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What is India’s corporate profitability...

…and what are its determinants?

* When anyone talks about India’s corporate profitability, we tend to narrow down our analysis to the listed sector comprising of about 6,500 companies. Corporate profitability in India, in this narrow sense, peaked out at 6.3% of GDP in FY08 and has fallen to a 27-year low of 1.5% of GDP in FY20. During the same period, corporate profitability in the US moved to 9% from 8% of GDP. The same for the UK rose slightly to 9.1% from 8.6% of GDP. In short, while corporate profitability in India fell in the 2010s decade, it rose to a record high in the US and was stable in the UK.

* This wide gap between India and the Western world in terms of corporate profitability is highly misleading because it’s like comparing apples with oranges. While the US and the UK are organized/formal economies, India has a very large unlisted/unorganized sector. According to the Ministry of Corporate Affairs (MCA), only ~0.5% of registered companies in India (6,741 out of 1.33m) are listed and less than half of them are actively traded. From an economic perspective, the large set of unlisted companies plays a very crucial role. In this note, we provide a long-term series on India’s corporate profitability, including unlisted companies. Since our estimates are based on a macroeconomic identity, we discuss in detail about the key determinants of corporate profitability in a nation.

* Using the macroeconomic identity, which we call the ‘Theory of Everything’, our estimates suggest that India’s corporate profitability (listed + unlisted) moved up from a paltry 5% of GDP in the late 1990s and early 2000s to its peak of 12.4% of GDP in FY08 and has been in a narrow range (8.5% to 9.5% of GDP) between FY09 and FY18. It fell to a 15-year low of 7.9% of GDP in FY19, before recovering to 8.9% of GDP in FY20 (subject to revisions). India’s corporate profitability in recent years was comparable to that of the US and the UK. However, there are two highlights: a) corporate profitability in India has weakened compared to pre-CY08 levels, while it has increased in the US and the UK, and b) the share of unlisted companies in India’s corporate profitability has risen to about 70% in recent years from less than half in the 2000s decade.

* We also analyze the only available data set on domestic private limited (unlisted) companies by the Reserve Bank of India (RBI) to get more confidence on these findings. According to RBI data, the profitability of private limited companies has increased at an average 21% during the past seven years (FY13-19) vis-à-vis an average growth of just 3% for listed companies. The rising share of unlisted companies in India’s corporate profitability is thus confirmed by RBI’s data set.

* Corporate profitability in an economy is dependent on the corporate sector and behavior of households, government, and the external sector. Corporate profitability is positively correlated with total investments and fiscal deficit in a country, while it is inversely correlated with household savings and current account deficit (CAD) in an economy. In other words, greater the investments/fiscal deficit and lower the household savings/CAD, the higher is corporate profitability.

* Based on these key drivers, the trends in India’s corporate profitability can be broadly divided into five phases in the past three decades. The rapid surge in profitability between FY03 and FY08 was entirely driven by higher investments, while the decline in the immediate period post-GFC (FY09-13) was led by higher household savings and wider CAD. Recently, corporate profitability has been stable, as lower investments were almost entirely offset by lower household savings.

* It will not be advisable to extrapolate trends of listed companies to the entire corporate sector, and thus, the economy. While listed companies have seen a rise in profitability in 2HCY20, unlisted companies are likely to have suffered more due to COVID-19. Also, we must appreciate the inter-linkages between different sectors and its impact on corporate profitability.

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