Opinion Is the investment slowdown likely to continue?

In the case of the private sector, investment activity has been fairly muted in industrial sectors — manufacturing, electricity, gas and water supply and construction. Over the entire decade (2011-12 to 2021-22), private investments in electricity, gas and water supply grew by around 7 per cent, construction by 25 per cent and manufacturing by 73 per cent. In comparison, total private sector investments grew by 141 per cent as firms invested more in services such as communications and transport (road, railways and air), and real estate, dwelling and professional services. To put these investment numbers in perspective — the overall economy grew by 169 per cent during the decade.

The investment slowdown in the household sector (this includes the informal sector) has been far more severe. Much of this is on account of the real estate, ownership of dwelling and professional services sector. Household investments in real estate grew by just 20 per cent over this decade, while overall household investments roughly doubled, driven by greater outlays in dwellings and building structures in sectors such as trade and repair, hotels and restaurants, construction, transport and services incidental to transport. Considering that much of this increase occurred during the pandemic years, when there were clear signs of labour market distress, the channeling of funds towards these sectors is perhaps indicative of the economic stress that has pushed households towards self-employment. (Data from the periodic labour force surveys shows that between 2019-20 and 2021-22, self-employment rose in both rural and urban areas.)

Many now believe that with the banking system having cleaned up its books, and the corporate sector bringing down its debt to more manageable levels, the economy is on the cusp of an investment upturn. But a return to previous levels will require investments by both the corporate (in industry and services) as well as the household sector (including the informal economy) to pick up pace. This process, however, will not be that straightforward.

For one, financial conditions have tightened considerably over the past year. But the effects of this are not being felt uniformly across firms and households. This will curb investment demand more in certain pockets of the economy.

Since May last year, the monetary policy committee has raised the repo rate by 250 basis points. The 91-day T-bill yield has gone up from 3.98 per cent on April 29, 2022, to 6.9 per cent on May 5, 2023. But at the longer end of the curve, the 10 year Gsec yield is actually lower than what it was before the pandemic. On April 29, 2022, before the MPC began to raise rates, the 10 year Gsec yield was at 7.15 per cent. While yields did rise briefly, they subsequently moderated, and are currently hovering around 7 per cent. In the case of corporates, the average yields on the 10 year AAA rated corporate bonds have recently been in the range of 7.5 to 7.75 per cent, while those for AA rated bonds are hovering around 8.5 to 8.85 per cent.

These changes in bond yields imply that even though real interest rates have gone up from a year ago, for the better-rated corporates, short-term borrowing costs have risen more than long-term borrowing costs. And as short-term borrowing is used to finance working capital, while long-term borrowing is used to finance investment, this yield curve has, perhaps inadvertently, raised the costs of working capital more than that of investment capital.

On the other hand, under the external benchmark lending regime – this determines the rate at which banks lend – the pass-through of the 250 basis points rate hike has been completed. And as small firms and households rely on banks for credit, they are faced with much higher rates than the better-rated corporates. For instance, SBI’s home loan interest rate ranges between 9.15 to 10.15 per cent, while that of HDFC is between 8.5 to 10.7 per cent. This suggests that the burden of tighter monetary policy is perhaps falling disproportionately more on households and smaller firms, which makes it all the more unlikely for their share in investments to pick up sharply in the near term.

But interest rates alone don’t determine new investment activity. Corporate investment decisions are ultimately influenced by various macro as well as micro factors. For instance, it may be the case that the bigger companies, the ones in better financial position, are more favourably inclined towards acquiring companies, perhaps through the IBC process, than in launching fresh investments. But, that the corporate sector, despite being in better shape than before, continues to be cautious on investments, suggests that risks still outweigh returns.

Now firms face many types of risks. These could be operational risks (problems with land acquisition or supply chain disruptions), currency risks (a sharp depreciation in the currency could make repaying foreign obligations difficult), business risks (global and domestic demand coming under pressure), political risks (political instability creates policy uncertainty), and, of late, the risk of hostile takeovers. While recent events would seem to suggest that some of these risks are diminishing, others such as the risk of global and domestic demand being under sustained pressure are very much present. How this risk-return matrix changes will ultimately determine if and when the private investment cycle picks up.

ishan.bakshi@expressindia.com