Rush to Quality

As lockdown opens across the country, India's micro economy is finally beginning to show signs of life even as the macro economy remains in deep freeze. But that's just one of the contradictions the nation's beleaguered economy is dealing with. Stock markets, for instance, are completely divorced from the real economy. Even when the GDP is set to shrink by a record 10-12 per cent this year, the Sensex - already past the 40k mark - hit a new all-time high of 42,645.33 on November 9, 2020. Among other contradictions, economic growth in rural India has been far better than in urban India for the past few quarters; and right through the slowdown of the last 18-odd quarters, larger firms have performed substantially better vis-a-vis medium and smaller firms.

This year's BT500 captures these trends. Combined market capitalisation of BT500 companies rose 1.08 per cent as against a fall of 1.5 per cent in the 2019 edition. But with stock investors avoiding risky investments and putting their money in large, perceptively safer companies, market cap of the Top 10 companies rose faster by nearly 12 per cent. "The top line is seeing formalisation as market share is moving to larger players. Their higher market cap comes from that," says Samiran Chakraborty, Chief Economist, Citibank India. Only 211 of the 500 firms reported an increase in market cap. In fact, smaller and medium firms registered a 21 per cent drop in their market cap.

Revenue Flat, Bottom Line Hurt

For FY20, corporate India's top line moved largely in sync with the economy. With slowdown playing out deep across industries, all BT500 companies together reported barely 1.2 per cent growth in total income during the financial year. But the real impact of the slowdown is evident in the sharp dip in profits. Net profits for the BT500 universe have fallen an astounding 21 per cent.

However, despite that, firms managed a healthy EBITDA, which indicates top order cost management.

"Broadly, corporate India's top line is in line with nominal GDP. What is different is that better companies have maintained or improved their EBITDA. So, cost control has been better. This cost-cutting is likely to continue," says Sachchidanand Shukla, Chief Economist, Mahindra & Mahindra.

Debt Rush

But the most interesting trend is in India Inc.'s indebtedness. Despite the pressure on top line and bottom line, the combined debt of non-BFSI BT500 firms grew 13 per cent. Interestingly, the bigger the company, the more additional debt it took over. And that's largely because while interest rates started crashing in early 2019, they have now hit lip-smacking rates that firms do not want to miss out on. Repo rate has fallen from 6.50 per cent in January 2019 to 4 per cent now. "For some companies, the prevailing rates are the lowest ever. I can't think of a time when the best companies got rates lower than what they are getting now. Even companies which didn't need funds have cornered debt," says Mahindra's Shukla.

But there is a catch. This applies only to large firms as banks have opened their purse strings only for large and established firms instead of companies they perceive as risky. "Barring top companies, you won't see the same interest rates," says Shukla.

As a result, top firms have raised debt at a frenetic pace. While debt on books of India's 100 most indebted companies increased 15.6 per cent, top 10 companies' debt grew 21.9 per cent. They accounted for 58.6 per cent of the total debt of BT500's non-BFSI universe. "Post April, only four-five banks got liquidity, and they disbursed only to the premier companies," says Shukla. Small and medium firms' ability to get the same rates was limited due to setback to their businesses.

Cost Management Accelerated

Up until Covid, a persistent slowdown lasting nearly 18 quarters had already got India Inc. into an expense tightening mode. In general, commodity costs have been falling; for better-run firms, the interest outgo has been dipping due to loan swaps and staff costs checked by hiring of temporary staff.

Organisations reaped maximum savings in material and labour costs and ensured tight control over travel and advertising & promotion costs. In the lockdown, for instance, a large chunk of companies brought down travel and advertising & promotion to near zero. Even though, as the economy opens, both these costs start to rise, digitisation brought about by the lockdown will leave a long-term impact on cost and productivity. "Everybody used this period to rethink and find different ways of doing business, which will increase productivity in the long run," says Citi's Chakraborty.

However, economists caution against the serious downside of aggressive expense management: direct impact on the informal sector. "Most important in EBITDA management is the line item of 'other expense'. It's the business of transport, canteen, etc. This is bound to hurt the informal sector," says Shukla. "EBITDA has been largely maintained because you are squeezing the informal sector. There are exceptional cuts in unnecessary versus necessary."

Dividend Rush

Then there's the dividend rush, peculiar and specific to FY20 due to a surprise announcement in the Budget. In the past five years, companies have, on an average, paid 43 per cent of the year's net profits as dividends. But FY20 was exceptional. Despite shrinking bottom lines, companies chose to distribute an astounding 66 per cent of their earnings in the financial year. As a result, despite a 21 per cent drop in combined net profit of BT500 firms, dividend paid shot up to a high of Rs 2.27 lakh crore during FY20, growing 14.7 per cent as against just 2.8 per cent in the previous year.

The new dividend taxation rules effective April 1, 2020, scrapped dividend distribution tax (DDT), which was paid by companies. Instead, it shifted the incidence of dividend taxation to shareholders at their applicable tax rates. This hit promoters the most. A promoter with income in excess of Rs 5 crore will now pay up to 43 per cent tax on dividend income. Under the previous tax rules, the effective tax rate was 20.56 per cent (including cesses and surcharges), borne by the dividend paying company. "Dividends need to be seen in conjunction with the Budget. Everybody is rushing to give it back to the promoters," says Shukla. Promoters of private firms rewarded themselves the most with Rs 68,845 crore in dividends, followed by government with Rs 35,686 crore.

Signs Of Life

There are definite signs of life in pockets of the economy but it would be fatal to mistake them for an about turn in slowdown. "Just because it's improving does not mean it will keep improving. Trajectory of virus is crucial. All is contingent on how the virus behaves," says Crisil's D.K. Joshi.

For instance, October auto sales have seen an astounding growth over October 2019; power demand is growing at a very healthy rate; GST collections hit an eight-month high in October, crossing the Rs 1 lakh crore for the first time this fiscal; e-way bills are showing a consistent upward trend and grew over 21 per cent in October. "In auto, the base was low. The numbers were dipping since July. When you adjust for low base and pent-up demand, even people in the industry are taken by surprise," says Shukla.

There are other signs of hope too. Since firms are raising output amid uptick in demand, manufacturing PMI rose to 58 in October from lows of under 30 during the lockdown. Petrol and diesel sales have breached last year's numbers, signaling greater vehicular movement ahead of the festive season. "Manufacturing is bouncing back everywhere. It's on a stronger footing. The sticking point will be services - airlines, hotels, restaurants, travel and tourism. Behaviourally, services will remain subdued due to anxiety," says Joshi. Also, CMIE's unemployment rate fell from the worst 23.5 per cent in April to just under 7 per cent in October.

"Don't get carried away by two-three months' numbers. Because this is how psychology works. People are hoping against hope. So far, vaccine hopes are not reflecting in consumer sentiment and faith in the real economy," says Shukla. Crisil's Joshi adds: "The initial pickup is because we fell very sharply. I won't extrapolate these trends."

With all-round growth still looking distant, the big question is whether the growth in pockets of the economy will sustain beyond the festive season. A similar cheer last year due to demand in September-February turned out to be a false alert. "Recovery back to pre-Covid level is definitely happening. The recovery index is at 90 per cent of pre-Covid. The last 5-7 per cent will be permanent damage. But the question is, how much of the recovery is from pent-up demand?" says Chakraborty. "There are two lost years before we get back to pre-Covid levels."

@rajeevdubey