Markets
Pricing edge may cost services firms
Summary
The services sector output was said to be supported by favourable demand, new client wins and positive market dynamics. A comparison of headline PMI data shows that momentum in economic activity remains higher in services sector than manufacturing.Business activity in India’s services sector moderated slightly in May. The seasonally adjusted S&P Global India Services PMI Business Activity Index fell to 61.2 in May from 62 in the previous month. Despite this, the latest reading indicated second strongest growth rate in just under 13 years, said services PMI survey report. A reading above 50 denotes expansion.
The services sector output was said to be supported by favourable demand, new client wins and positive market dynamics. A comparison of headline PMI data shows that momentum in economic activity remains higher in services sector than manufacturing. But this resilience could be put to test.
Although new export orders continued to rise, fall in new orders index points to softening in domestic demand, said economists. Further, headline services PMI got some fillip from employment sub-component, which rose to 51.1 in May, after languishing at around 50 lately. “Nevertheless, it still seems to us that the historical outperformance of the headline services PMI is looking increasingly exposed to a sharp downward correction. For a start, it is not as if backlogs of work are building up fast enough to provide a meaningful cushion," said economists at Pantheon Macroeconomics in a note dated 5 June.
Secondly, service providers struggled with input cost inflation in May with higher food, transport, and wage costs. Input prices rose at fastest rate since December. Consequently, service providers further raised selling prices in May. “Having quickened to the joint strongest in close to six years, the rate of charge inflation was solid," the survey report added.
Note that service providers are enjoying better pricing power than manufacturers (see the chart alongside). On one hand, this should aid margins of service providers. While on the other hand, it could dent purchasing power of consumers, and weigh on demand.
“Growth is proving resilient despite faster transmission of past rate hikes. If inflation pressures increase then it would dampen (services) demand," said Gaura Sen Gupta, economist, IDFC First Bank. She cautioned that sharp increase in output prices indicates that core CPI services inflation, which has averaged around 5.3% over the last 11 months, could pick up ahead.
For now, services firms are upbeat that business activity would increase over the coming 12 months. Advertising, demand strength and favourable market conditions were among reasons cited for optimistic forecasts, said survey report. However, business confidence fell a bit month-on-month on concern about competitive pressure. On this parameter, as chart shows, manufacturers fared better in May.
“Services sector witnessed strong growth in FY23 due to pent up demand. But that is unlikely to repeat in FY24 because prices across industries such as hospitality, education, and entertainment, have been revised higher," said Madan Sabnavis, chief economist at Bank of Baroda. So, the base effect and waning pent-up demand will lead to moderation in service sector growth in FY24, thus impacting India’s gross domestic product growth, he added.
Meanwhile, at its upcoming policy meeting this week, the Reserve Bank of India (RBI) is widely expected to maintain the status quo on interest rates. “We expect RBI to remain on pause in June and keep its stance unchanged as withdrawal of accommodation," said Sen Gupta. She added that a change in stance to neutral may give the wrong signal that the focus has shifted away from containing inflation.
