The advent of GST (goods-and-services tax) will force large parts of the economy to migrate from black to white. Entry into the formal economy will allow firms to avail affordable working-capital finance from banks and NBFCs rather than relying on moneylenders. Such financing will shorten working-capital cycles and boost ROCEs of the listed companies which are customers or suppliers of such informal-economy entities. Moreover, alongside these organized-sector beneficiaries, the big winners will be NBFCs, which will get access to a multitude of new working-capital-financing opportunities. In the column which follows, I elaborate upon how these new opportunities will open up.
The status quo
The working-capital cycle of the building-materials sector, which spans cement, paints, electrical equipment, tiles and plyboard, shows a clear pattern - the higher the share of organised players, the shorter the working capital cycle. So, for example:
1. In paints, the share of the organised sector is 65 per cent and the working-capital cycle is around 40 days
2. In tiles, the share of the organised sector is 50 per cent and the working-capital cycle is around 40 days for the leaders
3. In electricals, the share of the organised sector is 35 per cent and the working-capital cycle is around 35-40 days
4. In plywood, the share of the organised sector is 20 per cent and the working capital cycle is around 70 days for the leaders.
Ambit's analysts who cover these sectors suggest that the main driver of this relationship is access to financing from the formal sector. Specifically, the higher the organised sector's share of activity, the less black money there is in a sector and, hence, the greater the willingness of banks and NBFCs to finance activity. Thus, the availability of affordable financing from the formal sector results in lower debtor days, higher creditor days and overall lower working-capital days.
GST is likely to be implemented over the next one-two years and its implementation should result in a decline in the size of the informal sector as:
1. Downstream customers report to the taxman their upstream suppliers (customers have the incentive to do so because that is the only way they can claim input tax credit, which can mitigate their GST payment), thus destroying the cost advantage that the informal sector enjoyed (by dint of avoiding taxes).
2. At present, even large companies in the organised sector have to run fragmented operations (with distinct supply chains for almost every state) due to the prevalence of state-specific tax regimes. GST will allow such companies to run integrated pan-India operations, which will allow the full manifestation of economies of scale that the larger companies should have always enjoyed (but never did due to state-specific tax codes).
This double whammy for the informal sector will result in the size of the organised sector growing radically in the five years after GST implementation. To put things in perspective, the unorganised sector presently accounts for as much as 58 per cent of India's GDP (as per the Central Statistics Office). With GST, the unorganised sector which used to fly below the radar of the taxman will have to pay taxes.
Winners and losers
Whilst for the manufacturing sector, the winners and losers are easy to identify (large organised companies vs the unorganised sector), it seems entirely feasible that we will see a similar shift in the lending sector. This implies that organised lenders stand to benefit relative to the local moneylender.
For example, in the plywood sector, the working-capital cycle is around 70 days, primarily driven by inventory days of around 65-70 days. Discussions with companies in this sector suggest that several of their distributors and dealers are not in the formal economy and hence cannot avail of working-capital finance from the banking system. Similarly, several timber suppliers to this sector are also in the informal economy. Thus, plywood companies are currently squeezed at both ends as neither their suppliers nor their distributors can avail of working-capital funding from banks.
In the post-GST world, where several suppliers and distributors of plywood will be forced to come into the white economy, the working-capital cycle for these companies could easily drop by 10-20 days, from 70 to 50. That would lift their ROCEs from 23 per cent currently to around 26 per cent.
The plywood example is just the tip of the iceberg. In the upcoming GST era, as large parts of the economy move from black to white, hundreds of such working-capital financing opportunities will open up for lenders. For example, at present the working-capital cycle of truckers is almost completely financed by informal lenders (usually booking agents for these trucks) at rates north of 100 per cent per annum. Once truckers enter the formal economy, they will be able to avail working-capital finance from the same NBFCs that currently finance trucks. In fact, whilst the truck-loans sector is around Rs 550 billion (or $80 billion) in size, the working-capital finance opportunity in the sector is likely to be many multiples larger than that.
Saurabh Mukherjea is CEO - Institutional Equities at Ambit Capital and the author of The Unusual Billionaires.