The Hindu Business Line : Cost pressures ease, but what of demand? What’s in store

Rising input costs, dearer borrowings and exceptional forex losses have been the key impediments to India Inc’s earnings growth this quarter. However, even if you look only at the sustainable profit picture, it isn’t too heartening. After adjusting for extraordinary items, profit growth is still only at 7.4 per cent, for the 2,000 companies analysed. What should investors watch out for over the next few quarters?

Relief on margins

The meltdown in commodities over the past few weeks has cut down prices of critical industrial inputs such as petroleum products, steel and metals. The good news is that the decline was triggered by fundamental factors — slowing offtake and diminishing demand — though unwinding of speculative positions has also fed the downward spiral.

It is difficult to say if commodity prices will continue to decline. But with expectations of a slowdown in the US and China gaining ground and speculative froth receding from commodities, investors no longer need to agonise over a doomsday scenario of oil at $200! Sectors that use petroleum products, steel and metals as critical inputs can look forward to some relief on the raw material front. Sectors where companies have taken price increases — for instance, automobiles, FMCGs — may actually witness margin expansion over the next few quarters if input pressures ease off, as selling prices may not be pegged down immediately to adjust for lower costs.

Lag effect of rates

While the market appears to believe that declining commodity prices will soon filter down to interest rates, it may be some time before borrowing costs actually begin to decline. With inflation way above the central bank’s comfort zone, the RBI may be in no hurry to peg down policy rates.

Even if inflation numbers do tumble, interest rates are unlikely to beat a retreat as quickly as they rode up. There is also the lag effect of recent increases in lending rates to contend with. Some of the sharpest hikes in lending rates, which have taken place only last month, will trickle down to borrowing costs of companies only as they raise fresh funds to bankroll new projects. This suggests continuing pressure on earnings of companies in capital intensive and highly leveraged businesses. While borrowing costs may rise for companies, the days of easy money also appear to be over for the Indian consumer.

Rising default rates on retail loans are prompting a more cautious stance by banks on consumer loans, with interest rates on some segments getting quite prohibitive. This indicates that sectors that rely on credit-fuelled demand (durables, automobiles, housing) should brace for a further slowdown.

Slowing consumer juggernaut?

Margin pressures look set to ease off. But a new worry for India Inc may yet arise from a demand slowdown, which can restrict the scorching pace of sales growth managed by it over the past few quarters.

Will the killer combination of higher interest rates and soaring inflation, prompt consumers to tighten their purse strings? Will tighter credit reduce their appetite for big-ticket purchases such as homes and cars? Will higher interest rates prompt companies to postpone projects and thus quell investment demand for capital goods?

All of these are within the realm of possibility. The pace of sales growth will be a key number to watch for the next few quarters, even as investors breathe easier on commodity prices.

AARATI KRISHNAN