Future tense for India Inc

Corporate results confirm worst fears about growth trajectory

When the Central Statistics Office pegged India’s growth estimate in 2012-13 at five per cent, the government dismissed it. How would policy makers react to India Inc’s results for the third quarter ended December 31, 2012? Corporate earnings, excluding financial services and oil and gas companies, touched a new low; net sales growth decelerated for the fourth successive quarter, and its trajectory suggests it may decline further, diminishing hopes of an earnings revival in the near term. The aggregate revenues for nearly 2,000 companies analysed by this newspaper grew a tad over five per cent year-on-year. Adjusted for inflation, this suggests a contraction in the volumes of goods and services produced by companies. That production volumes have begun to falter is evident from the year-on-year shift in the key components of variable cost. Raw material costs during the quarter were up just 5.1 per cent, lower than wholesale inflation — which means companies were buying less raw material. Fuel and power costs were flat during the quarter, another sign of decline in business activity. Variable expenditure grew slower than revenues, indicating that companies still have pricing power in a high-inflation environment — but this was not enough to offset the decline in volumes, and operating margins contracted by 100 basis points sequentially.

Business can manage for a while with stagnant volumes, but alarm bells should start ringing when production starts contracting, forcing factories and establishments to run at levels much lower than their capacity. If allowed to persist, this could trigger a downward spiral of poor profitability, lower capital expenditure and lower demand for goods and services. A decline in business activity also translates into less money in the hands of workers, government and shareholders to spend on the goods and services that companies offer. A part of this is already visible in the results. Net profits adjusted for exceptional items grew by just two per cent, diminishing incentives for new projects. This also means less cash in the hands of shareholders during the next dividend payout season, which will start in June. That poor corporate profitability translates into tepid tax collection for the government is already evident from the fact that the direct tax outgo of companies grew by just 7.6 per cent in the December 2012 quarter. Adjusted for inflation, this means a decline in the government’s direct tax collection from companies in real terms.

This downward shift in the business cycle has not yet begun to bite because wages and salaries have remained partly insulated so far. Corporate expenditure on salaries and wages grew 12.7 per cent in the last quarter. Though lower than the preceding two quarters, it still translates into higher real income for households. The salary component has held up because labour-intensive sectors such as IT, banking and financial services, and public sector companies have so far remained insulated from the vagaries of the economic downturn. But what happens when the government begins a meaningful cut in public expenditure in the next financial year, to rein in rising fiscal deficit? The services sector cannot take India back to a high-growth trajectory on its own. That will require, essentially, a revival in India’s crippled manufacturing sector. The results season has shown that time is running out. The Budget has a hard task: the only way to start a new spiral of growth is to ensure that infrastructure projects do not suffer at the same time as the fiscal deficit stops crowding out private investment through high public borrowing.