There is a way India can seize the moment and make the most of the present circumstances.
How will India weather the global meltdown? It depends, because there is a way India could make the most of the present circumstances. It would require congruent action by policymakers on factors they have some control over and can manage. Clarity and prioritisation in objectives is the first step, while effective execution is the next.
Another significant driver of profit growth is consumer spending (within reasonable limits) to absorb the existing and additional capacity and growth. This implies, crucially, to a continuation of high savings, which then fuels further investment.
Paradoxically, if consumer spending is restrained, it will not only hamper growth directly, it will also constrain project implementation and plans for future investments.
Why Profits?
High profits result from robust, productive economy activity. As it happens, the economy is well-positioned for this after several good years, resulting in investment plans that are in the process of being executed. Investments in infrastructure in the next three to five years are expected to create assets amounting to almost as much as the total asset stock built in the last 60 years.*
The importance of profits to owners is clear: cash flows, access to inexpensive capital for equity and debt, and the ability to attract talent. There seems to be less appreciation, however, of just how important profits are to the government. We get a sense of that if we consider the enormous (government) investment needed in infrastructure, the effect of robust tax collections on the government’s ability to invest, and the likely effect of a slowdown.
A large and growing domestic market offers opportunities in this time of global turmoil. Strong continued growth in profits will elicit capital inflows reversing the weakness of the rupee, and help offset the increased costs of imported oil. The combination of profits and capital inflows will instil confidence in domestic and foreign investors to continue to invest.
If this happens apace, the rupee will strengthen. There should be clarity on the net benefits of the rupee’s strength or weakness: overall, it is most beneficial and equitable if we have a stable, strong rupee based on fundamentals and confidence in the economy, perhaps while seeking the benefits for some years of an undervalued currency through exchange rate management — that is, subsidising exporters at everyone else’s expense — to the extent possible.
Prospects For Profits
A year ago, analysts were expecting corporate profits to grow through 2009 at 18-20 per cent. Since then, there have been steep declines, and for June 2008, 1,638 companies reported profit growth of 10.6 per cent.
Prospects for profit growth are ominous because both the drivers, project implementation as well as consumer spending, are declining. Project implementation declined as a percentage of projects announced from 53 per cent in December 2006 to 45 per cent in June 2008. Power projects slowed from 50 per cent in December 2006 to 40 per cent, transport services from 62 to 45 per cent, and mining from 50 to 37 per cent. Meanwhile, consumer loans also declined steadily.*
Rejuvenating Profits
For profits to accelerate, (a) project implementation needs to improve, and (b) consumer spending has to grow.
Interest rates affect both. Financing costs within a range are policy choices affected by perception, mindset and execution. The benefits from a reduction in borrowing costs have been estimated as a 30 per cent increase in profits-before-tax for every 10 per cent fall in interest rates, or an increase of Rs 25,000 crore in profits for a 1 per cent reduction in interest rates. Also, lower rates will help to increase consumer loans and therefore spending, provided credit is available. An improvement in both factors is likely to have a positive impact on project implementation.
Therefore, steps need to be taken immediately to accelerate enterprise profits by:
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