Public and private balance-sheets indicate investments in the sector exceeded capacity or grew too fast
Large infrastructure projects, stuck for various reasons in the past few years, haven’t taken off despite quickened clearances. This is contrary to what was expected: The belief was that once the key obstruction points like environment, land acquisition were addressed, as indeed these have been to a large extent, private infrastructure investments would resume. But looking at the strained balance-sheets of infrastructure firms, which is inhibiting the appetite for additional risks, this conviction soon swung solidifying into an argument for raising public investment in infrastructure to fill the vacuum.
Relating this to developments in the past few years, when infrastructure investments were scaled up extraordinarily, it now appears that too much money or capital was invested in infrastructure projects. How does one weigh over-investment, though? Normally, such an assessment would be in relation to profitable returns from investments, i.e., income, interest or appreciation in value. A difficult exercise at the aggregate level for a segment where investments are made by both public and private agencies and time lags tend to be very long. An alternate route can be to look at financial capacity or the ability to invest. Examined from this angle, such investment does indeed seem to have been overdone.
Start with the public sector or government. The limits on its spending-borrowing decisions are implied by its budgetary constraint which relates these two elements; any gap between spending, inclusive of debt interest, and tax/non-tax revenues determines the borrowing required to finance the budget deficit. As fiscal policy is a critical component of demand management—both as automatic stabiliser and as feedback policy—there are implications for the effects of government’s budgetary constraint upon the economy. Against these limitations, what has been the scale of public spending on infrastructure?
Over FY10 and FY11, the total capital expenditure of central government (plan and non-plan, excluding defence) jumped a respective 27% and 46%, after a 40% contraction in FY09 (a crisis year); the growth in FY08 was 136%. Capital expenditure by state governments grew with a lag—at about 23-24% in FY12 and FY13, this followed a pre-crisis, annual average growth of 18% over FY07 to FY09. Assuming no leakages, this reflects a substantial and sustained escalation of public investments in infrastructure, which in itself got a big push from 2004.
Meanwhile, the Centre’s gross fiscal deficit doubled from 2.54% (FY08) to 5.99% of GDP in FY09; then to 6.46% in FY10; and sustained at relatively high rates the next two years (4.79% and 5.73%) before beginning its descent. Likewise, the consolidated general deficit more than doubled to 8.3% of GDP (FY09), rising further to 9.3% the following year and oscillating in the 7% region since.
While not going into the finer merits of raised levels of public capital spending, which was part of globally coordinated actions in 2009 to limit the decrease in demand and output, we focus on the constraints imposed upon fiscal policy by the imperatives of aggregate demand and the budgetary constraints: these years were characterised by extraordinarily high and persistent inflation, while on average, these deficits were fully financed by market borrowings.
What about the private sector? Here too, we observe unusually high investments in infrastructure in relation to financing capacity as observed from the enormous rise in corporate debt since. According to an IMF analysis last year “Domestic credit to corporates continued to rise during and after the crisis…, notably for infrastructure projects…. Corporate leverage rose as the equity market saw relatively few issuances…post-crisis.” One-third of the corporate debt in India has a debt-to-equity ratio of more than three, the highest degree of leverage in the Asia-Pacific region, noted the IMF. A recent Standard & Poor report observes that in the five years to FY14, debt in the infrastructure and utilities increased 2.5 times relative to a 1.5 times increase in overall debt of all Indian companies.
Other analysts also associate the rise in corporate debt to large-scale expansions from private sector entry into investment-heavy, capital-intensive sectors like highways, power, airports, ports and urban infrastructure in a fast growth environment. These investments were conceived and planned taking an 8%-plus growth as a given. Excess global liquidity and cheap credit (IMF notes that foreign currency debt, viz. external commercial borrowings rose 71% between March 2010 and March 2013) also influenced investment decisions no doubt. This optimism, which assumed free operating cash flows, obviously fuelled a debt-led expansion that far exceeded balance sheet capacity in these years. Several analyst reports note that often, companies bought businesses to either diversify or start fresh in these areas, lured by optimistic returns. All these are signs of euphoria, a typical context in which over-investment happens.
Subsequent developments provide further clues: Despite divestments and asset monetisation to consolidate balance sheets, most firms find it difficult to raise fresh equity to either retire debt or expand afresh as market values remain lower than debt; most also continue to have an unfavourable debt-to-equity ratio. Stake sales, distress asset sales, exits from local as well as global investments and acquisitions are other signs. As interest rates went up, many firms have also borrowed to make up for operational losses or to fund working capital as well. The persistence of high levels of debt in the books of firms is reflected in the system-wide, near-doubling of gross non-performing assets (NPAs) and restructured loans over FY11 and FY14, with much-higher levels for public sector banks; these are mostly concentrated in infrastructure loans.
Against this backdrop, the slowdown in infrastructure investments—admittedly due to policy constraints—seems a natural purging of past excesses that needs working out at a systemic level. This may seem somewhat surprising or counter intuitive considering the vast infrastructure deficit that would suggest otherwise. Consider, though, a counter-factual scenario: That infrastructure investments had sustained, the projects were executed and came on stream. What might then have been the consequences? In that event, the economy would probably have grown faster for a year or two, but inflation from the consequent demand-creation would likely have been even higher. Fiscal policy in this set-up would have had to be squeezed harder while monetary policy would have been even tighter, with subsequent impact upon growth. What this underlines is that any expansion beyond capacity cannot endure and is, in the end, unsustainable.
There may be lessons for the future at this point. The issue that surfaces is of pace: Is there a threshold beyond which both public and private sector investments are unsustainable? A significant and fast ramp-up of infrastructure spending that exceeds balance-sheet constraints is likely to hit absorptive capacity limits with adverse feedback consequences, viz. inflationary spillovers, pushed-up costs of other investments due to sudden, sharp increase in demand for factors of production like land and labour, financial vulnerabilities, and so on—that eventually serve to pull down future investment and growth.
And we are not even considering banks here, in which context the RBI Governor was probably fair to recently warn that the push to finance infrastructure should not override financial stability. As once again opinion converges to scale up infrastructure investment, from public resources to start with followed by private resurgence, it might be worth the while to figure out a sustainable pace of investment to avoid repetition of past excesses.
The author is a New Delhi based macroeconomist