India - In search of the middle class

Christopher Butel

McKinsey underestimates the Indian middle class size at about 50 million.

Estimating the size of the Indian middle class is an important issue for the markets as well as for the government. Politically this is significant because a large middle class is one marker of inclusive economic development, and one means by which the attachment of the citizenry to the market economy more generally is achieved.
For the markets, assumptions about the size and pace at which the middle class is growing are among the factors underpinning the direction of business investment. For the outside world, a sizeable and growing middle class brings greater confidence that the country is already a long-term profit centre in the global consumer market.
The McKinsey Global Institute has opined that the correct way to think about the Indian middle class is to pin it to households with annual incomes between Rs 2 lakh and Rs 10 lakh. This McKinsey believes produces an Indian middle class comprising some 50 million people living in 13 million households. My feeling is that this is an underestimate as IIMS Dataworks data indicate that there are at least 18 million such households containing 103 million people.
In this box we find rural as well as urban India. While India’s largest cities account for a disproportionate share of the households of interest (38 per cent), half are located in rural areas and in smaller towns. In the rural case, the non-farm sector contributes nearly half of middle class households. In the urban case, over half of these households are headed by either self-employed businessmen or government/salaried workers.
In states not containing a supermetro, the size of the middle class on this income measure is mainly a function of population size, with states with a large population like Uttar Pradesh having a significant middle class in numerical terms. The exceptions are Kerala and Punjab, where the middle class is over-represented in population terms. These are also the two states with the highest level of international remittance inflows which may be influencing this result.
In urban households, half of those with middle class income earners are under the age of 35, suggesting upward economic mobility for younger urban workers. In rural India, the age distribution of the middle class is more linear, suggesting that the core of the middle class continues to come mainly from "old money" but there is at the same time a perceptible bulge at the younger end. So the story is that the middle class is growing in both urban and rural areas.
A working definition of the middle class that appeals to me is that middle class households are those that have the capacity to self-service their own transport, communications and home entertainment requirements. In practical terms this translates into owning motor vehicles, telephones, computers, televisions and sound systems. Last year there were six million households in India containing some 29 million people who owned all of these items. This gives me the confidence to say that this group is upper middle class. The average annual income of this group is hovering around Rs 5 lakh.
If we take computer ownership out of the equation, households with the remaining range of assets mentioned jump dramatically to some 46 million, containing 232 million people. For me this is a better way of thinking about the emerging middle class. Importantly, three quarters of this larger group have an annual income of less than Rs 2 lakh.
A key missing piece in debates about the middle class is home ownership. Home ownership in India among active members of the workforce is quite high at 54 per cent. The equivalent number in the US as a point of comparison is a little over 66 per cent.
Admittedly, a fair slice of Indian housing is not of good standards but its influence on their consumption power is nonetheless significant. This is so because, unlike the US, nearly 90 per cent of residential properties in India are unencumbered. This means that 20-25 per cent of the incomes of Indian homeowners are released for general consumption purposes because home loan servicing costs are not a factor in their spending patterns. Unencumbered housing in India is also an important part of the explanation for high savings rates.
Americans may have a higher-value asset in the form of owner-occupied homes but high debt servicing costs lower their savings and consumption power more generally, forcing them to rely on credit to maintain general consumption preferences. In the Indian case, homes generally do not represent a high-value asset but the fact that they are mostly unencumbered means that a greater share of income is available for savings and general consumption purposes without needing to resort to credit. This partly explains why the credit card revolution has yet to take a stronger grip in India.
The evidence that home ownership partly drives Indian consumption patterns is compelling because for any combination of household assets of interest, the incidence of asset ownership among homeowners is something like three times higher than is the case for non-homeowners. Understanding this immediately disturbs the prevailing wisdom on the consumer power of Indian households. For governments keen to maintain high long-term rates of economic growth, boosting consumption levels is a critical path issue and promoting home ownership should be seen as an important part of the required policy mix.
The author is Chairman of IIMS Dataworks. The analysis in this article is based on the Invest India Incomes and Savings Survey