These assumptions suggest that the Finance Minister is banking on industry growth to give him funds to finance his expenditure. The assumptions also indicate that even if industry growth of this order materialises, profit growth could be muted. This could happen if taxes grow at a faster rate than profits. Rising employee and interest costs could also prove a dampener.

Impact of taxes: Profits of the corporate sector rose at a healthy pace of about 40 per cent in 2002-03 and about 30 per cent in 2003-04. This was despite excise duties and corporate taxes rising at a faster rate than sales growth of the corporate sector. The corporate sector could grow profits at a faster pace even after paying highertaxes because they were able to reduce interest costs substantially. Muted growth in employee costs in 2002-03 also helped, although employee costs rose faster in 2003-04. And efficient working capital management delivered rich dividends for the corporate sector.

The present financial year could be different. The Finance Minister is planning for a 27 per cent increase in taxes. He says that much of the growth would come from better enforcement and that contribution of fresh levies has been minimal. Let us thus assume that taxes and duties will grow only 20 per cent this year. Even then, profit growth could be of the order of 25 per cent. That is possible if employee costs and interest costs grow by 9 per cent and 5 per cent respectively. However, if employee costs and interest costs keep pace with GDP growth of 12.7 per cent, profit growth will dwindle to less than 5 per cent. This is where this financial year could be different because interest costs could indeed go up.

Impact of interest costs: Interest costs of the corporate sector could go up this year even in the absence of a rise in interest rates. Efficiencies in the form of better working capital management have already been achieved. Borrowings, therefore, may need to be stepped up to finance the increase in activity. That could push up interest costs.

If interest rates also rise, then, the growth in interest costs could be higher than GDP growth. Calculations suggest that even if taxes and interest costs both rise by 15 per cent and employee costs rise just 9 per cent, profit growth would be below 10 per cent.

Plan for historic averages: These factors suggest that we need to exercise caution in estimating profit growth for the corporate sector. It would be better if the average growth in profits in the past five years is taken as what is achievable. Generally, average growth in profits has been 10 per cent.

Assuming higher growth than that may be imprudent and more so now. You can consider stocks that quote at a price-to-earnings multiple that is marginally lower than the average growth in profit in the past five years. In addition, companies that are financially leveraged may face more pressure on profit growth than others.

Specifically, exposure in stocks with a debt to equity ratio of more than one may need to be reduced.

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