Inflation and apparel demand

By: Chandrima Chatterjee

Volatility has been the theme for the Indian Economy thisyear, be it capital markets, forex market or price lines. The recent hike infuel prices is expected to contribute around 2 percentage points to overallinflation and take it up from the present 8.2% to over 10%. Moreover, delays indata collection may mean big revisions to inflation: the final number for earlyMarch was almost two percentage points higher than the original. The latestwholesale-price inflation rate might therefore be pushed up to 9-10%.

There is hardly a silver lining for the industry andexporters, as it means a double whammy of increasing demands for wage hikes andincreased input costs.  However, the heat is not only being felt by Indianindustry, but many of the developed and developing economies worldwide. China's official rate of consumer-price inflation is at a 12-year high of 8.5%, up from 3%a year ago .In fact, five of the ten biggest emerging economies could haveinflation rates of 10% or more by mid-summer. Two-thirds of the world'spopulation may then be struggling with double-digit inflation. Will this mean adecline in demand and consumption of apparel or decline in profit margins for the industry?

Inflation

Globally, inflation has suddenly become an issue of concern.Both, producer price indices and consumer prices indices in many developingcountries are high. The average world inflation rate has risen to 5.5%, itshighest since 1999. The main cause has been the surge in the prices of food and oil, which has breached the $139 a barrel during May 2008. The higherheadline rates could push up inflation expectations, leading to bigger paydemands, and so trigger a wage-price spiral, as in the 1970s. With loose globalmonetary policy, the average world real interest rate is negative. This isespecially true for US and Eurozone. Inflation rates of 3.9% in America and 3.3% in the euro area are far higher than desired and inflation expectationsare rising.

An analysis of 57 developed and developing countriesworldwide (table 1) shows that the highest increase has been for some LACcountries like Venezuela (29.6%), Argentina (10.3%), Chile (6.7%), Columbia (5.5%), Brazil (5.1%). However this is low if compared to the past. Russia (13%) and Pakistan (12.1%) are among tour important trade partners to figures among top tencountries to witness high CPI hike.  Among important T&C production hubs, Pakistan, Egypt, Argentina, Turkey, Indonesia, India, China and Bangladesh have witnessed significant increases in CPI. Indonesian inflation, already 9%,is likely to reach 12%, when the government is expected to raise the price of subsidized fuel by 25-30%. A similar situation is expected in India. Most Gulf oil producers also have double-digit rates.

It has been highlighted earlier that absolute sales figures do not show any decline as yet, but consumers are looking for more value. Also exporters will have to devise strategies to use their production capacities to the full, in the face of falling demands. Emerging economies like India and China have their domestic markets to fall back upon, but this also requires change in production strategies and tailoring their product lines to the domestic tastes. Indian apparel industry has demonstrated the flexibilities required to survive under such changing times, and hence may be able to bite the inflation bullet successfully. 

About the Author:

The author is the Joint Director of AEPC.

Table 1: Change in consumer price Index

Source: National Statistics offices and Economic Intelligence Unit Estimates

Inflation already reached 20.20% in 2007, a record level in Asia, and could still be at 16.20% in the current year and 14% in 2009, according to a forecast by the Asian Development Bank (see table 2). This would result in a very strong cumulated rise in prices in only three years. Sri Lanka's apparel exports already suffered from inflation pressure in 2007. Such a double-digit increase in the CPI would not affect other Asian countries in the near term, the ADB predicted. In China, inflation rate would grow from 4.80% in 2007 to 5.50% in 2008 while rising from 7.20% to 9% in Bangladesh and from 6.40% to 6.80% in Indonesia.

Table 2:  ADB Outlook on Inflation rates in Asia

*Forecast

Production cost

The main contributors to the increase in Consumer price Indices have been food, fuel and energy costs this current rebound in inflation rates may result in higher production costs for apparel exporters.

One by one, countries across Asia and the Middle East are being forced to abandon price controls on fuel and energy. Egypt has raised petrol prices by 40pc, Indonesia has raised petrol prices by 33pc, Taiwan has mooted a 20pc rise, and Malaysia is to peel back controls. It may be assumed that fuel hike would contribute to 1 or 2 percentage points to inflation.

Table 3: Production Cost Index of developed and developing countries

Source: OECD Stats

As per OECD data, there have been over 5% to even 30% increases in production costs indices of developed and developing countries. 50% to 60% further increase has been witnessed in most of these countries in the last seven month, from September 2007 to April 2008.

Cost of inputs in the textile and apparel industry record increase during 2007-08. Looking at various production cost overheads, global energy costs have increased by nearly 20% between 2007 and 2008, as per IMF data. Input prices in the textile sector, like cotton, chemicals, packaging, etc had also hardened during this period.

Lower real incomes

The basic minimum monthly salary of a garment worker is around a $1 a day, but a family of four spends around half of this on food. Prices of rice have doubled in Bangladesh over the past year after a cyclone in November devastated food stocks. Food prices have increased in many other developing countries like Egypt, Cameroon, Ethiopia, the Philippines, Indonesia and Vietnam.

In low-cost countries, food account for 40% to 70% of monthly spending of citizens. This share is probably higher for workers in clothing plants and their families, in addition. Food prices rose about 50% in nearly all countries from a year ago and even surged 70% from their level in 2005, according to the International Monetary Fund. If only considering rice which accounts for a very large part of daily food consumption in Asia, prices soared from about US$300 per metric ton by January 2006 up to nearly US$600 by the end of March before surging to US$1,100 in April. The rice crisis could rapidly result in strikes at apparel factories, as already seen in the past weeks in Bangladesh or Egypt. Local governments started subsidizing food prices, however, and they began fighting inflation. This could however result in additional difficulties for apparel exporters in low-cost countries.

With food prices up about 50% in a single year in a large number of low-cost countries, workers in clothing plants may require higher wages, as already observed in Egypt, Cambodia, Bangladesh or Vietnam. The recent boom in rice prices may accelerate looming crisis in clothing industries. This rise in prices could boost clothing production costs, especially in Asia. The trend for declining apparel prices after the removal of quotas by many of the developing and small economies in Asia will not continue in the face of this increase in consumer prices and cost of living. In Vietnam for example, clothing exporters just raised their prices after inflation surged in the country.

Currency cost

For most of the apparel producing countries, like china (9.3%), Turkey (7.5%), Taiwan (7.6%) and till lately India witnessed appreciation of their currencies, it meant lower value realization for apparel exports. Since exchange rate determines the relative cost of the countrys exports, compared to exports of competing countries in the particular destination market, this phenomenon has had varying impact on different Asian suppliers. Many of the supplier countries had witnessed strengthening of currency last year, but have improved since the Federal rate cuts in USA. However, the above mentioned countries continue to have currency depreciation which has been contributing negatively to the apparel manufacturers realizations in these countries.

Source: Economic Intelligence Unit

Financial Costs

Borrowing costs are rising in a large number of countries with higher financial costs hurting exporters.

Source: National statistics and central banks

Demand side adjustments

Rise in inflation and resultant fall in real incomes can have an adverse impact on the market demands for apparel. Being one of the semi-essential commodities, correlation between income levels and spending on apparel is strong. So, are apparel sales declining? The available retail sale figures for US and EU suggest that apparel sales have not gone down to the extent expected. The EU's official statistics agency Eurostat shows retail sales in euro-zone clothing stores were 3.2% higher in January this year than last.

The US Department of Commerce shows US clothing store sales were 2.3% higher this February than last - and the UK's Office for National Statistics shows its clothing sales are 4.9% higher in February 2008 than last year.

But growing competition, the switch to the internet and an expansion in branch numbers mean that sales per outlet aren't growing as fast as the annual budget requires - or as fast as operating costs. And not everyone's sharing that growth: a very large proportion of the growth in the UK market is coming from value retailer Whether its novelty (Banana Republic and Abercrombie & Fitch) or better value (Primark), shoppers are not buying less, but differently, and exercising choice judiciously. There's no widespread collapse in sales (yet); they just aren't growing as fast as most business plans required, and they're not growing everywhere.

With operating costs rising, and some chains losing market share, retailers' profits are under pressure. But, overall, the inflation and credit crisis isn't creating huge sales collapses. This is also because of different strategies taken by the suppliers. The most common among them in the developing countries bitten by the falling demand in developed markets is shifting focus to domestic industry, which have so far been decoupled from the demand slide.

While China's overseas sales were going down, domestic sales grew by 30% - meaning factories overall were still selling more than a year ago. Some Indian manufacturers who were exclusively into exports earlier now have to turn to the domestic market.

In the case of India the growing middle class may provide a cushion to exporters turning to domestic market.   As per estimates, the domestic consumption of apparel that is being diverted from the export market to domestic retail stores has risen significantly. An average Indian consumed 25.66 metres of textile during 2007, 19% more than what he did in 2006.  And, he is expected to scale up his consumption to 31.66 metres during 2008 calendar year as retail shelves get cluttered with 'export-diverts'. Thus, the total domestic consumption will rise nearly 40% by 2008 end from the 2006 levels.

But this sale strategy goes hand in hand with changes in production strategies. Immense factories designed to create economies of scale in production for the huge runs US chains need to be trimmed for the smaller runs needed for other markets. Indian and Chinese companies are having to acquire new skills that might not keep mega factories going, but create higher, more sustainable profits than chasing after high-volume low-margin business in Europe or the US.

Economic and industrial growth

The traditional apparel markets like USA and Euro region are expected to record slow economic growth in 2008 and 2009. Lower growth of GDP, will mean slower growth of incomes and purchasing powers and demand for consumerables. USA is expected to have GDP growth of 1.7%, Japan 1.5%, Britain 1.7%, Canada 2.1% and Euro region 1.5% in 2009, as per some forecasts. This rule out the possibility of higher growth in demand for apparel in the coming seasons. However, the table below also highlights the higher growth in developing countries, some of which are important apparel suppliers also. China is expected to grow at 9%, India 7.1%, Indonesia 5.9% and Egypt 6.9%. Although growth in GDP in many of these countries will be lower than the present levels, it will be still significant enough to generate domestic demands. Thus, for the shift in market for demand considerations is reiterated.

Table 4: Output % change on year ago

Source: The Economist

* Economic Intelligence unit forecast

A look at the industrial production growth trends however shows a slowdown in many countries like India, Turkey, Indonesia, Brazil and Chile. This may lead to supply bottlenecks and a price spiral.

Overall trends

The recent inflationary trend worldwide has lead to increase in food prices, fuel prices, production costs and consumer price index. While this has reduced disposable incomes in the hands of consumers one hand, it has impacted production costs and revenue margins of the apparel manufacturers on the other. Given the spike in primary commodities and their significant share in disposable incomes in the developing countries, the spending on apparel is expected to be adversely impacted, though in varying degrees, across the globe. Retail sale trends show that demand in major markets in US and EU are still to show significant decline in apparel sales. Since the proportion of income spent on apparel in developing countries is less than that in developed countries, the higher fall in disposable incomes in these countries will have lesser impact on apparel sales. However, medium term trends will largely depend on the growth in industrial production and supply side factors too, as it will determine the extent of inflation also.