- Q2 has by far been the biggest surprise and is unlikely to be repeatedEarly indications of a post-lockdown revival came from the September quarter numbers of Corporate India. Directionally, it is corroborated by the gross domestic product (GDP) data for Q2 FY21. Silencing the naysayers, the real GDP decline of 7.5 percent was much above the consensus forecast.
The positive contribution of agriculture (YoY growth of 3.4 percent) was on expected lines. The surprises included: the marginal growth in manufacturing (0.6 percent), and the lower-than-expected decline in construction (at – 8.6 percent in Q2 against -50.3 percent in Q1) and the trade, hotels, transport and communication segments (decline of 15.6 percent in Q2 compared to 47 percent in Q1).
Although India has entered a technical recession with two consecutive quarters of GDP decline (Q1 FY21 fell 23.9 percent), there are reasons to be optimistic.
The expenditure break-up of GDP suggests that other than government expenditure, which was 78 percent of last year’s level, and imports (83 percent of last year’s level and a positive from GDP perspective), other components such as private expenditure, investments and exports are a whisker away from pre-COVID levels.
Budget 2021-22: Here's how you can share your ideas with government
In the absence of large volumes of disaggregate data points it is difficult to comment on the sustainability of the trend. However, we turn to the latest quarterly earnings report of listed companies to check the ground reality of the quarter and draw cues on the sustainability of this revival.
The weakness in government expenditure is reflected in the bulging receivables of companies dependent on government orders. However, with tax collections showing positive traction, these companies are expecting government expenditure to normalise in the second half.
What about the not-so-bad expenditure picture of GDP?
Source: Moneycontrol Research
The analysis of India Inc’s top line performance over the last two quarters clearly shows an across-the-board recovery, irrespective of the sizes of companies. The YoY decline in sales of 6.2 percent on an aggregate basis is broadly in line with the 7.7 percent fall in private expenditure in the GDP data. If the momentum continues, sales will likely see growth in the second half.
The moratorium – the joker in the pack so far
However, there are certain stand-out features of the Q2 numbers that merit attention. The July-September 2020 quarter was one that had the benefit of the moratorium. This might have helped some smaller companies. For instance, while the absolute interest payment of all listed companies as well as the companies belonging to the Nifty index was more or less flat, for smaller companies represented by the BSE Small Cap index there was a YoY decline in interest expenses by over 8 percent. This could have been because of the moratorium benefit.
The moratorium till the end of August followed by the Supreme Court’s standstill on asset classification resulted in no deterioration in asset quality for financial sector firms amid the overall weak economy. Savvy players have used the windfall to shore up provisions. On an overall basis, this had a significant positive impact on the banking sector’s profitability.
In Q3, the benefits of the moratorium would not exist. This could impact numbers, especially for financials and some stressed companies.
Extreme cost optimisation & its consequences
India Inc has cut down costs to the hilt in the September quarter. Even with a benign performance on top line and no great benefit of operating leverage, the number of companies that have reported a year-on-year improvement in operating margins is mind boggling. While softer input costs had some role to play, a greater contribution came from rationalisation of headcount as well as employee remuneration alongside stringent control over all discretionary expenses.
Source: Moneycontrol Research
For the overall universe of listed companies, 58 percent companies reported an improvement in operating margin. For Nifty companies, this was a whopping 74 percent.
Why this level of cost optimization may not be good news
Firstly, cost optimization of this magnitude is bound to impact fortunes of certain sectors in terms of lower purchasing power that could be a probable drag on GDP.
This could also inhibit a meaningful revival in corporate earnings, if demand remains lacklustre. On the other hand, with a gradual return of normalcy, if companies revert to close to pre-pandemic cost structures, then earnings surprise could be limited.Hence, a surprise of the magnitude seen in Q2 might not repeat itself although the quarters ahead could see a further return to normalcy - GDP growth limping back to positive territory and corporate earnings gaining traction. Savvy investors have to take note of the same.