*FYI* ** ** *T.o.m* --------------------------------------------------------------------------------------------------------------- India's middle class meets inflation Despite phenomenal growth, middle class may stumble
01 July 2008 00:00 *India's middle class is fueling the country's significant growth but rising inflation threatens to slow things down* *Sean Milmo/London* THE BURGEONING middle class of India has been one of the main driving forces behind the rapid growth of the country's economy in recent years. While the massive economic gains in China have stemmed from a fast rise in investment and manufactured exports, those in India have come from buoyant domestic demand centered on middle class consumers. They have played an important part in helping Indian GDP to grow by 8-9% over the last four years, and to push up GDP per capita by 7.5%/year, compared with an average 1.25% in the three decades from 1950 to 1980. In terms of purchasing power parities, India is now the third-largest economy in the world behind the US and China. Its large middle class population - amounting to around 200m in about 50m households, most of them with a single income earner - have become big end-users of chemicals through their purchases of housing, household items, automobiles and personal care products. *INFLATION HITS MIDDLE CLASS* However the expansion of the Indian middle class is now under threat because of a steep rise in inflation, which could hold back the enlargement of the key social group both in the short and longer term. In early June, the country's inflation rate rose to 11.05%, up from 4.3% in mid-2007. With the impetus coming mainly from higher oil prices and soaring prices for imported food, inflation is now at its highest for 13 years and double the target level set by the Reserve Bank of India<http://www.rbi.org.in/home.aspx>, the central bank. Double-digit inflation is unusual in the Indian economy, with the rate going above 10% only in the early 1990s and in 1994-95. Now, economists predict, it will remain in double figures for the rest of the year. The sharp increase in prices, together with higher interest rates, is hitting lower income groups hardest but there will also be an immediate impact on the spending power of the middle class, which has provided the foundation for the boom in the consumer market. "The prices of basic commodities like fuel, food, education and the interest rates on loans for durables are going up," says Anushree Singh, associate analyst at the country analysis practice of UK-based Datamonitor<http://www.datamonitor.com/>. "The average Indian is now paying more on their loans as the interest rates on home loans, for example, have gone up by 300 points in the past few months. "As such, the middle class cannot afford those goods that they had previously been able to," he adds. "It will adversely affect [their] lifestyle." *INFLATION JEOPARDIZES MIDDLE CLASS EDUCATION REQUIREMENTS* In the longer term, high inflation could also weaken the private education sector that has been playing a crucial role in raising the quality of India's workforce. More significantly, it has been the route for people to achieve middle class status. Inflation will jack up the expense of private education for which fees are already taking up a large proportion of household income because of the inability of supply to keep up with demand in the private sector. "A lot of parents will not be able to afford to send their children to private schools anymore," warns Christopher Butel, chairman of IIMS Dataworks <http://www.iimsdataworks.com/>, a market research organization at Nodia, Delhi. "The numbers going through private schools, which are the main means of acquiring the skills necessary for a middle-class income, will diminish. Inevitably there will be a slowdown in the growth of the middle class." Some experts have been predicting a relentless rise in the size of India's middle class. Management consultancy McKinsey & Co.<http://www.mckinsey.com/>has forecast that by 2025, it will amount to 583m. With China's middle class, together with China's own middle class, this will have an enormous influence on the world economy. *MIDDLE CLASS IS STILL TINY* At the moment, the core 50m-60m of Indians, whose earnings fund the expenditure of the country's middle-class households, account for only some 5% of the country's population. Middle class incomes are predominantly at levels well above those of average annual earnings of rupees (Rs) 70,000 ($1,630). According to recent figures from IIMS Dataworks, middle class earners typically include shopkeepers with average incomes of around Rs100,000, public and private sector salaried employees on Rs105,000-140,000, self-employed professionals on Rs320,000 and businessmen on Rs480,000. The top 1-2% of earners are the wealthy, some of them with incomes as high as their Western counterparts. "A typical middle class person can afford basic luxuries such as TVs, refrigerators, computers, cars, as well as being able to save money for both the education of their children and retirement," says Singh. *SALARIED WORKERS MAY BE INSULATED FROM INFLFATION* At a time of high inflation, the disposable income of Indian salaried workers will tend to be strongly protected while the incomes of the small retailers and businessmen will be the most vulnerable. India has around 12m shopkeepers. "The skills shortage is so acute that salaried workers should be able to ensure that their incomes keep up with or even exceed levels of inflation," says Butel. "For small retailers and businessmen the level of their earnings now depends on their ability to pass on price increases to their customers. For shopkeepers this could be very difficult because the retail sector is so competitive and margins are extremely thin." And an extra pressure on small retailers is coming from the spread of retail chains responding to the growth in the country's consumer expenditure. "Supermarket groups are selling food items at 30% lower prices than the small retailers because the chains have much more efficient supply chains," says Raphael Moreau, an analyst at UK-based Euromonitor<http://www.euromonitor.com/> . *AUTOS NOT IMMUNE* Signs of faltering consumer expenditure are already evident in the automotive market, which had been growing at rates of 15-18%. As the country's car companies start offering discounts to maintain sales, automobile executives are predicting only single-digit growth this year. Inflation has even been affected plans by Tata <http://www.tata.com/>, the industrial conglomerate, for its *Nano *car, which is scheduled to launch later this year at a price of Rs100,000, making it the world's cheapest car. The company is hoping that aspiring members of the lower end of the middle class will buy the *Nano* in order to move from two-wheelers into car ownership. However, the soaring cost of materials and the need to drive production cost down to the lowest possible levels has changed the design of the car. "Initially, I had conceived a car made by engineering plastics and new materials, and using new technology like aerospace adhesives instead of welding," Ratan Tata, chairman of Tata Group, said earlier this year in a company interview<http://www.tata.com/0_media/features/interviews/20080110_one_lakh_car.htm>. "However, plastics don't lend themselves to the volumes we wanted because of the curing time required." For many middle class families and others on lower incomes the priority during an impending period of high inflation will be the payment of private school fees for their children. Private education is one way of ensuring the earning power of the next generation when a skills scarcity still looks likely. Standards in public sector primary and secondary schools have been undermined by a static government education budget that is proportionately lower than in other emerging economies. However the substantial sums spent by the Indian middle class on schooling brings overall expenditure on primary and secondary education in India up to the level of developed countries, according to a report on India by the Paris-based Organisation for Economic Co-operation and Development<http://www.oecd.org/home/0,2987,en_2649_201185_1_1_1_1_1,00.html>(OECD). At the tertiary level, the addition of private spending still brings total expenditure in the segment to only 0.8% of GDP, around half that in both emerging and developed economies.
