From households to enterprises to markets, expectations drive decisions

Economic expectations are ubiquitous. Some are formed formally by deploying sophisticated modern mathematical tools. Others through natural skills honed by evolution. Both are powerful in their impact on the macro-economy.

Financial markets assign a great deal of importance to expectations. Managements of companies provide guidance and markets, in turn, build expectations regarding their profits. Professional economists spar similarly with macro-economic variables to build expectat­ions around growth, inflation and similar indicators of the health of the economy.

Expectations play an important role in decision-making. Enterprises and the financial markets, for example, allocate funds that reflect their expectations.

Similarly, consumers, too, have expectat­ions regarding the economy. These play a role in their decision-making. Consumers do not build complex mathematical models or consume the business and economic news disseminated by the government and private agencies. But, they do form expectations regarding the economy nevertheless.

Consumers form a view on the probability of them getting a job or retaining a source of income and, therefore, of their likely future income. They form a view on the condition of the economy by having a view on economic and business activities. Consumer expectations are often formed by learning from people who face similar economic conditions, similar threats and opportunities. They gain knowledge by a surveillance of the environment. Sometimes, signals from such a system coordinate simultaneous changes in expectations across large groups. This is when they start influencing the macro-economy.

Household decisions to spend, save or incur debt would depend upon their expectations of inflation, interest rates and wages.

In India in recent times, inflation and interest rates have been rising and real wages are falling. These indicators had turned particularly adverse in April 2022. Inflation rose to 7.8 per cent. This is the highest inflation rate recorded in India in the last eight years. It is way above the Reserve Bank of India’s (RBI’s) upper tolerance band of 6 per cent. Con­su­mers’ inflation expectations have gone up. According to the RBI’s surveys, during July 2021 through January 2022, about 63 per cent of respondents believed that inflation would be higher over the next three months than it was at present; and nearly 68 per cent believed that it would be higher over the next 12 months. Expectations of inflation have been worsening steadily in recent years. The ratios given above are the highest since 2013.

Interest rates have started to rise as well. They began rising well before the sudden off-cycle hike in the repo rate announced by the RBI on May 4. On April 18, State Bank of India hiked its marginal cost of funds-based lending rate (MCLR) by 10 basis points. This impacts home loans, vehicle loans and corporate loans. Almost 50 per cent of the bank’s loans are linked to the MCLR. Axis Bank, Kotak Mahin­dra Bank and Bank of Baroda also raised their MCLR rates in April. Now, with the RBI’s repo rate hike, the cost of borrowing is expected to rise across the board. Further, the expectation is that as inflation may continue to rise and/or the rupee may continue to weaken, the RBI may raise interest rates further to control inflation or to defend the rupee.

Year-on-year growth in rural wages was in the 2-3 per cent range during the first half of 2021-22. This rose to 4-5 per cent during the second half of the year. But, rural inflation during the first half was in the 4-6 per cent range and in the second half, it was in the 4-8 per cent range. As a result, real rural wages have been declining mildly. Rural inflation hit 8.4 per cent in April 2022. Real rural wages are, therefore, hit quite hard.

Consumers don’t read and analyse these statistics. They feel it through experiences, through social networks and their unstructured observations of their environment. Given the rise in inflation and interest rates and the suppressed wages, it may be logical for consumer expectations to be subdued.

CMIE’s consumer sentiments index tracks consumer expectations. The index of consum­er sentiments comprises two sub-indices: the Index of Current Economic Conditions (ICC) and the Index of Consumer Expectations (ICE).

In April 2022, consumers got distinctly cautious about their economic expectations. For the first time since April 2020, the ICE level fell below the ICC. Post the great fall in sentiments following the lockdown in April 2020, ICE was always ahead of ICC. House­holds always had greater expectations from the future compared to their impoverished conditions during the period of restricted mobility. Between April 2020 and December 2021, the ICE was always distinctly higher than the ICC. On average, it was 11 per cent higher than the ICC. In the preceding 21 months, it was only 0.8 per cent higher.

ICE levels compared to ICC started falling from January 2022. The ICE was only 4.4 per cent higher than the ICC in January. Then, it was barely higher than the ICC in February and March 2022. In April, it flipped to fall 1.6 per cent below the ICC. In the first two weeks of May, it was 0.1 per cent below the ICC.

While the ICE:ICC ratio is declining, both continue to rise and so does the Index of Consumer Sentiments (ICS). The ICS rose 

1 per cent in the first fortnight of May and 2.6 per cent in the week ended May 15, 2022.

The writer is MD & CEO, CMIE P Ltd