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Moneycontrol Pro Weekender | Inflation shock 

High inflation will sooner or later take a toll on demand

May 14, 2022 / 10:15 AM IST
Representative image.

Representative image.

Dear Reader,

The global economy faces twin headwinds of high inflation and slowing growth. In the US, the worry is Fed tightening may lead to a recession, while retail inflation is at 8.3 percent. In the UK, GDP contracted by 0.1 percent in March.

In India, overall retail inflation for April was 7.8 percent, with rural inflation at 8.4 percent. Inflation in rural Haryana, Madhya Pradesh, Telangana and West Bengal is in double digits. At the same time, manufacturing growth is a mere 0.9 percent from a year ago and the sector hasn’t grown at all in the last three years.

And yet, the S&P Global India Composite PMI, a yardstick of private sector activity in both manufacturing and services, was at a five-month high in April. Moreover, the survey said, ‘output charges at the composite level rose at the strongest pace since early-2013.’ This suggests strong growth in the corporate sector is pushing up inflation, as companies pass on the huge rise in input costs. The OECD leading indicator shows stable growth for India.

In spite of the increase in costs, CMIE data on the March quarter corporate results show that so far, non-financial firms as well as manufacturers, have been able to protect their operating margins, which are well above those in the pre-pandemic March 2019 quarter. That’s true of net sales growth too. Simply put, much of the corporate sector is able to pass on the rise in input costs.


This is also seen from the core inflation numbers. CMIE’s ‘core’ inflation (CPI excluding the food group, fuel & light group and petrol, diesel & other fuels for vehicles), has moved up from 5.4 percent last August to 6.5 percent in April.

As Shaktikanta Das said in his Governor’s Statement on May 4, ‘The risks of unprecedented input cost pressures translating into yet another round of price increases for processed food, non-food manufactured products and services are now more potent than before.’

In the US, a study by the Economic Policy Institute showed that it is corporate profits and not wage growth that contributed disproportionately to inflation. A study by the Bank for International Settlements said, ‘Firms’ pricing power, as measured by the markup of prices over costs, has increased to historical highs…….Indeed, this could be one reason why inflationary pressures have broadened recently in sectors that were not directly hit by bottlenecks.’

In India too, the ratio of corporate profits to GDP is going up.

Why then is growth in industrial production so tepid? That’s because the PMI and the CMIE corporate data look only at a small sub-section of the economy, while the industrial production numbers have a much wider scope. It’s another indication of the K-shaped recovery. Listed corporates are doing quite well, while inflation adds to the burden on the informal sector, already in bad shape as a result of the pandemic.

More evidence of a top-heavy recovery comes from our Economic Recovery Tracker, which showed that car sales rose, but two-wheeler sales slipped. We pointed out that SUVs are riding the K-shaped path to recovery.

In other words, while the bigger firms in some sectors are able to pass on their costs to consumers and will do the same for an increase in interest costs, smaller firms and those that depend on demand from the not-so-well-off and the informal sector will buckle under the additional strain. What monetary and fiscal tightening will do is lengthen the leg of the K, while the arm remains more or less intact.

For instance, the market seems to be painting too pessimistic a scenario for L&T. Tata Motors posted a reasonable set of numbers despite a severe shortage of semiconductor chips and input price inflation. TVS Motors put up a decent show despite the rise in raw material prices. Asian Paints’ EBITDA margins grew 9 percent year-on-year on the back of price hikes and cost control. Ramkrishna Forgings’ operating profit improved despite raw material price inflation. The recovery in the multiplex sector is playing to a full house.

RBI will therefore need to take into account the K-shaped impact of inflation. The sops in place for small businesses and certain sectors will need to be extended and perhaps widened.

High inflation will sooner or later take a toll on demand. There could be initial indications of that happening, with a key industrial metals index down 25 percent from its six-month high, although the China lockdown is also a big factor. The Dabur India management says the worry is from lower rural demand, rather than from margin pressure. The silver lining here is that the global food price inflation index declined in April.

For us, of course, the key question is the impact on the markets. We pointed out that the fall in the benchmark indices hides the carnage in the broader equity market. This FT story by Ruchir Sharma, free to read for MC Pro subscribers, said, ‘Those that enjoy the most blindly undiscriminating hype on the way up are the most vulnerable when the market starts to churn.’ Market expert Ajay Bagga wrote about the investment lessons from the investment trenches in challenging times.

My colleague Shishir Asthana wrote about how retail investors continue to repose their faith in Indian markets. Ed Yardeni struck an optimistic tone, writing that while a correction is called for, he expects to see the S&P500 in record high territory again next year.

Gaurav Kapur, chief economist at IndusInd Bank, told us about the outlook for the Indian bond markets. As for the meltdown in cryptos, this FT story says the sun is setting on crypto’s Wild West days.

During the week, we also analysed the prospects for Voltas, Cipla, JSW Energy, EIH Ltd, ABB Ltd,  Navin Fluorine, CSB Bank, UPL, the LTI-Mindtree merger, the Delhivery and Prudent Corporate Advisory Services IPOs, and Tata Power here and here.

We also had our regular features: Start-up Street, which talked of unanticipated early exits; The Eastern Window, on why China’s deal with the Solomon Islands is making the US jittery; Herd Immunity Tracker; FX Learn on how to use technical analysis to become a better currency trader; Decoding PLI, on the scheme for specialty steel firms; and we had the final story in our Algo Learn series, which said mastering emotions is the key to success as an algo trader.

We wondered whether the Open Network for Digital E-Commerce is a revolution or mere hype; whether Xi Jinping could vanquish COVID without crushing China’s economy; and whether the finance minister will consider helping the middle class. We analysed India’s policy failures on GM crops and discussed the roots of the Sri Lankan crisis.

As for the rupee, while we said neither the fundamentals nor the technicals are encouraging, the INR has been relatively resilient, despite all the breast-beating.

We are inclined to agree with Miss Prism, who tells her student in Oscar Wilde’s ‘The Importance of Being Earnest’: ‘Cecily, you will read your Political Economy in my absence. The chapter on the Fall of the Rupee you may omit. It is somewhat too sensational.’


Manas Chakravarty


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Manas Chakravarty
first published: May 14, 2022 10:15 am
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