And now the inevitable pickup in investments

A 7 per cent GDP growth rate may be lower than what India aspires for, but over a five-year horizon this means 40 per cent higher demand

After a long period of weakness, investment activity in the Indian economy has been picking up. Gross Fixed Capital Formation (GFCF) as reported by the Central Statistics Office (CSO) remains the most broad-based estimate of this activity in India: The GFCF-to-GDP ratio fell steadily from 2012 to 2017 from 40 per cent to 30 per cent, but has since risen to 32 per cent. Many expect this recovery to be short-lived, but a deep dive suggests it could sustain, and reveals some surprises. As we will see, contrary to consensus views, the slowdown in investments till 2017 was not driven by weak private sector activity, and the recent pickup has not been driven solely by acceleration in government spending. 

The CSO splits GDP statistics into three parts: Private corporate, public sector and household. The first is data from the MCA21 database, and is more or less the sum-total of half a million companies. Public sector data is the combination of state and central government budgetary expenditure as well as spending by public sector enterprises. The household sector is the ‘residual’, that is, whatever is left after the first two have been accounted for; it is so called because in most such informal enterprises, there is no separation between business and household accounts. Data availability for the formal economy, which is the private corporate and public sectors, is much better than for the household sector, where the CSO is forced to rely on proxies like cement consumption to track annual trends.

 

In 2017, 43 per cent of GFCF came from private companies, 25 per cent from the public sector, and the remaining one-third from the household sector. Interestingly, and much against popular belief, nearly two-thirds of the incremental investment between 2012 and 2017 was contributed by private companies, and a third came from the public sector. Households did not see any growth in five years even in nominal terms, mainly due to weak housing (most of this is self-built housing in villages and small towns). Corporate capital expenditure (capex) grew at 14 per cent a year in this period, faster than nominal GDP growth. Public sector investment growth was in line with nominal GDP growth of 11 per cent, and the pace has been maintained between 2017 and 2019, belying the view that the recent investment pickup is all due to government spending. This pace of capital investment can last: Three-fourths of public sector capex now comes from state governments and central public sector enterprises.

The evidence of strength in private corporate capex in a period where corporate commentary was overwhelmingly negative is so counter-intuitive that one needs to validate it against other data sources. We took two approaches. In the first, we aggregated capital expenditure data for companies. We could only find capex data for about 12,000 companies, adding up to nearly Rs 8.1 trillion(about half the total private corporate GFCF reported in 2016). Even this data was patchy, obviating any year-on-year growth analysis. However, the sectoral mix provides insights on major sectors that drive the overall investment number: Utilities (power generation, transmission and distribution), energy (such as production, refineries, distribution through pipelines), telecommunications and metals. 

In nearly all these segments, except thermal power generation and metals production, capex had not slowed, and is expected to continue. In metals and thermal power, construction and completion of projects had continued during this period even though new ordering activity fell sharply.

The second approach, of charting revenues of listed industrial goods companies, showed that the only company which saw a steep decline in revenues was an equipment provider for thermal power generation. The rest saw some slowdown in growth for a while, though no drop, and in the last several quarters, the reported sales growth rates have picked up. It is also worth pointing out that nearly a third of the incremental private GFCF between 2012 and 2017 was an investment in Intellectual Property (IP), which grew at a pace of 22 per cent a year. The IP investment, to our understanding, is mainly in software, for example, billing, supply chain or customer management. While it may not mean addition to machinery, its productive utility is significant: In many developed economies, intangible capex now exceeds tangible capex. Sales of construction equipment (like for earth moving during road-building) have picked up, and have stayed strong even though the demand slowed in recent months.

Rising utilisation levels are now triggering new investment plans: this is visible in sectors like steel, power, refineries, airlines and autos. After all, a 7 per cent growth in annual GDP may be lower than what the country aspires for, but over five years it means aggregate demand rises by 40 per cent. While the expansion of airports and new ordering of airplanes is now well known, even steel companies that have a viable balance sheet have already embarked on capacity expansion. India has again become a net importer of steel, as demand now exceeds domestic supply. In coal-based thermal power, where utilisation bottomed two years ago, if annual demand growth sustains at five to six per cent (it should), new capacity would be needed by 2024. Medium-term power tariffs are already at Rs 6 per unit, having risen steadily over the last two years from Rs 3.5.

There is no capex surge yet as was seen in the 2010 to 2012 period, possibly because stricter insolvency norms have obviated debt-fuelled adventures, making groups much more cautious in their planning, and also because we are still early in the investment cycle. Even if demand growth was to weaken a bit, the investment revival can continue in our view, but recent problems for Non-Banking Finance Companies (NBFCs) are a worrying prospect. Debt Mutual Funds are now also becoming less of a supplier of credit to the economy. Despite a pickup in bank loan growth, aggregate credit supply is slowing, and the number of business groups struggling for liquidity is rising even though the RBI continues to make record amounts of bond purchases in the open market. This can hurt not just informal (that is, household) capital expenditure, but also the formal sector. For now, though, the capital expenditure driven by competitive intensity as well as due to high utilisations should continue.

The writer is India Strategist and Co-head of Asia Pacific Strategy for Credit Suisse