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Two years of surplus liquidity, low interest rates, and huge corporate profits did not translate into private investments, leaving the government to do the heavy lifting in supporting the economy. Now as clouds emerge again over the global economy, any revival in private investments has only got tougher, especially for smaller businesses.

During the pandemic, cost-cutting helped companies make profits and repair their balance sheets. However, the initial recovery in the economy was not enough to get private investments up and running, as many economists feared. Despite aggregate profit growth of 27%, large companies saw net fixed assets contract by 0.1% in 2021-22. Capex expansion improved for small companies but was only slightly better with 0.7% growth.

Economists attributed the better capex expansion in 2020-21 mainly to stuck projects taking off after the lockdown. Since there were no clear signs of capex revival once those projects got completed, the numbers show a decline in 2021-22.

Chart 1a:

“Private investments seem to have missed the bus," said N.R. Bhanumurthy, vice chancellor at Dr. B.R. Ambedkar School of Economics University. The story has changed little in the new fiscal year: in the June quarter, project announcements saw the first sequential decline in six quarters. Global uncertainty, rising cost pressures, and interest rate hikes are clear risks to private investments.

However, there is still room for corporations to increase their efforts to increase capex and join the economic recovery process. “The growth now looks durable despite the headwinds and private investment revival is crucial for the economy," Bhanumurthy added.

High costs

The environment for private investment revival remains tough. For two years, the Reserve Bank of India kept the policy repo rate at a record low by ignoring even high inflation to support the economy. However, the steep inflationary pressures from the disruptions caused by the Russia-Ukraine war forced the central bank’s hand into hiking rates, as was the case with several central banks. As a result, businesses are now facing high borrowing costs globally and at home, with bond yields having shot up since the beginning of the year. Yields of AAA-rated corporate bonds have surged nearly 70 basis points (bps), while those of AA-rate have increased about 60 bps. The yields for the benchmark government bonds have also increased about 70 bps. On top of that, record borrowing by the government in the current financial year also poses the risk of crowding out of private investments. It is not yet clear whether it already has.

Credit revival?

As borrowing from the market has become costlier, corporations are again turning to banks for funds. The industry credit growth accelerated to 8.1% year-on-year in April and 8.7% in May, against an average of 6.0% in the previous six months. Non-food credit growth was 12.6% in May. However, not only was the revival driven by retail loans and base effect, painting a poor show by industry, it further falters when adjusted for inflation. Real growth in non-food credit was only 5.2% in May, having risen from just 2.3% in September 2021. Will this be sustainable in the current environment of hikes in interest rates and withdrawal of liquidity from the system? It could be, but smaller businesses stand to be hurt.

“Credit growth is sustainable up to a point," said Pronab Sen, economist and former chief statistician of India. “After a period of time, however, the corporates start eating into the credit of the MSMEs."

Animal spirits

The back-to-back budget commitments of huge capex helped in economic revival but failed to lift animal spirits to an ideal level. Capacity utilization, a key factor for influencing private investments in manufacturing, crossed 70% by 2021-end, but was still lower than the levels seen in 2019. Economists believe a level of 80% is ideally needed for around a year to suggest an expansion in private investments. That is still a long way to go.

To be sure, private investments have been teetering for over a decade now and corporate tax cuts announced in 2019 haven’t led to the intended results. As the global economy faces recession fears, big projects are likely to be held back. “The ones that are not going to be affected by global markets are the MSMEs," Sen said. “There should be a coordinated policy in terms of public capex that helps the MSMEs to boost private investments in the current environment."

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