Dear Reader,
It’s a familiar story with investors by now. India’s capex engine has been running mainly on government fuel with little support coming from the private sector. Optimists may say that when things go darkest it is then that the dawn is near. And so it may. But till then, we go by what the data is showing.
In today’s edition, my colleague Sachin Pal writes about excess capacity building up in the manufacturing sectors, . He cites examples in sectors such as room air-conditioners, where the government’s helpful PLI programmes have led to a sharp increase in capacity.
This has led to intense competition as total manufacturing capacity may have increased by as much as 50 percent in the past two years alone while sales volumes are growing by as much as 10 percent. The gap means underutilisation of capacity for some years.
There are other sectors too where this trend is visible, he adds, citing sectors such as renewable energy, paints, and cement where a price collapse has taken place. Even in the FMCG sector, the initial reports from the large players of soft demand conditions imply they will be in no hurry to invest.
Weak consumption is one factor. Consumption-oriented industries can be expected to have made their capex plans after taking into consideration market demand and what competitors are doing. It would appear that their estimates have fallen short or they decided to set up capacity when funds or government schemes were up for the taking. But they risk diluting return on capital employed till demand crosses a certain threshold. Excess supply therefore poses a risk to investors, points out Pal.
Today’s Chart of the Day is on a related topic of capex spending in manufacturing sectors. India Ratings had come out with a note that looked at trends in bank credit and pointed out how companies were not only having healthier cash flows that gave them the wherewithal to fund capex internally, but also that capex needs too were moderating, due to the modular nature of capex (meaning the absence of large greenfield projects). Therefore, a lot depends on new sectors for driving up capex-related credit. Large companies, in particular, are unlikely to tap banks for capex and may use a mix of internal accruals and fresh equity to meet a major portion of their requirements. A light balance-sheet is the new flex in Corporate India.
While this means banks may have to wait for capex to pick up on the one hand, on the other it may push them into the arms of willing but riskier borrowers. For instance, the smaller companies are the ones with net leverage higher than even 10 years ago. That signals appetite, but with dollops of risk.
Some temporary mismatch in demand-supply is a trait of certain sectors. Cement companies, for example, are known to play this game, where sometimes there is ‘production discipline’ that leads to prices rising, but then sometimes stiff competition breaks out and prices fall. But the real worry is consumption-oriented sectors, where healthy consumer demand is critical to companies to turn confident in investing. The sight of companies sitting on excess capacity will make others cautious. In a free market, some of this may seem inevitable. A certain level of confidence in domestic consumption is essential for companies to put factories on the ground. We have seen a mixed trend on the consumption front, except in the premium parts of the market that appear to be doing well.
When a new government comes in, it may need to take a second look at its hands-off approach to consumption while focusing on government investment and keeping inflation in check.
If its deliberations lead to an outcome of staying the course, which will become clear when the full Budget is presented, then a long wait lies ahead for consumption growth to recover. Then, the wait for private sector capex to recover could be longer.
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(These are published every trading day before markets open and can be read on the app)
Ravi Ananthanarayanan
Moneycontrol Pro
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