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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