For India's surging economy, small is beautiful

The country has more than 45 million SMEs, accounting for nearly 40% of GDP

For Rohan Sharma, business has never been better. Sales at his autoparts company in Gujarat are booming and the order book has almost doubled in the past year.

His Bhagirath Coach & Metal Fabricators has just invested nearly $120,000 in new machinery and plans to spend up to $1.2 million this year to expand capacity.

That's an encouraging sign for Asia's third-largest economy, where stressed balance sheets at big firms and heavy reliance on bank credit, which has dried up following a surge in troubled loans, have stymied efforts to revive private investment.

Sharma does not face such constraints. He says his firm is debt-free and relies mainly on internal resources to fund capacity expansion.

 

A survey from the Reserve Bank of India (RBI) shows he is not alone. The annual study of nearly 240,000 unlisted small-and medium-sized enterprises (SMEs) found they are saving their way to growth, helping transform India into the world's fastest-growing large economy in the past two years.

India has more than 45 million SMEs, accounting for nearly 40% of GDP. Most are unlisted, and their earnings growth has outpaced listed companies for the past three years.

"We never allowed exuberance to get the better of hard business logic," Sharma said.

Sales at smaller private firms grew 12% in FY15, the central bank survey showed. Sales at listed big companies rose 1.4% over the same period.

Operating profit of the unlisted firms grew an annual 16.6% in the year, three times the pace at listed companies, and they increased their gross savings.

While higher expenses halved net profit growth at private firms, they still grew at double-digit pace. In contrast, listed companies struggled with shrinking profits.

Debt-laden big listed firms, meanwhile, are still reluctant to undertake new investments, and foreign firms can find India's labyrinthine regulations overwhelming.

Also, infrastructure and resources needed for complex manufacturing, like roads, skilled labour and consistent power supply, is often lacking.

That led to a contraction in capital spending in the January-March quarter. Despite that, strong consumer spending helped power economic growth of 7.9%, the fastest rate among the world's major economies.

Flexibility an advantage

"Being a small-scale company has helped us in getting more orders," said Pramod Patel, managing partner at Reliable Paints.

Patel's company, which supplies industrial paint to the metals, chemical, auto and defence sectors, saw 25% growth in its order book in the fiinancial year ending in March.

"We can customise different paint shades for clients, unlike big paint companies which can only provide specific paint shades," he said.

Capacity utilisation at his Gujarat-based factory shot up to 80% from 50% in FY15. Now, Patel is buying new machines, hiring workers and spending more on marketing.

Helping power smaller firms has been Prime Minister Narendra Modi's plan to build 10,000 km of new national highways and upgrade another 50,000 km as part of $32 billion infrastructure spending this financial year.

This has boosted sales of heavy commercial vehicles and, by extension, auto ancillary companies.

Steel Strips Wheels , for example, reported a 55% jump in earnings per share in the financial year that ended in March.

The company, which supplies wheel rims to major automakers, has seen a big leap in capacity utilization. Its commercial vehicles wheel plant is now using 95% of capacity from little over 35% in FY14.

"Today our order book is more than our execution capacity," chief financial officer Naveen Sorot said. "So we are planning to expand our production capacity".

Patchy recovery

For India to consistently grow at or above 8% that it targets to generate jobs for a rapidly expanding workforce, major listed enterprises will have to come to the party.

Encouragingly, the infrastructure push has begun to feed through to the balance sheets of some bigger listed firms.

Corporate earnings at listed non-financial firms in the March quarter grew 18%, the strongest in the past two years, raising hopes of an improvement in their debt-laden balance sheets.

Nonetheless, the recovery in investment is patchy.Thermax Ltd , an engineering company, reported a 15% drop in its order book in the last quarter from a year ago.

With banks increasingly taking action against corporations that default on loans, a senior government official said companies are likely to keep a lid on capital outlays unless they see visible returns on new investments.

"Until then, government spending will have to do the heavy lifting," the official said.