Capex Cycle – Punctured and Paralyzed !!!

Delayed recovery in Investments to dent GDP growth…

Rarely can an  engine fire up on choked cylinders . India’s economic engine is sputtering with one of its key cylinders clogged . Sedate IIP ( Index of Industrial Production)  numbers for successive months  , pulled down mainly by capital goods,  is a cause for serious concern . It is this choked capex cycle that is causing challenges to the current political administration .

Economic cycles do have established  pattern . In early part of the cycle , consumer discretionary like Autos , Consumer durables etc lead the recovery . In the mid-cycle , Investment demand (capex) picks up as factories / plants come up on corporates scaling up capacity to meet the additional demand . On the later part , both feed each other to fuel boom in overall consumption . Is this familiar pattern playing out this time too or is this time different . Pundits who pumped up predictions based on the past patterns , stand  perplexed now with the investment engine refusing to fire up . Delay in capex recovery has miffed the mid-cycle macro numbers .

The concern on capex cycle is so severe that it needed no less than the PM to nudge corporate chieftains to start investing , in his recent meeting with India Inc. Corporate honchos on their part , had to find a scapegoat . They found it in cost of capital and raised their chorus for rate cuts , knowing well that it can hardly halt the slump in private investments.

If rate cuts can’t relieve the pain , what else ?. Let us start with what ails  India’s investment cycle that mars it from achieving its magical potential .  While land and labor reforms are key to structural shift for long-term growth potential , they hardly pose challenges for the current tactical turn in the investment demand. The ongoing investment inertia is more to do with huge surplus capacity across sectors . Roots of the malaise lie at the gross under-utilization in many sectors . High capital intensive sectors such as energy , metals , oil&gas suffer from serious surplus capacity globally . Slump in commodity prices has severely dented the sentiment in these capital intensive sectors . Slow down in real-estate has added to the capital woes , given its much broader impact on various other ancillaries.  As per one of the estimate , in the earlier boom cycle of 2003-07 , close to 45% of the additional investment demand came from these sectors . With these sectors now under severe stress  , huge quantum of capex demand has crumbled . Add to these , the scary surplus in global capacity ( on slowing Chinese demand) in many of these sectors ,the outlook gets much worse and grim.

All is not lost though . While private investments are looking peevish , public investments could pave the way for partial recovery , can’t compensate completely though . With India’s macro numbers ( fiscal and current account deficit) looking up on benign commodity prices , Govt. has a lot of leeway to provide stimulus by accelerating investments in infrastructure . Power transmission , road , railways and irrigation etc have seen heightened allocations from the Govt. this year . This , to some extent can offset the under-investment by the private sector.

For investors , deciphering the dynamics behind this  distress signal is key for critical insights to shape and build the right  investment strategies for the ongoing cycle . There will be winners and losers because of this underlying trend . For example ,  delay in recovery in private consumption could severely dent the prospects for PSU banks as a sector . The reason being the lending profile of these banks . With Capital goods and Infra accounting for a significant part of the lending books in PSU banks , credit growth will continue to be choked for a while in this space . Added with ongoing NPA menace , this down-cycle could be far more deeper for the sector . So is capital goods . For winners in this space , one needs to keep a close watch on where Govt. stimulus is spent . From that perspective , Road , Railways , Defense and Irrigation etc  are some that could offer solace in this sputtering space.
ArunaGiri . N

Fed Fever !

To put the Fed-rate fears in perspective , here is the chart (below) of US 10 year yield for last 5 years ( beginning 2011) . Turning back to taper tantrums (of 2013) might offer us some compulsive clues to what is in store now.  Then ,as now , mercury soared and markets were mauled on fears of spikes in interest rates on withdrawal of  Quantitative Easing ( referred as QE tapering) . Stocks slumped and currencies crashed across emerging markets in mid-2013 . There was a run on Rupee and it even flirted with 70 mark ( briefly though)  before stability returned .Did taper tantrums rattle the rates as markets feared?.  US 10 year yield did spike  to 3%+ , but failed to spiral as many had feared . The yield is far lower now  and is languishing around 2.25 level . That much for all the nauseating noise from taper tantrums . Now , what does the 10 year chart signal on the impending Fed rate hikes . Does it signal accelerated hikes from Fed or more sober ones at moderate pace.  If the lackluster trend is anything to go by , 10 year yield is not pricing-in anything dramatic from Fed . This does not mean that Fed is unlikely to hike , only means that pace may be much more moderate and measured , if one takes the cues from the bond markets .  Then why so much sensation surrounding Fed event this week? . May be a wrong question to pose , if  one understands the market’s inherent madness.