Are there green shoots of a capex revival?

For the first time in six years Srivats Ram, MD of Wheels India, a TVS group company, has begun worrying about capacity constraint. In fact, he has begun de-bottlenecking his operations to meet the demand from customers across the commercial vehicle, passenger car, bus, tractor and construction equipment sectors. Tractor-maker Escorts is looking at expanding its capacity from lakh units to 1.6 lakh units. A decision is likely next year even as tractor sales, in FY18, are set to touch a record 6.45 lakh units.

Ramco Cements is already investing ₹1,200 crore to expand two of its grinding units in West Bengal and Andhra Pradesh apart from setting up a new one in Orissa. While this is strictly not a capacity expansion (clinker is shipped from existing facilities to the grinding unit to be crushed and converted into cement), the investment, however, increases its capacity in the eastern market where the off-take is strong.

These are just some indicative examples. Media reports suggest that companies across the country have started talking about possible capacity expansion.

After an extended lull, signs of a possible revival in capital expenditure (capex) are becoming visible. That is good news for the anaemic Indian economy which has been suffering from a long drought of private investment and consequent capex spending.

It was not the case a decade ago when investment in the economy as measured by gross fixed capital formation (GFCF) was strong. It peaked at 35.57 per cent of GDP in 2007-08. That was the time when demand appeared insatiable and funds were available cheap for the industry to expand aggressively. Then the 2008 ‘great recession’ happened. The demand evaporated and the industry was, suddenly, sitting on large surplus capacity. In fact, capex spend never really recovered after the global financial crisis. A steady decline ensued as the private sector struggled to use the capacity effectively and by 2015-16 it had fallen to 29.30 per cent of the GDP.

At this point, lack of private investment began to bite as other engines of growth such as exports began to sputter. Economic growth which had touched a high of 9.2 per cent in fourth quarter of FY16 began to slide. The decline accelerated as demonetisation smothered domestic consumption, another critical growth-driver. High public spending by the Government was not sufficient to reverse the trend and growth slumped to 5.7 per cent in the first quarter of FY18 before recovering marginally to 6.3 in the second quarter.

While this recovery is predominantly due to restocking post- GST , there are other positive signs as well. Exports have begun to recover on the back of some major economies doing better. For the first time since 2014, the US economy has grown by 3 per cent or more in two consecutive quarters. Europe recorded a strong growth of 2.5 per cent in the third quarter of the current calendar year. Exports declined in October but that was more due to GST adjustment issues. A double-digit growth in exports is no more fanciful thinking, say experts.

Domestic consumption, aided by strong rural demand, has also revived as the economy has been sufficiently re-monetised. That apart, government spending to pump-prime the economy continues. It has just announced road projects spanning 34,800 km costing ₹14 lakh crore to be constructed over the next five years. And growth in GFCF has begun to pick up pace. In the second quarter of this fiscal it posted a year-on-year growth of 4.7 per cent compared to 1.6 per cent in the first quarter and a contraction of 2.1 per cent in the fourth quarter of FY17.

While this is a positive development, it is too early to celebrate as the capex revival is not broad-based. It is restricted to sectors that are consumer-focused (like cars, two-wheelers, FMCG and tractors) and those that are benefiting from government’s public spending (like cement and construction equipment). Some sectors that also happen to be capex-intensive continue to languish. They include power (plant load factor of just 60 per cent), telecom (stretched balance sheet and declining profits), construction (poor demand) and textiles (exports fell by 39 per cent in October).

A broad-based recovery in private investment/capex is key to a faster pace of economic growth. It has taken more steps recently to catalyse it, including recapitalisation of public sector banks. This should help lenders take haircuts thereby reviving some jinxed projects. If all goes well, we could see a broad-based turnaround in private sector investment and revival of animal spirits in the economy. But for now, that must wait a few quarters more.

COMMENT NOW