When it comes to capital expenditure by Indian companies, the previous decade (FY10-FY20) was, quite forgettable. The first seven years of the decade was lost to weak demand and excess supply.

Consequent low asset utilisation and poor cash flows came in the way of their ability to service the debt that they had piled up to aggressively expand earlier. It was only in FY18 that some investments began to happen. Bulk of these were driven by regulatory changes, especially the shift to BS VI emission norms. Apart from auto companies and their suppliers who had to upgrade their products to meet the new emission norm, oil companies too had to make huge investments to manufacture cleaner fuel.

This nascent revival in private investment was, however, smothered by the pandemic and it nosedived in FY20. Though it is yet to recover, conditions are ripe today for Indian companies to unleash their animal spirits and invest aggressively again. As the country emerges from the effects of the second wave and fears of a debilitating third wave recede on account of strong vaccine coverage, consumer confidence is returning and domestic consumption (the biggest engine of economic growth) is picking-up.

Export surge

RBI’s September round of Consumer Confidence Survey showed a sharp reduction in pessimism when it came to current and future discretionary expenditure. Apart from the revival in domestic demand, exports are booming. For the first time ever, India’s merchandise exports crossed $100 billion in a quarter (July-September: $101.89 billion). As the global economy bounces back from the effects of the pandemic, businesses across the world are replenishing their low stock levels thereby boosting exports.

India is also beginning to benefit from the adoption of China +1 policy by global players. Exports in the first six months of this fiscal touched $197 billion and the full year target of $400 billion now looks eminently achievable. A strong show considering that in the last five years merchandise exports hovered just around $300 billion.

All these have pushed up the capacity utilisation levels in select sectors. Large steel and cement companies are already posting utilisation higher than 80 per cent levels — a threshold where they typically start to execute expansions. Textile and pharma industries are also registering a higher asset turnover ratio.

Crisil has said that environmental approvals for capacity addition has already crossed 2019 levels, an indication that pace of capex has begun improving. That most companies used the pandemic to cut costs sharply and use the savings to de-leverage their balance sheet is coming handy now. They are in a better position to invest. An accommodative monetary policy followed by RBI which will ensure that interest rates remain benign for some more time (many emerging markets are already seeing their interest rates rise) is another incentive.

These favourable factors apart, government is catalysing private investment like never before through its production-linked incentives (PLI) schemes with incentives worth ₹1.97 lakh crore across 13 sectors. The scheme is time bound and the investments will have to happen in the next 3-4 years. Crisil estimates the PLI schemes to generate capex worth ₹2.2 lakh crore in this period. But for the PLI scheme, experts have estimated that private capex would take at least two more years to reach pre-Covid levels.

Will all these factors push Indian companies to shed their reticence and start investing after almost a decade of hibernation? Some will certainly do so but not all. That would mean a recovery in private capex will certainly be there but it will not be a sharp one that the government would ideally want. A gradual increase in private investments look probable now. There are reasons for it.

K-shaped recovery

Though the economy is bouncing back, the revival is not broad-based and appears to be two-paced. Some call it a K-shaped recovery. A small portion of the population has seen its income rise while the rest have either experienced a drop or status quo. Many studies have shown that the pandemic has pushed more people below the poverty line. This explains why consumption has been skewed. Demand for cars is more than two-wheelers. High-end television sets are selling faster than cheaper ones. Outcome of this recovery is that capacity utilisation is not uniformly high across all sectors. Sectors like steel, cement will invest while others will have to wait for a few more years before they do so.

Another unique feature of this recovery is that only big firms are faring well and registering higher capacity utilisation. Smaller firms, across sectors, are struggling. They will take time to recover and invest.

Uncertainty could also play spoilsport and force companies to delay their expansion plans. The pandemic has unleashed a massive demand-supply mismatch whether it is commodities, containers or even labour. Auto sector is hit hard by semi-conductor chip shortage and the car makers are forced to cut back production despite rising demand. Expansion is the last thing on their mind now.

While PLI scheme is seen as an effective tool to revive private capex, its implementation is key to tapping the full potential. The scheme has to be implemented in a timely manner and incentives dispensed on time. More importantly, success of this scheme may call for more interventions by the government apart from the incentives.

Consider this: assuming a company sets up operations in India under the PLI scheme, can it match China’s cost without the dragon nation’s benefit of scale and lower logistics cost? If it cannot, imports from China will continue to remain attractive and this will prevent the company from meeting the onerous targets imposed by the scheme. Demands to impose higher import duty on such Chinese products will raise. Will the government support such demands?

As things stand now, what is certain is that private capex cycle is certain to revive. The pace of revival will be moderate, to start with and will gather pace once the uncertainties disappear and the economic growth gets more broad-based. Till then, don’t expect miracles.

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