Lacklustre investment and capital expenditure have been key missing pieces in India’s growth story. Gross capital formation fell four ticks in the last three years, to below 30% of GDP by December 2015. This pales in comparison to China’s investment growth, which makes up 45-50% of GDP.
In India, both corporate and public sectors face headwinds. The leveraged corporate sector has in turn stressed banks’ balance sheets. Hence, the burden of spurring investment spending is increasingly pushed to the government.
While the government had the leeway last year, tough deficit targets narrow the fiscal headroom in FY16/17. This has increased the reliance on off balance-sheet funding, but its success is not guaranteed.
At the same time, foreign direct investments (FDI) inflows rose to a record high in FY15/16. Unfortunately, its distribution is not geared towards boosting the domestic capex cycle. These factors suggest that a strong turnaround in investment spending is unlikely this year.
The overhang of easing global growth has also amplified this slowdown. Domestic growth thereby is likely to be more about consumption revival than investment spending, this year.
Disappointing project execution, debt overhang remains
Growth of fixed capital formation has slowed from over 10% in FY13/14 to 5% in the first three quarters of FY15/16.
Stalling of projects has been a major contributor to this decline, with its stock rising to INR 11.4trn by March 2016 from INR 8.6trn in 2013.
Of the projects being implemented, about 12% face renewed hurdles according to CMIE data. Worryingly, more projects have stalled in the private sector compared to the government sector. Sector-wise, projects are not only stalling in the resource-based industries but also in the manufacturing and services sectors.
Contrary to popular narrative, land acquisition and lack of clearances are no longer the key reasons behind the stalled projects. These two factors accounted for about a tenth of the stalled projects last year, down from 27% in FY11-12.
A bigger hindrance instead has been lack of promoters’ interest and unfavourable market conditions. This has its roots in the uncertain investment climate, slowing external growth and insufficient demand revival to spur capex spending.
An increase in new investment commitments however provided a faint silver lining. Fresh interests by the private sector rose by a faster 10% YoY in 1Q16 from sub-8% in 4Q15, while the public-led sector was steady at 15%. Yet, scepticism remains. These projects only reflect intent to invest, and require clearances to be realized as actual investments.
Also adding to caution is the limited progress in private sector deleveraging. Corporate debt rose to a peak at 60% of GDP last year from below 50% before the global financial crisis. Expectations of an improving economic backdrop and demand pick-up drove the build-up in debt levels. However, slow progress on investment projects, high financing costs and difficult market conditions hurt earnings and profitability. Capacity utilisation rate has been easing, while the total inventory to sales ratio continues to inch up.
The corporate sector’s underperformance has stressed the banking sector. Including restructured and non-performing loans, banks’ overall stressed advances jumped to over 11% of total advances by September 2015. Infrastructure, mining, iron/ steel and two others make up more than half of the bad loans faced by the domestic banks. More pain is in store as the RBI expects stressed assets to be fully provisioned by March 2017.
Limited fiscal room increases reliance on off-balance sheet sources
While the corporate sector remains under pressure, the government has cut back on capex spending. Capital expenditure is budgeted to slow to 4% YoY this year, from 21% in FY15/16. Instead, revenue expenditure is up to accommodate a higher public sector wage/pension bill and banks’ recapitalisation needs. These commitments along with strict fiscal targets led the government to seek off-balance sheet funding options.
These Internal and Extra Budgetary Resources (IEBR) financing usually include support from central and quasi-government enterprises, institutional financing, partnership with the private sector and multilateral support. While this is not something new, the quantum of support sought this year is sizeable.
A cumulative INR 1trn is expected to be raised through IEBR support, to step up investments into crucial areas such as power, national highways, irrigation, waterways e.t.c. This amounts to about 45% of the total capital expenditure allotted, suggesting a bulk of the expenditure has been left off the books.
On the flipside, reliance on off-balance sheet funding exposes these commitments to the shifting market conditions and remains outside the purview of the government. Tapping the Public-Private Partnerships (PPP) arrangement has its own set of challenges, such as a weak regulatory framework, financing issues, rigidity in contracts, delayed dispute resolution, amongst others.
With most infra-related private sector participants under pressure, the appetite for PPPs will be limited. Finally, using extra budgetary resources also understates the true extent of the fiscal deficit.
FDI increase has not been beneficial to the capex cycle
While domestic drivers remain weak, higher FDI has also been of little help. Net foreign direct investments (FDI) rose 60% YoY to a record USD 37bn in 2015, with gross inflows up by a third from the year before. Regrettably, these flows were not geared towards boosting the domestic capex cycle or manufacturing activities.
Services attracted the most inflows in 2015, making up nearly half of the total stock. By contrast, the manufacturing sector’s share has slowed to a fifth and that of infrastructure to near 5% of the total flows. This contrasted with 2014 when services and manufacturing sectors each accounted for roughly a third of the flows. Even as FDI flows strengthened last year, it is unlikely to provide an immediate boost to industrial and investment activities.
Another year of uneven growth in store
This backdrop suggests the economy will face another year of uneven growth. While policy impediments are being ironed out, lack of promoters’ interests and unfavourable market conditions emerged as the main hindrance for the investment interests.
Domestic growth is thereby likely to be driven more by consumption demand, rather than capital investments. Private consumption is likely to grow 9% YoY in FY16/17 from 7% this year. Urban demand is already on the mend (will also get a hand from higher public sector wage), while rural spending is set to gain from a normal monsoon this year. An easy monetary policy is also of help. Net exports remain a drag as weakness in exports outweighs the benefits from a narrower oil imports bill.
In all, headline real GDP growth is likely to average 7.6% YoY this year from an estimated 7.4% in FY15/16. Downside risks stem from a steeper correction in investment growth and sluggishness in consumption spending if inflation worries return. fii-news.com