Bracing for a nasty inflation spike

The month of October is when most companies which are listed on the stock exchange report their quarterly results, for the quarter ending September. The good news is that corporate profitability, at least of the large companies is improving dramatically. Profits are rising because of 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.

HUL warned that the pace of input cost escalation is the steepest in more than a decade. This sentiment is echoed by other companies too

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 the high-end vehicles is rising more steeply whereas 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 which has hugely benefited from the rise in stock market wealth.

Even 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 dollars, which is one 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 of the quarter ending September. 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 shampoo to detergents to ice cream, i.e. makers of soaps, oils, skin care 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), of raw materials including metals and chemicals, and of costs imposed by supply chain disruptions which are being felt globally. The gap between consumer (CPI) and WPI based inflation is too wide, and is bound to narrow. Which means consumer price inflation will surely rise. Companies like Asian Paints have indicated that the third quarter may see steep increase in 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, all of it is sure to lead to consumer inflation. Indeed, the RBI itself is unsure of reaching its own target of consumer inflation of 4 percent before 2023. For nearly two years India’s CPI inflation has been at or above the 6 percent mark, which is the top end of the band allowed by the RBI. America too is experiencing record consumer inflation of about 5.5 percent, and so is Europe. The cost of gas used for home-heating in the winter, and also oil has spiked up. The Food and Agricultural Organization 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 which 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 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 otherhand there have been a number of distress sales of gold. And as such gold loans have gone up by a whopping 62 percent 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 gold prices start climbing, it indicates demand arising from a desire to hold on to something which is a hedge against inflation

If growth in income i.e., GDP 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.

(Dr.Ajit Ranade is an economist and Senior Fellow, Takshashila Institution)