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The latest grouse against Indian corporates from India’s Chief Economic Advisor is that they have short-changed employee compensation despite the 15-year high profitability. He warns that it will loop into a self-destructive spiral of lower demand. This comes in the wake of a sharp decline in 2QFY25 real GDP growth to 5.4 per cent vs the official projection of 7 per cent for FY25 and commentaries from companies highlighting concerns of shrinking urban middle class. CEA’s criticism contrasts the official position a year ago which attributed shrinking household financial savings to rising confidence of households about their future income and employment. Thus, this paradoxical shift towards carping them for inadequate compensation reflects growing concern of receding aggregate demand on India’s growth outlook. Earlier, corporates were criticised for lack of capex despite the supply side bounties and exuberant profit surge. Given the shifting stance it is pertinent to assess whether the causality of slowdown runs from low compensation to weakening demand or are we barking up the wrong tree? Companies employ more resources, including manpower and capital when they see a trend rise in demand visibility. Likewise, compensation slows as a lagged response to decelerating sales growth. This lagged response was stronger during the structural rise in sales till FY14. Since then, it has weakened considerably. For non-listed non-finance companies (CMIE sample), FY06-FY14 saw an uptrend in sales leading to higher compensation growth. The 10-year CAGR in sales accelerated from 12.4 per cent to a peak of 17 per cent while compensation growth accelerated from 11 per cent to 17.5 per cent. But since FY14 with sales growth decelerating to 8 per cent (10-year CAGR), more than the deceleration in compensation growth to 10.7 per cent. In the structural uptrend of corporate performance during FY91-FY14, compensation/sales ratio structurally declined from 7.6 per cent to 7 per cent. But in the slowdown phase, it consistently rose to 9.3 per cent in FY19. At 8.4 per cent in FY24, it is somewhat lower than the pandemic high of 10.6 per cent in FY21, reflecting the episodic rebound in corporate sales. Thus, given the extant high compensation/sales ratio, blaming under-rewarded workers for the weakening urban demand is untenable. Juxtaposing the decelerating compensation growth with high profits is also misplaced. The latter is associated with companies exploiting gains in market share, through monopolistic pricing afforded by various policies catalysing formalisation and supply side fiscal impetus including tax cuts and spending on infrastructure. Spending on compensation on the other hand, is a function of capacity utilisation and sales outlook which has been impaired by the accentuated K-shaped trajectory, characterised by a slender upper arm and a heavy lower arm. The latest data points towards a sustained lack of demand visibility, with sales growth decelerating to 3.5 per cent in 1HFY25, near the Covid lows and 10-year average at 8.4 per cent to a 20-year low. Hence, the most likely outcome will be further deceleration in compensation growth while companies continue to invest in capital deepening technologies that make labour increasingly redundant. The heightened tax incidence on households in an effort towards fiscal consolidation has also impaired the demand situation, thereby contributing to the languid employee compensation. Importantly, these trends were preceded by the income crisis at the broader level, demonstrated in the rising ruralisation, increased dependence of workers on agriculture (PLFS), contracting real income per worker (-1.6 per cent 5-year CAGR, KLEMS 2024), declining value addition in the unorganised sector (ASUSE, 2015-2023) and receding household savings. Thus, prior to the recent worries triggered by corporate commentaries, demand slackness manifested in prolonged weakness in rural demand, even as the truncated post pandemic rebound in urban demand and leveraged consumption camouflaged the persistent household fragility. Hence, the problem of consumption demand is much wider than just urban, and it requires an assessment of policy options. On the face of it the landscape is muddled with multiple constraints. Household income representing 78 per cent of GDP, is impacted by contraction in real worker income. Weak demand and declining profit margins would extend the slackness in private capex. Decline in profits and employee compensation are impacting direct tax collections even as indirect tax collection is slowing. Fiscal logjam is impacting GoI’s spending. It decelerated to 3.3 per cent YoY (FYTD, Oct’24), lowest since FY09, mainly due to cut-back in capital expenditure (-15 per cent YoY). RBI guidance of improved outlook, following the downscaled FY25 GDP growth projection to 6.6 per cent (-60bp), is pivoted on incrementalism from better agriculture and government spending. Rupee/dollar stability has been afforded by a significant rundown of FX reserves by the RBI; potential rapid depreciation could limit its ability to carve out dividends for the GoI. The impact of impending trade protectionism associated with Trump 2.0 is yet to pan out. From the peak 80 per cent credit-deposit ratio, the normalisation of the banking sector implies limited support to growth. The entwining constraints typify the constrictor knot, and its untangling will likely be a long process. In the near term one can expect a combination of the following quick-fixes and counter-cyclical responses. Greater emphasis on rural spending, resulting in lower government capex. Increased limit for bank’s uncollateralised lending to agri indicates falling back on directed lending. The proposed additional 35 per cent GST slab on sin and luxury goods, following the hike in capital gains tax foretell rising tax burden on the rich to shore up tax revenue. GoI’s constraint is also impelled by the global listing of G-Sec. Hence, fiscal support by ways of various forms of minimum income schemes are funnelled through State budgets. Blaming RBI’s restrictive policy stance for the slowdown could force premature policy rate easing. But it could risk inflation resurgence and exchange rate volatility, thereby impairing growth. India’s growth forecast appears to be faced with multifarious constraints. Hence, blaming corporates alone may be misplaced. A structural policy facelift is urgently required to regenerate growth buffers. This would encompass addressing the rising ruralisation, disguised unemployment and income fragility through a granular strategy to create productive jobs in the high employment elastic service sectors and small businesses, reduction of tax incidence on households, a progressive tax regime and a step down from the extant “national champion” approach to broaden the imperatives for private investments. The writer is is Co-Head of Equities & Head of Research - Strategy & Economics, Systematix Group. Views are personal Comments
