In the past few months, India has seen foreign inflows of over $15 billion, valuations of many companies are back to the pre-crisis levels and capital expenditure by companies has dramatically increased. The confidence of executives is high and many believe the new normal (after the crisis) is no different from the old normal (the "grow-grow" era).
Yet, the crisis has scarred businesses and owners, and some have emerged stronger than others. It forced businesses to scrutinise decisions and confront tough challenges. Our work with companies in India suggests this crunch situation established four imperatives among others: Dealing with volatility
The financial crisis reduced global capital flows from nearly $10.5 trillion to $1.9 trillion in 2008. Foreign capital flows to India dropped to approximately $50 billion in 2008 from over $75 billion in 2007. As the drop in the Sensex and Nifty showed, capital flows actually went into reverse as investors, companies, banks and other financial institutions sold foreign assets and took money back home. Such a rapid reversal had not been witnessed earlier. In November 2008, I was talking to a leading auto parts company and they said, "Our orders have fallen by 80 per cent. We've never seen anything like this before." In the next 4-5 months their orders were up by 60 per cent.
This sharp turn of events has made businesses acutely aware of the need to navigate uncertainty like never before. It heightened the need to be prepared to deal with inherent volatility, for example, continuous changes in monetary policy, emerging climate change related regulations, increased scrutiny from regulators and shareholders et al.
Managing the 'funding' bubble and rationalising costs
Easy access to capital since 2004, in particular low-cost foreign capital, led to hubristic decision-making. For instance, as businesses embarked on global acquisitions they relied excessively on debt as opposed to the right mix of debt and equity to finance them. Next, investments were made in projects that had poor or uncertain returns and in overvalued asset classes. As companies grew at over 30-40 per cent year on year, the emphasis was on finding people, building capacities, and covering additional ground at breakneck speed, often at exorbitant costs so as not to miss the opportunity. For example, in the financial services sector, salaries rose dramatically.
However, when growth slowed, these quickly became a huge burden and companies had to make significant corrections through layoffs, giving up of leases, cancelling contracts et al, and this has forced them to become more prudent with cash. The financial crisis of September 2008 and the subsequent liquidity crunch compelled a real estate company to undertake hurried sales of many projects to simply raise the capital required to pay off debts. Aghast by this change in the cash climate, in the next 9 months the company cut costs by about 50 per cent to conserve cash.
Becoming resilient and flexible
In the new normal, companies should expect shocks to occur rather than be surprised by them; for instance, the Dubai debt crisis. To effectively manage such shocks they need to be exceptionally resilient. Resilience amounts to building more flexibility into contracts, creating new organisational muscle in areas like risk-reward management, talent management, capital expenditure management and procurement. More importantly, it is about bullet-proofing strategies by testing them under different scenarios. A leading infrastructure company, for instance, has decided to keep a cushion should revenues drop by 20 per cent or grow by over 20-25 per cent. The management is currently stress-testing their strategies for resilience and flexibility. In the pre-crash times, one rarely encountered such foresight. But it's now fast becoming the norm rather than the exception.
Bolstering corporate governance
Soon after the meltdown governance issues came into focus. At present, this issue is conspicuous in the various debates underway on the true independence of "independent" directors, and on the soft aspects such as the issues on which boards spend their time, how they influence management through incentives, how they shape corporate culture and how they evaluate themselves.
The accent on establishing standards of probity and corporate governance in the country has not been higher in a very long time. For instance, since the crash a leading natural resources company has begun focusing on these soft issues: It has systematically started growing its group of independent directors, revamping how the board interacts with the management and defining the role the board will play during critical decisions.
Today, the real risk stems from the accelerated pace of recovery thanks ironically to India's strong fundamentals. Companies are once again more than awash with funds, especially foreign capital, and more recently consumer confidence has skyrocketed. The re-emerging signs of hubris could swiftly shift the focus of businesses from embedding the learnings into their management practices to reckless decision-making.
If this does occur, it is likely to be dangerous for the health of companies in the medium to long term, when the complexion and avenues of growth will be different. The champions will be those that deal with volatility, side-step the funding bubble, rationalise costs, are resilient and flexible and have bolstered governance practices.
— Adil Zainulbhai, 56, is the Managing Director, McKinsey and Company's India Office