The macro impact on India from the commodity price shock is significant and well known. If oil prices remain elevated, it could drag growth down, raise inflation, and widen the twin fiscal and current account deficits. What is not as obvious is the more granular impact of higher oil prices on firms and consumers, which in turn could become the leading driver of growth trends.
Not all firms will be impacted equally by the oil price shock. Through the pandemic, large and listed firms have performed relatively better than small and informal firms. And early indicators show that the oil price shock is intensifying this divergence. Let us explain.
Our study of the RBI’s database of around 2,700 firms shows that during the pandemic, large firms have taken market share from smaller firms. Their profitability has also risen while that of small firms has not. This is likely to be a result of several factors benefiting large firms more — their ability to cut costs, a lower interest rate environment, and access to buoyant capital markets.
The underperformance of small firms comes in two distinct phases — one, the lockdown periods (in early 2020 and early 2021), and, two, the commodity price shock period (commodity prices have been rising since mid-2021). Small firms, particularly in the informal sector, typically have smaller cash buffers to withstand long periods of turmoil. Several weeks in the lockdown is likely to have hurt them much more than large firms. And just as they were rebounding, the commodity price shock hit and pushed them back into underperformance.
For two reasons, we think the commodity price shock will hurt small firms more than large firms. One, India has become more energy-efficient, and this trend has been led more by the large firms who have taken more efficiency-enhancing steps than the small firms. Two, large firms, by their sheer size, may have more bargaining power when buying raw materials. They can also pass on more of the input cost increases to consumers.
It is clear from the corporate results that the burden of rising input costs since mid-2021 has been higher for small firms. Survey results show that many have been pushed to shut shop in recent months, when prices have been rising. It is, therefore, safe to say that high inflation is hurting the bottom of the pyramid more.
It’s not just the large firms that have done well, it’s also their employees. Staff costs of large firms have overshot pre-pandemic levels by a meaningful margin. On the other hand, staff costs of small firms have stagnated at pre-pandemic levels, implying a fall in the real purchasing power of their employees. The recently conducted ICE survey shows that the poorest 20 per cent in India have seen a 53 per cent decline in their incomes between 2016 and 2021, while the richest 20 per cent have seen a 39 per cent increase.
So what proportion of Indians have borne the brunt of the double shock?
Twenty per cent of the labour force works in the formal sector and has benefitted from improved jobs and wages. Both the outperformance of the larger formal sector firms and the wealth effect from buoyant stock markets have played a role. Job listings at agencies like Naukri.com have recently overshot pre-pandemic levels.
Eighty per cent of the labour force works in the informal sector, equally split between agricultural and non-agricultural workers. The latter group is typically associated with small and informal firms.
Agricultural workers did well in the first half of the pandemic, given good monsoons, an exemption from the lockdown, and government welfare spending in rural India. Thereafter, wages in this sector began to slow from mid-2021, led again by a variety of factors — a slowdown in MGNREGA works, volatile monsoon rains, weaker construction wages, and higher rural inflation.
Non-agricultural workers didn’t do well in the first half of the pandemic. But as the lockdowns ended, their fortunes began to improve gradually. With the commodity price shock, the risk is that this nascent improvement reverses. This group, divided equally between rural and urban India, is perhaps the most vulnerable at this point. All this has implications for GDP growth.
We have a lot of good data in India to help track the formal sector. But we don’t have as much real-time data for the informal sector. In the short run, the statistics office assumes that the trends in the formal sector are a good proxy for the informal sector. But, in periods when the informal sector underperforms the formal sector, this assumption can lead to an overestimation of GDP. Meanwhile, if the weakness in the informal sector persists, it eventually shows up as lower demand (even hurting the prospects of the formal sector) and growth.
The good…
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