by Rakesh Mohan
Omkar Goswami
Despite some ups and downs, there is no doubt that the corporate sector of India has flourished in almost unimaginable ways in the last quarter of a century. There have been two fascinating elements to this growth. Both involve ‘the churn’: one that threw aside a large number of inefficiently run, but hitherto famous, corporations; and the opposite that brought to the fore companies which were either non-existent or at the bottom of the pecking order.
An earlier chapter of this volume (‘Remembering 1991 … and Before’) touched upon the state of India before the launching of reforms in July 1991, and the effect that the first set of such reforms had on a country desperate for change. This chapter, which focuses on large- and medium-scale corporate entities and how these fared over the quarter century since July 1991, is no place to give further details on the many reforms that occurred—and those that did not—under Prime Minister P.V. Narasimha Rao, as well as his successors: H.D. Deve Gowda, I.K. Gujral, Atal Bihari Vajpayee, Manmohan Singh and the present incumbent, Narendra Modi. Nevertheless, a few points are worth making.
First, none can deny that over the last twenty-five years, there have been significant reforms in various sectors of the economy—telecommunications, capital markets, central and commercial banking, insurance, indirect and direct taxes, foreign portfolio and direct investments, to name some.
Second, while many of the reforms may have been carried out in a haphazard, stop-and-go manner, these have together created an environment to unleash entrepreneurial freedom and energy of the kind that India never saw over the forty-four years from 1947 to 1991, which has created a large and economically powerful corporate sector that, in most parts, takes its growth and investment decisions independent of the state.
Third, it is necessary to admit some economic failures: conspicuous lack of divestment or privatization, despite annual budgetary targets; insufficient labor-market reforms; poor infrastructure, be it roads, highways, ports or power distribution; inability to create a manufacturing ethos and raise its share from roughly 16 per cent of GDP; failure of bankruptcy processes; difficulties in acquisition of land for factories and in getting mining rights; and, perhaps most seriously, inadequate recognition of the fact that over the next fifteen years, India will have some 12–15 million people entering the potential workforce per annum, in an environment where increasing productivity of information technology and machines coupled with a distinct disinclination to hire more workers has led to negative employment elasticities across all sectors of the economy.
In essence, this chapter uses large databases of listed companies to evaluate how corporate India fared over the last twenty-five years since the advent of reforms in July 1991. Many themes emerge: unparalleled corporate growth coupled with enormous churning; the rise in corporate concentration across industries; the behaviour of critical costs such as wages and salaries and interest payments; the extent of leveraging; the story of state-owned enterprises (SOEs); why manufacturing still does not grow fast enough; widespread failure of infrastructure and, despite liberalization, the enormous difficulties in doing business in India; the deeply worrying reality of virtually employment-less growth; and some ideas of reform, if we have to do significantly better in the next twenty-five years than we have in the previous quarter.
Corporate Growth and ‘the Churn’: 1991 versus 2016
It is impossible to overstate the extent of corporate growth that has occurred in India since the summer of 1991. To understand this, we need to reflect upon the data for all listed companies given in Prowess, the corporate database prepared and updated by the Centre for Monitoring the Indian Economy (CMIE). These are given in Table 1 and Chart A. Consider some of the basic facts between 31 March 1991 and 31 March 2016:
The top-line (gross sales plus other operating income) for all listed companies was eleven times greater in 2016 than in 1991.
Profit after tax (PAT) was twenty-five times greater in the course of these twenty-five years.
Market capitalization was 118 times greater.
Simply stated, the top-line grew at 10 per cent per annum, PAT at 13 per cent, and market cap at 19 per cent. India had not witnessed such corporate growth rates—or anything remotely close—in the period between Independence and 1990.
There have been two fascinating elements to this growth. Both involve ‘the churn’, one that threw aside a large number of inefficiently run, but hitherto famous, corporations; and the opposite that brought to the fore companies that were either non-existent or at the bottom of the pecking order. The best way to understand this is to first pick companies that belonged to the top fifty in market capitalization, as of April 1991, and then examine their ranking across every five-year period, up to 2016. The other is to do just the opposite: take the top fifty in April 2016, and assess how these grew in prominence over the quarter century.
First the losers. Consider the top fifty companies listed on the Bombay Stock Exchange (BSE) on the first trading day of April 1991. These have been ranked in descending order of market cap. Table 2 gives the data. The sample has been arranged in groups of ten: the ten highest in market cap, then eleven to twenty, and so on. For the first ten in 1991, the mean rank is 5.5, or the average of the numbers from 1 to 10. Similarly, the next decile’s average rank is 15.5, and so on. Now, examine the top ten. Compared to 1991, this group’s average rank fell by 12.4 places in just the first five years, by 43.6 places in 2001 and by 75.3 places in 2016 vis-à-vis 1991. The second group of companies—ranked eleventh to twentieth in market cap in 1991—fared far worse. The average rank fell by 30 places in the first five years; by almost 80 in the first ten; and by over 202 by April 2016. Chart B depicts the data.
Here are some 1991 leaders that just could not cope with a more competitive milieu, and plummeted. Ballarpur (now BILT), then led by Lalit Thapar, was fifteenth in 1991. By 1996, its rank fell to fifty-six. Five years later, it went down to 110. This secular decline continued at an increasing pace. Despite significant investments and modernization carried out by Lalit Thapar’s successor Gautam, its rank stood at 441 in April 2016—a tragic outcome for what was once the flagship of a prominent business group. Escorts, a Delhi-based engineering and tractor-manufacturing major, founded by H.P. Nanda, was twenty-third in 1991. After the first five years, its rank had dropped to seventy-eight, five years later to eighty-six, and by 2016 it was placed at 332, completely outclassed by other tractor and earth-moving manufacturers. Bombay Dyeing, managed by Nusli Wadia, was ranked twenty in 1991. It dropped to the fiftieth position in 1996, to 183 in 2001, and was at a pathetic 420 in April 2016, prompting the cruel jibe of Bombay Dyeing becoming Bombay Dead. Mukand Iron and Steel, founded by the Shah and Bajaj families and then run by Viren Shah’s older son Rajesh, was thirty-ninth in 1991. In a decade, its rank had dropped to 329. By April 2016, it was at 550. Nocil, a major rubber chemicals manufacturing entity, founded by the Mafatlals, was at twenty-five in April 1991. Five years later, it was down to ninety-nine, by 2001 it was at 200, and in April 2016, it languished at 462.
Chart A: How Corporates Grew, 1991 versus 2016
Chart B: How Yesterday’s Mighties Fell (Drop in Market Cap Rank)
There were several others. The reasons for such a sharp decline in ranking were manifold, of which two need stating. First, many manufacturing entities of the early 1990s were inherently inefficient and had survived thanks to a cossetted, non-competitive regime of entry barriers and astronomical tariffs and quotas. Once these were removed, such firms were cruelly exposed to international as well as domestic competition. This, in 1993, prompted the so-called ‘Bombay Club’ to put out a petition urging a brake on reforms.1 Second, several new entrants, as well as those who were lower in the pecking order but could deal with greater competition, rapidly went up the scale and substantially changed the ranking.
Here are the facts:
Six of the top ten companies ranked by market cap in April 2016 were either not listed or non-existent
in April 1991. These were: TCS (ranked first in 2016), Infosys (third), HDFC Bank (fifth, which did not exist in 1991), Sun Pharma (sixth), ONGC (eighth) and SBI (tenth).
Eight of the next ten were either unlisted or did not exist in April 1991: ICICI Bank (eleventh and non-existent as a commercial bank in 1991), Wipro (twelfth), Bharti Airtel (thirteenth), Kotak Mahindra Bank (fourteenth, non-existent in 1991), HCL Technologies (fifteenth), Maruti Suzuki (seventeenth), NTPC (nineteenth) and Axis Bank (twentieth, non-existent in 1991).
Thirty-two of the top fifty companies ranked by market cap in April 2016 were either unlisted or did not exist in April 1991. Only eighteen were listed. The contrast gets sharper as one goes down the line.
Basically, then, the competitive churn threw up new enterprises that rapidly grew in corporate valuation as they relentlessly pushed down those that failed to adjust to the changing times. Nothing could have been better for the health of corporate India.
Corporate Concentration, Profits, Cost Structures and Leveraging
How did this churn affect the structure of corporate India? First, what happened to corporate concentration? Simply put, notwithstanding greater entry of companies, did the market share of the larger corporations increase or decline? To evaluate this, we look at the net sales (sales-less indirect taxes) of a large sample of listed manufacturing and non-financial-service-sector companies across two discrete time periods: 31 March 1991 and 31 March 2016. The answer is unambiguous: corporate concentration has increased quite substantially over the period of 1991-2016. There is nothing particularly worrying about this. Indeed, it is arguably inevitable. Greater economic freedom created an environment where larger firms disproportionately increased their net sales compared to their smaller counterparts. Table 3 and Chart C depict the facts.
Table 3: Increasing Industrial Concentration (Percentage of Net Sales)
% of net sales
% of companies
1991
2016
Top 10%
68.9%
79.1%
11% to 20%
80.6%
89.0%
21% to 30%
87.2%
93.8%
31% to 40%
91.4%
96.7%
41% to 40%
94.4%
98.3%
51% to 60%
96.5%
99.3%
61% to 70%
98.0%
99.6%
71% to 80%
99.1%
99.8%
81% to 90%
99.8%
99.9%
91% to 100%
100.0%
100.0%
Herfindahl Index
197.93
314.03
Sample Size
1811
1834
Source: Prowess, CMIE.
Chart C: The Rise in Concentration (Percentage of Net Sales, Manufacturing Companies)
The increase in concentration of profits is even more pronounced, be these earnings before interest, taxes, depreciation and amortization (EBITDA); earnings before interest and taxes; profit before tax; or PAT. Again, this is to be expected. In general, those manufacturing firms that have grown significantly faster than others have tended to generate greater profits than the rest.
What does this mean for ‘crony capitalism’? It is an indisputable fact that the Herfindahl indices and Gini coefficients have increased across almost all industry groups—in manufacturing, mining, non-financial services. However, the fact that concentration has grown does not automatically imply that this has been predicated upon crony capitalism—a state where it is assumed that most, if not all, companies at the top of their pecking order secured special advantages from the central and state governments to get to their dominant market positions. We tend to confuse this causality: crony capitalism certainly increases industrial concentration; but a rise in such concentration does not necessarily imply a ubiquitous regime of crony capitalism.
Having said so, in some sectors there is certainly reason to believe that corporate groups have reached the top echelons through systematically cultivated quid-pro-quo relationships with the state. This is true of mining, power generation, telecommunications, private ports and airports, and businesses that have needed large purchases of land. It is important to note that these are sectors where the State, be it the central or state governments, has not only enormous discretionary powers but also considerable say in who gets these resources and who does not. Not surprisingly, the two largest public scandals under the Congress-led UPA-I and UPA-II government (2004–14) were in the allocation of coal-mining rights to power-generating companies and in spectrum to the mobile-telecom operators—both of which led to draconian interventions by the Supreme Court of India which, while attempting to fix the malaise, pushed back growth by some three to four years.
Two issues need to be addressed before moving on to profitability, costs and leveraging. First, given substantial differences in profitability, cost and gearing between manufacturing and (non-financial) service-sector companies, it is necessary to distinguish these. Thus, instead of averaging the relevant numbers across both sets of firms, we report these separately, wherever appropriate. Second, there is a data issue. Until the financial year ending 31 March 2001 (FY 2001), all Indian companies were required to publish their annual accounts on a ‘stand-alone’ basis only. Thus, a listed company would give such data only for its stand-alone operations, but not for its subsidiaries, associated or joint-venture enterprises. This changed from FY 2002, when it became mandatory to publish consolidated accounts in addition to the stand-alone.2 In what follows, data for the period FY 1991 to FY 2001 are from stand-alone accounts, and from FY 2002 to FY 2015 are from consolidated financial statements. The exception is leveraging, where only the consolidated financials have been considered, because these give fundamentally more accurate estimates of a listed company’s total corporate debt and leverage.
What is the story of profitability between FY 1991 and FY 2015? Chart D plots the data for companies in manufacturing and non-financial-sector services. It shows that:
There has been no significant secular uptick or downtrend in EBITDA to net sales, either in manufacturing or in services. At the advent of reforms, the ratio was 12.7 per cent for the listed manufacturing firms. It fell to a trough to 10.9 per cent in FY 2000, with many firms still struggling to deal with greater competition, then gradually peaked at 15.9 per cent in FY 2010, after which aggregate demand compression and relatively lower GDP growth brought it down to 12.4 per cent in FY 2015. The EBITDA margin for firms operating in the non-financial-service sectors stood at 18.7 per cent in FY 1991; with some wobbles, this rose to 22.4 per cent in FY 2014 before settling at 19.8 per cent in FY 2015.
On average, firms in the business of providing services have consistently earned higher EBITDA margins than their counterparts in manufacturing. It is largely on account of the sheer weight of India’s major IT companies, which have always earned substantial EBITDA margins. It is also to be expected; after all, there is far more intense competition from imports in manufacturing than in services, which are in most part non-tradable.
Moreover, there has been a clear adverse effect of an uncompetitive and overvalued real, effective exchange rates. Facts bear this out. Since the early to mid-2000s, there has been a consistent inflow of about 6 per cent of GDP—half of it from exports of IT and business process outsourcing (BPO), and the other half in the form of remittances from non-resident Indians. Hence, India has had a constant flow of around 6 per cent of GDP from these two items of net invisibles. Consequently, even a manageable current-account deficit of 2 per cent of GDP translates to a merchandise trade deficit of around 8 per cent of GDP. This clearly indicates an overvalued exchange rate for manufacturing, which has put severe limits on exports of manufactures and, therefore, additional growth.
The difference in financial performance between listed manufacturin
g companies and their non-financial-service-sector counterparts also shows up in the return on net worth (RONW).3 Chart E plots the data.
The pattern is quite similar to the share of EBITDA to net sales, as depicted in Chart D. The onset of competition and rising interest costs from 1996 to 1999—as the RBI kept raising the policy rates to quell inflationary pressures—led to a drop in manufacturing RONW from a high of 25.7 per cent in FY 1995 to a trough of 5.7 per cent in FY 1999. Thereafter, it picked up, initially gingerly and then very rapidly to a peak of 47 per cent in FY 2008, in line with a GDP growth that surged first to 8 per cent and then for three consecutive years to over 9 per cent, with companies simultaneously getting leaner and more efficient in their manufacturing practices, working capital management and inventory turns. Then came the global financial crisis and decline in GDP growth, which, in turn, led to falling demand: consequently, manufacturing RONW steadily dropped to 15.8 per cent in FY 2015. It remains around the mid-teens today.
Chart D: EBITDA to Net Sales, Manufacturing and Non-financial Services
Chart E: Return on Net Worth, Manufacturing and Services
Throughout the period—be it in the downswings or upturns—the RONW for firms in the non-financial-service sector remained generally higher than their compatriots in manufacturing. Thanks to the IT majors, it peaked at 71.7 per cent in FY 2008, which was 24.7 percentage points higher than that of manufacturing for the same year. Subsequently, it declined thanks to international and national demand compression. Even so, it clocked 43.6 per cent in FY2015, which happens to be among the highest global average RONW for companies in services.
This raises an important question: how much of this distinct difference in profitability and return on net worth between the manufacturing companies and their non-financial-service-sector counterparts is on account of the consistently brilliant operational and financial performance of India’s IT and BPO entities? The answer is: a lot. Consider RONW, for instance. By FY 2005, IT and IT-enabled services such as BPO accounted for a third of the entire RONW earned by all listed firms in the non-financial-service industries. This share increased to over 50 per cent by FY 2011 and thereafter rose to over 75 per cent. Indeed, without IT, BPO and other such IT-enabled services, the overall profitability of services is sometimes no different from that of manufacturing, and in several years, lower. This is especially true over the last five years.
