Possible Reversals Ahead for India Inc

It wouldn’t be wrong to say that corporate India has had a good run for the past few years. Ever since the generous tax cuts given by the government in 2019, in order to boost investment, that is. We have yet to see the investment commensurate with such tax breaks, but that their earnings have improved and that many of them have been able to pare down their debt levels and improve their balance sheets is indisputable.

One shouldn’t grudge them that growth, but one ought to ask where are more job-creating investments that were meant to take place as a result of lower corporate taxes. Instead, most companies are announcing share-buybacks on a massive scale, and even through the pandemic years. Besides, if investments were as good as were expected from tax breaks, what was the need to announce still more incentives in the form of PLIs (production-linked incentives) in order to generate more investment? More about that later.

For now, let us look at the state of India Inc: its earnings and financial health, its production and sales, its capex plans, employment generation, concentration of market power, etc. And also, what are the headwinds they face in the months and years ahead.

From what I have been reading and hearing in the business news – and here I must once again point out the selective and paltry reporting of corporate earnings for the past many years in India, thanks to unprofessional PR agencies and their cronies – corporate India has been able to improve their financial performance somewhat, due to the tax breaks, as I said earlier. They have reduced their debt levels as well, but the fear is that with reduced debt, their investment appetite too seems to have reduced. Private sector capex plans – both greenfield and brownfield – prior to PLIs being announced has been none too encouraging. In many areas, according to CMIE, new projects have seen a good growth on a quarterly basis, from Rs 2.84 trillion in the June 2021 quarter to Rs 4.84 trillion in March 2022 quarter. However, the bulk of capex being undertaken is by central public sector enterprises, surging by as much as 21% year on year to Rs 5.6 trillion in FY22.

Would it be right therefore, to assume, that corporate India has been gaining solely on the back of tax breaks since revenue growth was flat in most sectors before the pandemic and there was still idle capacity waiting to be employed? I would say that based on whatever corporate earnings I have read, this was pretty much the scenario, through 2019 and until the Covid pandemic struck. The pandemic dealt a severe blow to the Indian economy, like elsewhere in the world, and the government announced whatever relief measures they could to keep consumer demand stable and to also help small and medium sized businesses keep people in their jobs.

We all know the effects that the pandemic has had on our economy, especially the various sectors of business. Services were the hardest hit, due to severe lockdowns, though manufacturing continued to function albeit at a lower level. Due to pent-up demand being released as lockdowns were lifted, and also due to the festive season in 2020, we saw a rise in consumer demand and sales. I was of the view even then, that this was a short bump up in consumption and that consumer demand especially in rural India was still weak. Unfortunately, due to the severe second wave of the pandemic that India experienced between March and May 2021, the economy slid once again, and whatever revival might have taken place in the latter half of 2021 was largely due to base effect. According to CMIE, listed companies saw revenue surge by as much as 30-40% in the second half of 2021, before now tapering off to around 15%. Similarly, for net profit, they seem to have come down to around 24%, from a high of over 100% growth in net profit in the June 2021 quarter. Some of this does reflect in better corporate tax collections in FY22.

The main thing to note is that much of this is due to a base effect, which is wearing off. As I write this, Q4 FY22 corporate earnings are still being announced, again selectively and at a glacial pace. From what I can see so far, the tech industry and private sector banks have done reasonably well. Technology companies were supposed to have gained hugely from the acceleration in digitization during the pandemic, and so they have. The couple of private sector banks that have reported corporate earnings seem to show a reasonably good growth in interest income and a reduction in bad loans. However, it appears that corporate lending is still weak and this is not a good sign for investment in the months and quarters ahead.

Large companies, as I had written earlier on my blog, even during the pandemic were able to raise capital through the markets, not relying on bank credit alone. But the engine of India’s growth and employment is also the large small and medium enterprises sector and these businesses find it hard to access bank credit easily. Many then turn to NBFCs for credit, and these were largely unregulated businesses who were mired in an NBFC controversy and implosion not too long ago. Today, these are being more closely monitored by the RBI to the extent possible and ought to be brought under its regulation through legislation.

In terms of production and sales, most companies were seeing a slowdown in sales and growth, even before the pandemic hit. Certain industries such as automobiles were particularly weak. The pandemic had forced a preference for private transport and so auto companies reported good sales through the pandemic. Now, however, with raging inflation especially in steel, aluminum and fuel prices, demand for automobiles is slowing down again. In some cases, it is forcing a shift to EVs, but for the larger part it is not good news for the industry. Besides, even exports of automobiles are reported to be slowing, thanks to high fuel prices and an economic slowdown everywhere.

FMCG companies – Nestle and HUL the only ones to have reported until now – would most likely face the pressure of rising commodity and input prices, as inflation takes its toll. As it is, FMCG companies have raised prices of most brands by at least 5%-7% over the past year. How much more room do they have to pass on price increases to the consumer, before it starts to crimp demand? It helps that FMCG businesses – especially foods and groceries – tend to be relatively resilient, but if the rural economy features in a large way in their market, they are likely to see a slowdown and a fall in demand. Other FMCG companies operating in areas of home care, sanitisers, disinfectants, etc. were already reporting a fall in demand for such products with Covid waning towards the end of 2021 and might report flat growth in revenues, that too due to price increases.

Luckily, even in the first quarter of this financial year corporate India should see the positive base effects from last year, with economic activity being depressed same time last year due to the second wave of Covid. However, nobody bargained for the Russian attack on Ukraine which has sent every business’, and country’s growth and investment plan awry. This is the big unknown that corporate India and indeed the entire Indian and global economy will have to deal with. For no one knows as yet how long it will drag on, nor whether there is a resolution in sight.

The other big unknown, which could actually upset the global economy in a sort of seesaw way, is the global supply chain issue and acute shortages of certain products, parts, components, raw materials, etc. Some of this is due to China’s overweight position in the global supply chain economy and its current obsession with pursuing zero-Covid policy. This has led to massive lockdowns in large cities in China, from Shanghai to Shenzhen and Jilin, all part of China’s connection with the global economy both through trade and finance. This will affect most other East Asian economies that trade a lot with China and are also part of the global supply chain.

As a result, India Inc should be prepared to cope with supply shortages and rising prices; in some cases, especially electronics and even automobiles, it could seriously hamper production. At an aggregate economy level, therefore, we could see manufacturing come under huge pressure, while services continue to recover and grow. Unless, of course, another wave or variant of Covid-19 strikes.

Thanks to raging inflation in most countries of the world, and weakening demand, India Inc will also have to be prepared for slower growth – and possibly even a decline – in exports. Through the pandemic years, you could argue that India was a beneficiary of the West’s huge stimulus and relief spending, since our exports grew significantly on the back of global growth. In FY22, India recorded merchandise exports of over US $ 400 billion. Now that is not likely to be such a strong engine of growth.

I have always believed that India’s domestic market is large enough to boost economic growth, and that we are not reliant on exports. Having said that, we need to accelerate employment generation and of good quality jobs, in order to grow consumption demand. This has not been the case, even with the worst of the pandemic behind us. Although unemployment in India has moderated from the highs of over 24% at the start of the pandemic, it is still at elevated levels and is rising once again. According to CMIE, India’s unemployment as of April 25, 2022 was at 8.1% which was the number for February 2022 as well, ticking down only slightly to 7.6% in March. According to this article, around 900 million people in India have stopped looking for work, which is a grave situation to be in. We are just not able to bring unemployment down on a sustainable basis.

Which brings me back to the issue of business investment and job creation. There has been much hype about PLIs in the news, but I am not sure how many of them will fructify soon enough to be able to boost growth immediately. I read that PLIs have received thousands of applications, but how many of those will go through? Besides, isn’t this another form of protectionism being practiced, and sops being granted to some companies? Is it also not a return of the license raj, something this country resisted so hard in the past and for which the BJP particularly has no taste or preference? It seems to be an insidious way to favour certain companies and industrial groups over others. Why is India Inc not speaking up about this government-led micro-managing of industry, when it is corporate India and the private sector in particular that has led the path of economic growth in this country?

I am more a believer in incentives being offered to industry to invest in areas that are economically backward and lack development and employment. India has pursued such policies for many years, with a fair amount of success, we would have to agree. New and young states such as Uttarakhand, Himachal, Telangana as well as old, but remote states such as Assam have benefitted hugely from such investment in the past. More of such industrial investment policies need to be pursued, with states being given the authority and responsibility to decide on these matters.

Immediate concerns for corporate India are high inflation of input prices and supply shortages. Manufacturing will be severely impacted as inflation raises costs of production and also crimps consumer demand. In services too, inflation is the main danger with fuel prices likely to dampen air travel, even as Covid restrictions ease and summer vacations are being planned. How many companies enjoy pricing power to be able to raise prices, is yet to be seen. And even if they do, the fact that India is largely a market of, and for the middle class, is bound to catch up soon.

All warning signs for India Inc to plan for scenarios facing their respective industries and still be able to invest and create jobs, which will boost demand. The long honeymoon of good profits with low taxes is coming to an end. In any case, it was never going to boost investment, and it’s clearly not enough to revive business.

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