ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Dissecting the Extraordinary Surge in Corporate Profits

Uneven profits across sectors, input cost pressures, and a rise in interest rates coupled with a weaker rupee could put the brakes on the pace of firms’ profits.

Radhika Pandey and Pramod Sinha write:

The COVID-19 pandemic derailed the economy but acted as a boon for the listed companies. The steep corporate tax cut in 2019 and pandemic-induced cost-cutting boosted the profits of firms. The pandemic year was also the time when Indian companies repaired their leveraged balance sheets. Due to the easy monetary policy regime characterised by low interest rates in financial year (FY) 2020–21, companies deleveraged by repaying high-cost loans through funds raised via bond issuances. Repayment of the existing high-cost debt reduced the interest cost and made companies more profitable. Going forward, the extraordinary surge in profits could see a moderation due to a rise in interest rates and a weaker currency.

The economic disruptions caused due to the COVID-19 pandemic led to a slump in the profits of the non-financial firms in the April–June quarter of 2020. However, with the gradual easing of restrictions, the profits of listed non-financial firms showed a healthy growth in the next quarter (July–September). In the July–September quarter of 2020, the rise in profits was primarily on account of cost-cutting, as the sales growth of firms remained in the negative territory. Firms opted for various cost-cutting measures such as reduction in salaries, deferring capital expenditure plans, and slashing advertisement expenses. However, in the next two quarters of FY 2021, the increase in profits was accompanied by an improvement in sales. Thus, the increase in profits in the second half of FY 2021 was on account of an increase in output rather than cost rationalisation.

Although profits have remained robust, rising commodity prices and building of input cost pressures have caused a moderation in the pace of the growth of profits in the last three quarters. With the Reserve Bank of India (RBI) increasing the policy repo rate, amid sustained inflation and supply-chain disruptions, the corporate sector could see a further erosion in the profit levels in the coming quarters.

While the headline profit numbers show a robust growth in the quarterly financial performance of firms since the pandemic, two questions beg attention. First, is the strong growth seen in profits broad-based or is it driven by a handful of sectors? This requires a deeper sectoral analysis of profits. Second, with the wholesale price index (WPI) inflation remaining in double digits for more than a year now, what is the picture on the overall profits after adjusting for inflation?

While the average quarterly nominal profits of listed companies are reported to have doubled in the eight quarters from June 2020 as compared to the preceding eight quarters, a disaggregated analysis could present an assessment of sectors that were hit hard by the pandemic. Nominal growth of profits during a period of low and stable inflation provides a true assesment of growth. However, in the recent months when the WPI has remained elevated for a sustained period, it is prudent to use a suitable deflator to express the nominal profit levels in real terms. Such an analysis could serve as a useful guidepost for policy intervention.

Rather than looking at the growth rate of a particular quarter, it is useful to do a comparison of the pre- and post-COVID-19 average real profits (using eight quarters from June 2020 onwards and the preceding eight quarters). This comparison would give a sense of those sectors that have staged a smart recovery and those that are still languishing below the pre-COVID-19 profit levels.

Analysing the inflation-adjusted profits of a common sample of non-financial, non-oil listed firms for the period from June 2018 to March 2022 reveals some interesting sectoral variations. Oil and finance firms are excluded as they follow a different revenue model. Sectors such as metals and machinery have recorded higher profits on the back of a strong demand in domestic and global markets as commodity prices have firmed up. Contact-intensive services such as hotel and tourism have reported lower profits as compared to their pre-COVID-19 average. Driven by a slump in consumption, sectors such as food and agro-based products as well as paper and paper products are still below the pre-pandemic average real profit levels. Due to an increase in metal prices, sectors that use metals as raw materials such as automobiles, transport equipment, and transport services saw a shrinking of their profit margins. Sectors such as textile and consumer goods have posted profits higher than their pre-COVID-19 average, but the extent of the increase is muted.

Going forward, rupee depreciation coupled with a spike in global crude oil prices would further inflate the input costs of companies and erode their margins, particularly those that are dependent on imported inputs and commodities. However, export-oriented sectors including labour-intensive sectors like textiles, garments, footwears and handicrafts could benefit. Moreover, for the benefits of a weaker currency to accrue, the volatility in the exchange rate needs to moderate. Services like information technology also stand to benefit from a weaker currency. But the sector needs to address its attrition-related woes.

Simultaneously, the rising borrowing costs due to two consecutive rate hikes by the RBI will hit the firms’ margins. A sustained rise in interest costs could reverse the deleveraging trend seen in the last two years.


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Updated On : 20th Jun, 2022
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