Despite regular predictions on how investment is picking up, the fact is companies are in no rush to add capacity. The private sector has been holding back on capex for almost four years now, save for maintenance capex, though the government sector is estimated to have spent close to Rs 3 lakh crore in FY17. While consumption demand has been growing—it grew at 7.9% y-o-y in the four quarters preceding demonetisation—large sectors of the economy such as construction and real estate have seen little activity.
Indeed, given there is surplus capacity of close to 25%, it is not surprising gross fixed capital formation, as a share of GDP, has dropped every year since FY13 when it was 34%, and was 29% in FY17. Order books at most engineering companies have grown at a very modest pace in these years. The new IIP series shows the capital goods sector—now reflecting work-in-progress rather than work-complete—contracted twice in the last five years and posted its highest growth of an anaemic 2.1% in FY16. And bankers will tell you there are virtually no takers for project finance, except perhaps those setting up renewable energy projects.
A recent report by HSBC says investment may finally be bottoming out after a six-year wait. However, it notes the pace of revival will be gradual and investment will start growing rapidly only by 2020, provided there is enough policy support—apart from the twin balance sheet problem, it argues, investors have to see a pipeline of reform before investing. It also observes that the government’s housing push, especially the focus on the affordable housing segment, could be the catalyst that kick-starts investments.
This seems broadly right. For one, although the cost of money has come down sharply, and there is money to be raised in the bond markets, it is hard to see promoters making plans till there is more visibility on demand. More critically, most business houses—the best and the biggest—remain highly over-leveraged and, consequently, their ability to borrow more is very limited. A February report by Credit Suisse pointed out that 41% of corporate debt was in the books of companies that had an interest cover of less than one. Also, while the stock markets may be on a roll, it is unlikely an over-leveraged company would be able to raise equity capital of a meaningful quantity.
Given their experience of the last few years, banks are unlikely to fund projects where the equity component is not chunky; a recent example of this is the road projects envisaged in the hybrid annuity mode, many of which banks have refused to support simply because the promoters’ equity contribution is just 9%. Indeed, top bankers have made it clear they would like to assess the ‘quality of the equity’ before committing money. In other words, promoters cannot be using the cash-flows from one venture—where loans are to be re-paid—as equity for another.
Given both large and mid-level promoters aren’t in a position to make equity contributions, it is difficult to see any big projects—or even mid-sized ones—being launched in the near future. While headline numbers for new project announcements might sound exciting, many of these are just that—announcements at state fairs, meant to hit the headlines. The ground reality is that number of projects under implementation is slowing and value of stalled projects is going up. Which is why, the capex cycle may not fully recover even in three years.