With all doom and gloom around in the world of economics, good news is a rare commodity. But here is a piece which should bring smile on the faces, and twinkle in the eyes of investors, who understand the market behavior and economic cycles.
“When you get into a tight place and everything goes against you, till it seems as though you could not hold on a minute longer, never give up then, for that is just the place and time that the tide will turn.” –Harriet Beecher Stowe
As per CMIE report dated October 7, 2019, India incorporation has made big progress in efficient utilization of capital. From a high of 200 days of working capital cycle, it is now reduced to 123 days. Lower this ratio, better it is for the profitability of the corporate sector. Gladly, this is the lowest since 1990-91, and hence a very good sign in the process of economic recovery. Eventually, it should ease some of the corporate earning worries over time.
Similarly, substantial improvement in ICOR (Incremental Capital Output Ratio) needs emphatic mention. To understand ICOR in simplistic terms, imagine this as the amount of capital required by an entrepreneur/business owner for generating Re 1 profit in a year. During 2002-03, India’s ICOR was around 3.5 (i.e. Rs 3.5 capital required for Re 1 profit). For comparison sake, around that time, ICOR for China was 4.2, and therefore India had an advantage over China. Gradually, as the Indian economy grew faster and capital became abundant, the ICOR deteriorated and touched a high of 8.7 in 2013-14. The ICOR breached level of 11.4 for a brief period. This meant that businesses were careless about capital utilization and taking undue financial risks. Blame it on expensive real estate, higher wages, bloated stock market, and over-leveraged balance sheets of India Inc. Around this time, China’s ICOR had also crossed the figure of 11. The side effects of expensive capital and inefficient capital productivity (high ICOR) are now known to all. For the last 6 years, both India and China have been struggling with NPAs (Non-Performing Assets / Loans), unemployment and poor economic growth.
Come 2019, India’s ICOR has already corrected deeply and is placed in a comfortable zone. The last 3 years’ average ICOR is now 4.23. For China, this figure is around 6 at present. In comparison, India’s appetite for capital infusion looks better than China. India’s ICOR is nearing the levels of 2003. It can reward entrepreneurs investors (FDI / FII / Domestic) who are willing to infuse capital.
As a disclaimer, a recent reduction in Corporate Tax rates, and increased efficiency in capital utilization (ICOR) along are not the guarantee for quick and sudden economic turnaround. But, they certainly indicate a new beginning and form green shoots of economic recovery. I believe, over the next six months, NPA problem would wane meaningfully, and Credit Ratings in the corporate sector shall improve. This automatically shall reduce the cost of capital further. Together with this, if the government makes right noises about the business environment, then we shall see businesses bouncing back over next 12 months.