The splurge surge

Beating The Street

As in other developed nations, including the US, consumerism is driven by credit against anticipated future earnings. So much so that, discounting capital gains, the American personal savings rate is negative.

There is a lot in favour of personal credit systems. They obviate the need for large cash transactions and cashless economies have far better tax compliance records. Such mechanisms also enable users to enjoy higher living standards than otherwise affordable.

Consumerism drives economic growth. Perhaps two-thirds of US GDP comes from consumer consumption and much of that is on some form of credit.

But private citizens are also more sensitive to sentiment than governments and consumer-driven economies can be very vulnerable to irrational moves.

In feel-good situations, with low unemployment, consumers rack up card limits. When the stockmarket is surging, the real economy can move up because investors borrow and buy against anticipated capital gains. In times of trouble, they might cut back sharply.

A little twitch in personal loan rates or a small change in unemployment ratios can mean large swings in the real economy.

Defaults are not uncommon in consumer economies when the borrowing is against securities that suddenly depreciate in value. This could be mortgages against property, or against bond and equity portfolios.

The US recession since mid-2000 has been mild with relatively little real economic contraction. Consumers have bought both real-estate and cars on the never-never, even after the stock market tanked.

This is because the US Federal Reserve cut rates to release a flood of liquidity. With cheaper loans and refinancing options, consumers responded with purchases that kept the US economy and, by extension, the global economy afloat.

The Fed recently announced that it won't cut rates again in substantial fashion. It can't "" the real rate is already near-zero. In response to the Fed policy reversal, US housing mortgage rates and refinance rates jumped.

That will inhibit consumers with floating mortgages. There will also be fewer new real-estate deals or splurges funded with real-estate as underlying security. US unemployment is at record levels.

Coupled to a stockmarket that hasn't really gone anywhere since June 2000, consumer confidence may finally take a hit. Especially without concrete closure on Afghanistan/Iraq.

If the US economy nosedives, it could take Indian stocks down. FII purchases have moved Indian (and other emerging market) stocks up strongly in the past few months.

That money could head back into safe havens like US bonds, or Euro forex markets if there is a rise in US rates or a drop in external returns. Large chunks of FII portfolios consist of export-oriented industries; these would be hit.

Improvement in the domestic economy could however buoy Indian stocks. Profitability has shot up across multiple sectors in the past six months.

A good monsoon will help drive Indian consumerism and the movement into retail finance by Indian financial players could also help. The next few months could see FIIs balancing off rising Indian consumer confidence indices versus dipping US consumer confidence indices.