The year 2011 has been an eventful one and the last few days of the current calendar year are unlikely to be contrary to this trend. In this context, the RBI report on financial stability and the FICCI survey on the global meltdown released during the last couple of days deserve particular mention. In hindsight, while a section of the RBI report highlights the key findings of the systemic survey (for those interested in details, deterioration in asset quality, risks from market volatility, global risks and risks from inflation in that order are the key risks) the FICCI report analyses the consequences of the heightened perception of such risks on India Inc. In this piece, we would like to highlight some of these impacts on Indian Inc and the way forward.
It is now clearly evident that corporate margins have declined significantly, particularly for the quarter ended September 2011. In particular, PAT/net sales have declined significantly in sectors like drugs & pharmaceuticals, automobiles, metals, etc, in the midst of declining sales. The squeeze in profitability ratios
reflects the fact that the increase in input and interest costs are having an adverse impact on margins and thereby on pricing power of corporates against declining domestic demand. For the statistically minded, corporate profits as a percentage of India?s GDP have declined progressively over the last three quarters!
There are some interesting anecdotes from the current economic slowdown with respect to India Inc. First, the uncertain economic outlook may have resulted in Indian corporates holding on to higher cash balances. This trend is strikingly similar to the fact that corporate cash is currently at high levels in the US, the UK and the eurozone (source: Treasury Strategies, UK) and nearly 30% of the corporates in the US expect it to only increase (juxtapose with the FICCI survey that reveals 50% of the corporates plan to conserve cash for the next 6 months). An increase in cash balances typically implies that corporates are holding on to their investment plans for better future opportunities. It may be noted that the sequential growth in GFCF was negative for the second quarter of the current fiscal. This trend is akin to that in FY2003, when also the economic outlook was uncertain in the aftermath of the 2000 dotcom bust and the WTC attacks. Sectors like metals, cement and food & beverages reported the maximum increase in cash balances.
Second, the uncertain economic environment has resulted in a significant decline in the value of the new projects added (see exposition 1), the lowest in the last 26 months!
Third, the increase in cash balances?a world-wide trend?may also result in increased mergers and acquisitions as companies may take that route as an option for growth when confronted with a continued slow recovery. This trend was clearly visible in 2010 when the global dollar volumes in announced mergers and acquisitions rose 23.1% in 2010, to $2.4 trillion (in the US, merger volumes rose 14.2% to $822 billion). In the Indian context, the size of M&As increased significantly in March 2011 to R487 billion (vis-?-vis R352 billion in September 2010) with an average deal size of R175 billion. However, economic and policy uncertainties may have resulted in a decline in total deal values to R324 billion at the end of September 2011, with the average deal size at R94 crore.
Related to the reduced pricing power of the corporates is the significant decline in capacity utilisation. As per the latest RBI Industrial Outlook Survey, there has been significant moderation in capacity utilisation, production, order books and imports and exports in the third quarter of the current fiscal, a fact supported by the latest FICCI BCS survey. Increased capacity utilisation is reflective of a situation where current output is below potential levels, leading to decelerating inflation as manufacturers lower prices to fill their excess production capacity. This is reflected in exposition 2. Excess demand of the economy is clearly visible during 2005-06 to 2007-08, before it declined due to the global recession in 2008-09. Since 2008-09 till 2009-10, the economy remained below the potential level of output. In 2010-11, the economy recovered (primarily due to the base effect), but in the current fiscal, the economy is operating with a supply gap!
Interestingly, the FICCI survey points out that even the current modest increase in non-food credit may be a statistical aberration. In fact, survey results show that a quarter of the credit demand may be diversions from overseas markets, while a whopping 50% believe that such an increase is purely for financing working capital needs, with a clear evidence of increasing inventory pile-up.
So what next? We believe that 2012 will be a difficult year for the global economy, with the next couple of months to set the course. In principle, close to the $300 billion of European bank debt is coming due just in the first quarter of 2012, and it remains to be seen how it will be funded. Any possible adverse news on this front is going to have a spillover impact on emerging economies. Back home, even as the outlook of Indian Inc remains somehow shrouded in uncertainties, the stickiness in oil prices is another matter of concern that may keep imported inflation high. This may result in significant challenges for domestic policymakers (read RBI) creating a corridor of uncertainties going forward.
We will end with a note of optimism, with the domestic core sector growth rates in November 2011 bringing a positive surprise! This apart, not many would believe that a more compelling story of our economic reforms is that outward FDI investment from Indian companies was $21.1 billion in the first half of the current fiscal, marginally lower than inward FDI inflows at $25.8 billion for the same period. This shows that Indian companies, based on their financial strengths, strategic insights and adroit management, are creating enormous value for stakeholders even in foreign countries, and with a little bit of a policy push can continue to replicate the same in India!
The author is director-economics & research, FICCI. Views are personal. The author thanks Sakshi Arora for research
