There were no indications of another round of quantitative easing in the US Federal Reserve’s Open Market Committee statement on Wednesday. With the prospect of easy liquidity no longer supporting asset prices and with lowered global economic growth estimates, there are expectations that commodity prices will soften in the months to come.
Some see the forthcoming decline in commodity prices, along with a good harvest and the base effect, as helping to rein in inflation in India. But inflation expectations continue to remain high. BNP Paribas Securities (Asia) Ltd, for instance, forecasts both headline and core inflation to remain at 8.5-9% levels for much of this year.
Also see | Cost Structure (PDF)
One reason for that could be that perhaps commodity prices have started easing some time ago, they still remain above the year-ago levels. Even if input prices decline dramatically—something which not many people have predicted—that impact takes some time to transmit through to companies since many firms lock in rates with longer-term contracts.
But is the fear of increasing input costs being overstated?
The cost structure of Indian firms has fluctuated a bit over the last decade. In fiscal 2001, raw material cost as a percentage of net sales was around 39% for all listed manufacturing companies. The metric is the same for the recently concluded fiscal. However, this is still way off from the peak reached during the last bull run—between 2003 and 2007. In 2005, the raw material cost proportion had ballooned to 42.66%, implying that there is still some way to go from the current levels.
The proportion of input costs itself may not be a big deal. There is limited spare capacity in several industries, as a recent Reserve Bank of India survey shows, and that means firms would be able to pass on the cost increases. However, that holds true only if demand increases. In 2005, net sales grew nearly 33%. But in the current scenario, with rates hikes and rising inflation, there is an increasing risk of demand slowing. No wonder, brokerages are expecting squeezed margins for the next couple of quarters as well.
Graphic by Yogesh Kumar/Mint
We welcome your comments at firstname.lastname@example.org