Much of the current gloom stems from a decline in funds raised by India Inc and a fall in the capital goods index - one is a reality while the other could be a data blip.
CHETAN AHYA,
ASEAN economist, Morgan Stanley
The overheating is caused by the fact that infrastructure spend lags other investment. This forces the RBI to hike rates, and the global slowing of capex inflows worsens things
After three years of above-trend growth, India is now facing major macro challenges in sustaining its growth rates at 8-9 per cent. Domestic overheating resulted in the RBI pursuing a tight monetary policy since the last quarter of 2006. This tightening caused a major slowdown in the credit-funded consumption cycle. Rise in the domestic cost of capital and weakening business confidence due to slowing consumption demand had caused the investment cycle to peak from the last quarter of 2007. The adverse global circumstances — high global commodity prices promoting additional monetary policy tightening and slowing capital inflows — are threatening a further slowdown in investments.
Despite some slowdown in the second half of 2007-08, total investments during the year are estimated to have reached a new high of 37 per cent of GDP from 35.9 per cent in 2006-07 and 22.8 per cent in 2001-02. The key driver of this improvement is the sharp pick-up in private corporate sector investments to 16.1 per cent of the GDP in 2007-08 from 5.2 per cent in 2000-01.
A number of indicators show that investment growth has decelerated over the last six months. Capital goods output growth has slowed to 6.8 per cent during the three months ending June 2008 from the peak of 24.2 per cent during the three months ending October 2007. Similarly, the trend for aggregate fund raising has also suffered over the last six months.
There are also domestic hurdles in the investment cycle. Overall investment growth has been strong, but micro-imbalances are challenging the sustainability of the high growth. For example, private corporate investments rose to 16.1 per cent of GDP in 2007-08 from 5.4 per cent in 2001-02, but infrastructure investments remained low at 5.3 per cent of GDP in 2007-08, albeit higher than 3.5 per cent of GDP in 2001-02. The micro imbalance in investments is one of the key factors behind the recent overheating of the economy. This overheating in turn forces the central bank to pursue a relatively tighter monetary policy, lifting the cost of capital, implying a lower sustainable growth rate. The current policy response for infrastructure is not strong enough to lift the equilibrium growth to a sustained 9-9.5 per cent in the near term.
Another key hurdle is an adverse global environment. Firstly, the high level of commodity prices and resultant input cost pressures has forced the central bank to tighten aggressively, lifting the cost of borrowing to 1998 levels. Even if commodity prices continue to fall, the RBI is unlikely to cut policy rates until the second quarter of 2009. Secondly, increased risk aversion in the global financial markets will result in a sharp slowdown in capital inflows into India. Capital inflows into India could slow to $40-50 billion over the next 12 months compared with $110 billion in 2007-08, unless there is a dramatic turnaround in the global credit market environment.
MAHESH VYAS,
MD and CEO, Centre for Monitoring Indian Economy
New projects announced have risen a fifth over a year ago. If the capital goods index still shows a fall, it is because it is faulty — this shows a fall even when sales of companies are growing
Investment announcements continue to gush, notwithstanding the correction in the equity markets, the rise in interest rates and the (unwarranted) fears of a slowdown. An average of Rs 173,000 crore of new investment projects were announced per month during April-August 2008. In 2007-08, the average new investment proposals made was Rs 144,000 crore and in the year before it was Rs 110,000 crore. The figure was a mere Rs 66,895 crore in the first full year of the current boom, 2005-06. Thus, we are in the fifth consecutive year of the investment boom and the rush does not seem to ease. On the contrary, it continues to rise.
The new projects would take several years to commission. For example, Videocon Industries’ Rs 8,000-crore LCD television project to be set up in Maharashtra is a greenfield project and it would take time to implement. So, would Jindal Steel & Power’s new Rs 18,000-crore steel project in Chhattisgarh. So would the other Rs 864,000 crore worth of projects announced since April 2008. And, this would sustain the capex boom in the coming few years.
Sure, some of the projects announced will not be implemented. This is normal. However, the gross additions are so large that even if half the outstanding projects were to be abandoned, the capex boom would continue for quite some time.The strong order book position of capital goods companies is a good indicator of the current capex boom. As of June 2008, the average order book of the top 15 capital goods and construction companies was Rs 266,000 crore. This amounted to 2.6 years of their annual sales.
Domestic capital goods companies are barely able to cope with the demand for capital goods. This is reflected in the sharp 58 per cent increase in capital goods imports during January-April 2008. Bank credit to industry has been growing rapidly and is quite unperturbed by the RBI’s efforts to curtail credit growth. Bank credit to industry grew by a robust 27 per cent year-on-year as of late May 2008. Most of this growth is in funding infrastructure industries and steel.
Again, this indicates robust capital spending by industries. The only indicator that raises alarm bells on investments is the fall seen in the growth of the capital goods industries in the Index of Industrial Production. However, this data is seriously faulty. For example, for the quarter ended June 2008, it shows a 30 per cent decline in the production of material handling equipment, while the sales of these companies had grown by 20 per cent in the same period. The IIP shows a mere 6.8 per cent increase in the production of machinery items, while companies in this segment reported a real growth of 12.6 per cent.
Official statistics may lead to faulty analysis but, industry is wise to be not fooled by them. They continue to invest happily.
