The recent study by Reserve Bank of India, on private corporate investment trends, is an eye-opener.  The two startling revelations from this are of an intensifying contraction in capital expenditures in FY15 and the drying out of pipeline investments in FY16 so far. This steep fall, the fourth consecutive year from FY12, raises serious questions about India’s potential output, current as well as future. Surely a negative rate of capital accumulation would affect a country’s capacity for GDP growth?

Altogether, the RBI study flags some critical features of immense significance for India’s growth path ahead. It puts out irrefutable evidence on the private corporate investment cycle, if only because of the comprehensive aggregation of fund-flows into capex financing. The base is actual funds raised from all sources (banks, other financial institutions, all type of external borrowings, equity) except internal accruals, private placements and foreign direct investment, which are but a minor fraction. The financial flows thus extend beyond bank credit to industry, the commonly-used gauge, making the picture quite accurate.

Summarily, these trends are identified. One, capex by corporates contracted 27% in FY15 year-on-year; both the number of firms (830) and estimated capex costs (R1.5 trillion) fell compared to FY14 (1,065 firms, Rs 2.1 trillion).

Two, not only was last year the fourth successive annual decline, but the pace of shrinkage doubled—capex dropped
– 27% relative to – 13.2% in FY14. Three, fresh investments in new projects in FY15 plunged a hefty 25.5 percentage points, the share in total costs declining to 39.7% from 65.2% in FY14. Four, the intended investments in FY15 were led by power and metal, followed by transport equipment & parts, telecom and textiles; the share of infrastructure projects increased 7 points above FY14. Last, but the most worrying by far is the drying out of pipeline projects in FY16, as gleaned from capex plans up to last year. Forget about a positive turnaround—in order to just stem the four-year, contractionary trend and maintain expenditure at FY15 levels, the private corporate sector must make new investments of at least R1.1 trillion this year.

What inferences can be made about India’s growth in the light of information? What could this imply for the country’s current and future potential output?

We can gain some insight into the FY16 capex prospects by combining specific developments in the lead sectors mentioned before with financing trends and some other features. Power sector, in which 42% of capex was contracted in FY15, is seeing significant loss of investor interest as observed from the lack of private bidders for ultra-mega power projects (UMPPs), producer exits from existing projects, impaired balance-sheets and their counterpart of stressed and bad debts at banks’ doorsteps, tepid power demand and consequently low purchases by the discoms and state utilities, which are themselves seriously damaged financially, rising costs and sundry issues demanding urgent reform. The metal sector (e.g. steel, iron ore, aluminium, etc.) is battling global oversupply, steeply falling prices, slump in demand, cheap imports and high costs of coal auctions and finance. It is rather a time for the industry to consolidate and build buffers rather than plan fresh investments; some have already announced plant shutdowns. Power and metal alone constituted 60% of capex costs incurred last year. Further, the 4% share of textile sector in total capex expenditure incurred last year, was itself a 6-point reduction over FY14 shares, no doubt reflecting a fall in export demand; there is little chance of investment picking up this year considering the pace of fall of garment exports and rising unemployment. Likewise, construction and cement sector (combined share of 8%) witnessed a 1.5-point fall over FY14 shares, corresponding to the rising inventories, falling transaction volumes, lack of appetite for infrastructure exposures and so on. These developments are buttressed by a steady decline in bank credit growth spread across small, medium and large industry.

For a fuller understanding of the effects on potential output, relate the private corporate investment trends uncovered by RBI to simultaneous evolution of fiscal policy. Consolidation to rectify public finances kicked in in the second half of 2012, when the government accepted the Kelkar panel’s recommendations on this. The axe on spending that followed fell heavily upon capital expenditure; as fraction of GDP, capital spending by the Centre dropped more than 20 bps in the two years to FY13, declining further to 1.5% of GDP from its 2% peak in FY11. This drop in public capex, which is well-known to stimulate private investments, confirms the economy’s productive capacity did not expand much via the government sector. In other words, potential output suffered a double blow, from both public and private corporate sides. In FY16, when fiscal policy is reoriented towards increased infrastructure expenditure, there could be an investment pickup but it is debatable if the multiplier effects are large enough to arrest a pronounced overall decline.

In the light of these developments, the concern is about damages to potential output, which has very likely suffered in this period. At the heart of the evolution of potential output of an economy are the supply conditions, in which capital or fixed asset creation is a key input apart from labor and productivity of these two factors. Looking at the negative variations in private corporate investments in conjunction with the squeeze in public capital expenditure for four successive years, the slowing capital accumulation raises concerns about the effects upon potential output. In June 2015, RBI assessed that as per the new GDP estimates, India had the capacity to grow in the 8-8.5% range given its production potential, although it stated that growth could be weaker than what the headline numbers suggested. The potential growth rate of 8-8.5% therefore remains tentative.

The above context indicates that the current growth potential itself might have lowered on account of damages from insufficient capacity addition/expansion on the supply-side for four consecutive years. Future potential is likely to lower further looking at the absence of pipeline capex in FY16 so far, weak demand conditions within and abroad, and escalated financial uncertainty. The advent of the global financial crisis in 2008 has seen the reduction of potential output in many countries and from diverse sources, including increase in unemployment levels and demographic changes (aging populations). It appears that India remained fairly immune to this trend until FY11, but has probably suffered a similar reduction in its potential growth capacity. This, of course, casts a question mark upon growth in the current year and medium-term prospects, commonly projected in the 8% region.

The author is a New Delhi-based macroeconomist