Where is the debt?

Robust equity markets are not enough to kickstart a private sector capex cycle. India needs easily accessible debt financing

Everyone is celebrating the India growth story. With the real gross domestic product (GDP) growth number now crossing 8 per cent, it stands out. Most investors now buy into the notion that in the coming decade India will deliver real GDP growth of between 6.5 and 8 per cent for the full decade. The perceived predictability and stability of this growth is one of the reasons why India’s valuation multiples are at the high end of their history. This growth path is critical to creating enough jobs and becoming comfortable with our internal debt dynamics. For the markets also, this matters, as this trajectory implies 11-13 per cent nominal GDP growth, which has historically been a reasonable predictor of corporate earnings.

When discussing the India growth story, the only chink in the armour seems to be private capital expenditure or capex. The government has done a great job boosting public investment, but significant follow-through from the private sector is yet to be seen. The popular narrative is that without acceleration in private sector capital expenditure the India growth story cannot sustain.

First, some numbers. When the Narendra Modi government came to power, public investment was approximately Rs 2.3 trillion. This number moved up to only about Rs 3.2 trillion in his first term. It was only in the second term that this number really accelerated, rising from approximately Rs 3.2 trillion to about Rs 11 trillion (FY25). As an example of public investment, just look at the railways, its capex budget has gone up 16 times in the last 10 years, from approximately Rs 15,000 crore to Rs 2.5 trillion. A similar trend is observed for roads, where investment has gone up nine times to Rs 3 trillion. Gross fixed capital formation has once again crossed 30 per cent, after dipping to 27 per cent, with aspirations to take this figure to 32-33 per cent. This is all fine, and it is a good narrative showing the step change in both the aspiration and execution ability of the government. This has to sustain and, hopefully, it will.

The reason everyone worries about the private sector’s role in stepping up its investments is the plateauing of public investments. From here on, we cannot expect public investment to keep growing at the scorching pace of the last few years. There are multiple reasons for this. First, with a fiscal adjustment agenda, targeting a fiscal deficit of below 4.5 per cent by FY26 and subsequently even lower, there is limited scope to keep increasing public investment by more than 10-15 per cent per annum.

Additionally, there’s an issue of absorptive capacity. I don’t think, for example, the railways’ capital spending can keep compounding. To even spend Rs 2.5 trillion per annum effectively is not easy; it requires huge organisational design changes and empowerment. Not every government department or company can make these changes. Even in the case of national highways, although the yearly construction has increased to between 10,000 and 10,500 kms, it has been stuck at this high level for the last five years. We may not be able to accelerate much from here. Again an absorptive capacity issue.

Given the above, the private sector has to now play its part. Contrary to the sceptics, there are indications the private sector will join the party. I have not had a single conversation with a large corporate in the last six months, where capacity addition was not brought up. Every company wants to add capacity, and is targeting global scale. Most have a strong balance sheet to fund these ambitions. Take, for instance, the recent announcements from top groups like the Tatas in semiconductors (over $13 billion investment), JSW in steel and autos, or the Adani and Ambani in renewables.

The capital markets are also supportive. The best performing stocks are in the power, defence and capital goods space. If any company announces capacity expansion, its stock price goes up. This is a far cry from even a few years back, when capacity expansion was frowned upon and the stock would be punished. Equity markets are now incentivising capacity addition and willing to support any fundraising efforts for such purposes. Entrepreneurs are reacting positively to the encouragement surrounding capital expenditure, and market incentives are clearly promoting asset creation. Beyond the government efforts through the production-linked incentive scheme to encourage manufacturing, which are bearing fruit, the capex-heavy sectors of the last cycle, such as power and metals, are also experiencing renewed interest. The setup looks clear. While the numbers may not yet show it, the private sector looks set to embark on significant investments.

The only question lies on the debt side. Here, a logjam persists, with debt being difficult to access for anyone other than the top borrowers. While equity is freely available to all sectors and parts of the market, the same is not true for debt. There remains hesitation among both banks and mutual funds to take on any type of credit risk, fearing the resurgence of a bad debt cycle. If a debt goes bad, somehow everyone assumes bad intent and no one wants to recognise that risk is inherent in business.

If an equity share drops by 50 per cent, and the fund loses money, no one jumps to the conclusion that there is some devious motive. Surprisingly, the same cannot be said for loans or bonds; any losses in this domain, and the knives are out. This may be due to the horrendous loan losses the banks suffered in the 2010-20 period, with double-digit system non-performing assets, or due to the mutual fund losses on corporate bonds. After getting so much stick from their shareholders/unit-holders for the credit losses, these institutions have limited incentive to take credit risk.

Whatever may have happened in the past, these institutions, banks and funds now need to regain their risk appetite. Credit has to flow across the market capitalisation spectrum and at appropriate pricing. Today, we have the unfortunate situation where equity is available but not debt for many projects and groups. This has to change if we wish to see a surge in private capex. The big groups can self fund from cash flows but most others cannot. Many projects need debt to bring the cost of capital down. Overseas borrowings are also no longer an option, given the current high costs.

If we wish to kickstart private capex, we need to ensure that debt is available to all actors at a reasonable risk-adjusted cost. Investors, regulators and the management teams of lenders, all have to play their part to ensure that risk is not a bad word for debt. Robust equity markets are on their own not enough. The debt markets have to also be open to all. The baggage of the last decade of poor credit decisions cannot be allowed to stifle a private capex cycle. Both bank investors and mutual fund unit-holders must cultivate tolerance for credit risk without assuming the worst in terms of motives. Our future growth depends on it.

The writer is with Amansa Capital