If India?s GDP growth is tottering today, it is in large measure due to the holes that have punctured growth in private investments over the past few years. Moreover, in the last few quarters, private consumption growth, which remained relatively stable even during most part of the global financial crisis, has slowed significantly. This twin slowdown has impacted India Inc?s performance, resulting in a sharp deceleration in revenue growth and continued pressure on margins.
Remedying these weak spots?particularly, reviving the private sector capex cycle?is going to be a long-drawn-out process. In the immediate term, therefore, a recovery in consumption will not only be critical for a modest economic revival but also to support a recovery in corporate performance.
Consumption has always been a significant part of the domestic economy, this is reflected in the fact that Private Final Consumption Expenditure (PFCE) accounts for nearly 60% of GDP. Between 2005-06 and 2011-12, real PFCE grew in the range of 8-9.4%. However, PFCE growth decelerated sharply and hit a decadal low of 4% in 2012-13 on the back of tepid economic growth and high inflation.
A similar downhill trend is also visible in corporate revenues and profitability over the past two years. Since 2010-11, there has been a significant slowdown in both investment-linked and consumption-linked sectors. During the March 2011 to March 2013 period, revenue growth in consumption-led sectors has fallen from around 20% to 6%. The fall has been sharper in the investment-linked sectors where revenues declined by 3% in the March 2013 quarter. The sharp slowdown in the revenue growth and the high inflation have taken a toll on the EBITDA margins, which have fallen on an average by 200-300 bps in the last two years.
So, what can we expect in 2013-14? We believe apart from policy actions by the government, four other factors will have a bearing on the macro-economy and India Inc?s performance: Expected moderate global economic recovery, revival in domestic consumption due to better agricultural production and waning inflation, lower commodity prices and some softening of interest rates.
Due to the improvement in the global economy, primarily the US and Japan, the reform measures that the government has undertaken on the fiscal and policy fronts, and the decline in inflation, we expect the economy to grow at 6% in 2013-14, a notable improvement over 5% growth seen in 2012-13.
With normal monsoons expected, agriculture will be one of the key drivers of GDP growth in 2013-14. We believe this economic recovery will be supported by an improvement in consumption, which is likely to revive on the back of decline in inflation and interest rates, coupled with relatively steady income growth across urban and rural areas. Consequently, PFCE growth is also expected to trend upwards to 6% in 2013-14.
We believe consumption-linked sectors will report better revenue growth in 2013-14. For example, two-wheeler demand is expected to rise to around 6-8% in 2013-14, double of the 3% growth seen in 2012-13. Real estate is another sector where fortunes are likely to reverse; absorption of new homes in the top 10 cities, which declined by around 7% in 2012, is expected to rise by 5-6% during 2013. PFCE growth will also provide impetus to the organised retail sector. After two years of sharp deceleration, the sector is likely to change gears and grow at 12-14%. Better rural growth and slowing inflation will benefit FMCG firms as well.
In contrast, we believe that the story on the investment front will not be as rosy. Our survey of 200 large corporates last year predicted a 35% yoy fall in private sector investments in 2012-13 due to factors such as policy logjam, low business confidence (due to the weak and uncertain demand outlook) and high interest rates.
The slowdown in investments is reflected in the sustained negative trajectory of order inflows for construction and capital goods companies. This is primarily the result of a sharp decline in industrial capex. The situation has been further compounded by sector-specific issues such as payment delays by state governments in irrigation projects, fuel availability concerns for power projects and the sharp decline in the awarding of road projects. As a result, both players and lenders are treading cautiously with respect to fresh investments. This is seen clearly in the decline in both the quantum of bank loan sanctions towards new projects (down 44% from 2009-10 to 2011-12) and the average size of loans sanctioned from peak levels in 2009-10 (down 36% in the same period).
These factors, coupled with the logjam around policy issues, imply that actual investments are unlikely to accelerate before 2014.
Impact on industry
Overall revenue growth for corporate India is likely to be around 12% in 2013-14, led primarily by consumption-linked sectors. Operating margins are likely to improve by around 25 bps due to the twin benefits arising from moderate pick-up in revenue growth and the reduction in cost pressures owing to relatively lower commodity prices.
It is pertinent to note here that the expected consumption growth can lift GDP growth only to a limited extent; for sustained GDP growth in the medium term, and for the economy to clock the growth seen in 2003-08 period, it is critical to revive private sector investments.
Concerted action is necessary on policy issues as well as fiscal and monetary fronts to achieve this. On the fiscal side, credible steps to rein in the fiscal deficit, further policy reforms and their effective and timely implementation will encourage foreign investors and improve business confidence. Monetary policy will have to ensure currency stability and, at the same time, make it possible for the industry to access funds at competitive interest rates. A holistic approach on all these fronts can ensure that modest gains that may accrue this year will be built upon over the next few years.
The author is president, CRISIL Research
