Corporate Euphoria Worries India’s Central Bank

Members of the monetary policy committee (MPC) of India’s central bank, Reserve Bank of India (RBI), must be worried. Recent headlines of India’s business newspapers frequently relate to fund-raising by major banks and housing-finance companies to satisfy high demand for loans, capacity addition announcements by businesses based on high consumer demand, and mega-project launches by new energy companies, with high initial costs. RBI’s hawkish announcements and cumulative 140 basis repo-rate hikes since May 2022 appear to have had little effect on the euphoria of business decision-makers.

Inflationary Expectations are Getting Entrenched

Q1 2022-23 results of major fast moving consumer goods (FMCG) companies reveal that they have been able to increase unit sales even though selling prices rose at almost twice the reported inflation rate, as calculated by India’s consumer price index (CPI). Apart from a display of strong pricing power, it indicates that second-round effects, such as wage hikes, must be in progress since consumers have the capacity to continue purchasing at higher prices. Entrenched inflationary expectations can lead to future inflation spiraling out of control, creating price-uncertainty and lower real growth.

60 basis point Repo Rate Hike in September

We expect RBI to hike its benchmark repo rate by a larger-than-expected 60 basis points in its MPC meeting this month to shock the market, dampen euphoria, and regain lost credibility. We feel that, by end-December 2022, RBI will hike its repo rate by an additional 35 basis points to 6.35%. In doing so, RBI will expect to reduce demand-driven growth in India, hoping that it will lead to lower price-increases for core (non-food, non-fuel) CPI components.

6.66% Real GDP Growth in 2022-23

Our model indicates that India’s real GDP growth in 2022-23 will be 6.66% - lower than India’s Finance Ministry’s projection of 8.50%, the International Monetary Fund’s (IMF) 7.40%, RBI’s 7.20%, the Organisation for Economic Cooperation and Development’s (OECD) 6.90%, and also lower than estimates by most Indian and global economists. We expect all expenditure components of GDP to moderate towards long-term averages, with imports falling from 31.04% of real GDP in Q1 to 21.47% in Q4.

Lower Margins & Higher Profits for Non-food Consumer Companies

In the first half of 2022-23, India’s core-product companies should manage to maintain gross margins at close to normal levels, using a combination of price-hikes and shrinkflation. However, they may find the second-half more challenging with lower-than-anticipated demand. This may force these companies to partially absorb input-cost increases and report lower gross margins for this period. But, with household consumption during 2022-23 estimated to grow 7.72% in real terms, as per our model, and RBI estimating full-year CPI inflation at 6.70%, companies in this sector should grow nominal sales at around 14.93% and profits in the low double-digits. So, there appears to be some method to the madness displayed by corporate India. Companies growing unit sales and profits need to borrow and invest, generating additional demand for resources, leading to higher prices, and making RBI’s task of inflation control more difficult.

By Gautam Chand, 14 September 2022