Initial corporate results for the March quarter show a slowdown in the pace of growth of sales as well as net profits. Analysts have been predicting a slowdown for years, as the impact of a higher base comes into play. So far, however, corporates have been able to successfully ward off a serious slowdown and the March quarter results are no different. As this newspaper’s analysis of the first 1,056 companies to declare their results shows, net profit growth has been 47%, which hardly qualifies as a slowdown. As a matter of fact, if allowance is made for one-off factors such as the extra general provisions that banks have had to make in this quarter, profit growth would have been even higher.
The factors that affected corporate earnings in the last quarter included lower crude oil prices and higher prices of commodities such as aluminium, steel and cement. On the other hand, rising interest rates have already led to a slowdown in the auto sector, especially in two-wheelers. The rupee’s appreciation affected exporters, including the software industry. But overall, while growth is expected to be lower, it will be well supported. Moreover, this is not the first time that earnings growth has slowed—earnings growth for the 30 companies that make up the Sensex fell to 12.3% in the third quarter of fiscal year 2006 and 15.9% in the fourth quarter of that year, well below the 20%-plus growth that has been the norm in recent years. That’s far lower than the 40% rise in net profits posted by the 19 Sensex companies which have declared their results for the March quarter.
Does it then mean that everything is hunky-dory and corporate India has little to bother about? If so, why has the stock market’s performance been so tepid this year?
In the last four years, India Inc. has seen phenomenal growth. At the macro level, growth has been driven by consumption demand, thanks to lower interest rates. Rising exports have been another potent source of demand, as Indian companies have become more competitive. That has also helped the bottom line. As companies shed flab and became leaner, the growth in revenues had an even greater impact on the bottom line, not only driving profits, but also expanding margins.
The big question is whether these positive factors have run out of steam. Higher interest rates are one area of concern. The impact is already being felt in interest-rate sensitive sectors such as two-wheelers, where demand growth has decelerated. So far, it hasn’t made much of a difference to the bottom line, mainly because companies are under-leveraged, have plenty of cash on their books and have been borrowing abroad at cheaper rates. But corporate India has reached the limits of its capacity utilization and as companies go in for capital expenditure, the impact will soon be felt in higher borrowing and depreciation costs. That will pare margins. Rupee appreciation is another factor that will squeeze margins, not just for exporters but also for those who produce for the domestic market, as competing imports become cheaper.
At the macro level, the Reserve Bank of India’s (RBI’s) efforts to moderate growth will hit consumer demand, but that is likely to be offset by an increase in investment demand, as companies expand capacity. Corporate balance sheets are strong enough to allow companies to borrow and the change in the financial structure in favour of debt will mean that return on equity may not be diluted in spite of capital expenditure. Earnings growth continues to be broad-based. But perhaps the best illustration of what constitutes a slowdown these days is offered by RBI, which wants to achieve a soft landing with a GDP growth of 8.5%. To be sure, there will be issues of overheating, of higher wage bills, of an appreciating currency, of skill and infrastructure shortages. But it’s important to realize these are problems of success.
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