Is the corporate turnaround for real?

Debate

K V K Kamath

Managing Director and CEO,

ICICI Bank

Two years ago, when I spoke to the chief executives of leading two-wheeler and auto component manufacturers, the mention of a certain five-letter word would usually elicit a frown or a worried look.

Today, the same word means a satisfied smile, at a job well-done. The word is "China" "" and the smile is anecdotal evidence of something tangible happening around us in India today "" the renewal of our corporate sector.

When we speak of the resurgence of corporate India, the reference is primarily to the manufacturing sector; the services sector has had a phenomenal decade. It is manufacturing that has been through a cycle of extremes.

In the past 10 years, we have literally seen it all "" the demand euphoria of the early 1990s and the huge capital outlays that it spurred; the shock of the economic slowdown and the global commodity downturn in the later years of the decade, which created severe problems of low-capacity utilisation and pricing that was inadequate to cover a relatively high-cost structure; and in recent years, the emergence of true efficiency and the articulation of international competitiveness.

This process of churning and restructuring has been a painful and difficult one, and has resulted in many players going down. The companies that have successfully come through this process are the true survivors, who are capable of holding their own in the global marketplace.

What is it that is driving this resurgence? Manufacturers are successfully implementing the learnings from these past few years. Indian companies have learnt the value of cost efficiency, higher productivity, quality and careful allocation of capital.

The old profligate approach towards using financial and physical resources has given way to extracting maximum value from the money spent.

This new efficiency shows itself in many indicators "" the reduction in working capital levels, indicating better management of finances and the increasing asset turnover ratios, indicating optimal utilisation of physical assets and correction of over-capitalisation.

In the context of global competitiveness, it is important to note that independent research shows that Indian companies are significantly more efficient in terms of asset turnover than their Chinese counterparts.

Another aspect of this efficiency focus is the attention to quality. Global auto majors today source large volumes of components from India, meeting stringent quality norms. This has successfully put to rest yet another myth, namely the absence of quality manufacturing capabilities in India.

Across several sectors, Indian companies are meeting stringent quality tests in many markets. What started off with light engineering is now spreading to consumer durables and textiles. If this trend continues, it will envelope the entire range of manufacturing businesses.

Armed with these strengths, Indian companies are now going out to take on the world. The growth in exports is evidence of their success as they compete in the international markets. They are also setting up manufacturing bases and registering intellectual property rights overseas.

When the process of liberalisation started, there were fears about multinational corporations crowding out Indian industry; today, it is Indian industry that is going out and making its mark in the world.

It is heartening to see that despite all this optimism, corporations are not falling into the trap of over-investment "" they are cautious about making investment commitments without a very high degree of assurance on returns in a global context.

While some see this as a bad thing, given our traditional approach to growth measured in terms of capital formation, this absence of investment underscores the fact that assets created in the past are now being sweated to extract value. In fact, this focus on efficiency and caution on new capital commitments improves the ability of the sector to make new investments when required.

To sum up, Indian corporations have tightened their belts, pulled up their socks, run a marathon "" and survived. Of course, they have yet to complete the race and the world continues to be a very competitive place, where the law of "survival of the fittest" operates with ruthless consistency.

But they have demonstrated their ability to run the race and compete with the best in the world. I believe that we have now created a sound foundation for sustainable, efficient growth in the corporate sector in India.

Subir Gokarn

Chief Economist,

Crisil

Looking at the economy from a business perspective, conditions couldn't be much better than they are to get investment going across a range of sectors.

Toplines and bottomlines are growing, companies are flush with cash and, if they need more funds, borrowing costs are as low as they might get. Capacities have been getting stretched for some time now. Years of rationalising capacity and cost structures have resulted in huge increases in efficiency, but further scope for growth of profitability from this source is probably quite limited.

Further growth can only be driven by more production, which necessarily needs more capacity. Therefore, fresh investment is a strategic imperative for many, if not most, companies.

The macro numbers on industrial performance, however, tell a different story. Aggregate activity seems to be keeping pace with last year, when a combination of housing, roads and exports provided significant momentum to industry from the second quarter onwards.

The combined impact of these factors was enough to generate 6 per cent growth for the industrial sector as a whole, despite the 3 per cent decline in agricultural GDP.

There is already, therefore, a high base set by the sector for the latter part of last year. In the absence of significant new stimulii, the growth rate for this year is bound to look a little pallid by comparison "" even though activity levels are still relatively healthy.

Going a little beyond the aggregates, a somewhat more worrying picture emerges. Industrial sectors that have done very well for a couple of months or so suddenly seem to drop off, while others that have been languishing whiz up the performance ladder. There is little sense of a sustained, even if moderate, growth pattern across sectors.

Also, prices of manufactured goods, in general, though showing some upward tendencies, are hardly going to impact toplines in a way which would presage a spurt in investment across the range of manufacturing activities.

Finally, the performance of the machinery and equipment sector, which should be a barometer of investment activity in the economy (unless all of it is imported), has been among the most sluggish sectors for quite a while now.

This is like the story of the blind men and the elephant "" what you think it is, depends on what part you first touch. It is tempting to dismiss the macro story as being driven by questionable data and obfuscating aggregation.

On the other hand, when good news on the corporate front comes in a heap, it is also tempting to see it as a fundamental change in the environment, rather than just a normal recovery from a rather low base.

Unfortunately, the clinching piece of evidence that would allow us to distinguish between the two perspectives is still not at hand. But that is neither here nor there.

Let us come back to the very tangible positives that presage an investment spurt and ask the question: is there anything on the horizon that might neutralise these factors? Three things come to mind. One, there is perhaps still room for significant efficiency gains in several sectors, through mergers and acquisitions and streamlining of operations.

These should be exploited before investment plans are put into action. Two, the threat of more intense import competition increases the risk of investing in significant new capacity. Three, new projects of any reasonable scale come with the added cost of captive infrastructure, at least in the near future.

So, how does one bridge the macro-micro disconnect? By pointing out that the negative factors do not affect every industry equally. While an across-the-board investment boom does not quite appear to be on the cards, sectors where the industry-wide rationalisation process is virtually complete; that still have relatively high import restrictions in place; and that have relatively low dependence on infrastructure, will see investment activity.

Which ones will make the cut is a question that good micro-analysis should be able to answer.