Project execution, not interest rates, is the problem. The government has no one else to blame
The discussion on India’s growth slowdown and investment slump typically vacillates between fact and conjecture. First, the facts. Investment-led growth is the only sustainable growth driver in a supply-constrained economy like India. A huge private capex surge underpinned India’s nine per cent growth in the mid-2000s. Equally, the slump in investment since the financial crisis, and the corresponding reliance on consumption-led growth since then, has been responsible for the elevated inflation over the past two years and a reduction in India’s potential rate of growth. This much is widely accepted.
So, what ails investment? Here’s where a healthy dose of conjecture is injected into the conversation: that elevated interest rates are at the root of the investment slowdown, and that substantial monetary easing will jump-start the investment cycle. This notion has been at the heart of the market clamouring for the Reserve Bank of India (RBI) to cut rates since the beginning of the year.
The only problem with this argument is that the facts get in the way. Real interest rates in India (whether the policy rate, deposit rates or AAA corporate bond rates) have been negative for almost all of 2010 and 2011, at the time that the investment slump began post-crisis. While real rates in 2012 are finally positive, they are still significantly below their mid-2000 levels, a time during which private investment was booming.
Another way to see this is to examine the differential between nominal GDP growth and nominal interest rates as a crude macro-economic proxy of corporate margins and the relative tightness of interest rates. Again, it throws up a similar storyline: that, even after all the rate increases of the two past two years, the gap today is higher than it was in the pre-crisis period. So, while the surge in other input costs may well be at the heart of corporate profits getting squeezed, interest rates are not the culprit.
So, what ails investment? The answer is more mundane but more fundamental. The ability to get things done on the ground.
To be fair, there has been increasing chatter about how investment is being affected by policy and regulatory uncertainty. That an increasing number of projects are being stalled because land acquisition has become difficult, if not impossible, coal shortages have become rampant and environmental clearances harder to obtain. While these concerns have existed for a while, the discussion has largely been anecdotal.
We now, however, have hard data to confirm that execution bottlenecks have become a key constraint on investment activity. The latest data from the Centre for Monitoring the Indian Economy (CMIE), which tracks investments at a project-specific level, is striking — it reveals a surge in the proportion of projects under implementation that have been stalled or had to be shelved.
Currently, 10 per cent of the total value of projects under implementation have either been shelved or stalled. Just five quarters ago, this ratio was five per cent. It used to be less than four per cent in 2005-08, when investment was booming. Interestingly, the number is lower in volume terms (just over six per cent of projects under implementation were stalled or shelved in the last quarter), suggesting that it’s the larger projects that are stuck — consistent with the anecdotal evidence.
The corollary of this phenomenon is that project completion rates have plunged. In the run-up to the financial crisis, on average, almost three per cent of projects under implementation in any given quarter would be completed by the next quarter. That ratio now averages just over one per cent. Project completion rates did increase appreciably in the quarter ending March 2012, but this seems to be a seasonal phenomenon, with reported completion rates rising in the March quarter of every year at the end of the financial year.
All of this has vitiated investor sentiment and, unsurprisingly, resulted in a marked reduction in new project announcements. Specifically, the quarterly run-rate of new projects announced (710 per quarter, averaged over the last three quarters) has plunged more than 40 per cent, compared to the 1,100 projects announced per quarter over the previous two years. To put these numbers into perspective, there were more projects announced during the three quarters during and after the Lehman crisis than there were in the last three quarters. Also, the fact that weak announcements have extended into a third successive quarter suggests that a cyclical phenomenon is turning structural.
Getting the investment cycle going again is critical from both a cyclical and structural perspective. Sustained sluggishness in investment has meant that capacities are getting increasingly constrained. In an environment of tight capacity, a weak rupee pressuring input prices is likely to result in a rapid transmission to output price shocks, and inflation remaining stubbornly high.
From a medium-term perspective, if India’s investment rate – which has fallen four per cent of GDP from the pre-crisis era – stays low, visions of eight to nine per cent growth will remain a pipe dream.
So, jump-starting investment has to be the government’s number one priority. In this regards, the bad news is that RBI’s 50 basis points cut is unlikely to have any material impact on the investment cycle. The good news is that the government can. Project execution difficulties is not an exogenous shock outside the purview of authorities. Instead, it is very much within its control. It is very much under government’s control to de-bottleneck land acquisition, environmental clearances and coal availability. None of this requires big bang reform. It just requires brass-tacks governance. If the government cannot get down to brass tacks, then it has no one else to blame.
The writer is India Economist for JP Morgan
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