A worrying sign: Brace for inflation

Corporate profitability, at least of the large companies, is improving dramatically, as seen in the results for the July-September quarter. Profits are rising due to higher demand, and higher prices being commanded. This is true for companies across sectors like fast-moving consumer goods (i.e., foods and staples), white goods like washing machines and toasters, home furnishing and improvement, fashion, and even commodity sectors like metals, cement, construction materials, chemicals.

Sales are booming on e-commerce sites. Fintech companies are recording higher sales and higher valuations. Even banks seem to be doing well, with ICICI Bank reporting the highest-ever quarterly profit. The automotive sector is also perking up, although the demand for high-end vehicles is rising more steeply whereas the same for two-wheelers is slow.

This reflects a K-shaped recovery. The upper leg of the K signifies goods and services consumed by the higher income, urban bracket, and the lower leg of the K signifies lower-income households and rural areas. The upper leg of the K is also representative of the segment of the population that has hugely benefited from the rise in stock market wealth.

Though retail participation in stock markets is increasing, especially through mutual funds, it still represents the higher income brackets. The value of all securities held in the National Securities Depositories Limited (NSDL) recently crossed $4 trillion, which is a third bigger than the size of the GDP. This is a new peak. All this surging demand and shopping frenzy is prior to the next quarter, which is when the festival buying push will be truly felt. If indeed the economic momentum is good, then even this Diwali and Christmas quarter should fetch good profitability.

But there is a looming worry. And that has been expressed by many company officials reporting their handsome profits in the September quarter. The telling remarks were by the Chairman and Managing Director of Hindustan Unilever, which is a leading manufacturer of all sorts of consumer goods, from shampoos to detergents to ice cream, i.e., makers of soaps, oils, skincare and food products. He warned that the pace of input cost-escalation is the steepest in more than a decade.

This sentiment is echoed by many other companies, too. The input cost-escalation is best captured by the Wholesale Price Index (WPI)-based inflation, which has been running at double digits for several months. It includes energy and logistics costs (of oil, petrol, diesel, coal), raw materials including metals and chemicals, and of costs imposed by supply chain disruptions that are being felt globally.

The gap between Consumer Price Index (CPI) and WPI-based inflation is too wide, and is bound to narrow. This means that consumer price inflation will surely rise. Companies like Asian Paints have indicated that the third quarter may see a steep increase in the prices of their products. This is likely to be emulated by other companies in many sectors.

The price of a matchbox was doubled, the first price hike of this humble product in the past seven years. Price revisions in shampoo bottles or noodles, toothpaste or edible oil, are all sure to lead to consumer inflation. Indeed, the RBI itself is unsure of reaching its own target of consumer inflation of 4% before 2023. For nearly two years, India’s CPI inflation has been at or above the 6% mark, which is the top end of the band allowed by the RBI.

America, too, is experiencing record consumer inflation of about 5.5%, and so is Europe. The cost of gas used for home heating in the winter, and also of oil, has spiked up. The Food and Agricultural Organisation says that the global food price index is the highest in the past seven years. The Bloomberg commodity price index, which captures energy, metals, fibres and chemicals, has also risen sharply. Ocean freight costs are still very high and will persist. All of these are called “input costs” but sooner or later will feed into consumer inflation.

To add to input cost pressure are high fiscal deficits that need higher taxes (such as on petrol and diesel in India) which can only aggravate inflation. A good agriculture harvest cannot offset these high costs. Inflation can suddenly spike up like the second wave of Covid. It does not rise steadily and predictably. And if we get into a wage-cost spiral (the government has already revised the DA rates), then putting the inflation genie back into the bottle might not be easy. Inflation fears have already made stock markets somewhat nervous. Some downward correction has started.

The inflation expectations as captured by RBI’s survey shows near double-digit expectations. It is difficult to bring it down, once it is stuck at higher levels. One other indicator of inflation anxiety is when people start buying more gold. If gold prices start climbing, that too indicates demand arising from a desire to hold on to something which is a hedge against rising prices. But this is by a wealthier and smaller section of the population. On the other hand, there have been a number of distress sales of gold. And as such, gold loans have gone up by a whopping 62% in the past year or so. This indicates the distress of inadequate incomes. Gold loans are often used to finance consumption spending, such as children’s education, weddings, illnesses, or to even meet household expenses.

If growth in income keeps pace with relatively higher inflation, then nominal GDP will rise faster, and so will tax revenues. This may have a salutary effect on the fiscal situation. But if growth slows down, and inflation remains high, then we stare at a stagflation kind of situation. Chances are that demand drivers are still strong to avoid stagflation. The leading indicator is growth in bank credit. And a lagging indicator of a rising economy is growth in hiring and recruitment, quality jobs and labour-force participation. This is something that must be closely watched. If the infrastructure spending, and labour-intensive exporting sectors, software and IT, see massive job growth, some of the pinch of inflation can be lessened.

(The writer is an economist and Senior Fellow, Takshashila Institution)

(Syndicate: The Billion Press)