Investment kicker

The Index of Industrial Production (IIP) for October indicates a lower growth rate than for October 2004, particularly in the manufacturing sector, but there is hardly any cause for concern. This sector grew by 9.6 per cent over the corresponding period of the previous year, compared with 11.9 per cent last year. The effects of a high base are clearly visible. For the year so far (April-October), growth has been 8.4 per cent, only marginally below last year's rate of 8.7 per cent. The manufacturing sub-set, in fact, has grown slightly faster than last year. Mining has been the main contributor to the decline, followed by electricity. Of these two, the continuing slowdown in the growth rate of electricity over the last few months is of greater concern, since it underscores the roadblocks that power sector reforms have hit and the fact that no significant new capacity is in the pipeline. However, manufacturing seems to be chugging along nicely, at least for the moment, relying on the sizeable captive power capacity that exists and whose output is not captured by the index.

The robust industrial performance has clearly been driving more and more companies to the limits of their capacities; investment activity has been an important driver of industrial growth over the last couple of years, gaining importance as the impact of factors such as falling interest rates wanes. It is reassuring from the viewpoint of sustaining growth that the investment impulse, if anything, shows signs of getting stronger. As reported in this newspaper earlier this week, the aggregate investment plans by the corporate sector total up to over Rs 300,000 crore, about 8 per cent of GDP. Obviously, all plans will not translate immediately into actual spending. However, they are a strong indication of the confidence levels in the business community about the longer-term prospects of the economy.

Of course, investment booms are not always good news, as the experience during the mid-1990s suggests. In that episode, companies went to town with new capacity, financed heavily by borrowing at extremely high interest rates. When the business cycle turned in 1996-97, a large accumulation of non-performing assets by the financial sector was inevitable. Not this time, though. The corporate sector has been accumulating internal resources because of healthy margins. About half of the new investment is expected to be financed out of these. External debt, both foreign and domestic, will play a relatively small role and, most importantly, in a far more benign interest rate scenario. The risks of corporate distress in the event of a slowdown are far lower as a result and those making these new investments should easily be able to ride out a business cycle downturn of moderate proportions.

However, it is important to remember that this rather rosy picture does have its share of potential thorns. One, about 20 per cent of the aggregate planned investment is slated for power. If this is for commercial generation, it will inevitably stall if the power sector reforms do not progress. If it is for captive capacity, it reflects a diversion of resources from true capacity expansion. But the most significant point is that investment plans can, and will, change in response to perceptions about the investment climate. It is incumbent upon the government to do whatever is within its control to keep that climate healthy.