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Economic Reforms and Corporate Performance in India

Dr. Rakesh Mohan, Deputy Governor, Reserve Bank of India

delivered-on ਸਤੰ 14, 2007


Motivation 1

Corporate Performance – Trends since mid 1990s

End March

Sales Growth

PAT Growth
Working Capital /Sales

Debt / Sales

1995

20.5

59.2

21.7

34.1

1996

23.7

23.9

18.3

31.7

1997

10.4

-26.6

15.7

33.7

1998

7.5

-13.7

12.0

36.6

1999

6.1

-20.9

13.8

39.8

2000

11.2

14.7

11.5

37.6

2001

9.9

8.3

11.3

35.0

2002

-1.3

-17.8

7.9

35.7

2003

8.5

76.2

5.5

31.4

2004

16.0

59.8

3.9

26.4

2005

24.1

51.2

5.2

22.5

2006

16.3

31.7

11.1

20.2

2007

26.2

45.2

..

..

Note : Working Capital is defined as Current Asset-Current Liabilities;
* Based on abridged results of the corporates; Source: RBI



Motivation 2

Corporate Performance - Recent Trends

Growth Rates (Per cent)

 

2005-06

2006-07

2007-08

 

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

Item

1

2

3

4

1

2

3

4

1*

 

 

 

 

 

 

 

 

 

 

No. of companies

2,355

2,361

2,366

2,415

2,228

2,263

2,258

2,356

1,364

 

 

 

 

 

 

 

 

 

 

Sales

18.5

16.4

13.2

19.5

25.6

29.2

30.3

22.5

19.0

 

 

 

 

 

 

 

 

 

 

Total Expenditure

18.0

16.3

12.7

18.9

24.6

26.6

26.9

19.5

19.0

 

 

 

 

 

 

 

 

 

 

Gross Profits

32.0

19.1

21.2

16.6

33.9

45.9

51.8

39.2

27.9

 

 

 

 

 

 

 

 

 

 

Interest Cost

-13.5

-8.0

4.6

3.8

19.9

18.0

11.9

32.3

2.8

 

 

 

 

 

 

 

 

 

 

Profits after tax

54.2

27.5

27.0

15.1

34.7

49.4

59.5

39.6

32.6

 

 

 

 

 

 

 

 

 

 

* Provisional;
Source: Reserve Bank of India

Profit Shares (% to GDP)


Note: Data are annual from 1960 to 2005.
Source: Ellis and Smith (2007), BIS Working Paper.

Facts and the Issues

  • Facts
      • Initial Growth in 1990s
      • Deceleration during the latter part of 1990s
      • Remarkable Recovery of Corporate Profitability since 2002

    Issues

      –  Is this sustainable?
      –  Is this Policy Induced?

    Scheme of Presentation

    •  Correspondence between  

    • Policy
    • Corporate Performance

    •  Policies

      1. Industrial Deregulation
      2. Trade Liberalization
      3. Tax Policy
      4. Monetary Policy
      5. Financial Sector Strengthening
      6. Capital Market Deepening

    • Concluding Remarks

    Some Conjectures On “Relating  Corporate Performance to Economic Reforms”

    1. Industrial Deregulation And Corporate Performance

    Industrial Deregulation

    •      Elimination of Capacity Licencing
    •      Dereservation of industries reserved for Public Sector
    •      Removal of MRTP Act and Restrictions on Large Companies
    •      Termination of Phased Manufacturing Programmes
    •      Better Access to Foreign Technology
    •      Revision of Patent Regime
    •      Freeing of Foreign Direct Investment
    •      Programme of SSI Dereservation

    Industrial Performance

    Growth of Corporate Sector: Population

     

     

    Estimated Paid-up Capital

    Year ended March

    No. of Companies

    Rs. Billions

    % of GDP

    1982

    72402

    189

    11.1

    1987

    140670

    440

    14.0

    1992

    250361

    846

    12.9

    1997

    450950

    1905

    13.8

    2002

    589246

    4058

    17.8

    2003

    612155

    4571

    18.7

    2004

    641512

    4988

    18.1

    2005

    679649

    6540

    21.0

    2006

    732169

    ..

    ..

    Sources: Department of Company Affairs, 50th Annual Report on the
    Working and Administration of the Companies Act, 1956.

    Industrial Investment: Number of Proposals

    Marked improvements in investments in recent times
    Data are on calendar year basis

    Proposed Industrial Investment: Amount

    Marked improvements in investments in recent times      
    Data are on calendar year basis

    FDI and Portfolio Flows to India

    India’s Direct Investment Abroad

    Technology-related Payments

       

    Source: Balance of Payments Statistics, RBI

    2 Trade Liberalization And Corporate Performance

    Import Liberalization Initiatives- 1

    •    Moving away from Import Substitution
    •    Phasing out of Quantitative Restrictions on imports
    •    Reduction  in  and  simplification  of  tariff structure

    Import Liberalization Initiatives- 2

    •   Sharp Reduction in Customs Duty Rates
    •   Simple Average of Basic Duty Rates 

    • 1991-92: 128 per cent 

    • 2004-05:   22 per cent

    • 2007-08: Peak duty reduced to 10 per cent for non-agricultural goods

    •  Collection Rate (import revenue to value of imports ratio) 

    • 1990-91:  47 per cent 
    • 2004-05:  11 per cent 
    • 2005-06:  10 per cent

    • Distribution of Duty Rates Has Changed Remarkably 

    • 1991-92:  4100 out of 5200 commodities Basic Rates above 100 per cent  2004-05: 
    • 4261 out of 5144 commodities Basic Rates Below  (BRB) 25 per cent 
    • 2007-08:  8537 out of 10084 commodities BRB 25 per cent

    Exchange Rate Management

    •   Initial Ex Ante Real Devaluation
    •   Switch to a market determined exchange rate regime since 1993
    •   Focus on management of volatility without fixed rate target.
    •   Underlying demand and supply conditions determine the exchange rate movements in an orderly way

    Movement of Exchange Rate
    NEER Trade 6 country (1993-94=100)

    Movement of Exchange Rate
    REER Trade 6 country (1993-94=100)

    Ex Ante Real Devaluation in the mid 1990s

    Export Intensity and Import Intensity – All Companies

    Export Intensity and Import Intensity of the Indian Corporates

    Amount in Rs. crore

    Year

    Number of

    Sales $

    Earnings in

    Imports

    Forex

    Imports to

     

    companies

     

    Foreign

     

    Income to

    Sales

     

     

     

    Currencies

     

    Sales

     

    1991-92

    1802

    107026

    8693

    7692

    8.1

    7.2

    1992-93

    1802

    120120

    10902

    10350

    9.1

    8.6

    1993-94

    1720

    127823

    13069

    11185

    10.2

    8.8

    1994-95

    1720

    154087

    17110

    17452

    11.1

    11.3

    1995-96

    1930

    212241

    22643

    27792

    10.7

    13.1

    1996-97

    1930

    234284

    26881

    30073

    11.5

    12.8

    1997-98

    1848

    246610

    33924

    33006

    13.8

    13.4

    1998-99

    1848

    261553

    33664

    33361

    12.9

    12.8

    1999-00

    1927

    284761

    40310

    38039

    14.2

    13.4

    2000-01

    1927

    312961

    50719

    41791

    16.2

    13.4

    2001-02

    2031

    322151

    61142

    57471

    19.0

    17.8

    2002-03

    2031

    349667

    71245

    64584

    20.4

    18.5

    2003-04

    2214

    442743

    90437

    83500

    20.4

    18.9

    2004-05

    2214

    549449

    128721

    118608

    23.4

    21.6

    2005-06

    1831

    565444

    137200

    147270

    24.3

    26.0

    $ Net of 'rebates and discounts' and 'excise duty and cess'

    Imports/Sales & Exports/Sales Ratio - All Companies

    Imports/Sales & Exports/Sales Ratio -Manufacturing Companies

    3.   Tax Policy And Corporate Performance

    Key Reforms Affecting Corporate Performance

    •    Reduction of Corporate Tax
    •    Tax on pidends
    •    Rationalization of Excise Duties
    •    Reduction in Customs Duties

    Rates of Corporate Tax (Per cent)

    Year Tax Rate on Domestic Companies

    1991-92

    40* and 50**

    1992-93

    45* and 50** (15)

    1993-94

    45* and 50** (15)

    1994-95

    40 (15)

    1995-96

    40 (15)

    1996-97

    40 (7.5)

    1997-98

    35

    1998-99

    35

    1999-00

    35 (10)

    2000-01

    35 (10)

    2001-02

    35 (2)

    2002-03

    35 (5)

    2003-04

    35 (5)

    2004-05

    35 (2.5)

    2005-06

    30 (10)

    2006-07

    30 (10)

    2007-08

    30 (10)

    * Widely held (in which public are substantially interested);
    ** Closely held (in which public are not 27 substantially interested)
    Note: Figures in parentheses represent surcharge.

    Tax on pidends

    1998

    • Tax on Shareholders pidends Abolished           
    • pidend Distribution Tax (DDT) Introduced

    2002

    • Tax on Shareholders pidends Re-introduced      
    • DDT abolished

    2003

    • Tax on shareholders pidends Abolished            
    • DDT Re-introduced (12.5 per cent)

    2004

    • DDT Increased to 20 per cent.

    2007

    • DDT raised from 12.5 per cent to 15 per cent.

    1999

    •    11 major ad valorem rates reduced  to 3 rates

    2000

    •    Uniform CENVAT of 16%; SED at 8%, 16% and 24% on specified goods.

    2001

    •    SED  at a single rate of 16 per cent.

    2002

    •    SED abolished on all except 8 items.

    2003

    •    SED on select items down from 16% to 8%

    2004

    •    Convergence to a mean CENVAT of 16%

    2005

    •    Of the 5 items attract 24%, duty reduced  to 16% for three items

    2006

    •    Duty reduced  to 16% for the remaining two items

    2007

    •    No change in the CENVAT rate (16 %).

    Customs Duty Rate –  Peak Rate (%)

    Year

    Peak Rate*

    1991-92

    150

    1992-93

    110

    1993-94

    85

    1994-95

    65

    1995-96

    50

    1996-97

    50

    1997-98

    40

    1998-99

    45

    1999-00

    40

    2000-01

    38.5

    2001-02

    35

    2002-03

    30

    2003-04

    25@

    2004-05

    20

    2005-06

    15

    2006-07

    12.5

    2007-08

    10

    * On Non-Agricultural Goods
    @ Reduced to 20 per cent in January 2004.

    Impact of Fiscal Policy on Corporate Performance

    Year

    PAT/Net Worth

    Tax provision /

    Retained Profits /

    pidends / Net

     

    (Per cent)

    PBT (Per cent)

    PAT (Per cent)

    Worth (Per cent)

    1980-81

    14.2

    43.8

    61.8

    5.4

    1990-91

    13.5

    32.4

    62.8

    5.0

    1991-92

    12.0

    36.5

    62.2

    4.5

    1992-93

    8.7

    33.3

    53.9

    4.0

    1993-94

    12.0

    3.7

    67.6

    3.9

    1994-95

    14.0

    20.2

    72.2

    3.9

    1995-96

    14.4

    19.7

    73.6

    3.8

    1996-97

    9.5

    27.8

    64.0

    3.4

    1997-98

    7.6

    26.3

    63.0

    2.8

    1998-99

    5.6

    31.4

    52.3

    2.7

    1999-00

    6.3

    33.2

    47.6

    3.3

    2000-01

    6.5

    32.3

    48.8

    3.3

    2001-02

    5.1

    36.7

    30.9

    3.5

    2002-03

    8.7

    31.3

    56.3

    3.8

    2003-04

    13.2

    28.1

    59.8

    5.3

    2004-05

    16.8

    25.7

    71.7

    4.8

    2005-06

    16.7

    24.3

    73.4

    4.5

     

     

     

     

    31

    Tax Provision/Profits Before Tax

    Any Pattern?

    Why this Steady Fall?

    Note: Sales Include excise duty.

    Impact of Tax Policy

    • No Obvious Correlation between Tax Policy and Corporate Profitability or Tax Payments

    • Business Cycle Appears More Important

    • High Profitability 1992-96

    • Low Profitability 1997-2003

    • Recovery Thereafter

    • Puzzle : Steady Fall in Excise Duty Payments

    4 Monetary Policy And Corporate Performance

    How were the 1980s?

    Till the late 1980s:

    Resulted in:

    Government Raised Funds
    Below Market Rate

    Distorted interest rate mechanism

     

     

    Automatic Monetisation

    Automatic Fiscal
    Accommodation through Ad
    hoc T-bills

    Adversely affected the viability and
    profitability of banks

    CRR Used to Manage
    Liquidity

    Transparency, accounting and
    prudential norms could not be
    strictly followed in banking
    operations

    SLR Used to Ensure
    Subscription

     

     

    No Depth in G-Securities
    Market

    Lack of incentive to seek efficiency

    Segmented and Under
    developed Financial Markets

    Complex Interest Rate Structure

    Paucity of Instruments

    Gross inefficiencies at the micro
    level

    Administered Interest Rate
    Regime

     

     

    Regulation of Deposit Rates

    Non-transparent accounting of
    intra-public sector financial
    transactions

    Interest Rate Deregulation –Deposit Rates

    April 1992

    • Interest Rates Freed between 40 days and 3 years. But ceiling prescribed

    October 1995

    • Ceiling removed for Deposits over 2 years

    July  2, 1996

    • Ceiling removed for Deposits over 1 year

    October 22, 1997

    • Interest Rates on Term Deposits Completely Deregulated

    October 2004

    • Minimum Maturity for Term Deposits Reduced to 7 days

    Interest Rate Deregulation –Lending Rate I

    April 1992

    •  Six Categories of Lending Rates
    • 5 slabs for below Rs.2 lakh
    • Minimum Lending rate Above Rs.2 lakh

    October 1994

    • Lending Rate freed for Loans above Rs.2 lakh & Minimum Rate Abolished

    October 1996

    •  Banks to specify Maximum spread over PLR

    October 1997

    • Separate PLRs permitted for cash credit/demand loans and term loans above 3 years.
    Floating Rate permitted.

    April 1998

    • PLR made ceiling for loans upto Rs.2 lakh

    Interest Rate Deregulation -Lending Rate II


    April 2000

    • Tenor Linked PLR Introduced

    April 2001

    • PLR made benchmark rate; Sub PLR permitted for loans above Rs.2 lakh

    April 2002

    • Bank-wise PLRs made transparent on RBI website

    April 2003

    • Computation of Benchmark PLR rationalized; Tenor Linked PLRs abolished

    Statutory Liquidity Ratio (SLR) since 1990 (% of NDTL)

    Prescribed Cash Reserve Ratio (CRR) –Per cent of NDTL

    Note: With effect from October 29, 2004, nomenclature of Repo and Reverse Repo has been interchanged as per international usage.

    Repo and Reverse Repo Rates

    Note: With effect from October 29, 2004, nomenclature of Repo and Reverse Repo has been interchanged as per international usage.

    Success on Inflation Front –WPI Inflation

    Key Achievement of Monetary Policy

    Non-Food Credit

    Recovery after 2003

    Bank Credit (% to GDP)

    Nominal & Real Interest Rates (%)

    Item

    1990-91 to

    1996-97 to

    2002-03 to

               

    1995-96

    2001-02

    2005-06

    A. Weighted Average Lending Rate of SCBs

    16.3

    15.3

    12.7

    B. Weighted Average interest rates on Central

    12.3

    11.6

    6.6

    Govt. Securities

     

     

     

    C. Average Cost of Aggregate Deposits of SCBs

    7.2

    7.4

    5.3

    D. Average Cost of Time Deposits of SCBs

    8.9

    8.9

    7.0

    Inflation Rate

    a. WPI

    10.5

    4.8

    5.0

     

    b. WPI-Manufacturing

    9.9

    2.9

    4.4

     

    c. CPI-IW

    10.4

    6.8

    4.0

    Real Interest Rate

    Borrowers

    6.5

    12.4

    8.3

     

    Central Govt.

    1.8

    6.8

    1.7

     

    Depositors

    -1.5

    2.1

    2.9

    Note: Real Interest Rate for
    Borrowers = A - b
    Central Govt. Sec = B - a
    Depositors = D - c

    Real Interest Rates

    Low Interest Costs -1 Growth in Interest Expenses of the Corporates

    Low Interest Costs -2

    Interest Expenses / Sources of Fund Ratio

    Changing Pattern of Sources of Fund

    Increasing Reliance on Internal Financing

    But External Finance Increasing Again: ECB?

    Debt Equity Ratio

    Major Change in Financial Structure of Firms

    Liquidity 1: Current Ratio

    Danger Signs or more efficient financial management?

    Liquidity 2: Interest Coverage Ratio*

    Recent increasing Trend: Recovering from strain to meet debt obligation  
    * ICR is defined as the ratio of earnings before interest and taxes to interest expenses.

    Inventory Management

    Capital Formation

    Saving & Investment of Corporate sector

    Source: National Accounts Statistics

    Monetary Policy and Corporate Performance

    • High correlation between real interest rates and corporate behaviour

    • Evidence of significant improvements in financial management in response to interest rates movements

    • Lower inflation rates and interest rates from 2002 have contributed to improved corporate performance

    5 Financial Sector Strengthening And Corporate Performance

    Financial Sector Strengthening

    • Competition Enhancing Measures

    – Operational autonomy and disinvestment of public ownership in public sector banks

    – Transparent entry norms for private and foreign banks

    – Permission for FDI and portfolio investment in banking

    • Strengthening of Prudential Regulation

    – Phased implementation of international best practices (CRAR / Provisioning / NPL Norms / Exposure Limits)

    – Measures to strengthen risk management

    – Guidelines on Ownership and Governance

    – KYC and AML Guidelines

    Banking: Capital Structure

    20 out of 27 public sector banks raised capital from market up to end-March 2006.

    Banking – Asset Quality

    • Marked improvements in asset quality
    • Public sector banks showed more credible performance in NPL management than private sector banks

    6 Capital Market Deepening And Corporate Performance

    Capital Market Deepening

    • Establishment of SEBI

    • Abolition of Controller of Capital Issues (CCI)

    • Removal of Pricing and Issue Control

    • Private Sector Mutual Funds

    • National Stock Exchange

    • Payment & Settlement Architecture

    • G-Sec and Bond Market Development

    Resource Mobilisation from Primary Market-Public Issues

    Market Capitalization

    Stock Market and Corporate Profitability:
    Has the Stock Market Movement been Rational?

    Some Conjectures On “Relating Corporate Performance to Economic Reforms”

    Global Growth, Indian Growth & Corporate Sales

    Global Growth rates are on Calendar Year basis, i.e 1995-96 =1995.

    Interpreting the Evidence 1

    1992-97: Exuberant Response to Deregulation

    • Surge in Investment

    • New Projects

    • Surge in Lending

    • Increase in Corporate Profits

    • High Industrial Growth

    Interpreting the Evidence 2

    1997-2002: Loss in Competitiveness

    • Significant Slowdown in Industrial Growth

    • Investment Slowdown

    • Loss in Confidence

    • Real exchange rate depreciation catches up

    • High Real Interest Rates

    • Period of widespread restructuring

    Interpreting the Evidence 3

    2002-now: Resumption of Growth and Competitiveness 1

    • Industrial growth resurfaces

    • Boom in Corporate Profitability

    • Return of domestic confidence

    • Emergence of International Confidence

    • Increase in Mergers and Acquisition

    Interpreting the Evidence 4

    2002-now: Resumption of Growth and Competitiveness 2

    • Consequence of restructuring

    • Low inflationary expectations

    • International business cycles

    • Investment buoyant

    Thank You


    Special Talk by Dr. Rakesh Mohan, Deputy Governor, Reserve Bank of India at FICCI-IBA Conference on “Global Banking:Paradigm Shift”September 14, 2007.

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