Mumbai: The mathematical theory of transitivity states that, if A is equal to B and B equal to C, then A is equal to C.

Given the latest cuts in corporate taxes, one would hope that this theory was as simply applicable to India’s languishing capital expenditure cycle: that, by reducing corporate taxes, demand increases, capacity utilization improves and consequently, private capex revives.

Of course, a tax cut is always welcome as it will add to companies’ kitties. But that doesn’t mean companies will immediately channelize the extra profits towards capex. Many analysts expect them to use this money to improve their balance sheet and net worth.

The biggest impediment to a revival in capex cycle is suboptimal capacity utilization levels across industries. “Manufacturing capacity utilization of around 80% at a composite level is needed to provide comfort for companies to commit fresh capex and build additional capacity," says M.S. Unnikrishnan, managing director and chief executive of Thermax Ltd.

Latest data from the Reserve Bank of India’s Obicus (order books, inventories, capacity utilization) survey shows capacity utilization was 76.1% in the fourth quarter of FY19. Industry experts reckon it could have fallen in the subsequent quarter.

Unnikrishnan adds that about 70% utilization in large ticket-size sectors (core) such as power, steel, cement and fertilizer are uninspiring for fresh capex to be undertaken. Meanwhile, light engineering industries such as automobiles tell a woeful tale of tumbling sales, rising inventory and production shutdowns.

Even if companies choose to expand, revival in big-ticket capex could take time, given challenges in global commodity cycle, demand-supply scenario, land acquisition issues and securing clearances.

(Graphic: Paras Jain/Mint)
(Graphic: Paras Jain/Mint)

Delayed payments by the government to vendors was one more logjam in the capex cycle. To its credit, the government has vowed to expedite payments to those it owes money. “My intention is to clear pending dues to goods and service providers with any of the ministries. No non-litigating dues should be kept pending," finance minister Nirmala Sitharaman said on Friday.

Once government dues are cleared, they will add to the savings of lower tax rate. Another plus of the tax cut is that it puts India on a par with its neighbouring regions. That would offer a big advantage in attracting business. Of course, Asian countries such as Vietnam and Thailand have already taken advantage of deteriorating US-China trade relations. They now charge only 10% corporate tax for units relocating from China, Taiwan and neighbouring regions. Suveer Chainani, chief executive of institutional clients group at Emkay Global Financial Services, said “the tax delta (the foreign direct investment, or FDI, deterrent) was 35-10=25%. Now, the tax delta is reduced to 15-10=5%". This should help attract FDI in manufacturing, especially now when Asian supply chains are getting reconfigured.

The Boston Consulting Group’s Manufacturing Cost- Competitiveness Index (2017) shows India on a par with some of the emerging markets. This, despite an increase in manufacturing costs such as labour and land costs in the recent past.

K.V.S. Manian, president of corporate, institutional and investment banking at Kotak Mahindra Bank Ltd, said that although the government step was a “bold move, tax cuts alone cannot dramatically change the investment climate". “The government must carry on with reform in facilitating quick approvals to start a business, labour and land reforms," he said.

In a nutshell, the capex cycle will turn, but how fast is anybody’s guess. Ranen Banerjee, leader-public finance and economics at PwC India, explains that it will start with a boost in sentiment from FMCG and white goods firms. Given the push for the infrastructure sector from the government, steel and cement could see improvements.

No doubt, tax cuts are the first nudge to make companies invest and put up factories. The government is also doing its bit to reduce capex risk aversion. But what remains is the conviction among companies to reignite the capex cycle.


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