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India Inc's deleveraging: A sign of the times?

ZappChai - Monday, Dec 30

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After repaying close to 43,000 cr in FY19, India Inc's top 50 companies have already reduced their debt by 60,000 cr in the first half of 2020. In a world where debt is available at historically low rates and the government is incentivizing the construction of new capacity this is quite the statement and speaks of how these top firms look at the times ahead. In today's post, we try to understand why India Inc is accelerating its reduction of debt and what it says about India's future.

Where can firms deploy money?

Before we look deeper into the implications of the deleveraging, it helps to look at the primary areas firms can deploy capital. There are three main areas where it can go: First on working capital and other operational needs(more marketing spend, larger inventory etc); Second reinvesting it in the business to generate long term assets (starting a factory, improving existing machinery or investing in R&D for example) and last is either returning the money to shareholders/debt holders or buying financial assets. The first spend for most cases generally carries on unchanged at whatever rate is needed to support the business, which makes the primary tradeoff between 2 &3.

How do firms decide when to build long term assets?

The decision is a tricky one, driven by a lot of factors, and is a decision that often goes wrong. The most important driver for growing long term assets would be stretched utilization levels. If you have your factory running close to 100% utilization and the market is growing, not investing in growing capacity could mean lost sales at best, and loss of market share at worst. Factors like how cheap it is to build these assets, driven in part by how cheap it is to raise capital as well as any other incentives like the government may decide to provide (tax breaks, SEZs, etc) also help the decision. The fact that both of these factors are currently supportive of increased spend, with national and international rates at historic lows, and the government introducing a limited period lower tax rate on new manufacturing facilities should both be good drivers to restart the capex cycle. The use of corporate funds in such a scenario to repay debt could signal how they view our future economic prospects.

The I-Street D-Street mismatch

While the fact that India is currently going through a tough patch economically is common knowledge. However, despite the slowdown, valuations of firms on the exchange continue to rise. The reason behind this is often stated as a world where the worst is behind us, and the market is pricing in the growth beyond. But if that were truly the case, and there was growth ahead, wouldn't firms have begun investing in assets in preparation of it, especially given how lucrative it is now to do so. The fact that industry leaders are actively de-risking by reducing debt seems to signal that the view from the industrial complex isn't as rosy as the view from the highrises of D-street and it increasingly looks like one of the two is wrong.


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