Harish Damodaran

Not by sentiment alone

HARISH DAMODARAN | Updated on November 24, 2017


This slowdown isn’t going to end without the government kick-starting investments directly

It is generally believed — without an iota of doubt, in fact — that the roots of India’s current slowdown lie in the policy paralysis and governance failures of the United Progressive Alliance (UPA), especially in its second term in office.

And that this could hopefully change, now that we have a stable, pro-reform government under Narendra Modi. As someone known to be decisive and who brooks no nonsense, Modi is expected to revive business sentiment, if he hasn’t already.

There are two implicit assumptions behind this thinking. First, corporates have pots of money waiting to be invested. Secondly, the only thing holding them up till now was policy uncertainty, which will lift with Modi firmly in the saddle.

Show me the money

The truth is that India Inc, far from being flush with investable cash, is neck deep in debt.

A Standard Chartered Bank report released two months back estimated the total debt of 11 large groups at a staggering ₹597,300 crore or 7.3 times their annual earnings before interest, tax, depreciation and amortisation. For them, and many others, the priority today is not investment, but deleveraging and disinvestment.

In the last few months, everybody from Jaypee, Videocon and GMR to Lanco and GVK have been engaged in divesting cement, power, oil, roads or airport assets in order to raise funds for lightening their debt loads. The situation is unlikely to change with a mere Modi-enabled boost to sentiment.

Bullishness in markets, at best, can improve stock valuations enabling promoters to bring in funds to meet immediate debt obligations and refinance longer-term loans. But there is still a lot of deleveraging to do, given that asset sales over the past two years form only 13 per cent of the outstanding debt of the corporates concerned.

Invest where?

Even assuming money isn’t a problem — and banks will resume large-scale project lending despite being saddled with huge existing non-performing assets/restructured loans — the question is: are there really many sectors to invest in?

Take power, where the 11th Plan period (2007-08 to 2011-12) saw some 50,000 MW of thermal and hydel generation capacities being added, as against 38,000 MW in the two previous Plans combined. Besides, another 38,200 MW capacity has been created during the first two years of this Plan.

The reason why further investments in power seem difficult is not because the nation doesn’t require them, but since there just isn’t enough fuel to run new plants.

While restructuring Coal India, auctioning blocks for private mining and reigniting investor interest in hydrocarbon exploration activity may be feasible with a Modi government, it will take years for these to yield increased domestic output. Nor can imported coal or gas be used beyond a point without power producers being allowed fuel cost pass-through — which again requires State utility reforms that won’t happen overnight.

The short point is be it power or highways — where even projects already awarded are struggling to achieve financial closure, with developers seeking deferment of premium obligations after having made over-optimistic traffic forecasts — there are operational and legal issues not amenable to quick resolution.

Likewise, doubts could be raised about investment possibilities in steel, cement, automobiles and many other such sectors wracked by overcapacity. When money is already stuck in projects not generating adequate cash flows, how many private players would venture to take up greenfield investments? While Modi may have brought back ‘sentiment’, most are likely to wait for others to invest — pehle aap (you first) — before taking the plunge themselves.

Those eight years

The current state of investment uncertainty is opposite to what it was 3 to 4 years ago. Everyone then was rushing to invest: the pehle main (I first) syndrome.

Between 2003-04 and 2010-11, India’s GDP rose by an average 8.5 per cent a year. The same period witnessed a mindboggling 22.5 per cent average annual growth in gross fixed capital formation (GFCF) by the corporate sector. Corporates went on an investment binge, putting up power plants without seriously looking into fuel availability and quoting huge premiums for bagging concessions to develop highway stretches on a build-operate-transfer basis.

Such animal spirits have ebbed since 2011-12, with GDP growth falling to below 5 per cent and GFCF by private corporates registering negative growth ( see chart). The present slowdown can be roughly traced to July 2011; the official index for capital goods production has recorded negative year-on-year growth in 25 out of the 33 months to March 2014.

While the blame for this can be laid on the UPA’s door, the fact is India Inc cannot absolve itself of responsibility either. This crisis has been brought about as much by reckless investments by corporates during the last decade — ironically under the same UPA! The price of this irrational exuberance, substantially financed through borrowings, is being paid by the banks, whose stressed assets now make up over a tenth of their gross advances. It was an unsustainable investment boom destined to end, with or without policy paralysis.

What next?

Can the investment cycle revive? Yes, provided the government does more than just manage sentiment. For that, it needs to be an active investor. The way to do it is not via the conventional public sector undertaking route, but through special purpose vehicles (SPV) to execute specific, carefully-identified projects.

We do now have such project-specific SPVs for implementing the Dedicated Freight Corridor (DFC) or the Delhi-Mumbai Industrial Corridor (DMIC) along the alignment of the former through five States.

Both projects have, however, made very little tangible progress even 6 to 7 years since the SPVs were incorporated. Land acquisition and other regulatory approvals for the DFC – both on the western and eastern legs — have only recently been almost completed. It’s worse with the DMIC: of the seven new ‘industrial cities’ planned, only in one — the Dholera Special Investment Region in Gujarat — has the development plan approval and transfer of land by the State Government taken place.

For the SPV approach to work, four things are required. The first is identifying the ‘right’ projects having demonstrable multiplier effects that the private sector wouldn’t ordinarily undertake. The second is clearly delineating project components and timelines for implementation. The third is managerial autonomy and insulation from bureaucratic-political interference. And last, but not the least, is uninterrupted funding from the government. The Delhi Metro’s success owed itself to all four conditions being met.

The project-specific SPV model has many advantages. Assured government equity contribution and implicit blessing for the project makes it easy to attract outside funding, including from capital-surplus sources such as Japan and China. Land acquisition and obtaining statutory clearances also becomes easier.

Once the government starts investing and awarding contracts in a big way — which will also help inject liquidity into firms — it will be only a matter of time before India Inc also gets into the act. That’s when sentiment will turn into something concrete on the ground.

Published on May 19, 2014

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