Revival of private corporate capex 18-24 months away, says UBS' Tanvee Gupta Jain

The Centre has been pressing hard on its capital expenditure pedal to revive growth but UBS Securities Chief India Economist Tanvee Gupta Jain says it alone "can't really swing the capex cycle significantly".

Jain said for the capex cycle to turn around, private corporate capex has to start picking up. “We believe the drag from the weak capex cycle seems to be over and a broader capex revival could follow with a lag of 18-24 months if the economic recovery continues in line with our baseline forecast," she told Moneycontrol in an interview over the phone.

Jain also spoke about the Reserve Bank of India's (RBI) troubling inflation forecast for FY23, India's potential growth rate and the need to promote the participation of women in the labour force. Edited excerpts:

The GDP data for October-December 2021 has been weaker than expected. What do the underlying numbers mean for India's economic recovery?

We have been highlighting that it's an uneven growth recovery. If you look at the December quarter data, growth was largely supported by pick-up in household consumption demand. A sharp deceleration was seen in the investment growth.

When we divide investments into public, private corporate and household capex, we see that only 20 percent of the total investment is led by public capex, which is central government, state government, and quasi-government enterprises' investment activity.

We are seeing an increased policy focus on boosting capex-led growth. However, even if we have a double-digit growth in the central government capex, as planned in the budget, it will act as a positive multiplier to growth but can't really swing the capex cycle significantly.

For the capex cycle to turn around, you need private corporate capex to start picking up. We believe the drag from the weak capex cycle seems to be over and a broader capex revival could follow with a lag of 18-24 months if the economic recovery continues in line with our baseline forecast.

The capacity utilisation levels on the ground are still quite sluggish at sub-70 percent. We need capacity utilisation levels to be around 80-85 percent for companies to start creating capacities and add to the capex demand.

For over a decade, corporate capex has stayed flat, while revenue and profit have risen 1.3x and 1.7x, respectively. Going forward, we believe the low debt on corporate balance sheets and improved profitability could create a tailwind for the rebound as and when demand improves, leading to higher capacity utilisation.

What is your baseline scenario for demand because private final consumption expenditure was up just 7 percent in October-December 2021?

If you look at the household consumption demand, it would be better to look beyond the year-on-year comparisons as there is a lot of base effect at work. If we adjust for the base effect, our view is that the economy is still growing below trend.

In our FY23 real GDP growth forecast of 8 percent, a large part of the headline GDP growth is on account of strong statistical carryover effect.

Moreover, the demand momentum in the Indian economy has seen a V-shaped recovery with the gradual opening up of the economy after each COVID-19 wave. This was largely supported by unwinding of household savings, which increased in every successive lockdown.

It is the organised sector demand which has recovered quickly but the demand conditions are still lagging in the informal economy, or the non-corporate India.

The increase in the government's capex target has come at a time when it is trying to revive the private investment cycle. At what point does the government's large borrowing programme starts crowding out private investors from the market?

We believe the demand momentum in the economy is still weak, hence it is not really crowding out private corporate capex. But yes, as demand conditions improve and conditions become conducive for a corporate sector revival and if the government borrowing remains stretched, then there is a risk of crowding out. But that is still 18 months away because we are not expecting a broader private corporate capex revival until then.

The RBI is facing the problem of “impossible trinity”— managing liquidity, currency movement, and the bond yields. But before the Russia-Ukraine conflict began, bond yields in India had come back to pre-budget levels and the RBI has been dovish.

Our strategists expect the 10-year government bond yield to rise to 7.5 percent by the end of FY23. However, on the policy rate cycle, we are only estimating a 50-basis-point rate hike in FY23 as per our baseline forecasts.

That said, we will be closely watching the spillovers from Russia-Ukraine on global growth and trade, which could have an adverse impact on India's growth as well. In case commodity prices, especially oil, remain higher for longer, there is a risk that the RBI may tighten more than our base case in FY23.

The RBI has, so far, managed to control the government's borrowing cost. With global factors turning adverse and talk of the central bank underestimating domestic inflation for the coming year, is the risk that the RBI may have one fire too many to put out at once?

This is perhaps the question I am asked most often–is RBI behind the curve? The US yield curve now incorporates over six Fed fund rate hikes by end-2022 and global oil prices remain elevated.

India's central bank faces a risk of currency depreciation despite the Indian rupee being much more resilient than the 2013 taper tantrum episode when it had fallen by 28 percent during May-August 2013.

To be sure, India has ample foreign exchange reserves that could help make the case for RBI not mechanically following the Fed.

The RBI governor recently clearly emphasised the focus is on domestic factors while setting policy despite the fact that the RBI's inflation forecast is much more optimistic than ours.

In the second half of FY23, the RBI is talking of only 4 percent inflation. Our forecast is at least 50 basis points higher than the RBI's for the second half of the year.

Inflation could be the key deciding factor for India and we think there is a risk of a higher-than-expected policy tightening of 100bps if inflation does not return to the target range later this year.

You see India's potential growth rate stabilising around 6 percent. What assumptions underpin this figure and what impact do incrementally weak GDP prints have on potential growth?

We see India's GDP growth for FY23 at 8 percent and estimate it to settle down so that the long-period average is 6 percent from FY24 and beyond.

We are estimating India's potential growth in the range of 5.75-6.25 percent. We believe capex, manufacturing and exports, and digitalisation could be the next key growth drivers for India.

Despite the COVID-19-related disruptions and balance- sheet concerns faced by a few economic agents, we think India's productivity has improved driven by a sharp pickup in digitalisation, which received a further push during the pandemic.

We also take into account a sharp pickup in the adoption of technology during the pandemic and this could alter the contribution of capital and labour mix when computing India's potential growth.

In FY12-FY14, India's average GDP growth was 5.7 percent. At that point in time, growth in total factor productivity was 2.4 percent. Our estimate is that this is closer to 3 percent today.

The key to higher growth is the quick implementation of recently announced productivity-enhancing reforms and investments, which could support India's integration into the global value chains and support the medium-term growth outlook.

The government also wants women to be the drivers of growth. Is the current set of reforms sufficient for women-led development for the next 25 years, as the finance minister said in her budget speech, considering the pandemic has hit women particularly hard.

Indian women are significantly lagging when it comes to their share in the labour force participation rate–it is around 21 percent for women, while for men it is 75 percent. And this ratio for women has gone down, not up, in the last few years.

We don't have the numbers on how this ratio would have changed for women during the pandemic. However, it seems that the pandemic has adversely impacted the informal economy, while the formal economy has done well. A large proportion of women in India are actually part of the informal economy.

I believe that access to education and promoting women's participation in the labour force is a more sustainable way for Indian economy to move on a higher growth path.

We need a much stronger push in terms of implementation of government reforms that have been announced. Women joining the work force could be a game-changer for boosting India's potential GDP growth in the long run.