Earnings and GDP data contradictory

With the new GDP series from late January, Budget likely to have factored in sub-par growth

A rising tide is supposed to lift all boats. But while the new series of gross domestic product (GDP) numbers suggest strong growth, corporate results don't suggest a broad-spectrum recovery. The new series (base 2011-12) estimates place GDP growth at 7.4 per cent in 2014-15. The new quarterly estimates of 2014-15 place Q1 and Q2 GDP growth rates at 6.5 per cent and 8.2 per cent, respectively, while Q3 GDP growth is estimated at 7.5 per cent. Where did the growth come from? There are many puzzling discrepancies. For example, the new series says government expenditure rose 32 per cent (net of inflation) in Q3, 2014-15, compared to Q3 in 2013-14. Yet, the Comptroller and Auditor General itself pegs government expenditure as up by only 5.1 per cent in Q3. The Index of Industrial Production (IIP) says year-on-year manufacturing growth was 1.7 per cent in December 2014.

In terms of sentiment, there should also be a strong sense of optimism if GDP growth is this strong. But that doesn't seem the case. Also, while the new GDP estimates incorporate data drawn from the balance-sheets of over 500,000 firms, the revenues and earnings of listed firms don't seem to be consistent with the higher GDP estimates.

A recent analysis of the results of 2,941 companies in Q3, 2014-15 by this newspaper revealed aggregate net profits shrank by 16.9 per cent compared to the same period of a year ago. After adjusting for extraordinary items, net profits still dipped by over six per cent. Revenues were down by 2.2 per cent. Those numbers suggest the inverse of strong growth.

Corporate revenues and profits are nominal and unadjusted for inflation. It is hard to adjust for inflation and impossible to make rigorous comparisons because the method of GDP calculation has also changed. During April-December 2014, the Wholesale Price Index (WPI) ran slightly negative, while the Consumer Price Index (CPI) ran at around six per cent annualised.

Historically, India has used WPI for inflation adjustment and WPI has very rarely run negative. There were multiple CPI series in use earlier. In periods when real GDP growth (old series) has been above seven per cent, corporate sales and profits have generally grown at a nominal 15 per cent or more.

The lack of profitability looks odd on several other grounds. The differential between WPI and CPI trends should translate into higher profits. Raw material input costs are at wholesale prices, which means expenses dropped for corporates. Again, the data don't show this.

Profits abroad did not pull up GDP either. Trade statistics show merchandise exports flattened as the rupee stabilised. In Q3, the information technology and pharma sectors registered four per cent growth in net profits and one per cent decline in net profits respectively, in rupee terms. Another industry with export-orientation, textiles, has seen an overall drop of 20 per cent in net profits. A closer look at Q3 results shows some turnaround. Fertilisers have done well due to the lower cost of crude and gas feedstock. Is this sustainable - it depends purely on crude price trends? Telecom majors have seen rising profitability as consolidation occurred. But the coming spectrum auctions might change the scenario. In other industries, companies like Crompton Greaves, Siemens, Ashok Leyland, Maruti, BPCL have outperformed. In each case, the investor must try and identify the reasons and see if these turnarounds are sustainable.

Obviously, most investors will be focused on the Budget this week. I cannot remember a period when the data was so puzzlingly contradictory. Will the finance ministry go with the mass of data, which indicates the economy is still struggling? If so, it must try to restart the investment cycle, if necessary by pump-priming and accepting a bigger fiscal deficit. However, if the FinMin trusts the new GDP numbers, it will accept the economy is already well into a strong growth recovery. In that case, it might go conservative and try to cut the spending.

Lower crude prices have given the government a $50-billion windfall or roughly 2.5 per cent of GDP. It could cut the spending by that amount or deploy that sum (or part of it) as subsidies or use it as deficit financing.

The Budget is most likely to have been drafted with the old series in mind. The new series was released in late January and seemed to surprise the finance ministry. Most of the finance Bill is put together by end-December and early January. The Budget is more likely to have been drafted under the assumption that growth is still sub-par.