Inflation touches ‘core' of manufacturing

The Wholesale Price Index (WPI) for February belied expectations of a softening trend and accelerated to 8.3 per cent over a year ago. The inflation reading for this month is worrying on two counts: one, it was believed that a moderation in food inflation would suffice to bring the headline inflation below the 8 per cent mark. This has not happened. On the other hand, a spike in core inflation or non-food manufacturing inflation seems inevitable, with a rising trend visible since December. This, in essence, means the beginning of testing times for corporate profit margins.

Food prices cooling off

Concerted efforts to lower prices of food articles met with some success for the month of February. Lower prices of fruits and vegetables and agri-commodities such as moong and urad resulted in food inflation (including manufactured food) tapering off to 6.5 per cent (9.3 per cent in January). However, a rally in global commodity prices as well as policy measures taken by the RBI to reign in inflation appear to have triggered a spill-over of inflation to the manufacturing side.

Manufacture worries

Core inflation for February rose 6.1 per cent (Y-o-Y) as against 4.8 per cent in January. The hike in price was broad-based, spanning across such sectors as textiles, paper, chemicals, basic metal products and minerals.

What does this higher manufacturing inflation suggest? It may, on the face of it, suggest that companies are passing on higher raw material costs in the final price. However, the question arises as to whether higher input costs have been passed-through fully. It looks unlikely for the following reason: One, raw material cost hikes are typically reflected in the inflation numbers with a lag. Two, the core inflation numbers are still not too high, compared with the commodity rally witnessed, suggesting that further pass-on may happen. For instance, inflation in manufactured items such as machinery and machine tools or transport equipment and parts, which receive high weights, have seen a 2-3 per cent inflation over a year ago. Clearly, the cost of inputs such as steel and other metals, significantly used to make these equipment, have risen much higher, suggesting that higher input costs have not been fully passed on to the final product.

If so, the March quarter corporate scorecard may see some pronounced pressure on profit margins. Two, even assuming price hikes are comfortably passed-on, it may significantly hurt end-users for a longer period. Why? Higher interest costs (as part of the RBI's measure to rein in inflation) appear to have curtailed corporate capex as well as production, if the IIP numbers are to be believed. Hence, supply-side pressures, arising from lower production capacities may well prolong the inflationary phase. Added to this, fuel — a key input for most industries — already on an upward trajectory since December, is expected to be hiked, post state-elections ending in May, given the global crude price scenario. As oil feeds into inflation, WPI may not take the downward trajectory any time soon.

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