Companies may lose competitiveness if cost of production remains high.
The Indian industry is classically caught between a rock and a hard place. If there’s one trend cutting across sectors this earnings season, it would be the poor pricing power of Indian companies.
From consumer discretionary companies like autos, to capital goods manufacturers, everybody’s been hit by the rising input cost.
In March, the input price index of the manufacturing PMI rose to an all-time high of 68.7, thanks to the rising cost of raw materials. Many may argue that companies have been undertaking price increases in a calibrated way over the last few quarters on the back of robust domestic and export demand, but data suggest it’s clearly not enough to maintain profitability.
Thanks to strong demand and rising input cost, manufacturing companies have raised their selling prices. This pushed up the output price index to 59.7 in March, the second-highest reading in the history of the series. Given the input price index stands at 68.7, there still exists a wide gap between input and output costs.
This is not where the bad news ends. It’s probably where it begins. Effectively, this means raw material cost will continue to rise, but not all manufacturers would be able to pass on the increase to consumers. The growth in manufacturing prices has been five-six per cent, with the overall inflation being nine per cent. Economists say companies will not be able to pass the entire increase on to the final consumer as imports will be more competitive. With the rupee appreciating over the last few months, imports, especially of select chemicals, auto components and engineering goods, have become more competitive. On the other hand, the cost of power, capital and raw material has been on a rise in India. With their pricing capacity gone, some industries will find it difficult to stay competitive.
Says Siddhartha Roy, chief economist at Tata Sons: “Indian industry has limited pricing flexibility, as the landed cost of imports provides the upper threshold value.”
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Nomura’s analysis of input-output price inflation across sectors suggests that margin pressure is most severe in tea and coffee, man-made fibres, wood products, machinery, transport equipment and fuel segments. With cost pressures on the rise and the demand outlook still reasonably firm, Sonal Varma, chief India economist at Nomura, expects core inflation (non-food manufactured WPI) to accelerate from 7.1 per cent year-on-year in March, to around 8 per cent by September.
Core inflation – as measured by non-food manufactured inflation – accelerated to 7.1 per cent on-year in March, as against an average of 4.8 per cent in 2010. Economists believe the cost pass-through is still incomplete and both headline and core WPI inflation will accelerate further in the first half of FY12, before retreating in the second half.