A Crisil Ratings' study on 3000 of its rated small and medium enterprises (SMEs) across industries in India shows that a 1 percent (or 100 basis points) decrease in cost of raw materials could boost the SMEs operating profit margins (OPMs) by 12.5 percent. In this study, Crisil has analysed the linkage between cost of raw materials and net sales and profit margins of the SMEs.

For 2010-11 (refers to financial year, April 1 to March 31), the average OPM of these SMEs was 5.62 percent on average net sales of Rs.27.1 crore. A decline of 1 percent in raw material prices could increase the OPM to 6.32 percent from 5.62 percent, indicating a rise of 12.5 percent (70 basis points).

Sachin Nigam, Senior Director, SME Ratings, CRISIL, said, "Given that the raw material cost accounts for about 70 percent of the overall cost of manufacturing for the SMEs, any positive or adverse movement of raw material prices has a major impact on their overall profitability. The SMEs operating in engineering, capital goods, textiles and chemical industries are most sensitive to movement of raw material prices."

Considering recent movements in price levels, which came off peak levels in end-2011 (refers to calendar year, January 1 to December 31) and have not seen much fluctuation through 2012, CRISIL believes that SMEs could look forward to declining raw material prices in the near future. Inflation based on the wholesale price index (WPI) declined to around 7.1 percent so far in 2012, compared to an average 9.5 percent in 2011. According to Crisil, prices of the key commodities, such as steel, cotton, commodity chemicals, plastics and rubber, which constitute a major portion of the SMEs' cost structure, will decline in 2012. Cotton and rubber prices are expected to move down by around 20 percent and 9 percent respectively. Prices of other raw materials such as plastic, flat steel and commodity chemicals, are expected to decline within the range of 3 to 6 percent.

Explained Yogesh Dixit, Director, SME Ratings, Crisil,"The recent decline in commodity prices, could ease cost pressures on SMEs. Additionally, with the Reserve Bank of India lowering interest rates, SMEs could also anticipate easier access to funds at lower cost of borrowing vis-a-vis that in 2011."

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