By Renu Kohli
A resurgence in business spending is believed to be in the offing by most stakeholders, including the government and the central bank. These expectations hinge upon, inter alia, strong profit growth and debt-light balance sheets of corporates, striking business optimism, brisk growth of capital goods, public announcements and signing of investment initiatives, confirmatory statements from officials, prominent businessmen, and commentators, etc. Collectively, these have formed a narrative saying this time is different, and real.
It may well be that these beliefs, or the general narrative about investment renewal, is well-founded. Or over-optimistic. Time will tell. Meanwhile, an evaluation of the central underpinnings shines a light on its prospective regeneration. What does this indicate?
The key metric is corporate profits. Incomes of corporations are earned from investments — new ones due to innovation and risk-taking or existing ones in production, i.e. sale of goods and services yielding revenues. The volumes sold are driven by consumer demand, of which there are two components, viz. final purchases by domestic consumers and by rest of the world or exports. Corporate profits are thus the fundamental measure for capital investments, which they mainly fund to enhance productive capacity. A close look is merited therefore.
Excluding taxes and as a share of GDP, corporate profits have successively risen from their 2020 trough across non-financial and manufacturing companies. Their trend decline, which began from 2008-2009, started reversing from 1% of GDP in 2020 to ~3-4% region in 2022. This restoration has been helped by three factors. The first shot came from corporate tax
Two, profit margins leapt during, and after the pandemic, as inflation combined with exceptional demand, bestowing significant pricing power to firms who could increase profits by passing on input costs. The Centre for Monitoring Indian Economy
Future improvement in private investment, thus depends on the progression of these factors. This is unclear and debateable.
For one, we need to observe whether and how the changes in tax structure have altered spending behaviour of firms. The budget analysis (FY24) identifies that 20.5% of the companies shifted to the new concessional tax regime in FY21, following the rate reduction from ~19% in FY20, not a significant change. One must also note the lower effective tax rate may be significant compared to the preceding four-year average (25.5%), but not so against the 22% average effective rate in FY09-FY13. In a sense, the FY20 tax reduction for existing firms may have reversed the FY16-FY19 effective rate, restoring it closer to former levels. Whether this was more a rollback or relief instead of an investment spur, all else equal, is not clear. Prospective demand, here and outside, forming a critical mass may be of greater importance in that context.
Two, with the moderation in producer price growth inflecting north, margins will depend upon the pricing decisions of firms and how they balance productivity and volume growth. Volumes have lagged profit growth in the post-pandemic cycle, especially fast-moving consumer goods firms, whose management has routinely flagged concerns about consumer demand, the impact of inflation, expressing hope for regeneration each quarter. At the aggregate level, real private final consumer spending slowed to 3% in FY24, less than half that in FY23 (7.5%). For January-March 2024, corporate results (~2,100 non-financial companies) indicate net profits grew -2.6%, while margins maintained around the previous three-quarter average (8%). Consumer goods’ volumes grew just 0.3% in FY23 (NielsenQ), which also boosts FY24 growth — some analysts have noted that significant price cuts by many firms failed to grow volumes, weakening net sales and profit growth. The anticipated zest in domestic consumer demand is still nebulous. Not the perfect environment for business expansion.
Third, the strong export growth is cooling. World merchandise trade volumes are forecast growing slower in 2024 by the World Trade Organization (2.6%) compared to its October prediction (3.3%), following a 1.2% contraction, and with high uncertainty. Global growth is expected to sustain at 2023 levels this year and next (3.2%), according to the International Monetary Fund which predicts it slowing in the medium-term — again not an ideal setting for private investment to turn around.
Some other points to note are as follows. One, the brisk 12% annual average growth in capital goods’ output in FY22-FY24 has lifted the index 14% above its FY20 or pre-pandemic level; this was about the same level as 6-7 years ago. Two, gross fixed assets growth, corrected for inflation, slowed across-the-board for manufacturing, and non-financial companies as a whole, showing no sign of resurgence at least in FY23. For now, we should certainly remain circumspect.
The author is a senior fellow at the Centre for Social and Economic Progress in New Delhi
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