Will 2006-07 be a peak year for investments in the economy, or will this year be better? Even with interest rates going up and showing few signs of coming down, India's top firms have healthy balance sheets and are hardly borrowing enough for it to appear to matter. The only thing that could spoil the party is that once demand comes down, as it has in a large number of areas, manufacturers may begin to rethink the timelines for their investments.
Brokerage firm Morgan Stanley, however, has a different take on things, and believes that while overall capex-to-GDP will decline marginally this year, it will drop significantly next year. It gives two reasons for this. First, high interest rates, and second, large shortages in infrastructure and issues like the problems in land acquisition (think Singur, think Nandigram) and the stretched capacity of domestic construction companies. It adds that the sell-off of risky assets globally might worsen things as there is a re-pricing of risk.
While many experts (bankers, corporate analysts and those tracking the economy) tend to disagree, it's useful to follow Morgan Stanley's logic. The company uses money raised by corporates as a proxy for the trend in capital expenditure, and says the total amount of money mopped up for capital expenditure by the corporate sector -- at $117 billion -- rose to a new high of 12.8 per cent of GDP in 2006-07. The study adds that if internal accruals are added to this, the amount available for investments would be close to 17 per cent of GDP. That again is considerably higher than the 11.2 per cent recorded at the peak of the previous capex cycle in the mid-nineties.
While corporate investment still accounts for just around 40 per cent of total investment in the country, disaggregated data show it is really corporate investment that is driving overall investments in the country. Public investment, which had been falling since 1990, recovered around 2002-03, but is still under 8 per cent of GDP. Household investments, which rose sharply till some years ago, have now flattened.
Will high real interest rates spoil the party? Driven by low rates, according to Morgan Stanley, bank credit has been the source for about half of the money raised by the corporate sector in the past three years. But now, in line with the central bank's wish to tighten money supply, interest rates are up by 400 basis points from the bottom to the current eight-year high. And that, according to Morgan Stanley, might just decelerate credit growth to 18-20 per cent in 2007-08. If that happens, it would be a steep fall from the 27.6 per cent clocked in 2006-07 and the 30 per cent notched up in 2005-06.
Is this happening right now? While loans to industry continue to grow at a brisk 27 per cent per annum (as compared to 8 per cent in 2003-04), personal loan growth in down to around 24 per cent, from 57 per cent in 2003-04. That is, the available data show the problem may not be too severe, but loans are not always a function of the day's interest rates -- indeed, Morgan Stanley uses interest rates with a lag of 18 months and then finds a close fit with credit growth.
According to Ajit Ranade, chief economist with the AV Birla Group, the earlier growth was never sustainable: "The current 24 per cent appears to be a more realistic level now that deposits too are growing at about 24 per cent." And, according to KV Kamath, managing director and CEO, ICICI Bank, higher rates don't seem to be pinching borrowers for the simple reason that corporate India is not highly leveraged.
"Most entrepreneurs implementing projects (except in the infrastructure space) have been working with a 70:30 equity-debt ratio. In many cases, even the 30 per cent has some portion of convertibles," he says. Kamath believes that while the increase in global risk aversion will raise costs, there is no shortage of liquidity, either locally or globally.
What of the infrastructure shortage? While spending is up, overall infrastructure investment is still at around 4.2 per cent of GDP. Here, there seems to be more agreement with the Morgan Stanley view. "In some instances, because a captive power unit is needed, the project cost goes up by 15-20 per cent, reducing the return on investments," explains Ranade.
Nor does the power situation look like it's going to get much better. As J P Nayak, president, operations at Larsen & Toubro explains, even if the 68,000 MW planned for in the 11th Plan were to be set up, there would still be a shortage for the government to raise infrastructure investment to the desired 8 per cent-of-GDP level, he says, gets more difficult each year since the GDP numbers are also growing at a faster pace.
Again, there's a dissenting view here, and economist and fund manager Surjit Bhalla argues that infrastructure spend will increase since it is now that the real demand has come in -- no one builds infrastructure before its time, is his thesis. The view, to a certain extent, is buttressed by the fact that investments in areas like telecom, oil and gas, steel and cement appear well on track.
According to Mahesh Vyas, managing director and CEO of CMIE, a database which tracks most sectors of the economy, there will always be some infrastructure constraints somewhere, but government spending has been increasing. Vyas contends that despite all the constraints, there appears to have been no slowing down of capital expenditure except in the odd case where some linkage doesn't materialise.
"According to the data that we monitor, there are about 9,656 projects, worth about Rs 48,00,000 crore ($1,200 billion), currently on the anvil and none of these has been put on hold or shelved; indeed we believe they should all come through in the next couple of years," he says. Adds Kamath, "We are on track to spend the $500 billion worth of investments that we have been talking about."
L&T's Nayak confirms that the order book continues to be robust. "At about Rs 42,000 crore (Rs 420 billion), our order book remains strong and we're looking to see another Rs 8,000-9,000 crore (Rs 80-90 billion) worth of orders coming in during the current quarter," he says, adding that L&T's capex plans haven't changed in any way. Nayak adds though that any signs of a slowdown would be felt by capital goods companies after a longer lag than that for makers of consumer goods.
Ranade, however, is convinced that the outlook for demand continues to be positive. "It's possible that there are some segments that are directly impacted by interest rates such as housing or automobiles where purchases may have been postponed. But that's not the whole story, because there is buying across other product categories," he notes.
That should be reassuring for manufacturers. But, even if some companies do have second thoughts and decide now may not be the right time to invest, they wouldn't lose too much time if they changed their minds later. That's because, as Kamath points out, the time in which projects can be put up these days has crashed; a plant can be up and running in 18-24 months.
Indeed, if the central bank chooses to loosen its hold over money supply, interest rates might move down again, prompting people to spend more. And that would be reason enough for firms to keep their investments going.
