Special Report: Is Corporate India Healthy? by William Ortel

As we continue our special coverage of India, it becomes important to ask the obvious. How are Indian companies doing?

For that, we turn to the chief investment officer of SBI Mutual funds, Navneet Munot, CFA.

Listen or read on to hear our discussion, and be sure to subscribe if you haven’t already.

CFA Institute: Navneet, I am looking at a report from the Reserve Bank of India that says corporate profitability, this is a broad group of corporations in India, is down about 2 percent. Now it’s still big, it’s one crore, 74 lakh crore rupees, but how does this make you feel about business fundamentals in India? Is it still a rosy picture?

Navneet Munot, CFA:  There is a part of economy that has got impacted more badly and that is investment side of it. So companies into industrials and infrastructure, those are the ones who got impacted. But if you look at the latest results there is another set of companies that have benefitted from a weaker rupee. So those who are exporters, those who are into information technology, pharmaceuticals, engineering they’ve got benefit because of the weaker rupee.

There has been pressure particularly in the financial sector, because given the downturn there has been stress the asset quality of the banking system. So financials have been a bit under pressure though the banks are financial services company who cater to the retail market, they seemed to be chugging along well because the overall retail delinquencies have not increased much in this downturn.

By and large I think the corporate profitability is bottoming out. Two things that kept pressure, one was that lot of people who expanded capacity, extrapolating the 9 percent growth that we were witnessing till 2008, came for a shock when the growth fell and the global environment turned very negative.

For them there is lot of capacity which is yet to come on stream and then generate revenues, and also because of the government’s slow decision making and the due to the political environment has resulted in lots of infrastructure projects which are at the last mile from lack of environmental clearance, land acquisition or forest clearance or several ministry bureaucratic clearances and they have been pending.

So that got impacted and also the pressure on margins because the raw material prices went through the roof, the labor cost in India was going up in excess of 15 and 20 percent, interest cost was going up, currency was weakening so they got impacted on margins. But from here on I believe as the cycle turns the asset turnover improves and also the pressure on margin recedes and I see better days ahead for corporate profitability.

I just want to drill in on one of those comments which is you mentioned basically companies that have dollar revenues and rupee expenses as being a particular bright point in this environment. Does that signal a return to sort of off?shoring and business process outsourcing based competitive structure for India or is that just sort of a short term thing?

I think that’s quite structural because all said and done India has got advantage in terms of having large English speaking educated talent pool and the cost pressure have receded for them while the global environment has turned positive with the growth reviving in US and other parts of the world.

These companies have got benefitted and also the rupee depreciation obviously is helping them. But we have other sectors who lost competitiveness between let’s say 2005 to 2008?09 when our economy was doing very well, the labor cost and as I previously mentioned I think the cost structure went up and the rupee was strong, so they lost competitiveness.

But we are seeing a renewed way of thrust on getting the competitiveness back and several sectors, autos is a classic example, and we saw the two?wheeler companies, the Bajaj Auto and then some others, we are gaining the market share in the world market.

Similarly several companies in auto ancillaries and in engineering particularly there are other factors where India has got the advantage of R&D skills and low cost labor. Across sectors a weak rupee is likely to help corporate India.

You are talking about the changing international investment climate. That’s something that has fascinated me as I have kept digging into India. I wonder if you could comment on flows a little bit. How important and how closely you’re domestic Indian investor, how closely are you watching international investors in equities and their flows in and out of the market, how material is that to you?

They have been extraordinarily important because what happens is that foreign institutional investors now almost own 22 percent or so of the market cap of India and if you have adjusted for the floating stock because a large part of the market cap is with the promoters, be it the government or the private entrepreneurs or some of the multinational companies, they own a substantial chunk of the floating stock. They are a large part of the daily volumes and their flows dictate the market.

To put it simply, we dance to the tune of global investors who get in turn driven by the global liquidity and the global risk environment. Why it is that because we run a large current account deficit obviously the country needs huge amount of capital flows. The flows by these foreign investors impact the currency market, impact liquidity and interest rates here and impact the sentiment in the equity market as well.

In the last couple of years the domestic savings, India has got a very high household savings rate but unfortunately a large part of that saving effect is not coming into the financial instruments but going into real assets like real estate and gold. The domestic investors are becoming very marginal players in the equity market, and that’s why the foreign investors, their flows make all the difference.

If you can do a chart of last 15 or 20 years every single year where foreign investors poured in money the markets did well, in every year where foreign investors were sellers, market didn’t do well.

But I hope that going forward domestic investors will start reallocating their savings into equities as equities are relatively becoming more attractive compared to the other asset classes and that equation may change going forward. But as of now, foreign investors are a very, very critical variable in the overall direction of our equity markets.

I want to pick up on the current account deficit thought in a second, but first I want to go to the comment you had about domestic investors. Now what really needs to happen in order to spur that growth in a domestic shareholder base basically? Is that something that’s just like a last mile problem similar to those infrastructure projects or is that really a big challenge?

A variety of things, in the last 20?25 years domestic investors, just like anywhere else in the world they came at the peak of the market, they didn’t have the experience with the equities. There were some structural flaws

1, 234  - View Full Page