Despite muted GDP growth, India Inc will look better

Written by Sanjeev Prasad | Updated: Dec 31 2013, 17:43pm hrs
The performance of corporate India and its earnings in CY2014 (and beyond) will largely depend on the new governments ability and willingness to provide a new economic vision for India, improve Indias governance and implement certain structural reforms. Corporate Indias performance is inextricably tied with Indias economic performance. GDP growth, interest rates, currency are a few variables that influence the profits of companies and a governments policies and performance can influence these parameters significantly.

The formation of a stable government after the 2014 national elections and continuation of economic reforms is, thus, critical for the performance of corporate India in CY2014/FY2015. However, the composition and nature of the government is less relevant than its commitment to address economic and social issues that have plagued Indias economic performance over the past few years. Any new government will have to embark on economic reforms in two areasone, fiscal consolidation to improve Indias weak fiscal position and, two, investment reforms to reverse Indias feeble investment climate. The former will help reduce high interest rates in the economy while the latter will address supply-side issues that have contributed to a persistently high inflation and help bring down inflation to more manageable levels eventually.

Fiscal consolidation will entail reforms in the areas of taxation and subsidies that will result in gross fiscal deficit (central government only) declining to a more manageable figure of 3% of GDP in the next 3-4 years from 4.8% in FY2014 BE. However, GST is unlikely is implemented before April 1, 2015, and food and fertiliser subsidies will increase in FY2015 with the implementation of the Food Security Act and increase in domestic natural gas prices. Thus, any new government will have to target reduction in fuel subsidies aggressively in FY2015 to contain fiscal deficit to a reasonable level (GFD/GDP of 4.5% or lower). Investment reforms will require structural reforms in all the inputs of investment in general, and in particular in areas covering government-industry interface such as approvals from various government agencies and allocation of natural resources.

CY2014 is unlikely to be a strong year economically but could be a year of transition for the Indian economy and corporate India if the new government implements measures that will propel the economy to faster growth in the future. FY2015 will see a modest economy recovery (5.1% GDP growth) given several constraints(1) continued high inflation, anaemic job creation and fiscal tightening will hurt consumption demand, (2) the governments weak fiscal position and fiscal tightening will constrain government spending and (3) weak balance sheet of corporate India and feeble economic sentiment will curb investment demand. However, the modest economic recovery in CY2014/FY2015 could gather momentum in case the new government starts addressing the aforementioned challenges. Also, a comfortable BOP position in CY2014/FY2015 and a stable currency arising from a manageable CAD of 2.2% of GDP (in both FY2014 and FY2015) will allow the new government to focus its energies on the fiscal and investment challenges.

Nonetheless, FY2015 will see a moderate recovery in corporate Indias net profits with the BSE-30 Indexs net profits to increase 13.1% compared to 9.5% in FY2014 and Nifty-50 Indexs net profits to increase to 13.3% from 6.8% in FY2014 driven by moderate pick-up in domestic industrial production and strong recovery in global GDP growth. Most sectors in the leading indices will see a mid-teens growth barring telecom (68% from a low base due to recovery in RPM and lower FX-related losses) and industrials (BHEL will continue to see a decline in net profits due to declining revenues).

Despite muted economic recovery over the next 12-18 months, net profits can grow faster given the composition of Indias earnings. A hefty 55-60% portion of the net profits of the BSE-30 Index or Nifty-50 Index comes from sectors or companies that have overseas revenues (IT, pharmaceuticals, Tata Motors); revenues and profitability linked to global cycles (Cairn, RIL, metals and mining companies); regulated profits (power utilities such as NTPC and Power Grid); and government-influenced profits (PSU energy).

A few sectors whose net profits can surprise positively include, one, energy where lower diesel subsidies from continued increase in diesel prices on a monthly basis (R0.5/litre) as a result of ongoing fuel subsidy reforms can translate into lower under-recoveries and higher net profits for the PSU energy companies; two, IT where stronger-than-expected global GDP growth in general and in the US in particular can translate into companies delivering stronger volume growth versus expectation of 12-15% growth for the tier-1 companies and; three, telecom where rapid industry consolidation can translate into better a better pricing environment for the well-entrenched incumbent companies.

The author is co-head, Kotak Institutional Equities