While the International Monetary Fund’s July World Economic Outlook shows India remains the fastest growing economy since last year, the investment cycle in the country is still sluggish. Weak demand—both external and domestic—has led to low capacity utilisation, inconsistent factory output and all-time low industrial credit growth. The balance sheet of companies also remains stressed.
Gross fixed capital formation, an indicator of new capacity addition by companies, contracted 1.5% in the three months to March this year, for the first time in seven years. At 26.9% of GDP in the January-March quarter, capital formation is the lowest ever (in base year 2004-05 and 2011-12), highlighting the muted trend in private sector investments; it also raises concerns about the quality of growth.
Private corporate capex has been on a weak footing for the last four years. Using the old series (2004-05) of national accounts, private corporate capex has declined from 12.8% of GDP in FY11 to 7% in FY16, according to Morgan Stanley research. However, public capex, which accounts for about 25% of overall investments, has held up better than private capex in the last 12 months, which is especially visible in road construction.
While the NDA government did take some major steps to revive investments, the green shoots are yet to take root. Capacity utilisation in factories, according to RBI’s OBICUS, has been range-bound at 71-72% for the past two years, clearly indicating excess capacity in manufacturing sector.
Some high frequency indicators too show that growth is wobbly. Production of capital goods, which is a reflection of the industrial and investment activity in the country, has shrunk for seven successive months. Import of capital goods has contracted since August last year, barring the month of March. The growth of eight core industries, which have 38% weight in the Index of Industrial Production, slowed to a five-month low of 2.8% in May. Credit to industry grew 0.9% in May 2016—second successive month of below 1% growth as bank lending dropped significantly in sectors such as infrastructure, food processing and transport equipment.
Cost and time overruns and slower-than-expected growth in the economy have made many capital-intensive projects financially unviable and companies are reluctant to invest. Banks are no longer lending aggressively to large projects, especially in stressed capital-intensive sectors such as power, metals and mining, which account for more than 60% of the the overall corporate capex. Stressed advances in the banking system rose to 11.5% of total advances in March 2016, from 9.2% in March 2013, according to the latest Financial Stability Report of RBI.
Corporate debt and leverage are sticky issues and will take time to resolve. Public sector banks are rationing credit due to mounting losses and capital constraints. A study done by India Ratings & Research shows that nearly half of the top-500 corporate borrowers hold 42% of the total outstanding debt of R28 lakh crore. Of this, R5 lakh crore is stressed and R6.7 lakh crore falls in the elevated risk of refinancing (ERR), raising concerns of financial stress for India Inc. It shows that already R4.6 lakh crore of the R6.7 lakh crore in the ERR category may have become delinquent. Incremental stress is likely to emanate from the remaining R2.1 lakh crore and refinancing could be a challenge for ERR entities whose interest cover ratio is below one.
A pick up in investments can come from an uptick in private consumption. Much of the consumption spending push can come from the Pay Panel bonanza as the government will be spending an additional R84,900 crore on pay and pensions in FY17. Of this, the Union Budget will bear R60,600 crore, while the Railways will bear R24,300 crore.
An increase in private spending will push up demand for consumer durables and automobiles. The boost to private consumption stimulus would be around R46,800 crore, or 30 basis points (bps) of GDP, according to an analysis done by Kotak Economic Research. The government will get an additional tax revenue of R13,000 crore and households would be able to save R25,000 crore. Moreover, a normal monsoon will also drive consumption spending, especially in rural India.
The revival of private investment, however, will be a slow process, and the cracks in the private investment cycle are likely to continue this fiscal. While the government has made efforts to improve the business environment by strengthening public-private partnership through dispute resolution mechanism in the Budget, policy-related issues will have to be resolved at the earliest so that companies step up investment and create employment opportunities.