Someone's nibbling at the grocery bag! - Views on News from Equitymaster

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Someone's nibbling at the grocery bag!

Sep 12, 2007

Inflation is a bane that has been imposed upon the mankind courtesy his unending greed in a world of limited resources. While there may be a debate over the fact that a steady inflation rate is good for the economy, there is hardly any ambiguity in the assumption that high rates of inflation jeopardize economic growth and cause some serious dents in purchasing power. More so in the case of essential commodities like food grains and vegetable oils. This is exactly the sort of problems that the Indian economy is currently grappling with and which, we believe will require some serious tackling. Shown in the chart below is the price trend of a few commodities over the past two years

As seen from the chart above, important commodities except sugar have seen a steep rise in the periods mentioned. While sugar too touched highs of Rs 20 per kg in August 2006, the prices fell in the latter half due to over supply. The price of palm oil has gone up nearly 48% over the last two years, while that of skimmed milk, which is another important ingredient also rose by 65% over the last two years. Wheat, which is the staple diet of most of the population, witnessed a 30% rise in prices between June 2006 and April 2007. Further, in January 2007, food prices were 10 % higher than what they were a year ago. Again, in January 2006, they were 7.6 % more than what they were in January 2005.

As per ASSOCHAM's recent report, prices of major commodities have shown maximum price fluctuations to the extent of 23% to 25% over the last one year. The recent increase in prices of essential products is clearly a case of demand exceeding supplies. Though the government has slashed the import duties on essential commodities and banned exports of wheat and SMP (skimmed milk powder), price rise continues unabated.

Not only the consumers but companies also are facing the brunt of higher prices. Raw material prices form nearly 30% to 40% of the topline of FMCG companies. Containment of margins and sustenance of growth have thus emerged as key challenges for the companies. While certain companies were able to pass on the hike in raw materials to the customers, not all companies were successful. While Godrej Consumers and HUL were able to hike prices of their soap portfolio by 5% to 8%, Britannia and Nestle were unable to pass on the increase in wheat and skimmed milk price to the customers, thus affecting their operating margins. The grocery bag for the consumer has become more expensive. Prices of select brands across categories such as detergents, soaps, toothpaste and atta are up by 5% to 20%, thanks to a steep surge in input and freight costs. The customers not only have to pay more for the essential commodities but also for the finished products. This in turn reduces their outlay towards other items or forces them to buy products lower in the value chain.

The efforts of the government to tame and contain inflation in essential commodities have so far proved to be of limited success. Further, the government's blames on external factors like poor harvest in Australia or higher supply from Brazil is of little help. The price hike in commodities clearly indicates a case of demand exceeding supplies. This imbalance would increase the inflation rate.

Going forward...
Public distribution systems, free quota systems are not the solutions. With strong economic growth, higher income and rising standard of living, the demand supply mismatch is likely to go up further. Rainfall, productivity and acreage are the key factors that determine the availability. Hence, the need is for reforms in these areas. Better infrastructure, better connectivity of places and proper storage facilities (40% of food stuff is lost in storage) are also a must. Unless things improve considerably on these fronts, we might continue to witness wild gyrations in prices.

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