When everything becomes a luxury good
This article originally appeared in The Brazilian Report (November 25, 2021).
The combination of high inflation and slow income growth is having a notable impact on the Brazilian durable goods market. Inflation-adjusted retail sales of household goods (including furniture and electric/electronic appliances) collapsed by 14 percent between June 2021 and January 2022. In the same period and using the same metric, demand for clothing, office appliances, and building materials contracted between 5 and 6 percent.
With average real wages down 9 percent from a year ago and stubbornly high inflation rates, the poor sales performance of durable goods does not come as much of a surprise. However, it is intriguing that prices show seeming indifference to a sharp contraction in demand: prices of manufactured goods rose 13 percent yearly (as of February), well above the 10.5 percent headline inflation point.
The annualized rate of inflation for the last three monthly readings of the category stands at 13.4 percent, evidence that price momentum has not abated.
This combination of slow demand and rising prices suggests that retailers can no longer accommodate price rises at the factory gates within profit margins. So, they are opting instead to raise consumer prices even with the implication of lower sales. This is a very different dynamic from the 2017-19 period when low demand meant low inflation in industrial goods.
The correspondence between wholesale and retail price increases, traditionally low and erratic, has become consistent. Recently, the equivalence has been almost 1:1.
Inflation-induced demand extinction is running deep in Brazil. In sectors with relatively scarce inputs, supply is shifting towards more expensive, high-value-added products.
The auto industry is a prime example: several carmakers halted assembly of their entry-level models, preferring to focus production on more expensive SUVs. With this new product mix, cars will remain less affordable even when global supply chains normalize and production ceases to be constrained by external factors such as microchip shortages.
A similar dynamic can be witnessed in less sophisticated sectors too. Beef consumption per capita plummeted last year to the lowest level since 1993, at 32.7 kilos – down 19 percent from the 2012 peak.
This plunge in consumer demand is driven by skyrocketing beef prices impelled by buoyant exports, as increased demand from China and America sustains historically high export prices. Consequently, local meatpackers rely less on domestic consumers to sell their products.
In this environment, the recent government initiative to cut taxes on industrialized goods may fall short of the stated goal of reducing consumer prices. Running paper-thin margins, retailers may prefer to not pass tax savings on to customers. Many will maintain old prices in a bid to pocket more profits and rebuild a price cushion instead of offering immediate discounts.
Furthermore, changes in the average consumer profile may have pernicious effects on future inflation and interest rates. Those that still demand some non-essential goods may be less sensitive to price changes, thus encouraging retailers to continue fattening margins even with decelerating wholesale prices.
Moreover, the CPI basket, which is likely to remain unchanged for years, does not capture substitution toward cheaper goods, and creates an upward bias on the price of the true average consumption basket, thus feeding into further contractionary monetary policy.
Continued price hikes on fuel and food prices, induced by the war in Europe, are likely to trigger another round of compression in available income for consumption of what are not considered strictly essential goods and services. More items will be added to the already extensive list of “luxury goods,” sadly defined as the essentials of a bygone era of seeming prosperity.