Demonetisation impact on corporate: When things were beginning to improve

The recovery in corporate earnings, which had begun in a small way in the last 18 months due to lower commodity and energy prices, has been derailed to a great extent by demonetisation. From the lows of January-March 2015, the core operating profit margin of 2,099 companies (ex-banking, finance and oil & gas) rose by 670 basis points in July-September 2016. 

This had enthused analysts that these profits would encourage companies to invest, thereby setting the stage for sustainable growth in earnings. “The demonetisation shock is expected to nip the minor recovery seen recently, as it will have a significant impact on demand, corporate performance and the labour market. There will also be a ripple effect on other variables,” says Dhananjay Sinha, head–institutional equity, Emkay Global Financial Services.

The results of demonetisation are already visible. “The Nomura Composite Leading Index (CLI) for India has slumped to its lowest level since the series started in 1996 and is consistent with GDP growth of below 6 per cent,” says Nomura’s Sonal Verma. 

“Data suggests that demonetisation has hit rural consumption demand harder than urban demand, services more than manufacturing, and exports more than imports,” the report added.  

The biggest impact will be on the informal sector that accounts for the bulk of the GDP and employment. “The informal segment contributes 50-60 per cent of India’s GDP. Nearly 94 per cent of the employed use currency as a means of transaction and wage payments,” Sinha adds. 

The decline in activity in informal sector will have a cascading effect on a number of sectors. This is already visible in the case of consumer goods companies and auto makers. Sinha expects India’s GDP to decline by 230 basis points over the next 12 months compared to the pre-demonetisation estimates. Corporate earnings will also get hit over the next four quarters. 

On the demand side, the impact of the note ban is likely to be amplified by a sharp rise in household debt during the first two years of the Narendra Modi government. Total personal loans, as a percentage of national personal disposable income, increased to 19.4 per cent in FY16 from 16.5 per cent in FY14. The rise in unemployment and income, in the aftermath of demonetisation will force households to either default or cut back on expenses to continue their debt servicing. Both will have an adverse impact on banks and companies. 

It’s not that India Inc was in the pink of health before the note ban. According to Credit Suisse, corporate health had deteriorated during the July-September 2016 quarter. Against this backdrop, a demonetisation-induced slowdown could lead to more stress for companies and bad loans for banks.

While analysts expect the government to offer fiscal stimulus to counter the slowdown, given the lack of clarity on the additional tax revenues this exercise will generate, it is a wait-and-watch scenario.