The decibel levels calling for the private sector to invest more have gone up ever since the goods and services tax (GST) rates were rationalised. The argument is that when the government has done everything within its powers to increase consumption and the Reserve Bank of India (RBI) has cut rates by 100 basis points, it is time for the private sector to deliver. It is expected that the private sector will respond by investing more, which, by itself, will help generate more jobs and thereby initiate a new virtuous cycle of spending. While this is a logical expectation, the real world could be different.
Investment is surely happening in the country—the gross fixed capital formation (GFCF) rate is at around 30%. But the proviso here is that it is not broad-based but concentrated in industries that are more aligned with infrastructure—steel, metals, machinery, chemicals, etc. It is also limited to a handful of companies in the consumer goods space. It does look like where there is increasing capex, the government spends at the front end, but there is also a backward linkage to the industries concerned. In the best of times, the GFCF rate was 34-35%, and at the same time growth in GDP also averaged above 8%. Why, then, is investment not forthcoming?
First, companies typically invest when they find robust demand—it is only when this level crosses 80-85% that companies do so. Here, both current as well as future consumption matter. Companies need to see a higher growth trajectory in sales for a prolonged period to go in for fresh investment. This varies across industries and companies as well as across time.
This issue gets tied up with consumption or the ability to consume, which has been hampered a lot by high inflation over the years. While inflation is down presently, household consumption has been affected by cumulative inflation in the past, with income growth not keeping pace. It can be hoped that with the fiscal concessions on both direct and indirect taxes, there would be a turnaround this season.
Second, when companies invest, they always have to evaluate the returns. Hence, the return on capital comes into play. Building capacity financed by leverage involves a cost. There has to be commensurate output and profit for any investment.
This is one reason as to why companies hold back on prospective investment until it is absolutely necessary. Governments, on the other hand, have an outlay specified in the Budget that can be spent once approved. The government doesn’t have to bother about return on capital and the money can be spent—the focus is on achieving targets in terms of project completion. This difference has to be noted as the motivations are different for the two entities.
Third, with interest rates being lowered, logically more projects become viable. This begs the question why the private sector has not yet started investing. But as stated earlier, no company borrows to invest unless there is opportunity. Interest rates are rarely the limiting factor. For instance from 2005-06 to 2012-13, the average GFCF rate was as high as 34% and the repo rate averaged 6.85%. Yet, investment flourished—there was opportunity to invest as growth was buoyant. Therefore, investment decisions are not taken because of interest rates but “need”.
Fourth, the quantum of uncertainty in the economy has increased since April when the tariff issue came up. Until there is greater clarity, several industries—textiles, leather products, engineering, auto components, electronics, pharma, etc.—would not be in a position to invest, especially if there is export orientation.
Lastly, in a sector like real estate, the build-up of inventory has hindered fresh construction. Further, a sub-section in the area of affordable housing has slowed down mainly due to fewer projects being taken up. It is often argued that the value of such houses needs to be increased, given the cumulative inflation. In the absence of such a review, these projects have become non-viable fore realty firms.
All factors taken together, it does appear that building momentum in private investment will take time. It can be expected to gradually pick up across sectors and it may take up to two years for a more definite picture to emerge. The preconditions have been met to a large extent by the government, with affirmative action on taxation. The Centre and states’ commitment to capex does offer favourable conditions for private investment. Interest rates are down, and there could be another rate cut during the course of the year, though indications are the rate cut cycle has ended.
To reach a 33-34% investment level, big investments in infrastructure are needed. This is the main challenge. During 2005-13, when investment boomed, heavy industry was the driver. This segment can provide a big boost to capital formation as the industries in the consumer segment do not require bulky investment. In short, one needs to be more patient.
