4/23/22, 11:33 PM Will India's Private Sector Step Up On Capex Front?

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Home / Economy / Will India's private sector step up on capex front?

Will India's private sector step up on capex front?

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The Indian economy is slowly recovering from pandemic blues. One of the key factors now will be the willingness
of the private sector to invest. . (Photo: Mint)

9 min read . Updated: 28 Feb 2022, 11:51 PM IST

Avinash Celestine

Capital expenditure by the government is one engine of revival. For a true economic revival, a
lot more has to fire.
While the government hopes that public-led capex can set off a virtuous investment cycle and
lift growth, analysts have pointed to the missing link—short-term steps to boost consumption

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NEW DELHI :
In her latest budget announced earlier this month, finance minister
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Nirmala Sitharaman announced an increase of over 35% in the central government’s

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capital expenditure to ₹7.5 trillion, amounting to 2.9% of GDP. On the increase,
Sitharaman said: “…the virtuous cycle of investment requires public investment to
crowd-in private investment. At this stage, private investments seem to require that
support to rise to their potential and to the needs of the economy. Public investment
must continue to take the lead and pump-prime the private investment and demand
in 2022-23."

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This is quite a shift. For years, governments had been saying that public investment
‘crowds out’ private investment, the implicit assumption being that the economy was
operating at full capacity. Thus, a rupee more of public investment would lead to a
rupee less being available for private investment. Further, the only way private
investment can rise is if private entrepreneurs ‘offer’ to pay higher interest rates to
mobilize funds for investment. The implication was that governments needed to cut
back on expenditure and borrowing at their end, in order for private investment to
flourish.

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In contrast, the crowding-in argument sees public investment as enabling private

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investment. As an example, public investment in road construction in remote areas
then leads to entrepreneurs building more factories in such areas, since they are now
able to move goods more easily to key markets. A 2015 paper by economists Girish
Bahal, Mehdi Raissi, and Volodymyr Tulin at the International Monetary Fund found
that for India, in the post-reform period, public investment does, in fact, ‘crowd-in’
private investment.

But will it work? The economy suffered a big hit during the covid period, but is slowly
recovering. Analysts across the board have argued that one of the key factors in any
recovery will be the willingness of the private sector to invest. Are the latest budget
proposals big enough to kick start private investment?

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Ghost of the financial crisis

Given the commonly held-belief that India was a ‘socialist’ economy in the pre-
reform era, it is striking to note that apart from a brief period in the mid-1980s,
private fixed investment has consistently been higher than public fixed investment as
a share of GDP (Chart 1).

Starting in the late-1980s, private investment took off, even as public investment
actually declined and eventually flatlined. In that sense, Sitharaman’s announcement
of a big jump in capital expenditure in the public sector, if it does come through, will
be a major economic policy shift in the post-reform era.

But the other key feature of this data is the trend since the 2007-08 financial crisis.
Private investment peaked at 27.5% of GDP in that year, and then began a downward
trend. By March 2020, on the eve of covid, it had fallen to just below 22% of GDP. And
while public attention is focused on the recovery of the economy from the disruption
caused by the pandemic, the problem of weak private investment predates the covid
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era and goes all the way back to the financial crisis. In a sense, the Indian economy
has never really recovered from that crisis.

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Even beneath this worrying headline trend, there are a number of other indicators
that point to a serious crisis in private investment. The Centre for Monitoring the
Indian Economy (CMIE) compiles data on capital expenditure, and the status of
industrial and infrastructure projects across various sectors and by type of ownership
(public sector or private). It classifies all projects into different buckets, depending on
whether such projects have been completed, are still under implementation or,
importantly, have ‘stalled’ for any reason (lack of funds, for example).

In an analysis of such stalled projects conducted in February 2015, the government’s

Economic Survey pointed out that the ‘stalling rate’ of projects—defined as the value
of projects reported stalled as a share of value of projects under implementation—
had risen sharply since the financial crisis. At that time, it noted, hopefully, that:
“The good news is that the rate of stalling seems to have plateaued in the last three
quarters."
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Five years later though, the stalling rate has only increased. The bulk of the increase
in the overall stalling rate is due to the stalling of private sector projects (Chart 2). A
study done by the central bank of private sector investment last year, based on the
CMIE data, reported that the time taken to complete a project, or even to reach a
point where it is reported as stalled or abandoned, has increased since the financial
crisis.
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One
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where most private sector projects are, in fact, public-private partnerships. This is
not surprising, given the persistent problems facing the sector for over a decade,
including fuel supply and regulatory clearances. High stalling rates are also seen in
manufacturing, though the rate has plateaued in recent years.

Interestingly, the Economic Survey cited above attributed different reasons to the
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stalling of projects in the private sector versus the public sector: “exuberance" and a
credit bubble in the former, and “policy paralysis" in the latter. It added: “First,
manufacturing is being stifled by a general deterioration in the macroeconomic
environment. Second, stalled projects in electricity are a victim of lack of coal (or coal
linkages)."

The Indian corporate sector had piled up a large volume of debt in the pre-crisis years
to fuel growth. This ‘debt overhang’ crisis in corporate India persisted well beyond
the immediate financial crisis that firms faced in 2007-08. The slow process of
unwinding that leverage has continued to impact the willingness of Indian companies
to invest in new projects. The share of new projects in the CMIE database as a share
of total projects under implementation has fallen from over 10% at the beginning of
the previous decade, to around 2% currently.

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The other side of the coin is the banks who lent money during the credit bubble. The
years after the financial crisis was a period of reckoning in many ways. Banks ran up
high levels of non-performing assets as borrowers did not pay their dues. It would
take a period of time before banks could clean up their balance sheets and be ready to
lend again.

Hope floats

Are there signs that this ‘balance sheet’ crisis of corporate India is finally coming to
an end, more than a decade after the global financial crisis?

Interest coverage ratios (the extent to which gross earnings cover interest payments)
have risen in recent years across public limited companies, indicating an
improvement in balance sheet health. Having ‘cleaned’ up their balance sheets,
companies could be in a position to invest in new projects. OPEN APP

Backing this up are results of the latest Industrial Outlook Survey by the Reserve
Bank of India (RBI). The central bank conducts this survey across a sample of over a
thousand companies, asking managers their assessment of the current business
outlook and their expectations going forward. As covid restrictions go, and commerce
and markets return to normal, the survey shows a clear uptick in business sentiment

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and expectations, going forward. The so-called Business Expectations Index,

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maintained by RBI, while having dipped slightly in the last quarter is still well above
levels of
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at least seems more optimistic than it
has ever been.

But an improvement in corporate balance sheets, and in business sentiment, going

forward, are only one side of the coin. As Roshan Kishore, in a recent article in the
Hindustan Times pointed out, there seems to be a stark divergence between
consumer sentiment and business sentiment.

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Businesses are upbeat about the future, but consumers are not. An RBI index of
consumer confidence (as opposed to business confidence) is subdued at best.
Consumers are downbeat about the present—the so-called ‘Current Situation Index’
is still well below pre-covid levels. They are only marginally positive about the future.
The proportion of consumers expecting to spend more on non-essential items one
year ahead is less than half of what it was pre-pandemic.

Perhaps reflecting this, the bulk of business executives in the Industrial Outlook
Survey expect existing production capacity to be enough to meet demand, going
forward. Very few businesses see current capacity as being inadequate to service
foreseeable demand.

What next

Given the weakness in consumer sentiment, it is still an open question whether

businesses, despite their new found optimism, will step in to fill the gap. This is
where public investment could step in. And Sitharaman’s is hardly the lone voice,

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when she talks about public investment crowding in private investment. In that
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sense, a 35% jump in capital expenditure by the government should be welcome.
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Yet, there is less to this increase than meets the eye. As CRISIL pointed out in a
research note following the budget, accounting for capital expenditure not just in the
Central government budget, but also that done by public sector enterprises, the
actual increase is less than the headline number.

This is because a part of capital spending done by public sector enterprises is now
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being done directly by the Central government, to address the problem of poor
execution by public sector firms. Further, another component of total public capex is
the grants by the Centre to the states for their investments. Putting these together,
the overall capital expenditure budgeted for 2022-23 is around 6% of GDP,
comparable to levels seen before the pandemic (5.9% in 2018-19 and 5.8% in 2019-
20).

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More broadly, argues CRISIL, the missing link is the boost to consumption
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short term—a step that could speed up recovery. It says: “This budget has thrown all
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its weight behind government-led capex in the hope of setting off a virtuous
investment cycle to lift growth. What it misses though, is the bridge—short term,
consumption-raising measures to address the unequal recovery so far, tilted against
large sections of the population particularly in the informal sector, still under
pandemic-led duress."

Indeed, allocations to schemes that have a direct impact on consumption, such as the
Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS), have
actually seen a dip in allocations for the next fiscal year. On the positive side though,
allocations to capital expenditure on roads and railways has increased.

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Finally, a major component of government capital expenditure is done by the states

from grants made by the Centre. In the past, state-level capital expenditure has often
fallen short of budgeted targets.

Ultimately, an overall economic recovery will be heavily driven by private sector

investment. Given the weak consumer sentiment, the only impetus can come from
government spending, whether to boost consumption (through schemes such as
MGNREGS) or investment.

Given that the actual capex increase is less than what the headlines have projected,
and that consumption-boosting measures have been muted, it’s clear the government
has opted to be cautious. The consequences of such a decision will become clear in
the coming months.

The writer is with howindialives.com, a search engine for public data

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