Pump-priming the capex cycle through higher public expenditure and greater investment outlays by CPSUs is key
Economic recovery remains anaemic. The reasons are not difficult to identify. Rural consumption weakness persists due to weak growth in rural wages, smaller increases in minimum support prices and a decline in government revenue expenditures. Aggregate consumption demand in the economy remains weak for similar reasons, and because of the welcome measures against black money and the cash economy. Thus, the demand impetus for stimulating growth has been missing. The much needed growth stimulus has to come from a turnaround in the investment cycle. This has the added advantage of generating a virtuous cycle through the multiplier-accelerator mechanism, which would generate a more sustainable growth momentum, as it also helps to address supply side bottlenecks.
Private investment would normally be expected to lead the upturn in investment activity. This is, however, unlikely at present because of stressed corporate balance sheets, weak prospects for both external and domestic demand and reluctance of banks to increase credit. The banks’ reluctance is understandable in the context of very high levels of gross non-performing assets—estimated at 4.45% (March 2015) of total assets—which rise significantly to 10.9% for the banking sector as a whole if restructured advances are included. These levels are likely to be much higher for smaller public sector banks. So, the onus for turning around the capex cycle has to be borne by the government. Three modalities can be used. First, directly raising public capital expenditure; second, indirectly through greater investment outlays by central public sector enterprises (CPSUs); and finally by de-bottlenecking projects under implementation.
The last two years saw sharp pruning of public capital expenditure to meet the fiscal deficit target. In the current budget, capital expenditure was slated to be 29% higher than in the previous year. In the first two months of current fiscal year (April and May), the government has managed to raise capital expenditure, albeit by a marginal 2.7%, despite lower revenue receipts and concomitant reduction in revenue expenditure. Notably, the government has significantly increased capital spending between March to May 2015 .
Based on recent trends, the government seems to be front-loading capex expenditure. This may have to be tapered off later in the year unless the lower subsidy outgo, due to muted oil prices and greater recourse to direct cash transfers, opens up further fiscal space for higher public capital expenditures to be sustained during the second half the year.
However, the government could make up for any slack in its direct capex expenditure by encouraging investments by cash-rich CPSUs. The budget envisages a sharp 34.1% increase in investments by CPSUs compared with a 10% drop last fiscal. CPSUs in the roads and railways sector are together expected to nearly quadruple their borrowings to R80,300 crore in FY16 from the bond market compared to last year.
Overall, it is clear that the government seems to have understood the importance of pump-priming the capex cycle directly through higher capital expenditure and front-loading the expenditure and supplementing it through higher investment outlays by CPSUs.
There are also signs of a modest pickup in private corporate investments. The CMIE capex related data shows that total projects under implementation grew at 8.5% yoy in quarter ending June 2015—highest since September 2012. Interestingly, projects under implementation by the private sector moved to the positive territory for the first time in eight quarters exhibiting some fragile recovery in corporate capex.
The number of stalled projects has declined for the fifth consecutive quarter with un-blocking of government projects in recent months. The government’s Project Monitoring Group is working to address various constraints like ministry clearances, unavailability of raw materials, coal linkages etc. As projects get operational, revenue inflows will alleviate corporate balance sheet stress and banks’ NPAs
Adding credibility to fragile recovery in the capex cycle, capital goods production within IIP has been growing at an average of 7.3% yoy since November 2014—7 consecutive months of positive growth. Such production tends to be lumpy and one needs to be cautious in interpreting this data, but the positive trend is visible. This is supplemented by an increase in sales of commercial vehicles—a lead indicator for the investment cycle.
There has also been a bigger push in the infrastructure sector under the new government. According to the ministry of surface transport, road construction, that had slowed down to 2 km/day in 2014-15, has improved to 12 km/day. The National Highway Authority of India has already awarded contracts for 3,000 km of road construction in 2015-16, twice that awarded in 2014-15. The Cabinet also recently cleared redevelopment of 400 railway stations and announced six-laning of Eastern peripheral expressway in the NCR.
The only weakness in the otherwise positive investment picture is the persisting weakness in the overall bank credit growth due to increased risk-aversion of the banking sector. In the meantime, corporates seem to be meeting their financing requirements through other sources like commercial paper that have increased by 64% yoy as on end-May 2015 and through FDI, which jumped up by 112% in April 2015.
There are thus welcome signs of an upturn in the investment cycle. This augurs well for a broad based economic recovery, which could be sustained if the government gets its act together in the Parliament and manage to pass the pending bills. The news of the impending recovery should give it greater confidence and be more magnanimous with the depleted opposition.
Kumar is senior fellow, and Das Krishna is senior researcher at Centre for Policy Research