A reality check on great CAPEX expectations

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Economists are predicting a potential virtuous capital investments (capex) cycle to kick in globally as we emerge from the pandemic. The Economist ran an article ,“Capex carnival: An investment bonanza is coming”. Morgan Stanley has predicted a “Red-hot capex cycle” globally, including in India. If lower interest rates and monetary support did not lead to a large capex cycle post the 2008 financial crisis, why are analysts upbeat this time around?

Corporates are less leveraged today compared to 2008. Indian corporates repaid debts of more than Rs 1.5 trillion. Companies are also more confident of durable fiscal and monetary support. Households have large excess savings built during Covid – $1.7 trillion in the US and roughly $300 billion in India as per a UBS report. Lastly, corporates are sitting on a large cash pile – S&P 500 firms’ cash has soared from $1 trillion pre-pandemic to $1.5 trillion now.

Some corporates are already pushing ahead with capex. TSMC – the Taiwan-based semiconductor manufacturer — has announced $100 billion in capex over three years and Apple, $430 billion over five years. The $1.2-trillion US Infrastructure Bill is already sending cement and steel company stocks higher. In India, the Gati Shakti Project, the push towards EVs, data centres, the production-linked schemes and the recent announcements for the semiconductor industry are all being seen similarly.

What does the data say? First, India’s fixed capital formation rate has steadily fallen from 36 per cent of GDP in 2008 to 26 per cent in 2020, while China and the US registered improvements in the capital formation ratio from 37 per cent to 42 per cent and from 18 per cent to 21 per cent, respectively. For a set of 718 listed companies for which data is consistently available from 2005, the capex growth rate has dwindled from 7 per cent in 2008 to around 2 per cent in 2020. The return on invested capital in FY21 is still low at 2-3 per cent compared with 16-18 per cent returns in 2005-08. Land acquisition is still tough, changes to labour laws have been slow, and reform uncertainty has resurfaced with the rollback of the agriculture reform laws. It is difficult to project a capex wave against this backdrop.

More current data does not provide a happy picture either. As per CMIE data, the quarter ending in June 2021 saw Rs 2.72 lakh crore worth of new projects announced. This fell to Rs 2.22 lakh crore for the September 2021 quarter and to Rs 1.80 lakh crore between October 1 and December 14, 2021. This is much below the average of Rs 4 lakh crore a quarter of new project announcements during 2018 and 2019. Further, new projects are concentrated in fewer industries (power, and technology) with the top three accounting for 44 per cent of the total of new projects announced. Importantly, capex stood at 16 per cent of total government expenditure for Apr-Sept 21, which is not higher than in previous periods.

At the same time, capacity utilisation for corporate India is at an all-time low. From a peak of 83 per cent in 2010, when capex was running hot, utilisation levels declined to 70 per cent just before the pandemic, and further to 60 per cent in June 2021 as per the RBI’s latest OBICUS data. The average order book size has collapsed by 30 per cent from Rs 243 crore in the March 2021 quarter to Rs 171 crore in the June quarter. It is hard to project strong capex when order books are falling and companies have 40 per cent spare capacity.

Capex is funded either from fresh debt or equity issues or from accumulated cash. Large firms are repaying debt. Though IPOs are booming, they form a small fraction of corporate fundraising. And historically, higher cash does not predict higher capex. For the 718 firms considered earlier, cash has increased from Rs 1.95 lakh crore in March 2017 to Rs 2.50 lakh crore in March 2020, without a corresponding pick up in capex. So the fact that cash has further increased to Rs 3.21 lakh core in March 2021 does not necessarily lead to higher capex.

The simplest regression analysis suggests that in India, the elasticity of capex to fresh debt is around 0.30, to fresh equity is around 0.48, but to cash is close to 0. This may reflect that companies build cash to ease liquidity concerns rather than fund upcoming capex.

Finally, it is too early in the cycle to predict anything with confidence, but to my eyes, we need more evidence to predict a capex cycle.
The writer is assistant professor of finance, Indian School of Business

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