Cost-push inflation due to past currency depreciation and high food inflation is squeezing corporate margins and hurting consumers’ real purchasing power in India
India’s industrial production (IP) moderated below expectations to 0.6% in August from 2.8% in July, due to contraction in capital and consumer durables output growth, while consumer non-durables and intermediate goods output growth improved. Looking ahead, better export growth and good monsoons have raised hopes of a turnaround in the industrial cycle. However, according to economists, leading indicators do not indicate any revival at this stage and the growth in real gross domestic product (GDP) may remain below 4.2% during FY14.
"Due to past currency depreciation and high food inflation, cost-push inflation is squeezing corporate margins and hurting consumers’ real purchasing power in India. Hence, even with better monsoons, we expect non-agriculture GDP growth to slow down due to weak domestic demand, hurting overall growth. We expect real GDP growth at a below-consensus 4.2% y-o-y in FY14 (Consensus: 4.9%) and 5.1% in FY15 (Consensus: 5.9%)," said Nomura Financial Advisory and Securities (India) Pvt Ltd in a research note.
India’s IP growth moderated to 0.6% y-o-y in August due to two factors. First, capital goods output growth – an indicator of investment activity, which was bolstered last month by two volatile categories (rubber insulated cables and ship building & repairs), slumped back into the contraction zone (-2% y-o-y) after rising an impressive 15.6% y-o-y in July. Second, despite higher car production, consumer durables output growth remained in the negative, possibly due to a sharper slowdown in white goods production.
"Intermediate goods output growth – a leading indicator of final demand - also improved to 3.6% in August from 3.1% in July. If final demand does not catch up, then this could lead to increased inventories. Export driven sectors such as textile products (wearing apparel etc) registered double-digit output growth. However, overall the IP data suggest that domestic demand remains very weak with a fairly prolonged bottoming out process," added Nomura.
Dr Soumya Kanti Ghosh, chief economic adviser in the economic research department at State Bank of India (SBI) said, "IIP growth for August 2013 at 0.6% fared worse than street expectations. May 2013 figures were revised down significantly to -2.5% from -1.6%. The growth in export oriented sectors slowed down in August 2013, notably apparel & leather. The good news is that investments in new projects are showing an improvement. The bad news is that projects completed are declining, indicating that the pipeline of fresh investments is not encouraging. Additionally, the number of projects dropped is still at an elevated level, indicating that the investment climate may not be witnessing any palpable signs of revival."
According to Nomura, better export growth and good monsoons have raised hopes of a turnaround in the industrial cycle. "In our view, leading indicators do not indicate any domestic demand revival at this stage. The OECD’s composite leading index for India continues to plummet. Production of medium and heavy commercial vehicles (MHCV) – an indicator of industrial and capex activity – has worsened: from a contraction of -2% y-o-y in Apr-May, MHCV output growth fell -54% y-o-y in September. Both the manufacturing and the services PMI have worsened in Q3 as compared to Q2. Export growth has indeed improved in Q3, but the export new orders index (of the manufacturing PMI) has softened, raising doubts about the sustainability of this momentum."
In addition, policies are turning pro-cyclical with both fiscal and monetary policy being tightened despite a sharp slowdown. Even as the Reserve Bank of India (RBI) has cut the marginal standing facility rate, which will lower the short-term working capital costs, the repo rate – which determines the medium-term interest cost, was hiked in September. The government’s fiscal deficit has reached 75% of the full year budget target during the first five months.
"This means an impending belt-tightening akin to last fiscal year (cut in spending and delay in payment during the next six months till March, in order to get closer to the budgeted fiscal deficit target. Additionally, cost-push inflation due to past currency depreciation and high food inflation is squeezing corporate margins and hurting consumers’ real purchasing power. Hence, even with better monsoons, we expect non-agriculture GDP growth to slow down due to weak domestic demand, hurting overall growth," Nomura added.
The retail industry is a high capex, low margin business. Both Bharti and Wal-Mart are not ‘in the pink of health’. This, coupled with uncertainty in regulation, may have forced them to call off their retail joint venture in India
US retail major Wal-Mart Stores Inc decided to purchase the entire stake of Bharti Enterprises in their 50:50 wholesale cash-and-carry joint venture Bharti Walmart. There are multiple reasons as to why the partners, who joined hands in 2007, decided to part ways. The major reasons are regulatory uncertainty in India and funding.
In May 2009, Bharti Walmart launched its first business to business (B2B), Best Price Modern Wholesale cash-and-carry store, in Amritsar. At present, there are 20 Best Price Modern Wholesale stores located at various places, including Zirakpur, Jalandhar, Kota, Bhopal Ludhiana, Raipur, Indore, Vijayawada, Agra, Meerut, Lucknow and Jammu.
The Indian government could not come up with a comprehensive policy for organised retail. One report estimates the 2011 Indian retail market as generating sales of about $470 billion a year, of which a minuscule $27 billion comes from organised retail such as supermarkets, chain stores with centralised operations, and shops in malls.
While India presents a large market opportunity given the number and increasing purchasing power of consumers, there are significant challenges as well, given that over 90% of the retail trade is conducted through independent local stores. Other challenges include, geographically dispersed population, small ticket sizes, complex distribution network, sparse use of IT systems, limitations of mass media and existence of counterfeit goods.
Uncertain policy environment
Until 2011, the Indian government denied foreign direct investment (FDI) in multi-brand retail, forbidding foreign groups from any ownership in supermarkets, convenience stores or any retail outlets. Even single-brand retail was limited to 51% ownership, with the burden of a bureaucratic process.
In November 2011, India's central government announced retail reforms for both multi-brand and single-brand stores. However, the announcement sparked intense activism, both in opposition and in support of the reforms. Finally, bowing to the pressure from the opposition, the Indian government, in December 2011, placed the retail reforms on hold till a consensus was reached.
Last year, in December, the government allowed 51% investment in multi-brand retail trade. Recently, it made amendments to rules after several retailers expressed concerns on the 30% local sourcing clause, yet-to-be-made changes in Foreign Exchange Management Act (FEMA) rules, among others. Interestingly, while some states decided to allow foreign supermarkets like Walmart, Tesco and Carrefour to open stores, other states were still not ready.
The opening of retail industry to free market competition, some claim, will enable rapid growth in retail sector of Indian economy. Others believe the growth of Indian retail industry will take time, with organised retail possibly needing a decade to grow to a 25% share. A 25% market share, given the expected growth of Indian retail industry through 2021, is estimated to be over $250 billion a year: revenue equal to the 2009 revenue share from Japan for the world's 250 largest retailers.
The Economist forecasts that Indian retail will nearly double in economic value, expanding by about $400 billion by 2020. The projected increase alone is equivalent to the current retail market size of France.
In addition, the government, while allowing foreign retailers in the country, added the local sourcing clause. In fact, Wal-Mart in July, was unable to meet the norm requiring it to source 30% of the goods from small industries, said it could source only about 20%. Others retailers such as Carrefour and Metro are expanding in India rather cautiously. Big names such as IKEA, H&M are yet to announce their formal store openings in India.
Money does matter in retail business
The big bang expansion plans of international retailers into fast-growing emerging markets may not fructify at this moment because of investment capital constraints (as is to be expected in a scenario where business in the home country is weak). Wal-Mart, for instance, said in 2012 that it will slow down launches of new stores in China and other Asian markets, indicating a greater focus on operational efficiency.
The business model for retail industry, especially in India is a high cost-low margin. This is the reason why most big retailers have lost money. In fact, Bharti Walmart lost Rs277 crore during 2011.Even Reliance Retail that was launched in 2006, and is supported by India's largest private company Reliance Industries Ltd (RIL), showed profit only during FY2013.
The flagship Future Group of Kishore Biyani, which is into retail business through Big Bazaar, Food Bazaar, e-zone and Pantaloon brands had a debt of over Rs8,000 crore late last year. Last year, the group hived off its flagship Pantaloon into a separate entity to sell majority stake in it to Aditya Birla Nuvo (ABNL), which agreed to infuse Rs1,600 crore. Biyani also transferred the debt of Rs800 crore to ABNL. Not to forget the risks Biyani took while expanding the Future Group beyond retail and in the process had incurred huge debt.
Biyani, in his book called “It Happened in India”, mentioned that he wants to capture every Indians’ wallet share, from the ultra-rich to the lower middle-class. It is with this one-track mind that he singularly focused on borrowing massive amounts of money, piling up loans, hoping to be the next ‘Wal-Mart’.
A slowdown in discretionary spending (only discount driven sales is pulling customers) and cannibalisation from new stores is limiting growth of most retailers. After all, retailing is a low margin business, a drawback that can only be overcome only with a strong customer pull.
Coming back to Walmart JV, the Bharti Enterprises group has been struggling with a debt of about $12 billion. During June 2013 quarter, Bharti Airtel, the country's largest mobile operator, again reported lower profits. This is the company's 14th consecutive quarter of falling profits.
In a joint statement, both Bharti and Wal-Mart said they have reached an agreement to independently own and operate separate business formats in India and discontinue their franchise agreement in the retail business.
As part of the proposed transactions, Bharti will acquire the $100 million worth compulsory convertible debentures (CCDs) held by Walmart in Cedar Support Services, a company owned and controlled by Bharti. Bharti Retail will continue to operate the 'easyday' retail stores across all formats.
Wal-Mart on the other hand, plans to continue to grow its business while working with the Indian government and interested stakeholders to create conditions that enable FDI in multi-brand retail.