Investors in pharmaceutical stocks should brace for more uncertainty in drug pricing. The government is planning to link price increases for drugs, even those that are not under price control, to the Wholesale Price Index (WPI) or to a special index for medicines. If implemented, it will replace the current system of a 10% cap on price hikes in a year for drugs that are not under price control.

Is tighter regulation justified? Are pharma companies rushing to increase prices, and thereby hitting the annual price cap?

Retail pricing data from AIOCD Awacs, a market research agency, suggests otherwise. In fiscal year 2018 (FY18), the pharmaceutical market grew by 5.7% in value terms, with price change at minus 0.8% indicating a decline. Volume growth and new products contributed largely to the increase in revenues.

But we are more concerned with the non-NLEM segment or drugs outside price control. NLEM refers to the National List of Essential Medicines.

Non-NLEM sales rose by 7%, growing ahead of the market; but again, price growth was only 0.5%. So price hikes played a very small role. Of course, the impact of pricing was unusually low last year. In the previous two years, prices grew by around 5%, but even in those periods, volumes and sales of new products together contributed more to revenue growth (see Chart 1). Overall, price growth has not been the overwhelming reason driving sales growth in the past three fiscal years.

Still, the overall picture could hide pockets of high price growth. Looking at different therapeutic categories, the top 10 non-NLEM categories showed a price change in the region of a decline of 0.4% to an increase of 1.3%. In FY17, when overall prices rose by 5.1%, the price increase of these categories varied from 2.8% in anti-infectives to 6.6% in dermatology (see Chart 2). Companies are staying well below the 10% limit in all categories.

What about at the brand level? Of all the non-NLEM drugs in the AIOCD Awacs database with a price increase of 1% or more in FY18, 89.3% saw a price hike in the 1-5% range, 5.6% in the 5-10% range and 5.1% in the 10%+ range. Combined with the category- level data, there does not seem a situation where high price increases are a norm.

The move to cap price hikes using a broad index will be a blunt tool that will restrict price increases in all categories and brands. While the 10% cap was also a broad limit, it gave enough headroom to increase prices in some brands. Capping the increase to an overall index will make it difficult for companies to take decisions specific to some categories/brands. Instead of WPI, if the government uses a specific index for drugs, that will be better.

The government has already identified a list of essential medicines (expanded from the original level) where it has imposed price controls. This new move leads to quasi-price control on drugs outside the essential list as well.

If the government approves this proposal, it adds another element of uncertainty for investors. Investors will be left judging how much the WPI (or any other index) will move to understand what kind of price-led growth is possible. The Indian market is second only to the US in importance for most Indian-owned pharmaceutical companies. The US market is already a source of worry as a tough pricing environment and regulatory action has dulled business. If India’s growth is hindered by a tighter policy grip, that could affect valuations too.

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