India’s Financial Economy: Post 9
This week’s article is on the capex cycle in India. We will look at the various segments of the economy and access their propensity to undertake capital expansion in the near term.
But before we do that, lets take a step back to review the role played by capital deepening in India growth journey thus far. I’m quoting from the 2018 KELMS study by RBI. They have estimated that of the 4.5% growth in labor productivity seen in FY08-FY17, 3.3% was contributed by capital deepening. Why is labor productivity important? Because it is a direct proxy for real wages in the economy and thus directly impacts the standard of living.
However this is only one half of the story. India’s Labor Force Participation rate is low at 52%, with the Female Labor force participation rate at an absurdly low rate of 24%. These numbers are amongst the lowest in South Asia where most countries share a similar social fabric. A study of incremental labor absorption in India by industry shows some interesting trends:
1. Some 2.4 crore net new workers were absorbed for employment.
2. A much larger number of workers (4.8 crore ) left the Agriculture sector and most of them joined the Construction Industry where the value added per worker is marginally higher.
3. The main reason behind the low productivity in Industries like construction is because of low Capital Employed per worked.
This creates a vicious cycle. Low Capital investment means low productivity and low wages. These low wages do not attract Agricultural workers and non-workers into the employment.
Thus for India, the next cycle of capital expenditure is a shot at bringing about a quantum jump in our GDP per capita through the various employment channels we discussed earlier. With this context in place lets go deep into the components of India’s Capex Spending.
Government Sector Capex
The FY19 breakdown of Government Sector Capex indicates that about 73% of Capex is controlled directly or indirectly by the Central government. The Annual Budget of the Central government states the Government’s plans on this front. This gives us an opportunity to delve into the budget announcement for FY22.
Thus we can see that there is almost a 18% growth in actual central government directed capex in the period of FY20 to FY22. During the same period the expected increase in Central Govt revenue receipts is only 6%. As a fraction of GDP, total planned Capex of the Central Government and its agencies stands at 4.48% which is lower than the FY13-FY19 average of 5.12%. However in this same period, the expected increase in Central Govt revenue receipts is only 6% and the planned increase in Revenue Expenditure (ex of Interest and including all Food subsidy) is ~8%. Thus the impulse of the budget is very much towards capital expenditure. In that context is it useful to remember that the Multiplier on Central Govt Capital Expenditure is high at 2.45X as determined by Bose and Bhanumurthy (2013).
However that is not enough to convince us that this capex plans will actually fructify. We also need to study the government machinery’s track record in implementing their plans. It is heartening to see that Central Govt capex fulfillment rate as a fraction of budgeted number has been steadily going up since 2009. In FY19 and FY20 the completion rate was ~ 100%
Finally we have to consider the capital expenditure plans of the states since they account for about 40% of the overall Government Capex. State Government Capex spending is expected to contract sharply in FY21. Data till November 2020 suggests that for these 8 months State Capex is down almost 27%. For FY22 the relaxation of Fiscal Deficit to 4% gives the states enough ammunition to boost their Capital Expenditure spending. Assuming that GST Collections work out as per the Center’s plans, I expect states to drive capex growth of at-least 10–15%. Between FY17 to FY20 the Capital Expenditure growth of the states in aggregate was quite muted at 3.8% CAGR. This is because of a stagnation in Devolution of Taxes from the Centers and lower than expected GST collections. Higher growth in Capex spending of states will have a significant fiscal impulse on the economy owing to a similarly high Fiscal Multiplier. According to an RBI study the Multiplier on State Capex Spending is about 2.39X.
Private Sector Capex
We look at two aspects of Private sector economy to ascertain the trajectory of Private Sector Capex through two dimensions: Capacity Utilization levels and the capacity of Private Firms to undertake capacity expansion by taking on Debt.
On Capacity Utilization, I want to point out a few aspects from recent Industrial surveys conducted by RBI:
1. 35% of Firms expect an increase in Capacity Utilization as of FY21Q3. Moreover only 11.3% of firms believe that their Capacity Utilization levels are likely to overshoot their expectations.
2. Capacity Utilization is tracking at 64% in FY21Q3
Debt levels of Non Financial Private Sector Firms are extremely healthy. I’m relying on an excellent study by Motilal Oswal Research, where they point out that the Ratio of Gross Debt of Non Financial Private Sector Firms stands at 52.9%. Between FY20 and FY21Q3 Debt has contracted by 0.20%. My calculations suggests that this ratio will likely fall below 49.50% in FY22. In addition to that Banking Sector Credit growth has been extremely muted. In FY21 thus far, the incremental credit to deposit ratio has been extremely weak at only 30%. Impact of COVID induced lockdown on the asset quality of Banks has been contained (Pro-Forma GNPA increase of 30–60bps and 9MFY21 Slippage rate of 3%) which has led to a sharp re-rating in the P/B ratio of banks. Despite creating COVID provisions ranging from 2–5% of their loan books, the Tier 1 of the aggregate banking sector has gone up from 14.7% to 15.8%. At the same time incremental lending rates have come down by 95 bps as a consequence of RBI’s activity on policy rates.
Finally we come to the crowding out vs crowing in debate. This year’s Economic Survey has an excellent passage on this which opened my eyes to the fact that much of what we learn in Economic theory may not be directly applicable in emerging markets like India. Government Capex as a fraction of India’s Financial Savings may hit all time in FY22 but that shouldn’t necessarily crowd-out private investments. This is because the capital deepening activities of the Government can drive both job creation and real wage expansion (via productivity growth) which creates a virtuous cycle in the economy that spurs aggregate demand. Ultimately this leads to generation of higher savings in the economy which counterbalances the initial strain caused by higher government borrowing. This is further validated by a recent study conducted by Nusrat Akber et al, where they found a positive elasticity of private investment to shocks in public investment. The elasticities are 0.45 and 0.5 in the short run and the long run respectively and are found to be statistically significant.
Small Enterprise Capex
This segment pertains to the segment which is typically referred to as Capital Formation for the “Household” sector. I have subtracted spending towards Home construction to arrive at this figure. The idea is to identify the capex spend of the millions of self-employed individuals. This part of the economy is the most opaque and is not well represented in official statistics. The only recourse we have is the behavior of small ticket SME loans. This refers to loans with a ticket size of less than 10 Lakhs. The Transunion CIBIL Report of October 2020 tracks about 90,000 crore of Small Ticket SME loans. According to this report the Gross NPA Ratio of these loans stand at 13.5% and rising. This is an attribute of the K shaped recovery that our economy is going through. The Government’s came out with an MSME credit guarantee scheme in June 2020 which has seen disbursement of around 1 Lakh crore thus far. Apart from giving these entrepreneurs access to liquidity and working capital, this scheme also gives them an incentive to formalize and become a part of the organized sector. In the long run this would lead to productivity improvements (with scale) and spur job creation.
I will conclude by saying that a counter-cyclical capex led Fiscal policy is perhaps the best medicine for India’s economy at the present time. My calculations suggest that about 40% of the incremental spending between FY20–22 has been directed towards Capex. It is not an easy decision as we can see from the capitulation in the bond markets. However, I do believe that it is the right one. We know that this spending has a high Fiscal Multiplier and we also have evidence that this kind of capital deepening generates productivity growth. Moreover stabilization in GST collections and a leeway for states on FRBM Act, gives us hope that States would be in a position to drive capex growth, which has been subdued for the last 4 years. A combination of central and state capex would drive aggregate demand and take the economy to a point where the the Private Sector can come in. Even though current capacity utilization levels are relatively low, we do have evidence of a Private Sector Crowding-In effect. The balance sheets of Private Corporates and Banks are well placed to support the next phase of Capital Deepening via the Private Sector.
References:
References:
- The Crowding-in/ out Debate in Investments in India: Fresh Evidence from NARDL Application. Nusrat Akber et al 2020
- Fiscal Multipliers for India: Sukanya Bose and NR Bhanumurthy
- India’s Debt Growth remains subdued in FY21Q2: Motilal Oswal EcoScope
