The importance of animal spirits

The government has given a clarion call for reviving the animal spirits in the economy, and India Inc ha responded, too. If the spirit is kept alive, there should be a turnaround in investment, which has been pending for a while. The government is right in asking for such a revival given that the PLI (Production Linked Incentive) scheme has been implemented in a big way and several other measures have been invoked under Atmanirbhar Bharat schemes.

The support of the government is palpable and consistent with the ideology of rewarding performers. The PLI does just that, where a certain predefined level of investment and incremental turnover over a time-frame for various sectors (13) get a reward in terms of a return of 4-6 per cent of the turnover.

The gross fixed capital formation rate in the country has declined continuously from 34.3 per cent in 2011-12 to 27.1 per cent in 2020-21. Therefore, the problem with investment is not the occurrence of the pandemic but an inherent demand-supply mismatch which was exacerbated by the NPA (non-performing asset) issue. Neither the Central nor State governments has been serious about capex targets, which has pushed back investments. All these knots must be untied. There are two parts to this puzzle: The first is where does investment originate, as there is a tendency to associate it with manufacturing. The second pertains to the various challenges that have kept investment back.

The Table provides the share of various sectors in gross capital formation as of 2019-20. It shows that investment is not just limited to steel, cement and auto sectors adding to their capital. It is broad-based. Real estate, which includes residential buildings, is important and must be supported by increased purchasing power and credit.

The government and the RBI have plugged the credit part but post the moratorium and uncertain future of individuals in the organised sector, this sector looks shaky today.

Capacity utilisation

Manufacturing probably is well on course, but would be dependent on the capacity utilisation rate. Ideally, a rate of 78-80 per cent is a threshold that leads to higher investment. The level of 69.4 per cent as of March means that generalised utilisation level is low, while it could be higher for some sectors like steel. Capital goods sector is still downbeat, and isn’t attracting further investments.

Transport, storage, and communication have their specific challenges. With the lockdown in force and movement of people still affected, the willingness to invest in transport (air and road) is much lower today. Unless there is more certainty about the future, companies are less likely to invest in new aircraft or buses and would confine themselves to existing fleet.

The lockdown has severely curtailed the activities of the services sector, too, especially trade and hotels. This has meant that these sectors are unlikely to make investments any time soon — hotels, malls, restaurants would be generally hoping to first commence activity with at least 60 per cent capacity rate before even thinking of the future. It’s a double-whammy for this sector.

Public administration refers to the government share in investment. Here, notwithstanding all the right noises, the States need to keep pace with the Centre to enable higher capex. The problem is that the States were tied up with the FRBM rules even before the pandemic struck and perforce cut back on their capex to meet the targets. Now there is more leeway provided by the government to the States as they can run a deficit of 4 per cent.

There are special funding outlets for such spending provided by the Centre. However, the uncertainty on tax revenues will continue to make States cautious in spending on capex which has been the case earlier too. It is in this context that economists have been talking of the government dedicating another 1 per cent of GDP as stimulus through capex.

Agriculture is a significant player again in investment, and an area not really recognised. Here land improvement and mechanisation are essential to improve productivity and output in the next couple of years. There must be a lead role played by State governments. At present, the focus is more on providing cash to farmers or employment through the MGNREGS. There is a need to think beyond this.

Power, construction

The construction and power sectors are the traditional infrastructure segments which are driven by the private sector along with the government. Here the problems are twofold. The power sector has high investment already and has problems on the viability of Discoms. Only if this problem is addressed will more investments flow in. Currently, the focus is more on renewables, which is a ‘cleaner’ segment in terms of viability. Construction of roads is a big project undertaken by the government along with the private sector in the PPP mode which is running the course.

The other issue which has to be addressed is the funding part. As seen above, the demand for such investments will time kick off and, hence, the animal spirits will be caged for most sectors. But when the cage is opened, banks and markets must be in a position to finance such investments. Banks today are cherry-picking customers, concentrating on the retail book. Debt markets are more oriented towards the financial sector and must work out ways to assimilate lower rated bonds and not just AA and above rated companies.

Quite clearly once the floodgates open for investments, the financial system must be geared to support this demand to ensure that the path is smooth.

The writer is Chief Economist,CARE Rating. Views are personal