Analysis: Indian growth hostage to vigour of investment cycle

BOMBAY: Every year India holds its breath to see whether the monsoon will bless the farm economy. This year, the strength of overall growth will depend on an extra factor: will corporate spending on factories and machinery finally take off?

Investment is India’s Achilles’ heel. There is a broad consensus that investment as a share of gross domestic product needs to rise to 30-32 percent from around 25-26 percent in the last couple of years if trend growth is to accelerate to the 8 percent pace needed to make deep inroads into poverty.

“It’s investment alone which will bring growth to this country,” Finance Minister Palaniappan Chidambaram told parliament last week. With the federal and state governments running a combined deficit of close to 10 percent of GDP, economists also agree that in the short term only the corporate sector can provide the investment fuel needed to fire up the economy. Companies, in fact, are in the process of doing so. Where economists disagree is how vigorous this corporate capital expenditure, or capex, cycle will be.

Ajit Ranade, group chief economist at the Aditya Birla Group in Bombay, says fast-rising credit growth, expanding capital goods imports and plump order books at companies that build and fit out factories and power plants all point to a solid upturn. “There is a lot of evidence to support the view that investment spending is on the rise,” Ranade said. India’s growing export prowess should also encourage business investment, he said. At many big groups, export sales were expanding faster than total sales or even profits. “There is an increasing sense of confidence of being able to service overseas markets, and that can also feed into capex spending plans,” Ranade said.

In the pipeline: Neeraj Gambhir, joint general manager at ICICI Bank in Bombay, added: “Talking to corporate customers reveals a decent amount of capex is being planned for the next 12-18 months.”

But how decent is decent? In the year that ended in March 2004, corporate capex rose to 4.5 percent of GDP from 4.3 percent the year before and should reach 6.1 percent in the year to March 2007, according to Chetan Ahya at JM Morgan Stanley Securities Pvt. Ltd. in Bombay.

But this would be well below the peak of 9.6 percent scaled at the top of India’s last major investment cycle in 1994-96.

Unlike China, which is struggling with too much investment, India is struggling with too little, Ahya noted. He said capital goods imports, though rising, made up only 0.2 percentage points of the 2.2 percentage point widening in India’s trade deficit over the last two years.

And while the value of announced investment is rising fast, especially in the minerals and metals sectors, past cycles suggest that not all the projects will materialise. “These announcements have been going on for many months now, but we still haven’t seen a big uptick in implementations. I would want to give the benefit of the doubt, but the industrial sector has been relatively strong for almost the last two years now,” Ahya said. The federal government’s Planning Commission in New Delhi is also surprised that business investment has not yet kicked in more vigorously.

Rates on the rise: The commission had been counting on Indian industry by now to have exhausted all but 6-7 percent of its capacity, close to the 5 percent mark that it says is typically the point that triggers rapid capex growth. Instead, according to Pronob Sen, a senior official at the commission, industry is still operating at 12 percent below capacity.

Sen said he expected the 5 percent threshold to be reached in the financial year starting on April 1. The risk “a little while after that”, he acknowledged, was that the government’s fiscal deficit would start crowding out a resurgent private sector in the credit markets, pushing up interest rates.

For now, the private sector is not too worried about the crowding-out risk. What makes this cycle different, said Gambhir at ICICI Bank, is that the banking system is awash with cash.

To head off excessive money and credit growth, the Reserve Bank of India, the central bank, sells securities to mop up, or sterilise, dollars it buys in the market to prevent strong capital inflows from boosting the local currency. The amount the RBI is currently sterilising is 741 billion rupees ($17 billion).

“If the demand for credit is seen to be more investment-generating, my guess is that the central bank will be willing to let this liquidity seep into the system and allow some sort of more robust credit growth. And that should keep some sort of lid on interest rates,” Gambhir said.

Birla Group’s Ranade agreed. The government is set to raise twice as much on the bond market in the coming year as it raised in 2004/05, but the central bank could gradually release the dammed-up funds to control the impact on borrowing costs. “Interest rates will go up, but the Reserve Bank will try to make sure they go up in an orderly, predictable way rather than in sudden spikes,” he said. —Reuters

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