Arvind Singhal: The Shadow of Inflation

MARKETMIND

The spectre of rising inflation has now engulfed many economies in the world ranging from the US and the UK to China, West Asia, and India. The symptoms were in the making for some years. The Iraq war marked the onset of high and higher oil prices. There was a steady rise in the prices of most commodities in the global markets including metals and food in the last three years for various reasons including substantially increased consumption in new markets such as China, Russia, India and West Asia. However, till recently, most economies were able to manage such price escalations through classic macro-economic management tools. Something has changed in the last 12 months, which has rendered frantic interventions from most of the governments and governors of central banks across the globe ineffective. The last straw has been the onset of a near certain recession in the US and the precipitous decline of the US dollar, which has put even more pressure on the other economies of the world "" both developed as well as developing.

Not surprisingly, growing inflation has now become the single most important issue in India too. In the backdrop of the general election year, this issue is probably going to be the most important one for the UPA and its many adversaries. Unfortunately for the UPA, the roots of the current inflationary spiral lie outside India and hence it would be a herculean task for it to do anything rational that can curb the inflationary pressures in the near term. Imports are certainly not an option since the prevailing global commodities prices are already sky-high and hence even zero import duties will have little impact on prices of food in particular. Subsidies may work but with the inherent weaknesses in the public distribution system, it is likely that the benefit of any such subsidies will be cornered by unscrupulous elements, leaving the lowest and middle income strata exposed to the searing heat of rising prices.

The initial data on inflation indicate a much higher rise in prices of food items, and that too more in urban India with the largest cities including Delhi and Mumbai bearing the maximum brunt. This will certainly have a major ripple effect on many industrial and service sectors in India. In 2008, spending on food and grocery accounts for almost 42% for all Indians and over 47% for Indians in the lower income strata. A 10% increase in prices of food and grocery reduces the available discretionary incomes by almost 5% for most other than the rich and the affluent. Of course, with the inflation rate officially above 7% already, the decrease in spending power will be much more than 5%. The immediate impact will be a reduced spending on non-food categories with most vulnerable being clothing, eating out, consumer durables, leisure and recreation, and two wheelers/entry level four-wheelers. In some cases such as clothing and eating out, consumers will not only reduce purchase /consumption frequency but will also "downgrade" to lower-priced options. In others such as consumer durables and lower-end automobiles, the consumers are likely to defer purchases unless they absolutely need to buy a new refrigerator or a TV or a motor cycle. Major investment categories such as new housing are likely to be impacted even more as the capacity of the middle class Indian households to take up the burden of high EMIs will be increasingly restrained.

For most businesses, the prescription is unpalatable but unavoidable. Where possible, they have to offer more cost-effective options to their customers if they wish to maintain at least their current business volumes. In this backdrop, value retailers like Subhiksha, Big Bazaar, Vishal Mega Mart, and Reliance Retail in certain formats such as Reliance Trends are well placed to increase market share. Value brands/ retailers like Koutons and Cotton County are also well placed. The reported move, if true, of mid-market retailers like Shoppers Stop and Westside to a more premium positioning is likely to be counter-productive for them. Likewise, clothing and other consumer product brands that are positioned at the middle or lower premium end of the market rather than either value or otherwise upper premium or luxury end are also likely to be caught in no-man's land and are likely to face increased pressure on sales in coming months. For such players, increased advertising or promotional spend is unlikely to do much good in current circumstances.

Beyond making more value-priced options available for the customers, businesses have to make a very serious effort in curbing internal cost-inflation. Executive pay in India has already reached unsustainable proportions. There has been steep rise in other operating costs including office rentals, travel, etc. All the extra fat has to be worked away immediately.

It is going to be at least a year or more before the global and Indian inflationary trends are tamed. Till then, if business has to go on, then appropriate action has to be taken. It cannot be "business as usual" for most.

arvind.singhal@technopak.com