#237 Looking Under the Hood

Course Advertisement: Admission to Takshashila’s Graduate Certificate in Public Policy (GCPP) programme is now open. Start your 2024 with a course that will equip you with the tools to understand the world of public policy. Check all details here. India Policy Watch: In Search Of Growth Current policy issues in India — RSJ A quick macro update. The RBI’s Monetary Policy Committee (MPC) met this week and, as was widely expected, kept the repo rate unchanged at 6.5 per cent for the fifth consecutive time. The Governor gave the usual explanation of global political risk, higher volatility in global financial markets, and continued inflationary expectations as the reason for keeping the policy stance unchanged as ‘withdrawal of accommodation’. And the Governor was quite clear that there is no ‘inadvertent’ signalling to the market that it has actually moved to a ‘neutral’ stance with its prolonged pause on rate hikes: “Reaching 4 per cent (inflation target) should not just be a one-off event. It has to be durably 4 per cent and the MPC should have confidence that 4 per cent has now become durable. We are very careful in our communication. There is no inadvertence in any of our communication. So, if somebody is assuming that it is a signal to move towards a neutral stance, I think it would be incorrect.” Well, that takes care of any possibility of a rate cut before next year's elections. And what’s the need, really? Between now and the elections, there’s always an inflation risk on vegetable and food prices. Also, while crude oil price has been on a downward trend during this year which has helped on the inflation front, there’s no guarantee how that will trend given the global geopolitical situation remains uncertain. Most importantly, what’s the need to signal any rate cut when the GDP growth numbers are coming in significantly above even RBI’s somewhat optimistic forecasts at the start of the year? Q2 GDP grew at 7.6 percent, almost a full percentage point above estimates, leading the central bank to up its full-year forecast to 7 per cent. All good news so far. Further, the RBI note had this optimistic comment for the near term: “The healthy twin balance sheets of banks and corporates, high capacity utilisation, continuing business optimism and the government’s thrust on infrastructure spending should propel private sector capex.” Well, you can go back to the past six quarters, and you will find similar sentiments about an impending private sector capex boom from both the government and the private sector. But it is turning out to be a bit of a mirage. While both the corporate and bank balance sheets are the healthiest they have been in the past two decades, there is a continued ‘wait and watch’ approach on capex, which has mystified most observers. While the consumption growth remains robust, there are early signs that this lag in private capex is beginning to slow down corporate revenue growth. From the Business Standard: “.... the slowdown in corporate revenue growth over the last one year has begun to reflect in India Inc’s capital expenditure as there is a close correlation between growth in net sales and investment in fixed assets. The net sales of 725 companies, excluding BFSI and state-run oil & gas firms, were up 4.2 per cent year-on-year (Y-o-Y) in H1FY24 – the lowest half-yearly increase in the last three years and down sharply from 12.2 per cent growth in the second half of FY23 and 31.3 per cent growth in the first half of FY23.” As if on cue, the Chief Economic Advisor (CEA), picked the issue of sluggish private capex at a CII event this week. Instead of the expected anodyne address at events of this nature, he made some very insightful points. First, he correctly pointed out that to expect consumption to continue to drive GDP growth while private capex sits out for as long as it has defies logic. Consumption, as we have pointed out more than a few times here, is the residual factor. And that’s exactly the point the CEA made (again quoting the Business Standard): “Waiting for demand to arise before they start investing will actually delay the onset of such demand conditions happening, because usually consumption has to be the residual. Investment leads to employment, which leads to income generation and which in turn creates consumption and then the savings are recycled back into the investment. So the more the corporate sector delays its investment, this virtuous cycle will not materialise.” Then he mused on what might be holding the private sector back despite strong balance sheets, robust GDP growth and a general sense of global optimism about India’s prospects: “So what is holding it (corporates) back? It is easy to say that there is general demand uncertainty. Post Covid, recovery has started. But one thing we have to remember is that this decade is going to be the decade of uncertainty, whether we like it or not. So for us to wait for the uncertainties to abate or recede, [its] like waiting for the waves to subside before taking a dip in the ocean. That is not going to happen.” I won’t be surprised if there will be more plain-speaking to corporate India coming in the next few quarters on private capex from the government—three reasons for that. First, the government has pushed its capex targets in the last two budgets and, somewhat surprisingly, kept pace with them. The public capex has grown at a CAGR of over 30 per cent in the last three years. It is now about 3.3 percent of GDP as opposed to the 1.5 per cent it used to be pre-pandemic. The government has found resources to fund this capex by trimming subsidies following the pandemic and by the continued growth in tax collections because of the efficiencies brought in with GST and the rapid digitalisation of the financial system. However, given the fiscal deficit constraints, this public capex growth will be difficult to sustain at this clip. Couple that with the recent data that shows household savings at a multi-decade low of 5.1 per cent of GDP, there is no other lever of growth to pull except private capex. Second, given global uncertainty and the ‘higher for longer’ expectations in developed economies, the annual FDI flows have been the lowest in this fiscal year than at anytime in the past decade. The venture money in the form of investments by VCs and PEs has also dried up with a general ‘funding winter’ that has left all but a few startups untouched. While there’s stronger global demand for the MSME sector that’s visible across the board, it will start hitting the wall of lack of funds in the near term unless large capex projects take off and the general sentiment of investment picks up in the private sector, which then lifts all boats. Third, this government is instinctively fiscally conservative and likes to stick to its targets. It has set a target to reduce the fiscal deficit by 1.5 per cent of GDP in the next two years. That apart, the imminent inclusion in global bond indices will also mean a greater level of scrutiny of public accounts. The government would like to project an image of fiscal prudence to boost confidence of investors. So, I don’t see a continued heavy lifting through public capex as has happened in the past couple of years. Which then brings us back to private capex and that question of what’s stopping it from taking off. I think CEA has a point on the general aversion of the corporates to any kind of uncertainty which has continued for so long that it seems like despite all the talk, they are unable to take the final leap in making that investment. Will this go away in due course? I guess it is possible that the Lok Sabha elections may be the final trigger which may kickstart the process. But that apart I think there are two other points that remain unaddressed. One, the promoters are yet to come to terms with the new regime of greater scrutiny by banks when they borrow, an insolvency process where they can lose control of their companies and the limited deg… This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com