Under Prime Minister Narendra Modi, consumption by India’s 294 million households has nearly trebled to $2.07 trillion over the past decade. It is the top engine of the $4 trillion economy and drives around 60% of GDP. Yet consumer spending is weak and has decoupled dramatically from the path of national output since the year ended March 2023, according to economists at state-owned Punjab National Bank.

Beyond the luxury market where well-heeled Indians are spending big on the high life, cracks are appearing; car sales crawled during the usually busy annual Diwali holiday in October-November. Indians are eating out less often. Starbucks (SBUX.O) and its partner Tata Consumer Products (TACN.NS), meanwhile, are pushing the brakes on expansion; their target to hit 1,000 coffee stores by 2028 is unchanged but they are slowing the pace of new openings. Starbucks has more than 6,500 stores in China.

As it stands, India expects its GDP growth in the current year to March will hit a four-year low of 6.4%, the lower end of the pace policymakers envisioned the country sustaining for the next decade. In short, consumption is fading before it has had a real chance to flourish.

A weak jobs environment lies at the heart of the problem. The abundance of labour in the world’s most populous country is making wages crawl. It puts a perverse spin on the vaunted demographic dividend: casual and regular workers in 2023 earned an average real monthly wage roughly 1% lower than in the previous year, an International Labour Organization report based on official data shows. That’s prompted fears of a middle class shrinking instead of growing.

As a result of stagnant real incomes, middle-class Indians don't have much left over for the kind of discretionary purchases that would power a U.S.-style consumer economy.

"There used to be a middle segment, which used to be the segment that most of us fast moving consumer goods firms used to operate in, which is the middle class of the country, that seems to be shrinking," Suresh Narayanan, chair of Nestle’s India (NEST.NS) unit, warned in October. His peers have sounded an alarm about weak consumption in rural India for years.

The problem is worryingly broad-based. IT companies, typically the biggest private sector employers, are making fewer hires and paying less. Demand for their services like those provided by Tata Consultancy Services (TCS.NS) is growing slower. Automation and advances in technology including artificial intelligence are killing repetitive jobs in outsourcing and financial services, so firms are not backfilling roles when they fall vacant.

Farmers’ incomes benefited in 2024 from a strong monsoon but it’s a brief respite after two years of stagnating incomes for the 46% of the workforce depending on agriculture. Climate change is upsetting weather and food-inflation patterns: in June, rating agency Moody's tipped water stress as a sovereign credit risk to India.

The long-term answer is to create more jobs outside of agriculture. Modi’s administration is pushing manufacturing investment in the hope that factories will absorb workers and pay them better. However, the foreign direct investment required to speed progress is declining.

In the short term, New Delhi needs to act to avoid a return to a trend of weak output and consumption growth following a two-year phase of post-pandemic revenge spending. The reduced private spending is hitting growth directly and shrinking tax collections. Poor demand also means lower private investment, and that burdens the government with an even bigger role in turbocharging GDP.

Authorities could cut taxes to stimulate consumption. They are considering lower levies on personal income in the budget in February, Reuters reported in December, citing two official sources. Yet New Delhi will be hard-pressed to forego revenue without imperiling its goal to consolidate the fiscal deficit to 4.5% of GDP by March 2026.

A larger deficit could further beat down consumption if it prompts a spike in the government’s borrowing costs, triggers a lower sovereign credit rating and weakens demand for the rupee in international currency markets. That would make India’s oil import bill heftier and prompt a surge in inflation: Oil prices are already spiking following U.S. curbs on oil tankers supplying Russian crude.

Those problems could quickly compound if, as expected, Indian policymakers try to keep exports competitive by allowing the rupee to track the weakening yuan. That currency is getting battered by fears of a second trade war between China and the United States under Donald Trump’s imminent presidency.

Alternatively, the central bank could boost consumption by making it easier for individuals to tap credit. New governor, Sanjay Malhotra, will be wary of risks stemming from eye-popping growth in consumer loan books as the banking system only recently recovered from a corporate bad debt crisis. The Reserve Bank of India raised risk weights for unsecured lending in November 2023. These measures added to a chill in consumer spending – personal loans are growing at nearly half their pace a year ago. Nonetheless, the RBI expects banks’ asset quality to weaken.

The rosy narrative of strong growth and macroeconomic stability is fragile. If policymakers do intervene, they would be better off doing it sooner rather than later.

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