What inflation has to do with falling revenues

And why margins tend to move in the opposite direction according to Deutsche Bank

Falling inflation numbers are expected to help corporate India in a number of ways, not the least of which is by nudging the central bank towards lowering interest rates. However, the recent decrease in inflation may also have played a less-than-helpful role in the disappointing revenue figures that companies recently reported, according to a note by Deutsche Bank.



The India Equity Strategy report noted that revenue growth has fallen sharply over the last two years. It says that one of the reasons for the falling growth is also a steep reduction in inflation numbers. The report looked at data for WPI (Wholesale Price Index) inflation figures and revenue growth over a 10-year period and noted a strong co-relation between the two.

Lower inflation leads to lower realisations. In other words, when inflation is rising companies get a growing amount of cash when they sell their goods (because prices head higher). This cannot happen if inflation drops to zero or lower as has happened recently (-2.65 per cent for April).



But there is some good news. While sales may not grow as fast as earlier, the profit that companies make for every rupee in sales will go up.

"....we believe that a declining inflation environment will likely lead to margin expansion for corporate India, while keeping topline subdued," said the 28th May report authored by research analysts Abhay Laijawala and Abhishek Saraf.

This is because lower inflation also translates into lower costs for companies manufacturing the goods. They have to pay less money to procure raw materials, and even things like packaging costs can come down with a fall in crude oil prices.

"Past 10 years data suggest a reasonably strong negative correlation between inflation and EBITDA margin and with inflation now appearing to stay at low levels, we believe that corporate India will likely witness a sustainably higher EBITDA margin in next few years," it added.