A time to fret and stress

Sikka's exit is the latest blow to IT sector; banks still on shaky ground over NPAs

Markets reacted to political turmoil in America. After Neo-Nazi rallies and US President Donald Trump’s lukewarm condemnation of racism, corporate leaders resigned from the Strategic & Policy Forum and the Manufacturing Council, forcing Trump to dissolve both bodies. USA Inc no longer thinks Trump can enable business-friendly legislation.

Elsewhere, Japan is sustaining economic expansion for the second successive quarter. The European Union is also experiencing positive growth despite misgivings about Brexit. China is cooling off a little. US-North Korea tensions continue to rumble.

In India, the resignation of Infosys’ Vishal Sikka provoked a firestorm with public accusations traded by Sikka, the Infosys Board, and founder N R Narayana Murthy, who provoked the crisis. The stock tanked nine per cent, wiping Rs 750 crore off Murthy’s net worth. More volatility is likely given impending investigation of alleged securities fraud in the USA. A buy-back is also due. Given Infy’s status as a market leader and the perception that it’s ethical, more hammering could impact sentiment across the beleaguered information technology (IT) industry.

Downgrades in corporate earnings have exceeded upgrades on the basis of Q1 results. An analysis by Business Standard (“Corporate earnings hit fresh roadblocks in Q1”, August 16) shows combined net profit of 1,261 companies, excluding oil and gas and banking, was up just 0.3 per cent year-on-year during April-June 2017. This is marginally better than a decline of one per cent year-on-year during January-March 2017. Revenue growth hit a six-quarter low at 4.4 per cent. If banks and O&G are added in, net profits declined 0.8 per cent year-on-year for 1,654 companies, revenue growth was 8.7 per cent year-on-year for the whole sample.

By consensus the combined net profit of the Nifty 50 was expected to grow 26 per cent during 2017-18. But the combined net profit of 46 Nifty companies declared so far in Q1 was flat. Many downgrades have occurred. More are on the cards.

The disruptive impact of GST is likely to be high for an economy hit by demonetisation. Exports are flattening with IT and pharma both under the gun. Pharma revenues contracted and profits halved. Domestic consumption also slowed in June-July as GST rolled out and dealers deferred stocking. The Index of Industrial Production contracted 0.1 per cent year-on-year in June, a sign that credit demand is unlikely to increase.

Banks look shaky with non-performing assets and stressed loans expanding, albeit at a slower pace. The Economic Survey (Volume 2) makes the point the telecom sector could be a new source of stress. The interest cover (operating profits as a ratio of interest payments for the same quarter) of half of telecom service providers is below 1. That means debt is unserviceable from normal operations.

The power sector continues to look in terrible shape, with 70 per cent of outstanding power debt owed by companies with an interest cover of less than 1. Bank disbursal of corporate credit is at an all-time low, partly due to lack of demand and partly due to caution on the part of public sector banks with shattered balance sheets.

The Economic Survey (Volume 2) sounds gloomy. The economy was slowing through the last fiscal even prior to demonetisation. Volume 2 says comparison with historic data from other emerging market nations with similar financial profiles of weak investment, low export volumes and low credit growth makes it likely that current official GDP growth rates are unsustainable. Consumption and government expenditure are the only things pushing growth. Consumption has eased; pumping up government expenditure will be hard without pushing the fiscal deficit up.

In any case, the fiscal deficit is likely to climb. Tax collection is uncertain. Budgetary assumptions of February can be junked — those ignored the GST. The Reserve Bank of India’s (RBI) transfer of Rs 30,659 crore surplus to the government is Rs 45,000 crore less than the budgeted assumption of Rs 75,000 crore. (The RBI transferred Rs 65,000 crore in 2015-16). It’s a far cry from the Rs 3 lakh crore, pro-demonetisation analysts were confidently touting.

Inflation is picking up, on the back of rising food prices. In July, retail inflation rose to 2.36 per cent year-on-year, which is above the lower limit of the two per cent to six per cent band of tolerance, and perceptibly above June levels of 1.54 per cent. Wholesale inflation hit 1.9 per cent in July, up from 0.9 per cent in June. Commodity prices of non-ferrous metals have also risen, with the London Metal Exchange Index up by seven per cent in the last month. Rubber, naphtha and coking coal have also got more expensive. The central bank is unlikely to cut rates again in a hurry.

Worsening financials have led to a change in investor attitude. The proximate trigger was the Securities and Exchange Board of India’s precipitous action of banning trading in listed shell companies. Foreign portfolio investors have sold equity through August. Domestic institutions, aided by massive equity mutual inflows, have propped up equity markets.

The Nifty saw a correction from 10,130 to 9,685 before it had a small recovery to 9,900. If selling continues, the 9,700 support will be tested again. If that breaks, “programmed selling” might take the index down till 9,500, or lower.