<b>Ishan Bakshi:</b> Expect an uptick, not a big leap

With public sector capex likely to increase marginally and private sector data looking sombre, investments will only inch upwards. There is little chance of a sharp recovery in the figures next fiscal

For those worried about flagging investments, last week brought some more bad news. The capital goods segment in the Index of Industrial Production, a proxy for investment demand, contracted by 20.4 per cent in January. Over the entire April to January period, it has contracted by 0.6 per cent. Clearly, the task of reviving the investment cycle is proving harder than anticipated.

The fundamental question is whether the prospects of a turnaround in the investment cycle are any brighter in the coming year? Notwithstanding the new gross domestic product (GDP) series, a look at the two principal pillars of investment - the public and private sectors - suggests a modest uptick at best.

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Let's first look at public capex. Public sector investments, broadly speaking, encompass spending by both central and state governments as well as public sector undertakings (PSU).

Now, with the National Democratic Alliance government shifting its expenditure priorities - it's pumping more money to prop up the rural economy, coupled with its pivot on parsimony - the Centre's capital expenditure is budgeted to grow at a mere 3.9 per cent in 2016-17, after growing at 20.9 per cent in 2015-16. As a percentage of GDP, it's expected to decline to 1.6 per cent in 2016-17 from 1.8 per cent in 2015-16.

In the years following 2016-17 too, one shouldn't expect a sharp increase in the Centre's capex. The medium-term fiscal policy framework laid out in the Budget documents says the share of capital spending in total expenditure is likely to increase by a mere one percentage point in 2017-18 and by two percentage points in 2018-19. This means the big public sector capex push isn't likely to come from the Centre.

Public capex could, however, be ramped up through greater spending by PSUs, as in the current fiscal year. But here, while data point to a robust expansion, growth is likely to be lower than last year's. Plan investments by PSUs, excluding budgetary support, are expected to grow at 24 per cent in 2016-17, lower than the 40 per cent growth observed in 2015-16.

This implies that of the three pillars of public spending, two are likely to grow at a slower pace in the next financial year.

Another channel through which public spending can be increased is via states. The clamour for greater spending by the Centre ignores that, put together, states spend more on investment than the Centre.

With past data showing that capital expenditure by states has risen steadily from 2.25 per cent of GDP in 2012-13 to 2.86 per cent in 2014-15, it is possible that states may well do the heavy lifting of public spending. But it's difficult to know for sure.

A preliminary reading of a few state Budgets for 2016-17 suggests that states have reoriented their spending patterns. States such as Bihar and West Bengal have taken advantage of the flexibility provided by the 14th Finance Commission to increase social sector spending. This increase will obviously come at the expense of capital spending.

Only when all states present their 2016-17 Budgets will we get a clear idea about the level of capital spending in the coming financial year. But one could say that unless states ramp up capital spending aggressively, at the aggregate level, public sector capex is likely to grow at a slower pace in 2016-17 than in 2015-16.

On the private sector side, data make for a sombre reading. According to the Centre for Monitoring Indian Economy, new project announcements fell off a cliff to Rs 69,000 crore in the third quarter of 2015-16 from Rs 2 lakh crore in the second quarter. This suggests that the private sector has remained impervious to the stimulus measures.

While many point out that previously stalled projects could come online quickly, a closer look indicates that may not be the case, as many of them are simply not viable in the current environment.

Of the total number of projects stuck, over three-fourths were concentrated in four sectors - power, steel, petroleum and natural gas, and road transport and highways.

Let's take a look at each of the sectors. In the power generation segment, given the level of unused capacity that exists, it seems unlikely that new thermal generation projects will take off immediately. While some capacity addition is possible in the renewable space, it is likely to be limited.

In the transmission space, the Power Grid Corporation of India has a virtual monopoly, but its plan investment in 2016-17 is expected to remain at the same level as in 2015-16. In distribution, which is largely dominated by state companies, the Ujwal Discoms Assurance Yojana (UDAY) plan could potentially act as a catalyst to spur investment. But this will only play out over the next two to three years.

In the steel sector, with low cost products streaming out of China, it would take a brave promoter to set up a new project. Even in the PSU space, plan investments in the sector in 2016-17 are expected to increase by a mere Rs 440 crore over 2015-16.

In the petroleum and natural gas sector though, one could see greater investments, with the government moving towards a calibrated market pricing strategy and trying to resolve legacy issues.

The one area that could potentially kick-start the investment revival is the roads sector. The shift to EPC (engineering, procurement and construction) contracts, which essentially guarantee an income stream, could potentially revive private investments. Add to this the boost in public spending and the sector's prospects look bright. This could push demand for cement and steel which in turn could stimulate other sectors as well.

But with other drivers of investment waning, the most one can hope for is an uptick, not a robust recovery.

The Long View is an occasional series that analyses different scenarios