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Is India’s capex cycle ready for a rebound?

he production-linked incentive schemes, coupled with a strong increase in retained earnings, are driving business groups to embark on diversification paths and announce significant investment plans. (Photo: HT)Premium
he production-linked incentive schemes, coupled with a strong increase in retained earnings, are driving business groups to embark on diversification paths and announce significant investment plans. (Photo: HT)

  • A capex cycle is key for the labour market, which has been struggling to create enough jobs in the last few years
  • Some experts believe that the ongoing capex announcements aren’t widespread but sectoral. A bulk of the new manufacturing projects in June were in metals, chemicals, machinery sectors.

NE DELHI : The chief executive of India and south Asia at Hitachi ABB Power Grids, N. Venu, doesn’t miss a chance to hard sell the medium-term prospects of his firm. When a Teams video call with Venu gets interrupted by a sudden power cut, Venu quips, “Remote working needs reliable power infrastructure," adding, “We need to have 24/7 power, quality power, reliable and affordable power."

Hitachi ABB Power Grids is in the business of power technology. The company sees enough triggers for its business, going ahead. After all, over the next two decades, India may have to add a power system the size of the European Union in order to meet its growing electricity demand, the International Energy Agency (IEA) noted in a recent report. India is also in the middle of an energy transition because of renewables and the country requires cutting-edge technology to manage the shift.

The company is therefore investing about 200 crore to boost its production capacity for grid integration technologies, transformers and high-voltage products. Its latest capital expenditure (capex) cycle started during the pandemic.

Early signs
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Early signs

Bigger manufacturers have even bigger plans. Manufacturing investment project announcements have more than doubled to 2.1 trillion in June 2021 from March, data from the Centre for Monitoring Indian Economy (CMIE) showed. This is over six times the investments announced in June 2019, a ‘normal’ year. India last saw investment announcements at this scale in December 2015, when new projects worth 2.4 trillion were reported.

Over the past few months, state governments have cleared the investment proposals of several large firms in a hurry. In July, the Odisha government approved five steelmaking projects worth 1.46 trillion—this includes proposed investments from Bhushan Power and Steel Ltd, Tata Steel Ltd and Jindal Steel and Power Ltd, among others.

In June, Reliance Industries Ltd announced an investment of 75,000 crore for its new renewable energy business. And, in May, Adani Green Energy Ltd said it would boost its capex to 15,000 crore in 2021-22 from 8,500 crore the previous year.

All this begs the question: Is India at the cusp of a new capex cycle, something which the country hasn’t seen in years? A capex cycle is crucial for India’s battered labour market, which has been struggling to create enough jobs over the last few years. The two waves of the pandemic and subsequent regional lockdowns have only made things worse.

According to data from CMIE, India’s unemployment rate is trending at 8.3%, higher than the 6.68% of September 2020. Urban unemployment is worse off, at nearly 10% in August this year.

“Various large industrial houses have recently made announcements about their capex plans and there seems to be buoyancy and forward-leaning capacity building in general," Ajay Goel, group deputy chief financial officer at mining company Vedanta, said. The company will spend about $2 billion in capex this year.

BofA Securities, an investment banking firm, believes that the government would be the primary driver of capex for now. “We see India at the cusp of a multi-year capex cycle, similar to that seen in FY03-12. We expect $356 billion of orders to be awarded over (the next) two years, mainly led by government capex (80% of orders)," BofA Securities stated in a recent note.

About $95 billion of this order flow is expected to be in the roads sector, $51 billion in power and $46 billion in railways. This implies supplemental capex investments from private firms in sectors ranging from construction equipment and solar photovoltaic (PV) to those who produce towers and rail coaches. Substantial orders are also expected in hydrocarbons, water projects, power, and defence.

“Private sector capex would see green-shoots, but its contribution would be muted at 20% of FY22-23 orders. We expect the private sector and PSUs (public sector undertakings) to accelerate (the) capex cycle growth from FY24 onwards. Government opening up large monopolies within gas/power distribution, railways and mining would drive private capex," the BofA report added.

Deleveraged and ready

Over a call, B. Santhanam, chief executive officer of Asia Pacific and India region and chairman at Saint-Gobain India, spoke of how the firm survived the pandemic lows and then thrived. There is a K-shaped recovery in India—some sectors have picked up, others haven’t. Saint-Gobain, a French multinational that manufactures materials for construction, mobility, healthcare and other industrial application markets, is doing just fine.

“In 2018, corporates were troubled by a balance sheet crisis and huge debts. They had high cost structures. They had to deleverage. Therefore, there were no private sector investments," Santhanam said. “Now, many of the good corporates have deleveraged. They have a sense of confidence in their own resilience. Coupled with the strong rebound in growth in US, Europe and China, companies are looking at investments in a big way," he added.

Compared to the last three years (between 2018 and 2021), Saint-Gobain will invest 50% more between 2021 and 2024 in India. About 2,500 crore will be invested between 2021 and 2023 to expand the manufacturing capacity of products ranging from glass and ceramics to gypsum and construction chemicals. “Our plans have got accelerated. We are bringing ahead some of the investments we thought were for the longer period. I see this confidence in investing for the future even in other companies," Santhanam said.

The greenshoots of capex are therefore stemming from a combination of several factors. While large industrial houses have deleveraged and are probably ready to invest again, banks, on the other hand, may loosen their credit flow to corporates. Financial services firm Credit Suisse in a report, titled India market strategy, published in July stated that the economy is now primed for a revival in credit growth. “Monetary conditions are easy. Leverage in the financial system is at record lows—for both banks and non-banking financial company (NBFCs)—and tier-1 ratios have risen since FY19. Borrowers have also deleveraged: both debt-to-EBITDA and debt-equity ratios were at decadal lows in FY21, and if profit growth in FY22-23 is as currently projected, they may fall further," the report noted.

A low interest rate regime, therefore, has manufacturers interested. “Interest rates are low globally. Even in India, over the last 24 months, the cost of capital has come down. Companies are emboldened to take a risk," Harsh Pati Singhania, VC & MD JK Paper and Director of JK Organisation, said. JK Organisation is a diversified business group with interests in tyres, paper, and cement, among other sectors. “People who have stronger balance sheets, and those who see long-term potential (in demand), are taking the advantage of the low cost of money," he added.

The Credit Suisse report also noted that “a strong increase in retained earnings (helped by corporate tax cuts) and PLI (production-linked incentive) schemes are driving business groups to embark on diversification and announce significant investment plans". While Reliance Industries has forayed into renewable energy, Tata Sons is investing in technology hardware and e-commerce. The Aditya Birla and JSW groups are diversifying into paints; the Vedanta group is increasing its exposure to the oil and gas sector.

Beyond PLI

Sunil Vachani, executive chairman of contract manufacturer Dixon Technologies (India) Ltd, spoke of his new investments in a rapid-fire sort of a way over the phone. Two mobile phone manufacturing plants that can produce 12 million smartphones a year and 24 million feature phones; a factory to make laptops and tablets with a capacity of 1 million units; a refrigerator plant in greater Noida, Uttar Pradesh, with a capacity of 1 million units a year. “These are fresh investments that have come online this year. Some are in the process of coming online. Investments would total 500 crore," Vachani said.

Some of his investments—such as mobile phones and IT hardware production—would qualify for the government’s PLI scheme, the new fulcrum of ‘Make in India’. The scheme has a triple objective—attract foreign direct investment (FDI), help domestic manufacturers scale, and make India globally competitive in exports.

While many analysts, and even some industrialists, see PLI as a driver for a new capex cycle, a direct PLI impact will, however, be limited. Credit Suisse estimated that PLI schemes can trigger new investments of only $21 billion in direct capex—most of it in auto, batteries and mobile phones. However, PLI could result in indirect investments. “Sectors and firms not directly benefiting from (the) PLI schemes but from the surge in domestic production volumes (in general) are also likely to drive fresh investments," the firm stated.

Firms will need to invest in new capacity in sectors such as mobiles, laptops and tablets because of a long-term demand cycle, driven by both consumer and enterprise needs. “The current demand (for personal computers) is because of remote learning and the hybrid work environment. Devices per home are shooting up. Also, there is digital transformation spending by enterprises and small and medium businesses," Shailendra Katyal, managing director, Lenovo India, said. Over the long term, India’s new education policy may emerge as a trigger because it will force schools to invest more in computers, he added. As a result, Lenovo is expanding its personal computer manufacturing plant in Puducherry. Tablets and smartphones (Motorola) assembly are outsourced to contract manufacturers such as Dixon Technologies.

Reality checks

While some executives and analysts are optimistic, not everyone shares that sentiment. Some experts believe that the ongoing capex announcements aren’t widespread just yet—they are sectoral. Of the 2.1 trillion in new manufacturing projects announced in June 2021, a bulk of it was in metals, chemicals and machinery sectors. Mahesh Vyas, managing director and chief executive officer of CMIE, said that the high investment number in June is largely due to three large projects from Reliance, Adani and Bhushan Steel. “These add up to most of the new investment proposals in manufacturing. I don’t see a capex cycle building up yet," he noted.

Sunil Kumar Sinha, principal economist and director of public finance at India Ratings and Research, also has his fair share of doubts. “The average household income in US is up versus pre-covid. It is not because wages have increased but because of the income transfer scheme of the US government. A large part of that stimulus is being spent on consumer durables," he said. “The fear is that the fiscal stimulus driven consumption may not last for long as we move into the calendar year 2022. Once it starts unwinding, all emerging markets, including India, may be impacted," he warned.

On the domestic demand and supply front, a potential third wave and its intensity remain concerns. Businesses need both demand and consumption, and a severe third wave can scuttle the gains. Harsh Pati Singhania of JK Organisation points to the persisting pain in the unorganized sector of the Indian economy. Anecdotally, everyone acknowledges that small companies and the informal sector are the worst hit. That may come back to bite larger businesses soon. “Ultimately, they are linked to the economy. Large businesses are linked to MSMEs (micro, small and medium enterprises) and their suppliers," Singhania added.

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