors are affected while others are not. We have not seen any significant job lay offs yet in numbers large enough to cause a recession; even the IT sector has not massively retrenched yet, though they have put fresh recruitment on hold. Exporters, big and small, are in trouble, auto companies are slowing down as consumers hang on to their cash and play the wait and watch game.

Government employees, many more in number than the IT sector, are doing quite ok, and for the many low income consumers consuming low ticket items, accounting for about 30+% of consumer expenditure, life goes on, humdrum as usual—so far. Many of them don't even have bank accounts leave alone mutual funds. The bottom 70% of Consumer India , by income contributes about as much to consumer expenditure as the top 20%,

True, the income growth that we have got used to seeing is not happening. Replacement / big ticket purchases amongst middle and upper class consumers are also being postponed, thanks to the uncertainty in the environment and the expectation that prices will come down or that credit will become cheaper. However the slowdown in consumer purchases that we are seeing is not so alarming that it needs to be treated with a multi-pronged assault.

It isn't consumer demand that is in the ICU yet, but companies who are gasping for cash to stay afloat, and many of them are not admitting it openly yet.

Companies are not in a position to finance themselves through self -generated cash—even if there were no slow down in consumer demand. The trucking sector is definitely affected, (and people whose livelihood depends on that sector are affected) since steel and cement, their biggest verticals, are not being transported very much at all. But new housing projects will not get off the ground and start construction because home loan interest rates have been slashed and there are buyers. As my broker told me this morning, wait a little more and you may get it far cheaper. New housing projects will come up when banks lend to the housing projects and get them off the ground.

If company collapses are allowed to happen, there will be a domino effect through vendors and distributors leading to a problem that will cause jobs to disappear and consumer income to sharply decrease. Then we will have a recession.

The need of the hour in terms of policy is to keep consumer incomes safe by helping companies tide over this temporary crisis and stay in business—by making banks lend to fundamentally healthy companies going through a hangover of boom-time financial imprudence.

Otherwise, a mere demand slowdown leading to some amount of pain could end up snowballing into something more serious and more terminal. All the packages of stimulating consumer demand cannot work if companies are too sick to survive.

The author is an independent market strategy consultant and author of 'We are like that only—Understanding the Logic of Consumer India'