Financial Daily from THE HINDU group of publications
Friday, Jan 02, 2004
Corporate - Insight
India Inc: World's `reforms' playmaker
India Inc has since 1990 seized the opportunities spawned by economic reforms to improve its managerial capability, creativity, effectiveness and responsiveness. It has smartly improved its capital asset productivity, profitability from operations and value delivered to customers, and its contribution to the exchequer through corporate tax.
Over a 13-year period since 1990, India Inc. and its dominant shareholders, chief executives and managerial teams have served the interests of society, suppliers of capital, customers and government admirably well. By so doing, they have smartly transformed themselves into aggressive playmakers in the context of market-oriented economic reforms.
They have collectively become a global benchmark against which other emerging economies, and their governments, corporate organisations and households could calibrate their expectations and future performance. Consider the following.
First, productivity of capital assets measured by net sales to capital employed of a portfolio of 250 companies (almost all from the Business Line 250) has increased by 59 per cent between 1990 and 2003.
Second, sustainable profitability from operations measured by earnings before interest and taxes (EBIT) to capital employed has increased by 80 per cent.
Third, and by contrast, sustainable margin measured by EBIT to net sales has increased by merely 13 per cent. That is, sustainable margin on net sales has increased at less than 0.95 per cent annually between 1990 and 2003.
It is clear that the benefits of the significant increases in capital asset productivity and sustainable profitability from operations have been fully captured by customers of India Inc. in an aggressively competitive market.
Customers of India Inc. have gained in a period characterised by ownership and capital market reforms, lower entry barriers to businesses, freedom of businesses to expand, lower excise duties, lower import tariffs and freer imports. Customers of India Inc. have gained because India Inc. has responded to the new market forces by raising its performance. The `market' has served customers of India Inc. admirably well.
Fourth, government has been the most significant beneficiary of the rising productivity and profitability of India Inc. Corporate tax to capital employed by the 250 companies in the portfolio has surged by 425 per cent between 1990 and 2003 because of the rise in capital asset productivity. Corporate tax to net sales has surged by 230 per cent because of the rise in sustainable profitability from operations. The benefits of the significant increases in capital asset productivity and sustainable profitability from operations have accrued to government, and thereby to the economy. The `market' has served government admirably well because India Inc. has responded to the new market forces by raising its performance.
India Inc. has redeemed government's faith in economic reforms. It has emerged as the government's partner in making economic reforms work for all segments of society. But what is poignant is that the surge in tax inflows has occurred in a period when the corporate tax rate declined.
The corporate tax rate declined from 50 per cent (prior to Finance Minister Prof Madhu Dandavate's epochal Budget on March 19, 1990) to 35 per cent (a consequence of Finance Minister Mr P. Chidambaram's dream Budget on February 28, 1997). India Inc. has redeemed their faith in tax reform.
Everyone has won
SpearHead Asset Research Company's analysis of corporate performance in 15 emerging economies shows that India Inc. and its managers have made everyone a `winner' by raising corporate performance.
The government's responsiveness to India Inc.'s pursuit of efficiency and effectiveness, competitive markets and freedom of customers to choose, minimum alternative tax, and transparency and fairness in tax administration have played a critical role in making everyone win.
The unique structure of India Inc. has contributed too. Its uniqueness is the result of the significant `inside ownership'. Government is the significant inside owner of equity in public sector companies. Entrepreneurs are the significant inside owners of equity in private sector companies.
Productive and smart
Society has gained because of the increase in capital asset productivity. The ratio of net sales to capital employed has increased from 0.82 to 1.31 (Graph 1). By raising the productivity of capital employed, India Inc. has shown that it would serve the future consumption needs of a growing population without staking a big claim on household savings and global capital.
Suppliers of capital have gained because of the increase in the ratio of earnings before depreciation, interest and taxes (EBDIT) to capital employed. EBDIT to capital employed has increased from 15 per cent to 24 per cent (Graph 2). Suppliers of capital include generic lenders, banks and equity investors.
From such a perspective, EBDIT to capital employed is the gross return to suppliers of capital and government. Taxes are government's claim. The rise in EBDIT to capital employed by 62 per cent shows that India Inc. has appreciated the truth that assets do not know how they are financed or at what rate of interest a company borrows.
Capital employed is the same regardless of whether a company has more debt or more equity. Since EBDIT is computed before reckoning with interest rates and interest, EBDIT is not dependent on the debt-to-equity ratio and interest rates.
Therefore, the rise in EBDIT to capital employed is certainly not because of lower interest rates. The significant increase in EBDIT to capital employed shows that India Inc.'s managers have become smarter and more efficient users of capital and capital assets. They are equipped well to face higher interest rates too.
The significant increase in EBIT to capital employed by 80 per cent (Graph 3) shows that India Inc.'s managers can sustain asset productivity after setting aside earnings for replenishment of depreciable assets. Over the long term, they will produce such EBDIT as to replenish depreciable assets and then payout interest, taxes and dividends.
India Inc.'s managers have demonstrated this capability by reinvesting a large part of earnings into capital assets. There is more ploughing back into corporate assets now than a decade ago. Ploughed-back capital has doubled from 23 per cent of capital employed to 47 per cent (Graph 4).
There is greater dependence on internal generation of surpluses now than in the past. India Inc. has entered a virtuous spiral of internal value creation.
India Inc.'s gains in productivity and profitability have not been at the expense of customers. India Inc. could have improved net sales and EBDIT through higher prices or margins or both. But the gains in net sales have been achieved in a period marked by low price inflation of manufactured goods and services. And customers have had to bear lower margins too.
EBDIT to net sales has remained static at 18 per cent (Graph 5). EBIT to net sales has risen by merely 13 per cent since 1990 (Graph 6). India Inc. has quite clearly earned its aggregate margin by serving more and more customers than by raising prices or margins. That is, India Inc. has expanded markets for its output and served more customers, albeit without hiking unit margins.
India Inc. has entered a virtuous spiral of value creation for its customers through market expansion. India Inc. is the master of mass markets for the masses. A billion and more customers deserve such a response.
Government and the market
For long, leading economists the `government-or-the-market' economists have argued that societies have to make a choice between government and the market in the context of improving their standards of living. They have regarded government and the market as mutually exclusive forces. These economists have argued that markets and companies cannot and will not simultaneously create value for their stakeholders, customers and society. But India Inc. has created value for itself, suppliers of capital and customers. There is more. It has become a playmaker for government in achieving the objectives of market-oriented reforms.
Corporate tax to capital employed has risen from 1.38 per cent to 7.24 per cent, a surge of 425 per cent (Graph 7). Corporate tax to net sales has risen from 1.68 per cent to 5.54 per cent, a surge of 230 per cent (Graph 8). India Inc. has proved the `government-or-the-market' economists wrong by simultaneously creating value for its stakeholders who belong to the marketplace and to government that has erroneously been regarded as an outsider to the marketplace.
Government belongs to the market because it derives value from the market. India Inc. has made government a beneficiary of the gains derived from productivity, profitability, effectiveness and smart management. Has India Inc. set off the `government-and-the-market' wave in economics? Perhaps, yes.
(The author is a financial analyst. Analytical assistance provided by V. Subrahmanyeswara Sarma, a graduate student of the Institute for Financial Management and Research, Chennai, is gratefully acknowledged. Feedback may be sent to firstname.lastname@example.org)
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