|
Capital investment and economic growth
Capital investments are those investments made in infrastructure, like roads, railways, ports and airports, factories, agriculture, machinery and warehouses.Such investments, made to increase production and productivity, are indispensable for economic growth. Capital investments create new jobs, not just in the act of creating new assets, but also later, when these assets are put to use.
Importantly, the initial capital investment sets off another cycle of investment, by increasing the demand for goods and services; which inturn spawns demand for more capital investment. In economics,when an investment multiplies itself over time, it is called the 'multiplier effect'. This is a key factor in pushing economic growth.
Investment cycle
This is called the investment cycle; when investments start multiplying and replicating, to fulfill ever increasing demand. Fresh investments have a tendency to push further investments leading to new growth and a higher GDP. Thus it is vital that the investment cycle is booted up, to get the economy going.Obviously all this investment generates employment, both directly in the projects themselves, then by the employment generated when these assets are put to use; and lastly in the investments catalyzed by the initial investments.
How is Capex measured?
Investment activity is measured in terms of Gross Fixed Capital Formation (GFCF). This represents the total amount spent on creating long term assets. It is measured on a yearly basis and studied as a proportion of the GDP.Fixed assets can be created by governments, households and businesses and farmers. Currently the GFCF in India is 36 lakh crores,or about 28% of the GDP. The GFCF ratio has fallen off in the last few years. For over five years, before the Financial Crisis, fixed capital formation had grown at a brisk 14%. It grew fastest at 33%, in the 2004- 2008 period, prompting the 8% plus surge in the economy.
Fall in Capex
In contrast, capital formation growth has plunged to a meager 1.6% in the last three years. This was mainly because public sector companies reduced their investments. These companies' capex, increased 27.8 per cent from Rs 1.32 lakh crore in 2012-13 to Rs 1.69 lakh crore in 2013-14, and declined 23.5 per cent to Rs 1.29 lakh crore in the year ended March 31, 2015.If this is bad enough there is more bad news on the private sector front as well. A recent study by the RBI revealed that capex in the private sector plunged 27% in the same period.
"There is a problem on the demand side. There is surplus capacity across industries. So, companies would rather invest their cash reserves in debt market securities than in fresh capacity. Also, given the problems in the power sector and the collapse in crude oil prices, it is unlikely the PSUs in these sectors will be cajoled into launching fresh investments," according to CARE Chief Economist Madan Sabnavis. (Business Standard, September 21, 2015).
L&T, which is a leader in the infrastructure sector, reported a 37% decline in profits in the first quarter of this fiscal year. Similarly other corporate results have been disappointing. The RBI survey also points out to the poor capacity utilisation. Obviously capex investments will kick off only when firms start operating at full capacity.
"Not much is happening. The steel sector is in a bad shape. Barring the road sector, in particular the rural roads where some movement is seen, investments are not taking off," says Devendra Kumar Pant, chief economist, India Ratings & Research. (Business Standard, September 21, 2015).
Current scenario
Yet the fact is that capital spending,both private and public, is necessary to jumpstart a Capex cycle. In the present situation, with the economy still in recovery mode, both capex spending and consumer spending has to expand to push growth. The capital goods sector as revealed by the Index of Industrial Production has grown at a brisk 10% in the last three months. This is reinforced by the fact that sales of companies producing capital goods have been rising at roughly the same rate in the last six months or so. Further, lending to the infrastructure sector grew 7% in the last quarter. Another telling piece of evidence that the cycle is moving up is the increase in the sales of commercial vehicles in the same period.
An important reason for this cyclical pickup is the government's success in its debottlenecking efforts. Many projects stalled due to environmental clearances are now moving forward. The coal sector too is moving ahead. The other important factor is the emphasis on government capex spending, which soared 138%, in the first months of the fiscal year. This has given a substantial boost to the investment cycle. (Business Standard, July 5, 2015).
The next factor pushing investment is the easing in the monetary situation, with the RBI cutting rates steadily over the last year. Interest rate policy is a prime indicator of the way the investment/capex cycle moves. Higher interest rates deter investments thereby impacting growth in the near term. On the other hand lower interest rates encourage investments in physical infrastructure. This not only increases consumption (through increased output) but also generates capital for future growth.
Grounds for optimism
Increasingly many analysts feel that a corner has been turned in mid 2015. They point to the last three months of strong industrial growth, a reviving mining sector, a pickup in urban consumption, which will increase further with the implementation of the Seventh Pay Commission early next year.The National Highway Authority of India, NHAI's, order books grew 13%, while Larsen & Toubro reported a growth of 28% in orders in the last three months. NHAI plans to build about 20,000 kms over the next couple of years, at a cost of Rs. 50,000 crores.
"For now, let's at least heave a sigh of relief that the much-awaited capex cycle - lying dormant for many years - may finally be shaking off some of its slumber," writes Sajid Chinoy writing in the Business Standard. (Business Standard July 5, 2015)
"...there is a lot of stuff under the hood that is happening, a lot of projects are going to come through, government spending is going to accelerate. So you will see positive momentum in the economy over the next six months with perhaps it being more visible 9-12 months from now," Mr Dhar said.(NDTV, October 27, 2015)
Markets wait with bated breath for this "stuff happening under the hood" to start showing up in terms of tangible growth numbers, sooner rather than later. Fund managers believe that India's growth cycle will be spurred initially by the investment cycle getting kick-started by Government spending on infra projects. This coupled with rise in urban consumption can then soak up the excess capacities in the private sector, thus setting the stage for private sector capex to join the growth bandwagon at a subsequent stage. When rural consumption finally comes to the party, you will then have all four engines firing in what we hope will be a sustainable virtuous growth cycle. All eyes for now are however fixed on stage 1 - revival of India's investment cycle through Government spending on infra projects.
Share your thoughts and perspectives
Do you have any observations or insights or perspectives to share on this issue? Did this help you understand the topic better? Do you disagree with some of the observations? Please post your comments in the box below ..... it's YOUR forum !
Share this article
|
