Aspects of India's Economy Nos. 36 & 37: The Real State of India's Economy

The Real State of India's Economy
III. Where Are Corporate Profits Coming From?

Improved corporate profits are not necessarily an indicator of greater economic activity -- contrary to what the financial papers would have us believe. Sometimes even they cannot help noting this fact, albeit indirectly. Business Standard, n its annual study of 1,000 top Indian firms (BS 1000: India's corporate giants, January 2004), titles its piece on corporate profits: "Unravelling a mystery: Profits have risen far more sharply than sales. Why?"

In the last several years, the corporate sector has refrained from carrying out investment, but has placed its funds in bonds, shares, mutual fund units, and government debt. The corporate sector's earnings from these sources (called "other income", to distinguish it from sales income) account for a large share of its profits. According to an RBI study,¹⁰"other income" of the surveyed 1,267 public limited companies in 2002-03 accounted for as much as 35.5 per cent of their profit before tax.¹¹ At end-March 2003, the top 24 corporates alone had as much as Rs 46,424 crore (Rs 464.24 billion) in cash and highly liquid assets, up from Rs 34,629 crore (Rs 346.29 billion) at end of 2001-02¹² — indicating their decision not to invest in productive activity, but to deploy their funds in interest-earning instruments or for speculation.

Secondly, the Government has brought about large reductions in interest rates paid to the financial institutions or the public by the corporate sector. The corporate sector has replaced much of its old debt at higher interest rates with new, lower-interest debt. The RBI survey cited above shows that interest costs of the private corporate sector fell by 11.7 per cent in 2002-03 over the previous year. Interest costs as a percentage of sales fell by 1.1 percentage points. At the same time, profit before tax as a percentage of sales rose by 1.6 percentage points. Thus the bulk of the increase in profits came from reduction of interest costs, not from greater efficiency or larger sales. It is important to note that the last several years of interest rate cuts have not spurred more productive investment by the corporate sector (as was the officially claimed purpose of the interest rate reductions), but merely helped the corporate sector to boost its profits.

These trends continued in 2003-04. Business Standard notes that its study of the top 478 companies "shows that interest costs fell by 18.2 per cent during the second quarter of 2003-04.... The result has been much higher profits.... Apart from interest costs, the 21.38 per cent growth in 'other income' was also responsible for the mismatch (ie profit growing much faster than sales)... In the last few years, there has been precious little investment by corporates in plant and machinery, since industry was plagued by excess capacity..."¹³

Behind the paucity of demand: growing poverty
Why did the corporate sector not make major investments? Why instead did it hold onto its cash, and use it to speculate on the financial markets? The reason was that there was not enough demand even to fully use the existing capacity, let alone add to it. The state of demand in the rural areas and among the mass of ordinary consumers is particularly reflected in the poor performance of fast-moving consumer goods (FMCG) in the past few years. The FMCG sector includes soaps, detergents, packaged tea powder, biscuits, toothpaste, toothpowder, shampoo, scourers, and so on, a large share of which are used by the poor, including in the rural areas. Even if the per capita income and the distribution of income were to remain the same, one would still expect FMCG sales to rise merely because population is rising.

However, FMCG industry estimates show that sales have actually been falling, and the trend has deepened over the past four years (see Table 3). A survey found the same situation continuing in September 2003, with sales for 15 of the top 20 categories, including soaps, detergents, tea and toothpaste, down; in February 2004, industry sources were quoted as saying they did not expect a recovery before mid-2004.¹⁴

	2000	2001	2002	2003 H1
Soap	6.1	-9.9	-6.1	-1.6
Detergents	5.7	-2.9	-2.1	-4.6
Toothpaste	10	2	-5.5	-12
Packaged Tea	0.3	2.4	-10	-14.1
Shampoo	12.5	10.7	7.8	-5
-- The Hindu Survey of Indian Industry 2004, based on FMCG industry estimates. Last column: first half of 2003.

It is worth noting two trends in the FMCG sector over the last three years. First, as poorer consumers have been forced to reduce their use of even such essentials as soap and detergents, sales of the FMCG giants have fallen; in the case of Hindustan Lever Ltd (HLL), from Rs 11,400 crore (Rs 114 billion) in 2000 to Rs 9,950 crore (Rs 99.5 billion) in 2002. HLL sales rose by a mere 1.8 per cent in 2003 to just over Rs 10,000 crore (Rs 100 billion). Indeed they fell in the last quarter of 2003, despite the good monsoon. The firm, which estimates that 45 per cent its sales are in the rural areas, says that even in the last quarter of 2003 rural markets showed no "palpable" increase in demand. It has had to sell off several of its businesses, including its edible oil ("Dalda") line, which had been selected two years ago as one of the "power brands" on which the company would focus.

Secondly, several medium-sized firms have noted an opportunity in the stagnating/falling sales of FMCG giants: that there are customers who need these goods, but are unable to afford the grossly overpriced products currently dominating the shelves of grocery stores. A number of these medium-sized firms such as Jyothy Labs (soaps) CavinKare (shampoos), Anchor (toothpaste), and several detergent firms in different regions have entered the market. They are of course unable to compete in advertising (HLL's advertising budget in 2002 was 10.4 per cent of its domestic FMCG sales, or Rs 845 crore (Rs 8.45 billion) . This is as large as the sales of Bombay Dyeing, the 128th largest firm in India). However, as they have priced their products 25 to 30 per cent below the equivalent products of the large firms (or even 50 per cent lower: a 200 gm pack of Colgate or HLL toothpaste costs Rs 40; Ajanta, till now a clock manufacturer, sells the same for Rs 20), they have been able to grab a share of the market. Again, targeting the section of consumers who cannot make large cash purchases at a time, the new firms have sold much of their products in small sachets.

Loath to sacrifice their fat profit margins despite their poor sales, the big firms have taken a long time to begin cutting their prices; in fact prices continued to rise up to 2001. HLL claims its profit margins are 25 per cent on soaps and detergents and 37 per cent on personal care products (they may in fact be higher). While they finally have been forced to lower their prices somewhat and hike their distributors' margins, it is likely that they will do this only for the period needed to drive the new entrants out of the market, as they have done several times in the past, following which the earlier price hikes may be repeated. The current targeted price-slashing drive has led to peculiar situations: for example, HLL has priced its 20 gm sachets of Surf Excel at just Rs 1.50, which comes to Rs 75/kg, whereas its one-kg packs are priced at Rs 135; Procter and Gamble's Tide similarly sells at 80 per cent more by weight in its large packs than its sachets; and this holds true for various other products as well. (This gives some idea of the real scale of these firms' margins.) Sachets and small packs (generally targeting the poorer sections) are said to account now for more than half of sales of several FMCG products.

Sales of cotton and man-made textiles too are linked to the purchasing power of poorer consumers. The growth rate of man-made textiles fell from 5.8 per cent in 2000-01 to 4.4 per cent in 2001-02 and 3 per cent in 2002-03; the corresponding figures for cotton textiles, by and large consumed by the worst-off, were 2.9, -2.2, and -2.7. In July-November 2003, cotton textiles actually declined by 5.9 per cent over the same period of the previous year. In major powerloom towns like Bhiwandi and Surat, thousands of powerlooms and powerloom workers are forced to be idle. The poverty of the consumers of cheap cloth has translated into poverty for the workers who make the cloth: Unemployment of the people leading to poverty of the market, and poverty of the market leading to unemployment.

Press reports suggest that in recent months there has been a boom in luxury electrical and electronic goods, and the Index of Industrial Production indicates that consumer durables production is picking up sharply (after years of depressed growth following the mid-1990s boom). Sales of automobiles are estimated to have grown by 30 per cent in 2003-04, fuelled by cheap and easy credit from banks, which have made such retail lending a major part of their portfolio. No doubt learned economists will inform us now that all this indicates that people's tastes are shifting from bathing soap and tea powder to automobiles, but the truth is pretty plain for all to see: namely, that growing inequality has depressed demand for items of mass consumption and fuelled a distorted growth of items of luxury consumption.

The lifestyle of the Indian elite, and their ties abroad, can also be seen in the ballooning payments for travel abroad. In the past, payments for foreign travel were generally between one-fourth and one-third of receipts from those travelling to India, so travel has been a net earner of foreign exchange since 1956-57. Since 1996-97, however, travel payments have risen rapidly. In 2002-03 travel receipts were $3.03 billion; travel payments, at $3.47 billion (Rs 16,761 crore, or Rs 167.61 billion), outstripped receipts for the first time in five decades.

	1996-97	1999-2000	2002-2003
In $ mn	858	2,139	3,467
In Rs cr	3,049	9,268	16,761
-- RBI Bulletin and Handbook of Statistics on the Indian Economy

Notes:

10. "Performance of Private Corporate Business Sector", RBI Bulletin, October 2003. (back)

11. In another RBI survey of the private corporate sector for three earlier years and with a larger sample, "other income" accounts for about two-thirds of profit before tax. (RBI Bulletin, October 2003).(back)


Nos. 36 & 37, March 2004