Easing Inflation Isn't Helping SMEs. Here's Why

While commodity prices have fallen, margin pressures have not eased as much as costs remain high and sticky.

<div class="paragraphs"><p>Source: Grayom on Unsplash</p></div>
Source: Grayom on Unsplash

Amid flailing demand in the pandemic and a surge across commodities, India's small businesses struggled to pass on costs and were forced to sacrifice margins. Now, while commodity prices have fallen, margin pressures have eased but not as much as other costs remain persistently high and sticky.

Inflation measured by the Wholesale Price Index stood at 5.85% in November—the lowest, and also the first time it has fallen below retail inflation, since February 2021. According to yet another indicator of manufacturing activity—the Purchasing Managers Index—the overall rate of input cost inflation slipped to the joint-lowest in 28 months in November. Cooling cost pressures prompted companies to purchase more inputs and add to their inventories.

A continuous fall in commodity prices means that Ebitda margins for small and medium enterprises are getting better, though they are yet to see a return to pre-pandemic levels, said Vinod Kumar, president of the India SME Forum.

Currently, SME margins are likely in the range of 6.7-6.8% across the sector, he estimated. While that is higher than during the pandemic, when they fell to less than 5%, they were at slightly above 7% before Covid, he said.

Suman Chowdhury, executive director and chief analytical officer at Acuité Ratings and Research, said margin pressures are easing in the ongoing quarter aided by lower commodity prices, after having persisted across the board up to the previous quarter.

Demand too is good, said Maguirish Pai Raiker, chairman of the National Council for MSMEs at industry body Assocham. "If you have capacity and wherewithal, you can make money," Raiker said, adding that demand for most products is increasing, along with capacity utilisation. In fact, some of those who have managed to pull on through the pandemic are now looking at expanding capacity utilisation, he said.

However, the pace of improvement differs across industries. Sectors using steel, like construction companies, are expected to report better margins as prices of the alloy have fallen even as prices of other inputs such as cement have not changed much, Chowdhury said. Auto ancillaries, too, are expected to see benefit aided by lower steel prices, said Raiker.

Other industries such as gems and jewellery and bulk drugs have seen a pick-up as well, said Kumar, while some like agri processing continue to see high input cost pressures.

However, maintaining margins remains a tightrope walk for MSMEs, said Raiker. Prices of raw materials have not come down as much for SMEs while other costs such as electricity, rents and wages have risen, he said.

Chandrakant Salunkhe, president at the SME Chamber of India, said while international commodity prices have fallen, domestic correction is not commensurate. "It's not like gold rates that are published daily," Salunkhe quipped. Overheads such as electricity and fuel remain expensive and continue to impact SME profits, Salunkhe said.

Also, SMEs usually need to keep stocks of raw materials. As such, unless lower prices are sustained over a period, the impact on margins is not very different, he said. An improvement in margins across sectors will take still more time, he said.

Cost Of Financing Rises

Consistent hikes in the benchmark lending rate have meant a rise in financing costs. All banks have increased cost of any form of working capital, said Kumar.

The increase in benchmark rates is being passed on to SMEs too and how much margins improve also depends on how leveraged they are, said Chowdhury. Whether margins have improved also depends on whether an SME is export oriented or caters to domestic demand.

Domestic demand has been steady and SMEs catering to local consumption should see an improvement in margins, he said. Relief for export-oriented SMEs is limited amid the export slowdown, he said, adding that revenues will likely be slower as order books have declined.

SMEs remain cautious amid dampening demand in exports and a weak outlook considering a visible slowdown in Europe and forecasts of a downturn in the United States, said Chowdhury.

Salunkhe, however, said there is a seasonal lull in activity because of winters and output tends to ease before it picks up again in the last two months of the fiscal year.