Talking Point. Whither private capital investment?

Those constantly demanding interest rate cuts argue that our current growth, while strong at 7.6 per cent per annum, is driven by private consumption and government spending and corporate investment is needed to carry the baton forward. With banks nearly done with balance sheet repair, the belief is that rate cuts will get banks to lend and corporates to invest in projects.

While this is compelling logic, evidence that credit and its cost are holding back investments is not so strong. Factors such as aggregate demand, excess capacities and the preference for short-term over long term have a lot to do with the absence of animal spirits.

The RBI Bulletin for September 2016 has a section on prospects for Private Corporate investment that highlights this well. It provides data on projects funded by banks and foreign investors as also through external borrowings and equity issues. While institutional credit is the largest source of funding, it has been sharply declining (from 68 per cent of total project costs in FY2011 to just 50 per cent in FY2016). Even the number of projects taken up and funded by institutions has declined steeply from an average 800 per annum during FY2007-11 to around 450 during the past five years. This, in spite of continuous decline in lending rates during 2014-16.

More than the absolute decline, two other aspects of the investment data are striking — first, over 50 per cent of project investments have been in infrastructure, when the expectations were from manufacturing.

While infrastructure is undoubtedly a thrust area, this is a sector where returns on investment are much lower than manufacturing and therefore it may be too much to expect private sector to have an infinite appetite. The fact that conventional manufacturing sectors (textiles, cement, food, chemicals, etc) have seen negligible investments is a reflection of both excess capacities and muted demand, which suggests that lower lending rates may not mean much.

Secondly, even within infrastructure, the average size of projects has come down significantly from around ₹15-20 billion in the past to about ₹5-6 billion in the last five years. Especially in the power sector (which accounts for over 80 per cent of investments under infrastructure), there have been a large number of smaller-sized projects in the last three years. This seems to indicate a preference for smaller, shorter gestation projects, while what we are looking for is big-ticket spending in infrastructure to deliver growth. It would seem that the segments which require large investments, such as ports, roads and highways, urban infrastructure, will continue to be the responsibility of the government.

The other argument proffered for low credit offtake, viz. high corporate leverage, also seems unconvincing when we look at the numbers from another RBI report on the finances of non-government, non-financial private and public limited companies, which covers a sample of about 17,000 public and over 2,37,000 private limited companies. The overall average debt-to-equity ratio for the last three years was only 45 per cent and 46 per cent for public limited and private limited companies, respectively, while the interest coverage ratio averaged between 3 and 5, not exactly signs of a sector struggling with debt. Even distressed sectors such as mining and iron and steel had reasonable numbers, although the infrastructure sector did show signs of financial stress. Therefore, the cost of borrowing may not be the real issue.

Interestingly, corporates have preferred to invest in markets rather than plants — money parked in mutual funds by public limited companies was ₹2.1 trillion in FY2015 while capital work in progress was ₹1.6 trillion. This was so during all the three years ending FY2015. This is further corroborated by macro-economic data which reveals that gross savings of private sector companies jumped from ₹8.3 lakh crore in FY12 (when private investments started tapering off) to over ₹15.8 lakh crore during FY15. Clearly, short-term profitability is overriding long-term investment appetite.

Finally, several trends taking shape could well make institutional credit or its cost less relevant in the debate. For one, private placement of debt has grown from ₹270 billion in FY2012 to ₹1,175 billion in FY2016, which is nearly as much as the institutional and external funded amount for that year. No details of the sectors involved or purpose or terms of debt are available, making it difficult to predict whether it is here to stay or would disappear when bank lending resumes. Further, with the services sector becoming the dominant growth contributor, there could be shifts in financing patterns, with institutional debt being replaced by equity private placements and FDI in future.

The writer is an independent consultant

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