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INDIA INC HAS come up with an encouraging performance in the second quarter of the current fiscal. Post-tax profits have increased by over 30 per cent, but can that heady pace be sustained? For, the operating profit margin — an indicator of sustainability — has been flat with the exception of steel and pharmaceuticals sectors. The overall earnings growth has been fuelled by a spurt in `other incomes' and the continuing decline in interest costs. While there is still some scope for sourcing funds at lower rates and thereby improving profitability, a plateau may have been reached vis-à-vis the latter. The returns from equity and debt market investments have been responsible for the jump in `other incomes'. Considering that interest rates have stabilised in the economy and equity valuations are at the peak level of earnings capitalisation, any dramatic improvement in portfolio gains looks unlikely.

Because of these two factors, companies may find the gap between the growth in operating profits and post-tax earnings narrowing fairly quickly. They are unlikely to find much relief in cutting manufacturing costs. In fact, the scope for further cost reduction may be limited as companies, especially in such key sectors as automobiles and cement, already face a situation of rising input costs that they are unable to pass on to buyers because of the intensity of competition. One area that offers some scope for cost cutting is labour as companies continue to prune their workforce through employee separation programmes. Yet, the gains made here may not adequately ease the pressures likely from the lower contribution from declining interest costs and the modest revenue growth. These pressure points will have to be eased if the earnings growth, that is `fundamental' to the current rally in stock prices, is to be sustained. The gainer has been the customer who has never had it so good.

Yet, the strong resurgence in demand, both in the industrial and service sectors, has not translated into commensurate revenue growth because of the intense competition. An improvement on this score is crucial to driving earnings growth. The key issue that merits a close look is whether companies can push through price hikes and still enjoy the volume growth of the 2003 kind. The low level of interest rates may keep the demand growth at healthy levels in the housing and automobile sectors. The spillover effect would be felt in such areas as steel and cement. But even this may not sustain the growth rates at levels seen over the past 12 months. A more modest earnings growth rate appears on the card, if not immediately, certainly a couple of quarters hence. The situation only underscores the need for policy initiatives that will spur both public and private investments in the economy so that the resultant rise in demand secures corporate sector growth.

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