Investment-led growth unlikely in the short-term despite sops from the government

#FICCI, #RBI, #RBI’s OBICUS, #UBS Securities

A quarterly survey of eleven major manufacturing sectors by industry body the Federation of Indian Chambers of Commerce and Industry (Ficci) found that capacity utilisation improved a little by the end of the first quarter of 2021-22. This survey report released over the weekend found that capacity utilisation was between 60% in electronics and electricals to 80% in cement and ceramics in April-June 2021, with the average capacity utilisation level at 72%.

Earlier last month, the Reserve Bank of India’s quarterly OBICUS or Order book, inventories and capacity utilisation survey estimated capacity utilisation at a shade under 70% during the January-March quarter of 2020-21. That was before the second wave of the Covid19 led to localised lockdowns in many states. Capacity utilisation levels had improved gradually from 47.3% in April-June 2020 quarter when the economy was under a harsh lockdown.

While the two surveys are not entirely comparable, they have a similar conclusion. Capacity utilisation has improved but not enough to nudge companies to plan for fresh investments.

The industry expects capacity utilisation to improve over the coming quarters. Of those who participated in the Ficci survey, just about a third had plans for the next six months to expand. The cement and ceramics industry, which is a beneficiary of a revival in construction and infrastructure creation, plans to add capacity in the coming months. Cement plants have a long gestation period, necessitating early planning for capacity expansion.

Some companies in the automobile sector were also optimistic about capacity expansion, although a shortage of semiconductor chips is weighing down the industry. Most companies manufacturing capital goods, electronics and electrical, textile machinery, textiles, and metal and metal products have no such plans for expansion at this point, given their low levels of capacity utilisation.

A UBS Securities India research report in late August said that it saw no meaningful step-up in the corporate investment cycle in the next couple of years despite the government’s push to boost capital expenditure. It expects growth to be consumption-led in the second half of the current fiscal, due to pent-up demand for contact intensive services.

Caution is the watchword 

The cautious approach of the industry means that the demand for capital goods such as machinery, plant, and equipment from the corporate sector will stay relatively muted for the next year or more. That means that capital formation in the corporate sector will grow at a slow pace, which does not augur well for rapid economic expansion. Replacement and renewal orders have been flowing in but that is not enough to perk up the output of capital goods or significantly improve capital formation in the private sector.

Capital goods production has been insipid since April 2019, with positive year-on-year growth recorded in just six months, three of which were in the current fiscal year. On a sequential basis, output rose in June and July 2021, from a fall in May 2021 amid the second wave of the Covid19 pandemic.

Planning for new investments usually begins when capacity utilisation is at 75-80% and demand strengthening. Capacity utilisation in India’s manufacturing sector has stayed below 70% for seven consecutive quarters starting from July-September 2019, according to RBI’s OBICUS. The GDP growth in real terms in the corresponding seven quarters of 2019-20 and 2020-21 was below 5%. It includes two quarters when the economy had contracted. Capacity utilisation in the manufacturing sector had last climbed above 80% in the January-March 2011 quarter. That was also the last time when quarterly GDP growth had exceeded 10% in real terms on a year-on-year basis.

Economists expect the overall capacity utilisation to stay depressed for many more months even though demand is recovering. This is because the execution of several projects that began before the onset of the Covid19 pandemic was completed recently or is nearing completion and raising the level of total installed capacity. The current capacity utilisation reflects some additions that came onstream in the past year. It is expected that the rise in installed capacity will continue to outpace the growth in demand for at least a couple of quarters.

Changing landscape

Private sector investments emerged as one of the critical drivers of economic growth in India after the industrial sector was liberalised with the dismantling of licensing raj in 1991. Until then, the capital formation was driven by the public sector and the household sector.

Private sector investments grew rapidly with the opening up. Their contribution in capital formation grew as they built new factories or expanding brownfield projects, invested in infrastructure projects such as power plants and invested in capital goods – all of which increased the productive capacity of the nation. The private sector’s contribution to capital formation rose to match that of the public sector in 1995-96. However, the pace slackened between 1997-98 and 2000-01. It bounced back strongly from 2002-03 to rise to 43% of the gross fixed capital formation just before the global financial crisis.

The share of the private sector has again climbed over the last few years to 36% of the gross fixed capital formation in 2019-20. In comparison, the contribution of the public sector, including that general government, was at 24%. National accounts data show that the private sector’s investments in fixed assets such as machinery and equipment, buildings and structures and intellectual property from 2011-12 to 2019-20 were 59% higher than public sectors, measured at constant 2011-12 prices.

A significant variation was also seen in the investment patterns of the public sector and private sector. The public sector invested more in creating buildings and structures rather than in machinery and equipment. The private sector, in comparison, invested a larger share in machinery and equipment. It was also seen that the private sector’s investment in intellectual property exceeded investment in buildings and structures in recent years.

Capital formation in the public sector is unlikely to see any major increase, given that many are on the list for disinvestment or privatisation. Those expected to continue in the public sector don’t have enough internal resources to finance expansion plans, given that they paid out large dividends demanded by the Union government. The creation of the National Monetisation Pipeline will also discourage new capacity creation in the public sector.

Thus, future expansion of production capacity will need to be led by the private sector. But, they won’t invest till demand returns.

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