"The automobile industry has seen a drop in the turnaround times for inventory as well as credit periods" Krishnamurthy Vijayan/Chief Executive Officer/JM Mutual Fund

Try this quick quiz: Over the past few years, India Inc has been able to make huge savings in interest costs because:

A: Interest rates have been coming down

B: Companies have been restructuring their high-cost debt

If you've chosen A-which appears the most obvious answer-you, of course, wouldn't be wrong. But you'd be equally on the button if you attributed corporate India's savings to the financial restructuring a host of chief financial officers have been taking recourse to. Along with excess employees, company managements have been pulling out all stops to get rid of their high-cost debt. While some of them are replacing it with lower-cost loans, in the process bringing down their interest burdens, others have gone one drastic step further and paid off their debt all together. Example: Textiles major Raymond. "We have prepaid the debt wherever possible. Most of our high-cost debts have already been repaid and only areas like old retail fixed deposits (that can't be prepaid) are still remaining," says R.A. Prabhu Desai, Executive Director (Finance), Raymond.

The steady increase in the number of companies going in for debt reduction year after year is reflected in the industry aggregates as well. As the chart (See Forsaking Debt) indicates, the debt/equity ratio of India Inc has been coming down over the years. This is based on a sample of 400 companies (only non-finance companies) whose audited figures are available for all these years. During these years, most of the zero-debt companies in the sample have maintained status quo. The best example for this is Infosys. Meantime, those companies with small debt components have shrunk them further. For example, Hindustan Lever has reduced its debt/equity ratio from 0.15 per cent in December 1998 to 0.02 in December 2002. A deeper look at our sample reveals that there is not much of a change amongst the traditionally less leveraged sectors (like software services and fast-moving consumer goods). The real action has taken place among the mid-cap companies from the manufacturing sectors. The table (See Fat-Free Diet) lists out 10 companies whose debt has come down by the most.

Now for the question: Why is corporate India on a massive debt reduction exercise when interest rates are at very low levels? To be sure, aversion to debt has become quite a fad with India Inc. Bump into any CFO, and chances are he'll either wax eloquent about how he made his company a zero-debt firm, or how he is working towards that goal. "We do not take on debt unless it is required, irrespective of interest rate levels," says Bruce Inglis, CFO, Philips India. Worldwide Philips operates with no more than 30 per cent debt. Inglis says that in India Philips will attempt to keep the debt portion within the 0-20 per cent range.

Dalal Street Likes Zero Debt

The reason for that zeal is pretty evident: Most of the fancied companies on the stockmarkets are zero-debt ones. That obsession of Dalal Street for zero, or near-zero-debt stocks, is explained by the fact that such companies are better equipped to withstand economic downturns. So, although highly-leveraged companies are better placed to chase higher growth, they have a higher element of risk attached to those ambitions. Stockmarket investors for their part demand a premium for this higher risk in the form of lesser price. It's not just Dalal Street, but even the lenders that prefer a zero-debt company, and they express their penchant for such firms by offering lower interest loans. "We have decided to become debt-free company now with a clear objective in mind. When we identify a strong project and approach the market with it, we should get very good credit rating and should be able to raise funds at best possible coupon rates," says Amit Ghosh, General Manager (Finance), Tata Metaliks.

Also, the focus of India Inc has moved from creating assets to increasing shareholder value. In other words, companies now have started looking at profitability and not just size. "They are now concentrating more on profit growth quarter on quarter and year on year," explains N. Jyothimani, Fund Manager at CanBank Mutual Fund. So the focus is now only on new projects that can generate positive returns. "The interest cost is only one part of deciding on new projects, the other (and more important) part is the business environment," adds M.R. Rajaram, CFO, ICI India. Clearly India Inc has realised there is no meaning in generating debt and squandering it just because it is cheap. "The way we look at debt is like the industry treats the bridge loan. Either short or long, at the end of the day it has to be repaid," points out Ghosh, of Tata Metaliks

Indian managements are also learning to allocate their capital more efficiently. After the initial euphoria of liberalisation, when capacity expansions across disparate industries took on mindless proportions, India Inc today is more focussed and sticking to what it knows best. This is done by way of getting rid of businesses that are outside their core area. For example, a company like Raymond has generated surplus cash by selling its cement and steel businesses. Idle assets like real estate are also being hawked. ICI India has generated more than Rs 150 crore by selling its properties. The money generated from these sales are used not just to prepay debt but is also ploughed back into the core businesses. Kalyani Steels has managed to put up a co-generation plant with a capacity of 7.5-8 mw at a cost of around Rs 27 crore even after reducing its debt by Rs 146 crore during the last four years. "Once it is completed in 2004, we will be getting electricity with out any fuel cost," said C.G. Patankar, Executive Director, Kalyani Steels.

Working Capital Efficiency

Doubtless one of the most important reasons for the aversion to debt is the tremendous improvement in working capital efficiency. Companies have adopted technology (by installing packages like ERP, sap, etc) to streamline their operations. This has helped reduce the turnaround time of inventory (of both raw material and finished goods). Credit periods too have come down. "The best example of this is the automobile industry where inventory carrying costs used to be very high earlier," points out Krishnamurthy Vijayan, CEO, JM Mutual Fund. Since the debt component includes working capital, a lower working capital requirement naturally means lower debt. "And this is a very healthy signal," says Mr Tridib Pathak, Fund Manager (Equity), Principal Mutual Fund.

The consolidation of manufacturing capacities too has played its part in debt losing its attractiveness. As JM Mutual's Vijayan explains, during the manufacturing boom four-to-five years ago, plenty of capacities were created. "This resulted in low margins for companies. Today, though, many of them can manage with the existing capacities, without having to create new ones," he adds. "Our production can be increased from 2.9 lakh tonnes to 4 lakh tonnes without installing any additional capacity. So we are using the cash flows to repay high cost debt," confirms Patankar of Kalyani Steels.

However, as the demand-supply imbalance eventually disappears, the next wave of capacity creation is inevitable. And that could once again enable debt to regain its lustre. However, the frenzied asset-creation one witnessed post-liberalisation is unlikely to repeated this time round.

"Industry has become more mature now," avers M.K. Srinivasan, Senior Vice President (Finance), Paper Products. What's more, rather than just looking at the domestic demand, promoters have got to factor in the global outlook. "Unlike the past when companies used to look only at the Indian situation before setting up capacity, any new capacity addition has to be globally competitive now," agrees ICI India's Rajaram.

Clearly, the advantages India Inc stands to gain from debt reduction and improving internal efficiencies will ensure that they continue to follow on the same path. "Profitability has increased because of falling cost of funds and improved efficiency. Companies are using these cash flows to reduce debt and improve the efficiency, which will improve profitability further," explains Ved Prakash Chaturvedi, CEO, Tata Mutual Fund. Amen.