With credit slowing and demand weak, India needs a fresh burst of investment, but that requires across-the-board reforms
The sharp surge in stock prices in the run-up to and after the election results last week suggests investors are supremely confident the government will put the economy back on its feet and that corporate earnings will rebound. Else, it is hard to understand the risk appetite for such an expensive market at a time when growth is faltering; GDP grew at just 5.8% y-o-y in the March quarter, and the FY19 growth, at 6.8%, was a five-year low.
To be sure, India is a longer-term play for investors, given it will remain one of the fastest growing economies in the world. Going by the evidence on the ground, however, the situation could get worse before it gets better.
As the corporate results for Q4FY19 reveal, consumer demand is very weak, and that has put a lid on both volumes and prices, crimping profit margins. For a sample of 1,693 companies (excluding banks and financials), operating profit margins contracted 160 basis points year-on-year (y-o-y) while net profits fell 10% y-o-y , with revenue growth not making it to double-digits and coming in at 9.9% y-o-y.
There doesn’t seem to be enough purchasing power to allow companies to command prices that leave them with enough of a margin. Across the spectrum—from telecom to two-wheelers—companies are learning to live with limited pricing power and the inability to pass on costs fully. At Bajaj Auto, too, margins declined, led by price cuts in the home market. At HeroMotoCorp, volumes fell 11% y-o-y as the firm cleared inventories after the dull festive season. Truck sales, too, have been sluggish; at Ashok Leyland, both gross margins and ebitda margins contracted this time around.
A clutch of FMCG firms has reported weak volumes—Hindustan Unilever, for instance, grew volumes at the slowest pace in six quarters. At Shoppers Stop, same-store sales grew just 3.7% y-o-y despite a very weak base of a negative 4.1%; at Asian Paints, margins contracted 230 basis points y-o-y. Indeed, a pick-up in discretionary consumption spends looks unlikely before the festive season. RC Bhargava, chairman Maruti Suzuki, said a few days ago that he wasn’t seeing consumer interest picking up yet. That is not surprising since a big source of consumption is rural India, where incomes remain modest following a collapse in prices.
The first half of FY20, therefore, could be a washout for sectors such as automobiles, consumer durables, retail and real estate, and companies will see profit margins under pressure as the scale of operations remains modest.
The bigger issue for corporate India is that, without fresh investments by the private sector, consumption simply cannot get the sustained big push it needs. Government expenditure and the employment opportunities that this create can just give consumption a bit of a nudge. To convince the private sector to create capacity, the government—states and the Centre—must tighten labour laws and facilitate land acquisition.
Only when this happens will investments pick up adequate pace. As is known, order books of the manufacturers of capital goods haven’t seen any big increase in the last few years; order inflows at BHEL fell sharply in Q4FY19. To fund the infrastructure build-out, the government must look for additional resources by privatising and selling more PSUs.
Even as it does that, it must have lenient policies that pull in FDI; the FDI inflows FY19 were smaller than those in FY18. Even if the government pulls off the privatisation target of `80,000 crore by March 2020, it will take a while for the funds to be invested. At a time when there is little capital available for investing, given balance sheets remain leveraged and real interest rates remain elevated, it is important to attract foreign capital. Moreover, real interest rates need to be brought down.
The interest bill for the sample of 1,693 companies rose a sharp 18% y-o-y in the three months to March, and it is critical that the government ensures flow of bank credit at affordable rates. With some part of the NBFC sector in trouble, the PSU banks need to be capitalised to be able to lend. Most state-owned banks are financially in poor shape; the total provisions made by 19 state-owned banks increased 58% between December 2018 and March 2019, to `86,841 crore. The big jump in provisions for loan losses seen in the March quarter suggests the worst of the NPA cycle may not be over.
With some uncertainty on the monsoon, lenders’ exposure to businesses in sectors such as MSME, real estate, agriculture, power could be in trouble. If this plays out, banks will be short of capital. The FY19 fiscal accounts show revenues have slipped and expenditure has been curtailed to meet the 3.4% deficit target.
With consumption slowing, GST revenues will be under pressure in FY20 too, at least in the first half. Consequently, the FY20 budget revenue estimates will need to be modest, which, in turn, means the expenditure too will be restrained and there won’t be too much room for fiscal stimulus. In such an environment, it is hard to see corporate earnings revive meaningfully.