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High Prices: An Economic Phenomenon or Capitalism?

By: Aryan Govindakrishnan

Abstract

In recent years there has been a significant increase in prices of FMCG goods. This article will try to understand the reasons behind the increase in the prices, how  it is affecting the economy, why the companies are trying to increase prices and if this is a sustainable way for the companies to grow.

Introduction

The Indian economy is one of the fastest-growing in the world, with a large and diverse workforce and a rapidly expanding middle class. This huge market attracts a lot of big FMCG companies to set up their bases in India. FMCG stands for Fast Moving Consumer Goods. These are items that are sold quickly and at a relatively low cost, such as food, beverages, toiletries, and household cleaning products.They hope to tap into the Indian market which has an enormous number of consumers with varied taste and style  and is diverse in terms of language, religion, and purchasing power. 

The Indian FMCG market grew dramatically since liberalization in 1991 after the then finance minister put an end to license raj and opened the economy of India to the global market. Companies flooded in to tap into the Indian economy. Competition increased from before more products were available to Indian consumers with more affordable rates and easier to get their hands on them. Nonetheless, liberalization came with an opportunity for these companies to tap into the Indian market. After entering the market and creating brand loyalty among Indian consumers, now the companies were focused on creating profits. 

Indian Market Characteristics

Before diving right into the price increase, let’s  first look into the Indian household to understand the mentality and how an increase in price would affect them. Indian households are generally characterized by their strong emphasis on family values, respect for elders, and tight-knit social structure. The diversity of Indian households can be seen in terms of their economic standing.  According to the data published by NSSO, 27%of households in India fall below the poverty line and the rest 73 percent are classified as non-poor. Out of this 73 percent roughly 65 percent are classified as middle-class households. Middle-class households in India are growing  rapidly and are said to become the highest-income demography in India by 2025. Recent years have seen changes in social norms due to a fast-paced world. Indian  households are adapting and changing as well. 

As Indians, we tend to look at the prices of goods and services and look for the cheapest possible alternative for the goods and services  that are needed . The change in prices often affects us and we tend to make decisions around it. 

Price Increase Mechanism 

The change in prices of goods and services on the consumer’s side is measured and monitored using the Consumer Price Index (CPI), which is a measure of the average changes in prices of goods and services consumed by households over time. 

While measuring CPI certain factors are investigated. The factors are:

  1. Food and Beverages
  2. Transportation, fuel, and electricity
  3. Housing
  4. Clothing and Footwear
  5. Miscellaneous 

Each of these categories is further divided into subcategories which can provide a more detailed look into the consumption patterns of Indian households. The weights assigned to each category are revised periodically so that it reflects the changes in consumption patterns.CPI is affected when companies increase their prices for various reasons like increased production cost or changes in demand and supply or just to increase their profit margins. The effect on CPI depends on whether the item of which the prices have increased belongs to the CPI basket. For example, if there is an increase in prices of cereals or pulses which belong to the category of food and beverages there might be an increase in CPI, but if the prices of luxury goods increase it might not have a significant impact on CPI as it does not belong to the basket. The current increase in prices can be looked at through three lenses. The first is to look at the elasticity of FMCG goods. A second look into the inflation aspect and thirdly, at the Producer Price Inflation. 

FMCG goods like food beverage-packed goods have relatively low prices and are sold out quickly. The elasticity of FMCG goods depends upon various factors like the availability of substitutes, brand loyalty, level of income of the customers, and many more. Generally, the price elasticity of demand for these products is low i.e., the change in prices of these goods has a small impact on the demand for these goods. Although one of the major determinants that affect the elasticity of demand is brand loyalty. Consumers who are loyal to a brand that they have been using for years might not change their preferences due to an increase in prices. This behavior might lead to an increase in CPI. Since the prices are increasing there is a financial burden upon the consumer which can increase the consumer price index.

Inflation & Consumer Price Index

Inflation has a significant impact on CPI. When inflation is high the prices of goods and services  increase and this would impact CPI. 

In the past two years, India has seen high inflation as seen in the above graph which has influenced the consumer price index of the country. The 2021-22 period saw high inflation prices due to COVID, chip shortages, supply chain disruptions, etc. As inflation kept on increasing, the CPI started rising as well, as is evident in the graph given below  This shows how closely related CPI and inflation are and how the change of one can affect the other.

Producer Price Inflation

Finally, we look into the aspect of the producer and why they are increasing their prices. According to an article published by business today, FMCG companies have seen an increase in their revenues but the volume of sales has not seen a significant increase. When we investigate the numbers, we see that the FMCG companies have fuelled their growth by increasing their prices and by a little offtake of their product volume. According to data, a negative spiral caused by the recession in the rural market and high commodity costs is making it difficult for FMCG firms to strike the correct product-price balance. According to market research company Nielsen, volume offtake decreased by 4% nationwide in Q3FY23 due to a 6% reduction in the rural market and a 3% decline in the urban market. Nonetheless, FMCG value growth in the December quarter was driven by double-digit price increases throughout the industry, by 10% in the urban market and 4.5% in the rural market, with cumulative growth estimated at 8%.  

Producer Price Inflation (PPI) refers to the rate at which the prices of goods and services at the wholesale or producer level are increasing. It is a measure of the average change in prices received by domestic producers for their output. It is calculated based on the prices of goods and services at the producer or manufacturing level, and it includes both domestically produced and imported goods. 

The above graph shows the producer price inflation which was considerably low. Low PPI can have both positive and negative effects on the economy. On the positive side, a low PPI can help to keep inflation low, which can help to support consumer purchasing power and economic growth. Low PPI can also make it easier for businesses to maintain profit margins and may lead to lower prices for consumers. On the negative side, a low PPI can be an indicator of weak demand for goods and services, which can lead to lower production levels and slower economic growth. Low PPI can also lead to lower profitability for producers, which can lead to job losses and reduced investment. The current low PPI has been having an adverse effect on the company’s profit. Since the PPI is low it means the cost of raw materials that the company needed for producing the goods was low which can’t be the reason for the increase in prices of their goods. As mentioned above, due to low rural consumption the company revenues stagnated, furthermore due to volatile times in the Indian market, and the companies needing to show numbers to the shareholders to maintain confidence among them they took the approach of increasing the prices to increase their revenue despite sales volume remaining low.

Solutions and Conclusion

The sustainability of this approach is questionable. For this approach to be sustainable it will depend upon these four factors:

Satisfying these factors in the recent market is very difficult and we can say this approach is not a sustainable way to increase revenue. 

As of today, we  can see that the current CPI is lower than the previous quarter as well as the inflation is lower compared to the last quarter, but the recent price hikes might show an increase in CPI in coming quarters. This uncertainty can cause an increase in inflation of the country putting further pressure on the consumers and causing a financial strain on  the economy and the Indian households.From the above reasons we can say that the current increase in prices is a combination of both economic agents and capitalism. And a fall in prices can’t be expected anytime soon.

About the Author

Aryan Govindakrishnan is a first-year student at the Jindal School of Government School and Public Policy, pursuing Masters in Economics. His research interests include finance policy and economics.

Image Source: https://twitter.com/BDieplattform/status/1566357619136151553

 

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