India’s capex cycle has been quite
slow in the recent years, as evident from the fact that Gross Fixed Capital
Formation (GFCF) grew by a muted 4.9% and 3.9% in 2014-15 and 2015-16
respectively; despite the fact that GDP growth was a little over 7% in each of
the years. And the cycle has shown no signs of improving, in fact, quite the
contrary. GFCF has posted negative growth averaging at around -4.3% in the
first half of 2016-17.
Limited private sector capacity to ramp up investments
Given the current trends broadly
reflected by the private sector, this could provide a necessary boost.
Consider, for instance, capital goods’ production. The index has shown an
average decline of 15.7% every month during the April-November 2016 period.
Even though the index has finally turned the corner in November, it is a data
point for only one month so far and that too on a weak base. If credit offtake
is anything to go by, the trends are more tilted towards the downside than the
upside. In December 2016, credit offtake fell to a low of 5%, and credit to
industry in particular continues to decline for the period up to November 2016
(the last data point available).
While some would argue that this
is partly a supply side problem – a banking sector in need of
re-capitalisation, rising NPAs in public sector banks and still high interest
rates – soft demand is a contributor as well. The RBI’s quarterly order books,
inventory and capacity utilisation survey continues to indicate that firms are
operating far below capacity. As per the last reading capacity utilisation was
at approximately 73% of total capacity.
Centre’s role in supporting the capex cycle
Enter, the government.
And it turns out, that there is a
bigger case for the centre supporting the capex cycle than just because the
private sector is unable to do so at present. Growth in the centre’s capital
spending has been low the past three years of the current government. While
total expenditure has shown an average growth of 6%, capital spending has grown
only 2.6%; as revenue expenditure – which accounts for a major share of total
spending – has grown by 6.6%. With capital spends going into critical capacity
creation in infrastructure sectors, there is no denying the continued requirement
for higher capital expenditure. In contrast, revenue spends tend to be used for
the upkeep of government functioning. These, while important, do not contribute
to lasting capacity creation that could enhance India’s overall growth rate
going forward.
But it is not just about the
government increasing its allocation to capital spending. It has to be
reflected on the ground as well.
An analysis of centre’s spending
numbers of the last 5 years’ full year data reveals that in three of the years,
total spending has been lower than envisaged, by a margin, coming in between
90-95% of the budget estimates. Capital spending has seen a far bigger hit than
revenue spending. In these years, capital expenditure actually declined to
between 81-83% of BE. This is partly because the centre is committed to the
FRBM act, which mandates meeting its annual fiscal deficit-GDP ratio targets.
Since revenue spends are on ongoing expense that cannot be easily reduced,
capital spends tend to get hit first. To this extent, it can be argued that it
might be time to revisit a single point goal for fiscal deficit targets, and
have a target range for the fiscal deficit, instead. This is particularly so,
since the
centre could miss its fiscal deficit target in 2016-17, this acquires
further significance.
If the centre were to ensure that
allocated spending would actually be incurred, that by itself could boost India’s
capex cycle. Moreover, if funding could be re-allocated from revenue spending
to capital spending, even at the margin, that would provide a further boost. This
is possible, since revenue spending has also been slightly smaller, at 98%,
than that envisaged over the past five years as well.
It then follows, that without
reducing the actual revenue spends, 2 percent of the allocated funding could
instead be allocated to capital expenditure. Since revenue spending accounts
for the bulk of 87% of total spending as per the past 5 years’ average, while
capital spending accounts for the remaining 13%; even a small reduction in
budgeted spending on revenue expenditure could make a significant difference to
overall capital spending.
Consider the case of the current
fiscal year, 2016-17. A 2% reduction in revenue expenditure allocation amounts
to INR 365bn. This addition to the allocated capital expenditure, would hike
growth in the same over 2015-16 B.E. to 17.4%, from the present 2.3%. Further,
the dent to revenue spending would be relatively limited: its growth rate would
decline to 10.3% from 12.7% as initially envisaged.
While even these incremental
changes, the centres capital spends would be a small proportion of total
investments in the economy, it would be better to have more capex, than not.
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