Tata Motors, Hindalco and Suzlon are among the few companies that have been in the news in recent weeks for the wrong reasons. All of them faced difficulties in raising finances. Analysts have written at great length of the troubles that these companies are facing in raising monies in the domestic and international markets. The general perception that emerges from these anecdotes is that India Inc is facing substantial financial stress.
In a relative sense this is true. Compared to the recent past when money was easily available, the last ten weeks have been quite stressfull. Money markets have been tight in spite of some quick interventions by RBI to infuse liquidity. While RBI’s actions did solve the immediate problem for most companies, it was not possible to restore the conditions that prevailed before the crisis emerged. Besides, the international financial markets have continued to remain in turmoil. As a result, companies that required to raise large sums of monies during past ten weeks were the ones that faced the most difficulties. Many others also face problems in raising finances because we had got used to an easy-money environment. But, if a global liquidity crisis were to happen, we can say that there could not have been a better time anytime in the past for such a crisis to have happened. This is because India Inc had never been financially stronger than it was in September 2008.
At the aggregate level, the manufacturing sector is comfortably geared, with a debt-equity ratio of 0.8 times as of March 2008. The sector’s reliance on bank credit is marginal as 55% of its working capital was financed by suppliers’ credit. Thus, if banks were stressed during the crisis, the corporate sector was hurt only partially as a result. Most importantly, liquid assets were nine times their working capital requirements. In this case, the corporates were financially strong but, the mutual funds were stressed to honour the liquidation of some of these assets as they had mismatched assets and liabilities. This mismanagement by the mutual funds caused stress amongst corporates during the crisis.
Interest payments of India Inc accounted for a comfortable 16.5 % of their profits before interest and tax. All this was as of March 2008. Companies did see their profits erode in the first half of 2008-09. As a result, these ratios could have deteriorated during the past six months. Yet, manufacturing companies as a whole are in good financial health. Interest payments as a per cent of profits before interest and tax of non-refining manufacturing companies were still only 19% in the first half of 2008-09 compared to 15.5% in the first half of 2007-08.
A good indicator of India Inc’s health is its net profit margin. In spite of high raw material costs, high energy costs and high interest rates, net profit margin of manufacturing companies has remained exceptionally healthy in 2008-09. At least since 1981, the net profit margin rarely crossed 5%. It touched 6% for the first time in 2006-07. Listed companies have a higher net profit margin and according to the quarterly interims published by the non-petroleum manufacturing companies, the ratio was nearly 9% in 2006-07 and 2007-08. In the first half of 2008-09, the net profit margin of manufacturing companies had declined but it was still a handsome 7.8%.
Thus, on an aggregate basis, the Indian corporate sector in general and the manufacturing sector in particular was in good financial health as of March 2008 and also as of September 2008.
While India Inc as a whole is in good financial health, this does not hold true across size groups of companies. We divided 3,328 companies into ten equal size groups and checked the financial health of each of these groups to see how the health of manufacturing companies varies across size groups. The results are not surprising. Smaller companies were clearly more vulnerable than the larger companies.
The debt:equity ratio of the top two deciles was very comfortable at 0.7 to 0.9. But then it systematically remains higher than one for all the groups. The low gearing of the top companies indicates that there is a lot of head-room for borrowings by the large companies. These are the companies that matter more than the rest. However, these companies are also the ones that have borrowed a lot from overseas. And, given the fall in the value of the rupee against the dollar, they stand to suffer a higher debt servicing ratio. But, this is not a problem since these companies have a low interest to PBIT ratio of around 18%. The rest of the companies are not in a pretty position on this count.
On an average, interest payments account for a significant 44% of the profits before interest and tax of the middle six deciles. The smallest two size groups cannot even pay their interest costs from their profits before interest and tax. So, they are the worst hit. But, even the middle six deciles are quite vulnerable. These smaller companies have suffered the high interest cost regime of the first half of the current year. They would continue to suffer the tight liqidity and the effective high cost of funds in the third quarter. But, they would benefit from the fall in commodity prices. And, in spite of the crisis, even the smaller companies would fare better than they did in 2004-05 or even 2005-06.
—The author heads the Centre for Monitoring Indian Economy