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Uh! Oh! We Are in Trouble!

Omkar Goswami


My wife Radhika has a weird sense of humour. Whenever I call on her mobile, it blares a song: “Uh! Oh! We're In Trouble / Something's Come Along And It's Burst Our Bubble / Yeah! Yeah! Uh! Oh! We're In Trouble”. As I poring over the corporate results for India in 2005-06, the song came back to me in a flash.


Corporate India is in trouble. More so in 2005-06 than it was for four previous years. We in CERG Advisory have compiled the data from a large and representative sample of 1,416 listed manufacturing companies What the facts say ought to worry most CEOs.


From 2000-01 to 2004-05, net sales (sales minus excise duty) was growing at a rapid clip. Even in 2004-05, net sales had grown by 24 per cent over the previous year. Despite three consecutive years of extraordinarily robust GDP growth, this sales engine is showing signs of sputtering. Growth of net sales for manufacturing in 2005-06 was 18 per cent. No doubt, some sectors did better than others; but the average growth rate was definitely less than before.


Far more significant is that profitability took a sizeable hit in 2005-06. Profits before depreciation, interest and taxes (PBDIT) grew by 23 per cent in 2004-05 over the preceding year. In 2005-06, this growth rate had reduced to below 7 per cent. It was the same for profits after tax (PAT). After growing by 33.5 per cent in 2004-05, the PAT growth rate fell to 6.8 per cent in 2005-06.


Not surprisingly, manufacturing profit margins have dropped. Thankfully, the fall is not  precipitous. The ratio of PBDIT to net sales has reduced from 18 per cent in 2004-05 to 16 per cent in 2005-06; and the PAT margin has dropped from 9 per cent to 8 per cent. Moreover, these margins still happen to be among the best in Asia. Even so, the fall does not augur well for the next couple of years. Let me explain why.


First, the average price of crude oil in 2006-07 and probably 2007-08 will be greater than what it was in 2005-06. A conservative estimate for 2006-07 is an average international price of $80-$85 per barrel. That would be 23-30 per cent higher than the 2005-06 average. Thus, companies using diesel or furnace oil for meeting their energy needs will face higher costs than before. Many have opted to set up thermal, hydroelectric or co-gen captive power plants. But most of these will get commissioned some time in 2007-08. Till then, therefore, they will be hit by higher energy costs. Blame China.


Second, raw material and commodity prices will also remain hard for the next two to three years — copper, steel, aluminium, petrochemicals, polyethylene, PVC, caprolactum, soda ash, cement, minerals, you name it. Again blame China.


Third, interest rates are definitely hardening — and this will probably happen at a faster pace than what we have seen in the last six months. I would be surprised if the benchmark rates for corporate lending do not rise by at least 1.5 percentage points in the course of the next three quarters of the year. Since every CFO worth the name has squeezed out the very last rupee worth of interest costs in the last four to five years, the only way this will go is northward. This will affect day-to-day operations as well as investment outlays that were structured on floating interest rates. Blame the US Fed and RBI’s fears of inflation.


Finally, barring perhaps a few odd industries, it will be increasingly difficult for the manufacturing sector to blithely pass on higher material and energy costs on to consumers. Most of the Indian market has become far too competitive for that to happen.


So, the next few years will be challenging for Indian manufacturing. Thankfully, this sector had faced even greater challenges during 1996-2000, and came out stronger than before. It can once again. But for our manufacturing CEOs, COOs and CFOs, it will back to the basics, and not to the champagne soirees of Davos.


Published: Business World, July 2006


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