The Budget this year was announced amidst optimism, which was followed by an accommodative stance by the RBI. The Finance Minister had flagged concern on investment which was however supposed to change track in FY23 with an initial nudge being given by the government through higher capex.

But things have changed with the war erupting later in February and there being few signs of a solution in the near future. Things do not look the same from an investment perspective. There have been simultaneously other monetary action developments in the West which have made foreign investors rethink their options. How do things stand on investment — both domestic and foreign today?

After getting in around $80 billion as FDI in FY21, it was largely expected to be replicated in subsequent years. For the first three quarters of FY22 there have been flows of around $60 billion of which equity flows are around $43 billion. This was slightly lower than that in the previous year.

War clouds

FDI has been a useful source of funding for investment in the country as it supplements domestic efforts. However, there there are two things happenings here. The first is that the West has started raising rates ostensibly on the back of rapid economic growth (which would slow down due to the war), and this has opened new opportunities for investors.

The second is that the war and the resulting uncertainty which has been flagged through sanctions can make investors cherry pick their destinations. The first can affect the decisions to go out to the emerging markets or stay invested within their countries. The second can make investors tend towards being cautious and prefer to remain within the closed group of western nations.

The same also applies for portfolio investment where typically future returns based on valuations influence decisions. But it has been seen that FPIs have been whimsical in the equity market this year and tended towards withdrawal which can be attributed again to the uncertainty in the geopolitical situation. For debt the interest rate differential will be the clinching factor and as long as we have a very accommodative monetary policy, these dynamics may not be favourable.

Currently, the domestic investment scene is a mixed bag. On the manufacturing side, as per RBI data capacity utilisation rates appear to be increasing and had touched 72.4 per cent by December. Manufacturing seemed to be on the threshold of sustained improvement, which was expected to lead to higher investment as demand picked up. The crux is how households behave in these uncertain times as increase in consumption is a prerequisite for better capacity utilisation, which in turn leads to higher demand for investment.

There is now uncertainty over consumption mainly due to the sharp increase in inflation which is close to 7 per cent and is unlikely to return soon to the sub-5 per cent levels. Prices of all commodities have gone up. Food prices have gone up with pressures arising on the edible oil front as Russia and Ukraine are major suppliers of sunflower oil and disruption has affected prospects for all oils.

Wheat prices are up even with a very good crop as export opportunities present attractive options for farmers/traders. Fuel prices remain high and while it does look like that the equilibrium would be around $110/barrel for crude oil, the absence of any measure on the government’s part to lower taxes means that prices will remain high.

Inflation worries

Manufactured products had borne the brunt of the first round of inflation of 2021 for the first three quarters of the year and since September have been passing on the higher input costs to consumers. The new round of global commodity price boom will definitely invoke another round of price rise during the course of the year as companies work towards protecting their profit margins.

This is not good news for consumption because with broad-based higher inflation there will be a tendency for more money to be spent on necessities which include food items and daily products and services, leaving less money for discretionary consumption. This in turn will affect overall capacity utilisation and hence investment. Unless things change quickly in the next couple of months, such a scenario is bound to come in the way of investment.

The other area driving investment is infrastructure. The Centre has put in a lot of effort in enhancing the outlay for capex to ₹7.5 lakh crore for the year. This can contribute but not drive investment as the private sector has the most important role to play. There were expectations that this part of the puzzle would fall in place this year. In fact, given that the banks had put the NPA issue behind it after making all the efforts at resolution, they have become more open to long-term funding. This could have been a turning point.

But there are two forces at play. The first is that given the disruption in global supply chains and higher prices, the entry of private players in the infra space may take a backseat till there is more clarity. Second, interest costs have already started moving up, which is evident in the bond market to begin with. Banks too have been recalibrating their lending rates which in turn can be a subtle entry barrier for the private sector.

Therefore the entire dynamics of investment has changed in the last two months. To begin with, it was felt that the war cannot possibly last for a long period of time. The imposition of sanctions has not quite reduced the hostility but disrupted supply chains and prices significantly which has affected all countries in this globalised world. The exports scenario no longer looks that attractive and with surging inflation there is potential to push back consumption, investment and growth.

Forecasts are already lower than they were in February. Even a resolution of the war by June will still keep business jittery in this vale of uncertainty. It will be another year of wait-and-watch for investment.

The writer is Chief Economist, Bank of Baroda. Views expressed are personal

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