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Posted by: Deepa Vasudevan on Mon, Oct 21st, 2013

Economic Slowdown and Corporate Profitability

The Reserve Bank of India will announce the Second Quarter review of Monetary Policy on October 29, 2013. Signals from the economy are conflicting: inflation is rising again, but growth has fallen. The current account deficit appears to be under control, but there is less confidence on management of the fiscal deficit. Given these contradictory indicators, a key factor in policy formulation should be the state of the private corporate sector, especially in terms of the impact of the slowdown on corporate balance sheets.

 

A recent RBI report shows that the post-2008 years of low economic growth have significantly damaged corporate profitability[1].  The numbers for 2012-13 show a steep decline for sales growth due to the slowdown in demand for good and services.  PAT is about 50% lower than what was seen in 2007-08. 

 

Table1: Key Profit Parameters


Table1: Key Profit Parameters

Source: RBI

 

An economic slowdown reduces sales, employment and profit. If accompanied by higher food and fuel prices, as was observed in India during 2010-12, it leads to higher production costs and declining margins at both gross and net levels. As large companies protect their bottom lines by cutting discretionary expenditure – typically marketing and R&D expenses- smaller companies that supply them with goods or services are negatively affected.  An increase in interest rates accentuates the problem leading to sharp fall in net profit margins as can be seen since 2011-12.

 

The RBI study classifies companies into size categories based on sales: small companies are those with sales less than Rs. 1 billion; medium between 1 and 10 billion and large companies are defined as those having sales over Rs. 10 billion. As the following three pictures show, small companies show declining sales growth steadily since 2008-09. In the worst year, 2012-13- sales of large companies grew by 10.7%, while sales of small companies fell by nearly 10%.

 

Pic 1: Sales Growth (%) by Company Size


Pic 1: Sales Growth (%) by Company Size

 

Margins have been similarly affected. Operating margins of large companies is much higher than that of small companies.  Small companies posted a net loss of 5% of sales in 2012-13, a steep fall from the net profit margin of 5% in 2007-08. The higher interest burden on the smaller companies is evident from the positive operating margin converting into a negative net profit margin for this group.  However, across the board, the net profit margin is lower and reducing, indicating the need for lower interest rates for the revival of corporate profitability.

 

Pic 2: Operating Margin (%) by Size

 

Pic 2: Operating Margin (%) by Size

 

Pic 3: Net Profit Margin (%) by Size

 

Pic 3: Net Profit Margin (%) by Size

 

As Pic 4 shows, the smallest companies were the worst hit since they began with the highest interest outgo; as a percentage of sales, in 2012-13, they  bore twice the burden of interest rates, compared to large companies.

 

Pic 4: Interest Cost as a % of Sales 

 

Pic 4: Interest Cost as a % of Sales

 

These data points are useful for two reasons. First, in the small or medium category, the financial performance has clearly worsened in the last two years. Another interest rate hike in the next monetary policy could push some of them into default, or towards corporate debt restructuring.  Second, the private corporate sector is the key driver of investment activity. An investment boom usually starts after a couple of years of corporate profitability. Without a conducive policy environment a hike in interest rates would only delay the investment cycle even further. 


[1] Performance of Private Corporate Business Sector 2012-13, Published in RBI Monthly Bulletin, October 2013, based on data from 2931 non-government non-financial companies 

Subash Joneja on Thu, Oct 24th, 2013 6:34:02 am

India is in deep trouble , Rahul is talking about his Dadi & Father who were killed by opposition ,opposition is wasting public money in parliament sessions without any result ,no one is concerned how a poor, middle class family is surviving. U r giving black cat security by burning imported fuel for criminals who have become ministers ,M. P's , MLA. Cut down all these wasteful expenses curb usage of fuel and ban import of non essential Gold which is being hoarded ,locked in rich man's lockers at least for 2 years. Ban imports from China and impose 300% custom duty on imports on non essential so as to revive the dying Small Scale Industry. Enforce strict labour laws no strikes , every one who works earns wages .Tell the ruling party and the opposition to behave and do productive work ,stop serving them 5 star food & snacks when they are tired and do only shouting in the parliament.India's medical services, educational institutions, Soft ware and many other hospitality industries can be fully exploited to earn enough U S $ and RBI Governor will not have be changed so often.Else nothing will happen ,u will have the the excuse of Delhi Elections ,followed by main election 2014 . Jai Hind Subash Joneja ( Indian ) New Jersey ,USA

Gopinathan Nair on Wed, Oct 23rd, 2013 7:05:43 pm

Madam' Valid information. Thanks

jignasa talajiya on Tue, Oct 22nd, 2013 2:18:55 pm

Very true

krishna kishor tiwari on Tue, Oct 22nd, 2013 1:49:16 pm

This time we are hopeful that RBI while declaring there policy on 29oct.economic growth shall be given priority over inflation and rates at LAF facility shall be further reduced to increase liquidity in the market.However repo/reverse repo may be increased marginaly by 25 basis points.

Makarand Joshi on Tue, Oct 22nd, 2013 1:00:01 pm

Everyone including our finance minister is expecting a series of quick rate cuts. This may improve the profitability of the corporates for a while but in a long term the inflation will reach beyond control of anyone and everyone. RBI should make rational decisions with strong bias towards long term stability for the economy.......

C N ANNADURAI on Tue, Oct 22nd, 2013 7:54:15 am

DEAR SIRS, GREETINGS. GONE THROUGH THE RECENT CHANGES EFFECTED BY THE NEWLY TAKEN OVER RBI GOVERNOR WITH A VIEW TO STABILISE THE ECONOMICAL CONDITIONS PREVAILING IN THE PRESENT TIME. THE GOVERNMENT OF INDIA IS TAKING STRINGENT MEASURES TO CURB THE INFLATION FOR IMPROVING THE GDP AS WELL AS THE GROWTH PERCENTAGE DURING THE ENSUING FINANCIAL YEAR. HOWEVER, THE INDEFINITE HIKES IN OIL PRICES AND OTHER ESSENTIAL COMMODITIES HAVE PUT THE CITIZENS OF INDIA IN AN UNREST DILEMMA AND THE PURCHASING CAPACITY OF THE CITIZENS HAVE ABNORMALLY COME DOWN. HENCE, THE SAVINGS ASPECT HAVE BECOME SLUGGISH. MOREOVER, THE UNCERTAINTY IN THE POLITICAL SITUATIONS HAVE ALSO MADE SUFFICIENT IMPACT IN THE LIVELIHOOD OF THE PEOPLE. IN TOTO, THE PRESENT CONDITION OF THE INDIAN ECONOMY IS IN A DOLDRUM AND THERE IS NO SYMPTOM OF GROWTH IN THE NEAR FUTURE AND THIS FINANCIAL YEAR WILL END UP IN UNPROFITABILITY FOR MOST OF THE CORPORATES AND THE PEOPLE TOO. LET US CAREFULLY GAUGE THE SITUATION AND ACT ACCORDINGLY. REGARDS, C N ANNADURAI PRESIDENT COIMBATORE IFA ASSOCIATION COIMBATORE

naraynan sethurao on Tue, Oct 22nd, 2013 6:42:53 am

Unless growth initiatives are not visible and supply side economics improves by direct government's policy and fiscal measures,inflation and growth will chase each other like the Dog trying to bite its own tail going round and round....

Gautam Haldipur on Tue, Oct 22nd, 2013 12:30:24 am

The R.B.I.'s business is to manage monetary policy & believe me they were, are & will continue to do a wonderful job with the limited options available for them. The Crux is the Fiscal Policy managed by our revered political class (read Parliamentarians). This needs a complete overhaul & has to be in sync with Monetary policy else anything done will amount to artificial tinkering & will not cure the malaise.

Mahendra Mone on Mon, Oct 21st, 2013 8:34:27 pm

Yes I do agree that at one side RBI is trying to curb inflation which is really a job of the Government and at other end it is afraid of bring down the interest and last so many months this is going on the markets are fed up of RBI policy and seems to be endless financial illness of our country for years to come, food security, new elections are going to add fuel to fire what else one can say....wait until dark.........

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