Corporate profitability is no more a mere function of indicators such as firm size, leverage, liquidity etc, macroeconomic factors such as inflation, interest rate, exchange rate etc also influence corporate earnings, says a new study by the Reserve Bank of India (RBI).
With the rapid development of the corporate sector since 2001, factors influencing profitability have altered.
However, since 2009, the domestic economy became more integrated with global economy and also more sensitive to external shocks, the study notes.
The most notable feature of global economic integration, however, was the increasing importance of exchange rate, mainly rupee-dollar rate, in determining profitability of corporates.
When the rupee appreciates against the dollar, corporate profitability is likely to get a short-term boost, though the long-term impact would depend on import and export elasticities, it adds.
In the post-crisis period, many large private non-financial corporates in India have also been behaving like financial intermediaries to take advantage of the easy liquidity abroad.
In this respect, it may be noted that several big corporates such as Reliance Industries Ltd use their treasury operations to boost profits. This has amplified the impact of exchange rate volatility on their profitability.
Thus, when the forex market is under stress, it is observed that the exchange rate becomes the only critical factor to determine corporate profitability, dominating all other factors.
In other words, in a scenario of persistent large depreciation of domestic currency, the performance of the corporate sector is expected to be impacted negatively, which may in turn affect the banking sector, the paper notes.
The corporate sector in the country has witnessed a significant growth over the last two decades and has become an integral as well as key strategic part of the economy.
The RBI working paper seeks to analyse corporate performance in order to assess the significance of firm specific and macroeconomic factors on corporate profitability under two distinct regimes.
RBI has placed on its website, the working paper titled `Is Exchange Rate the dominant factor influencing Corporate Profitability in India?' The paper is written jointly by Shaoni Nandi, Debasish Majumder and Anujit Mitra of the Department of Statistics and Information Management, Reserve Bank of India.