One of the reasons why the monetary policy has been in the tightening mode is because of higher commodity prices, which in turn are being passed through to consumers by companies. The argument is that companies have now reached the limits of their capacities and have, thus, acquired pricing power.
RBI (Reserve Bank of India) governor’s post-policy conference call with analysts had an interesting conversation between Rajeev Malik, senior economist at broking firm CLSA Asia-Pacific Markets, and Subir Gokarn, deputy governor of RBI.
Also see | Margin Compression (PDF)
Malik’s contention was that margins were not increasing, so how could one say that the extent of pass-through had increased. Gokarn pointed out that although margins had been under pressure, they hadn’t collapsed dramatically. According to him, “The sense is that the compression has not been very significant and that reflects there may not be an escalation, but there certainly is significant pass-through.”
If one looks at the HSBC Purchasing Managers’ Indices (PMI) for India, the rise in pass-through is clear in the services sector. Here’s what Leif Eskesen, chief economist for India and Asean at HSBC, had to say of the April numbers: “Input costs have risen for 17 straight months now, driven by supply shocks and rising labour costs, as companies are continuing to hire in a tightening labour market. In addition, demand-led price pressures are beginning to take over as the key driver of inflation, which are allowing businesses to more easily pass on the higher input costs to end-consumers.”
The April services PMI showed the prices-charged index rising to 55.4 from 55.1 in March, although the pace of increase in input prices cooled somewhat. A reading over 50 indicates expansion. The manufacturing PMIs also show a slowing pace of growth for both input and output prices, but they continue to increase. The PMI indices also show that input prices have been growing more rapidly than output prices, which is leading to margin compression for firms.
We took a look at the operating profit margins of 166 non-financial companies—all of them part of the BSE-500 Index of the Bombay Stock Exchange whose results for the March quarter have been declared—and compared them with their performances in the previous quarters. The results show that though operating margins have fallen from 18.21% in the June quarter to 17.02% in the March 2011 quarter, there hasn’t been much of a change in them during these three quarters.
So, while it’s true that margins have not expanded, they have not contracted by much also. (Of course, many companies are yet to declare their results and the final picture may change, but we expect the trend to sustain).
The extent of pass-through has been, therefore, more or less the same in the last three quarters. What has changed is that input prices have gone up and, accordingly, so have output prices. What strengthened RBI’s anti-inflationary stance, therefore, was not the increase in the pass-through, but the central bank’s assessment that “global commodity prices, which have surged in recent months, are likely to, at best, remain firm and may well increase further over the course of the year”, as the policy statement said.
But if RBI succeeds in slowing the economy and curbing demand, margins will be squeezed even more.
Graphic by Yogesh Kumar/Mint
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