Problems of plenty

BS OPINION

The IPO boom of the mid-nineties created excess capacities across the board, and companies are still recovering from the hangover induced by that spending binge. Obviously, therefore, there has been very little capital expenditure.

On the other hand, especially over the past year, company bottom lines have recovered, powered by buoyant exports, an upsurge of retail finance, and government expenditure on building roads. Lower interest rates and a focus on cutting costs, improving efficiency and better working capital management have also resulted in companies using cash far more economically.

The net result has been a large increase in cash on company balance sheets, funds that have been invested mostly in debt instruments or debt funds. This state of affairs is also reflected in banks, where the absence of lending opportunities has led to a situation where on an average about Rs 40,000 crore is regularly parked in repos.

But sitting on cash is not an efficient use of shareholders' funds. One option is to return the money to shareholders, and many companies have taken the opportunity to increase the size of their dividends, now that profitability has risen.

There are also a few signs of a revival of capital expenditure, with an increasing number of companies announcing their expansion plans. Of course, fixed investment in the services sector "" in telecom, retailing, insurance, banking, and in the BPO area "" has shown continuous growth, but it is only in recent weeks that manufacturing companies have started announcing investment plans.

Nevertheless, it may be unreasonable to expect a quick rise in capital spending, since considerable excess capacity still exists in many industries. A recent survey showed that only around 57 per cent of firms reported capacity utilisation of more than 75 per cent.

However, the sharp rise in commodity exports and export demand in industries such as auto ancillaries, if sustained, could lead to a rapid exhaustion of available spare capacity in these industries, prompting companies to expand. And finally, some of the cash is waiting to pick up companies listed for disinvestment by the government.

The real surprise, however, is why cash-rich companies have not used their money to acquire other companies. In a situation where companies are plagued with excess and fragmented capacity, one would have thought that M&A deals would have been an obvious use of cash.

True, there has been some pick-up in M&A activity, including the recent trend of acquiring firms abroad, but there is scope for consolidation in practically every industry.

One of the reasons is that much of the excess capacity is in small and unviable units, perhaps using outdated technology, which cannot be turned around. It isn't any use acquiring such firms. A second reason is that the country's financial institutions, which own a large chunk of corporate India, find it far simpler to restructure their loans than to push for a change in ownership.

In sum, some of the excess capacity is the result of keeping alive unviable firms on artificial life-support systems, thanks to which they are able to undercut healthy companies. The sooner this deadwood is destroyed, the faster will be the growth of new and more efficient plants.