India Economy

How public capex can boost GDP

Sonal Varma Neha Saraf | Updated on March 10, 2018 Published on September 18, 2016



It can lift India’s medium-term growth potential and add to productivity

There are a number of reasons why India needs more public capex. The latest growth figures show that the economic recovery is going through a soft patch — fixed investment growth continues to fall and with ample spare capacity, high leverage and a weak global growth outlook, a recovery in private sector investments seems elusive. It is in this context that all eyes have turned to public capex to fill the void.

Big push

The government is aware of the urgency. It has made regulatory modifications to remove existing bottlenecks, such as the one-time fund infusion into stalled road projects, the revised hybrid annuity model for roads and easier exit policies for road developers, among others. Additionally, boosting public investment in new infrastructure projects is one of its key reform agendas. The focus is on various sectors, including railways, roads, renewable energy, inland waterways, ports and smart cities.

In the FY17 Budget, the Centre announced a 17 per cent increase in public capex, equating to 3.7 per cent of GDP. The government plans to more than double the pace of road construction over the next five years, raise rail investment to 5.7 per cent of GDP over FY16-20 from 2.4 per cent over the last five years, and implement port-led development projects worth ₹2.45 trillion (1.6 per cent of GDP). The total planned spending is substantial.

PSU funds

Given the size of the capex requirement, the obvious question is where the funding will come from. Historically, the majority of public capex has been funded by public sector units (PSUs), rather than the Centre. For instance, in FY15, of the 7.4 per cent of GDP in public investment, PSUs contributed 3.2 per cent and States another 2.6 per cent while the Centre’s was only 1.6 per cent. Even this year, two-thirds of envisioned infrastructure investment is to be funded off the Centre’s balance sheet via loans, equity and PSU profits. This implies that funding capacity critically relies on PSUs, rather than the Central government.

The good news here is that except the telecom and power sectors, where PSUs have high debt levels, other PSUs like those in the capital goods and infrastructure sectors have strong balance sheets and negative net debt-to-equity, which indicates that PSUs have the funding capacity. There are other sources of funding as well. The railways, for instance, have secured loans from the Life Insurance Corporation of India against a portfolio of 24 project corridors. Multilateral agencies and market borrowings are also partly funding the capex plan. As such, funding should not be a constraint.

Execution challenges

More than funding, execution has historically been a bigger challenge. Between FY08 and FY13, actual capex through internal and extra budgetary resources of PSUs was on average 17 per cent short of budgeted levels. In April-July FY17, the Central government has spent only 28.9 per cent of its budgeted capex compared with 35.6 per cent over the same period in FY16.

That said, the government did exceed its off-balance sheet capex target in FY16, which itself was 40 per cent higher than a year ago. Last year, the port sector added 94 million tonnes of capacity — the most in a single year – suggesting that execution under the current government is improving. In railways, electrical and civil contracts awarded for the dedicated freight corridor are around 80 per cent complete.

Data on road construction and awarding paints a similar story. The pick-up in project-awarding activity suggests that actual construction should gain traction in the coming quarters.

The economic impact of public capex depends on its efficiency, the quality of investment projects and the state of private capex.

A 2015 IMF study noted that about 27 per cent of the potential benefits of public investment in emerging markets are lost due to process inefficiencies. The government’s recent execution track record, curbs on corruption and strict timelines suggest that it is focused on improving efficiency.

The quality of spending is also high. Of the budgeted ₹5.6 trillion in Central government public capex, more than 50 per cent (₹3.1 trillion) is focused on building transportation infrastructure, which should help reduce logistics costs for private sector manufacturing firms. This could ‘crowd in’, rather than ‘crowd out’ private investment.

According to a 2013 RBI study, public capex (Centre) can have significant multiplier effects on GDP: 2.1x in the same year, rising to 3.84x in three years. Using this, we estimate that the budgeted public capex by the Centre and PSUs could add 0.9 percentage points to FY17 GDP growth. This may not seem huge given the focus on public capex, but with most of the spending focused on infrastructure where gestation periods are long, the full benefits will accrue only over the next two to three years.

In all, a successful launch of public capex would not only drive near-term growth, but it would also boost India’s medium-term growth potential by adding to the capital stock and productivity. Hence, even though public capex is off to a slow start, it is moving in the right direction and will build a solid foundation for sustainable growth.

Sonal Varma is Nomura’s Chief India Economist and Neha Saraf is an India Economist

Published on September 18, 2016
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