No Profit, Only Loss
Does higher operating income mean higher operating profit? Not always, especially when you are trading against appreciating rupee. A study conducted by FIEO says that exporters are losing their overall profits despite moderate increase in income. FIEO President Mr. Ganesh Kumar Gupta, alongwith Chairmen of many EPCs, met Additional Commerce Secretary Mr. R. Gopalan on 14 November and presented him the findings of the study alongwith the suggestions to extricate exporters from falling prey to the unbridled appreciation of domestic currency.
The rupee has appreciated by about 14% in the last one year. As a result, export growth has come down to 18.5% in the first half of the current fiscal from a level of 27% during the same period last year. In rupee terms, the decline is sharper, from 48% to a meager 5.34%. This clearly shows while the volume of exports saw moderate growth, export margins dropped terribly. The Commerce Ministry may draw some comfort from the figure of 18.5%, but for exporters, the net impact is dreadful.
In an effort to offset the impact, the Reserve Bank in April 2007 announced a subvention of 2% for select export sectors and exporters with a turnover of less than Rs.10 crore. The facility was later extended to 11 more sectors. As a result, the overall reduction in the effective rate of interest to the export sector was 25 to 50 basis points. On the other hand, the Benchmark PLR since last year has increased by more than 200 basis points. Also, sectors like pharmaceuticals, gems & jewellery (other than SMEs) etc. have not been extended this benefit. In such circumstances, it is further suggested that banks should be made to provide export credit at par with bank rate.
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In the next tranche, the policy announcement made on 30th October gave some leverage to the export sector, but this is of more use to large corporate in the form of hedging facility and writing options, rather than the small and medium exporters, who are the worse sufferers. The main problem confronting the export sector is the stability of the currency. In the wake of high volatility of Indian Rupee, exporters are not inclined to enter into long term contracts or negotiate new contracts with the buyers. While little fluctuation in currency is inevitable in a market determined exchange rate, sudden and sharp fluctuation in currency is not desirable for any segment of industry. |
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With a view to providing exporters with some comfort level, the Government may consider fixing the value of dollar for the purpose of exports only. The exporters should be credited with the exchange rate as determined in this regard and the gain due to rupee depreciation should be pooled in an ‘exchange neutralisation fund’ which can be used when there is appreciation of Rupee. In case, there is no balance in the fund, the same should be met by the Government. Government should make an initial contribution to start the fund. The fixed rate for exports may be announced on quarterly basis. Such a system will provide the much needed relief to the exporting community and ensure desirable export growth.
The government has provided refund of service tax on seven notified services. However, the important services like commission to foreign agents, overseas travel expenditure, professional fees, fees to CHAs, courier charges etc., are still not eligible for refund. Secondly, the whole process of refund is time consuming, requires lot of paper work and entails transaction cost. The Federation suggests ab-initio exemption from payment of service tax on notified services. Such an exemption can be subjected to random scrutiny of account. Moreover, the refund of output service tax may also be allowed under the existing CENVAT Rules 2004 to dispense with the need to apply for refund. This may require some modification in CENVAT Rules which needs to be carried out immediately so that the process becomes simpler and automatic.
The DEPB Scheme is scheduled to expire on 31st March 2008. Till date, no alternative scheme in its place has been notified. A wide section of exporters using DEPB Scheme would be handicapped to do costing of their export merchandise for orders to be executed from January 2008 onwards. So, the DEPB Scheme should be extended up to 2010 when GST would become operational. The introduction of GST would do away with the need for such a Scheme.
Additionally, DEPB & Drawback rates should be increased by 5 % to offset the losses due to currency appreciation and the rates should be effective for a period of one year so that exporters could do competitive costing. Exporters, not dealing in DEPB/DBK (including those exporting under Advance authorisation, DFIA, Free Shipping Bill, EOUs and SEZs units), should be given additional incentives of 5% to offset the losses on exchange front through a separate transferable instrument or through DEPB.
When dollar was strengthening against rupee, RBI had stipulated higher rate of interest for post-shipment credits if the tenor of the bill was longer or if they were not paid on due date. Thus, few exporters who were speculating with the higher exchange rate earning were discouraged as they were obliged to pay much higher interest for delay in payments. The fallout is that all exporters are being punished for giving longer tenor or export bills being delayed for none of their fault. At present, the scenario is reversed and exporters lose by continuous strengthening of rupee. They already suffer by way of paying interest for longer period in such situations. Therefore, punishing them further for higher or penal rate of interest should be stopped.
Banks are often not in a position to offer PCFC in other major currencies like Euro, Sterling or Yen. Besides, sometimes it is very difficult to get Packing Credit or working capital loan in dollar due to non-availability of funds with most of the banks. If this is made possible, the export sector would be better placed in a competitive environment.
In the past under Section 35 (B) of Income Tax, a weighted deduction of 133% was allowed against export promotion expenses such as product development, quality upgradation, and market development. Alternatively, the earlier scheme of ‘export profit reserve’ may be considered for reintroduction in addition to the above to encourage the exporters to broaden their capital base for further expansion of export business. Exporters should have the option of maintaining export profit reserve upto 50% of their annual gross profit. It is suggested that Sec 35(B) or the scheme of export profit reserve should be considered for offsetting the additional dual burden of rupee appreciation and hardening interest rates.
With the appreciation of rupee, cost of export merchandise for all sectors has increased substantially. Therefore, relief on income tax front may be extended to exporting units. Income Tax exemption under section 80 HHC and comparable sections such as Section 80-HHB & 80-HHBA for project exports, Section 80-HHD in respect of earnings in foreign exchange made by the hospitality sector/ tour operators etc. may be re-introduced.
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RBI intervenes Corporates have been allowed to use instruments in the derivative markets such as hedging and conditions for the same have been relaxed. Earlier, an exporter could sell dollars at a future date with a pre-agreed price. The amount to be sold depended on the average performance of the last three years. The hedge earnings could be used at a later date when the next export order is anticipated. No documents were required under the scheme. However, once this limit was used, it could not be used again during the year. This condition has now been relaxed by the RBI. Now, and exporter can hedge his receivables for a later date and the past performance limit is once again available to the exporter and can be used several times in the same year as long as the underlying documents are available. In the writing option provided by the RBI earlier, exporter could ‘buy’ an option (exercising the ‘call’ option) to sell the dollar, it would receive at a future date. While the corporate had the right to sell the dollar, there was no compulsion and a premium had to be paid to the bank which arranged for the option transaction. With the present dispensation, the corporate has also got the option to ‘sell’ the dollar (exercising the "put" option) to the Bank. Bank will pay a premium income to the exporter/corporate. In case the dollar depreciates very significantly, then in such a case, Bank will understandably not ‘buy’ the dollars but the corporate may sell the same in the open market as per the prevailing market rate. On the eve of the announcement of the mid-year Monetary & Credit Policy i.e. the October 29, 2007, RBI issued bonds amounting to Rs. 6000 crore with an aim to suck excess liquidity from the financial system (3 year bonds amounting to Rs.3000 crore through auction and another tranche of an equal amount and maturity at a coupon rate of 11.30% on November 1, 2007 under the market stabilization scheme). The Bank has been selling securities every week in addition to those scheduled for the year to drain cash that may stoke inflation. The Bank also sold bonds worth Rs.6000 crore under the stabilization plan on October 25, 2007. These measures of intervention and strong dollar demand from corporates contained the rupee. As a result of these measures, the forward premia rates on the one month contract edged upto 1% (0.97%) while rates on the 6 months contract inched down to 1.11% (1.16%). Among the other measures taken by the RBI to contain the rupee, the auctioning of the foreign loan quota to help moderate ECB inflows which are currently running at $25 billion a year. The Reserve Bank is considering the possibility of levying a sterilization tax on all ECBs. The apex bank has as on November 1, 2007 brought over $ 61 billion from the open market since January and has had to sterilize a lot of liquidity (local currency) released into the system. It loses about 3% on such sterilization efforts – the difference between what it earns on deploying reserves in mainly US treasuries and the interest it pays in the domestic market for sucking out liquidity by issuing the Government securities. The idea behind imposing the sterilization tax on ECBs is to increase the cost of borrowing for those companies who are doing so by this route and minimizing the interest rate arbitrage. Higher interest rates in the country have resulted in corporates borrowing from overseas impacting the credit offtake from the Indian Banks. This would also discourage corporates to avail funds through ECB route. In August, the Government disallowed any rupee expenditure in excess of $ 20 million from company through ECBs. |
The Government has been extending employment in the rural sector under the National Rural Employment Guarantee Programme (NREGP). The exports sectors, particularly labour incentive ones, have been a key driver in providing employment to skilled and semiskilled labour in the rural and semi-urban areas. Ministry of Commerce should take up the issue with the concerned Ministry to earmark corpus of funds so that the identified labour intensive sectors could be incentivized by providing additional drawback/DEPB/ any other alternative route for a certain employment-turnover ratio and beyond.
All unrefunded taxes and duties falling under the purview of central or state governments should be reimbursed to exporters within a timeframe of 30 days, failing which interest @15% should be paid to exporters for the delayed period.
Suitable modifications should be made in Market Development Assistance (MDA) Scheme so that all exporters are made eligible for MDA benefit without any threshold criteria. At present, only exporters having turnover upto Rs 10 crore are eligible for the assistance. Moreover, there is restriction on number of visits for participation in trade-fair/exhibition and Buyer Seller Meet organised by EPCs/FIEO. The restriction should be done away with. Moreover, direct participation in BSM /Trade fair/exhibition may also be permitted.
Out of court settlement in respect of income tax on DEPB and service tax on certain services used during the course of exports should be initiated. Many cases are being contested by the exporters in various courts. A lot of money and energy of the exporters are being wasted in meeting the legal requirements and attending to these matters. Few High Courts have already given relief to the exporters. Moreover, the government’s contention is technical rather than substantive. In view of this, the government should consider out of court settlement and provide relief to the exporters in respect of payment of income tax on DEPB for those having export turnover of over Rs. 10 crore. Similarly, no service tax should be charged from the exporters for previous years and the same should be charged either from the date from which refund has been notified or from 1.4.2007, if the intention is to provide for refund of service tax to exporters from 1st day of the current financial year.
Study by FIEO
Export profits are being severely eroded due to appreciating rupee. The labour intensive sectors are the most affected. They include: textiles, handlooms, handicrafts, carpets, leather, etc. In order to gauge the sector-wise impact of stronger rupee on export earnings, FIEO conducted a study of listed exporting companies in different sectors like textiles, chemicals, pharmaceuticals, software and agriculture.
The study reveals a reduction in export margins vis-à-vis export sales or income i.e even at higher levels of operating income; net profit margins have shrunk as a result of the appreciating rupee. Data from listed companies having substantial export discloses shrinking operating profit margins vis-à-vis export sales. Some corporate treasury divisions contacted during the study revealed that they had taken ECB loans in 2003, 2004 and 2005 when rupee was of the order of Rs. 45 to a dollar, as a result of which, the corporates have not only gained on the present differential between the rupee and dollar as also the lower cost of credit through the ECB route.
Textiles & Garments
Export margins between April and September this year with percentage change in US$ during this period varied from -10 to -30. For example, the spinning industry usually makes good operating profits (earning before interest, taxes, depreciation and amortization) of about 16-20%. The data shows a downtrend which is attributed to the overall decrease in export growth due to rupee appreciation.
The textile sector depicts that inspite of higher operating incomes the net profit margins and operating profit margins have shown a downtrend.
Gokaldas Exports Ltd, for e.g. has witnessed a 45.88% year-on-year dip in its net profit for the 2nd quarter (Q2) ended September 30. The net profit for the period stood at Rs.11.25 crore down from Rs.20.79 crore recorded in the Q2 of the previous fiscal. The fall in net profit was accompanied by 11% decline in the operating income which stood at Rs.249.92 crore in Q2FY08 compared to Rs.280.99 crore in Q2FY07.
Vardhaman textiles Ltd, with operating income (Rs million) of 5,661 and 5,283.30 for Sept 2007 and Sept 2006 respectively experiences downtrend in net profits of 373.70 and 457.50 for the respective years. Here it may be noted that inspite of higher sales/operating income in Sept 2007, the net profit has decreased. Operating profit margin and net profit margin for Sept 2007 were 17.64 and 6.60 (Rs million) and for Sept 2006 were 18.73 and 8.66 (Rs million) respectively.
The company results in its highlights of March 2007 state that "the polyester filament market is currently experiencing substantial volatility with large swing in crude oil prices, mismatches of supply & demand in raw material & strengthening of the rupee. While this will affect the division’s performance in the immediate future, the institution of cost saving measures & diversification into high value fiber business is expected to substantially reduce the adverse impact".
Agriculture
In the agri sector, a downtrend was observed with decrease of net profit margins and operating profits even at relatively higher volumes of sales/operating incomes.
A conglomerate like ITC Ltd with diverse businesses [where key drivers were food, lifestyle retailing stationary business (ITC Bhadrachalam Ltd.) and packaging businesses (earnings per share for the quarter stood at Rs.2.05)], the company’s profit growth suffered due to a massive 78% fall in the profitability of the agri business, which also reported a 12.5% decline in the net sales after being compelled to dispose of commodities in the domestic market at prices lower than those paid to farmers through the e-choupal network.
The reasons given for the above were the sharp appreciation of the rupee affected realizations on exports contracted in the past at dollar denominated rates. Besides this, ban on exports of certain products was also cited as a reason. In fact the results were offset by a jump of 162% in other businesses to over Rs.200 crore.
Tata Tea also listed as an example with operating income (in Rs million) of 6,090.60 and 5,283.50 in Sept 2007 & Sept 2006 respectively at net profits of 1,078.10 and 2,084.80 respectively showed decreasing operating margins (in Rs. million) of 25.94 and 35.40 in Sept 2007 and 2006 respectively. The net profit margins also shrank very significantly to 17.70 (Rs million) and 39.46 (Rs million) in the respective years.
Godfrey Phillips exported merchandise of approximately Rs. 80 crore in 2006-2007 of its total turnover and could offset costs/losses made in exports only by the foreign currency loans taken.
Chemicals
As per the primary data received, the chemical sector is at a cost disadvantage vis-à-vis the competing countries to the extent of 30%.
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Net Profit Margin = Net Profit x 100 Turnover
= Profit before Interest & Taxation x 100 Turnover
[Net Profit = Gross Profit – Expenses]
The net profit margin tells us the amount of net profit per unit (Rs.) of turnover a business has earned.
Operating Profit Margin=Earnings before interest & Tax[EBIT] Sales |
The rupee appreciation has significantly reduced the profit margins, is evident from the data of listed companies such as Ashapura Minechem Ltd., Tata Chemicals, Deepak Nitrite Ltd., BASF, etc. Ashapura Minechem is one of the largest exporters of bentonite from India. Operating income for Sept 2007 (Rs million) is 3875.70 while the net profit margins and operating profits have plummeted to 10.03 and 14.5 respectively. The net profit margins and operating profit margins for Sept 2006 were 14.33 and 23.21 respectively (all figures in Rs million). |
The rupee appreciation has significantly reduced the profit margins, is evident from the data of listed companies such as Ashapura Minechem Ltd., Tata Chemicals, Deepak Nitrite Ltd., BASF, etc.
Ashapura Minechem is one of the largest exporters of bentonite from India. Operating income for Sept 2007 (Rs million) is 3875.70 while the net profit margins and operating profits have plummeted to 10.03 and 14.5 respectively. The net profit margins and operating profit margins for Sept 2006 were 14.33 and 23.21 respectively (all figures in Rs million).
Tata Chemicals with operating income of Rs. 12,551.20 in Sept 2007 showed a significant decrease in operating profit margins and net profit margins at 19.49 and 11.36. The operating profit margin and net profit margin in Sept 2006 were Rs. 23.57 (million) and Rs.14.00 (million) respectively.
NOCIL Ltd., with an operating income of Rs.859.70 million ending Sept 2007, showed operating profit margins and net profit margins (Rs. Million) of 4.85 and 1.64 respectively. Operating profit margins and net profit margins were 14.92 and 10.99 at lower sales volumes of 794.10 in Sept ending 2006 (all figures in Rs. Million).
Pharmaceuticals
Cipla Ltd. at an operating income of Rs.10,963.90 million in Sept 2007 had an operating profit margin of Rs.24.2 million (0.22 % of the operating income in that year) as against a operating income of Rs. 8,961.10 in Sept 2006 which had an operating profit margin of Rs. 27.52 million i.e 0.31% of the operating income in Sept 2006.
Cadila Healthcare Ltd. with an operating income of Rs.4,474 million in Sept ending 2007 had an operating profit margin of Rs.23.67 million and a net profit margin of Rs.15.94 million which was less than its net profit margin and operating profit margin in Sept 2006 when the operating incomes were Rs.3,820 million.
Software
IT companies such as Infosys Technologies Ltd., Wipro Ltd., Satyam Computers Ltd., Hexaware Technologies Ltd have shown a steep fall in the net profit margins and operating profit margins inspite of higher operating incomes vis-à-vis Sept 2006.
Other sectors
A respondent from the floriculture sector gives the percentage variation in exports between April and Sept with percentage change in rupee as ranging from -4.65% to 8.79%. Competing countries for floriculture export were identified as China, Thailand, Sri Lanka, Indonesia and South Africa.
Lakhani Engineering Works, Rajkot, Gujarat recorded a percentage variation in the exports between April and Sept 2007 as ranging from 2% to 15% vis-à-vis the change in rupee, and a cost disadvantage with other competing countries of 10 to 15%.
The FMCG sector showed a variation in exports between April and Sept 2007 with percentage change of -4% to -14% in rupee values. The competing countries were the Middle East, Africa and some ASEAN countries.
For the leather sector, the monthly percentage variation in US$ is approximately 7 to 8.5 in Rupee terms it averages from -6 to -8 from April to September 2007. Direct losses for individual companies range between 10-15% of turnover and products have been rendered uncompetitive by 15%.
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ADB. FIEO to hold Seminars on Services Projects Head, PAU of Asian Development Bank’s New Delhi Office Mr. Shigehiko Muramoto visited FIEO Head Office on 12th November and had discussions with Mr Subhash Goyal, Convenor, FIEO Committee on Services and Mr Ajay Sahai, Director General, FIEO, exploring how the two organizations could join hands to promote India’s world trade in services. They decided to hold joint Seminars along with Exim Bank in Delhi, Kolkata and Mumbai during December. ADB has been floating important projects in various sectors in services across Asia for its developing country members. Indian firms have good business scope in such projects. The Seminar will educate service providers, especially in the field of consultancy, construction, infrastructure, about how to participate in such projects. Procurement specialists from ADB Manila would join the deliberations at these seminars. |
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(From Left to Right): Mr Sandeep Gupta, Director, FIEO; Mr C M Arora, Sr Analyist Asian Development Bank (ADB); Mr Ajay Sahai, Director General, FIEO; Mr Shigehiko Muramoto, Head PAU, Asian Development Bank (ADB); Mr Subhash Goyal, Convenor, FIEO Committee on Services; Mr Vinod Pal, Joint Director, FIEO |
