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Business News/ Market / Mark-to-market/  Inflation data implies margin pressure for businesses
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Inflation data implies margin pressure for businesses

That retail inflation has remained sticky at 4.8-4.9% indicates that firms are finding it difficult to pass on the rise in commodity prices, leading to a squeeze in margins

The difference between WPI and CPI inflation, which was merely 25 bps in November last year, has increased to 290 bps in February this year. Photo: BloombergPremium
The difference between WPI and CPI inflation, which was merely 25 bps in November last year, has increased to 290 bps in February this year. Photo: Bloomberg

Inflation as measured by the Wholesale Price Index (WPI) surged to a 39-month high of 6.55% in February. On the other hand, retail inflation rate measured via the Consumer Price Index (CPI) was at a comparatively much tamer 3.65% in the same month.

With that, the difference between WPI and CPI inflation, which was merely 25 basis points in November last year, has increased to 290 basis points in February this year, thus widening the gap between the two (see chart 1).

One basis point is one-hundredth of a percentage point.

What could be the implications of this divergence?

The rise in wholesale inflation has been driven by higher input costs, which means that margins of firms could get squeezed if they fail to pass the cost increases on to consumers. According to Nomura Securities, a breakdown of WPI components into input costs and output prices shows that input cost inflation surged to 9.1% year-on-year in February from 6.8% year-on-year in January, while output prices moderated to 2% from 2.4%.

The fact that retail inflation, especially core inflation, has remained sticky at around 4.8-4.9% indicates that firms are finding it difficult to pass on the rise in commodity prices, thus leading to a squeeze in margins.

Now consider the Nikkei Markit India Manufacturing Purchasing Managers’ Index (PMI) survey’s seasonally adjusted input and output price indices. Chart 2 shows that the input price indices, both for manufacturing and services, have been higher than the output price indices. This is true especially for the manufacturing sector, while the gap has been much narrower for the services sector. That suggests that margin pressure will be more for manufacturing firms. That is unsurprising, given the rise in commodity prices. The PMI numbers therefore corroborate the inference from the inflation data.

Could the pressure on margins be offset by higher sales, the consequence of increased demand? Robust demand will enable businesses to pass on input cost increases. “One may argue that pent-up demand in the system due to demonetization may be a saviour, but in my opinion, that cushion (on margins) will be a limited to specific industries where demand came down due to this scheme, for e.g. auto," said Madan Sabnavis, chief economist at CARE Ratings.

At present, however, the jury is still out whether demand will increase, but there is little doubt that margins of firms are under pressure.

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Published: 16 Mar 2017, 08:27 AM IST
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