By Charanjit Singh
India’s investment cycle has been moderate over the past decade, with private investment remaining stable despite a 1.7-fold increase in corporate profits. It was only government capital spending that had supported infrastructure spending with a CAGR of 13% in fiscal year 10-20. The most relevant question to be answered at the moment is: what factors drove the investment supercycle of fiscal year 03-07 characterized by a high investment ratio to GDP and are we seeing similar factors in the current environment?
We believe the investment cycle has bottomed out as the contribution of investment to GDP fell to 26.7% in FY21, from a peak of 36% in FY07. . We see all the building blocks of the new investment cycle in place as at the start of the previous cycle, namely the reduction of NPAs on banks’ balance sheets, low cost of funds and a low and competitive corporate tax rate at globally at 15% for new manufacturing companies.
Reforms have also played an important role in reviving the investment spending cycle. Some of the reforms carried out in the past such as GST, RERA, IBC, etc. have started to bear fruit. The gradual implementation of reforms such as corporate tax rate, production-related regime, labor reforms, increasing the FDI limit will further strengthen the investment cycle. During the last cycle, the Electricity Law (EA) of 2003 brought about key reforms in the electricity sector, such as the removal of licenses for the production of electricity, which resulted in an increase in additions capacity by the private sector. Multiple attempts over the years to reform the distribution sector have not yielded results. Therefore, the government wants to pass the Bill amending the Electricity Bill 2021, which proposes to remove distribution, strengthen renewable energy portfolio obligations and make electricity regulatory commissions more independent states. As part of the solution, this will require investments in smart meters and smart grids. In addition, the decommissioning of electricity distribution will allow private sector participants to enter the sector, which would yield positive results. India is aiming for 24×7 power for all and 450 GW of renewable capacity installed by 2030. In addition, key government initiatives of Make In India or Aatmanirbhar Bharat would require high quality power at a reasonable price. which will be possible thanks to the implementation of these reforms.
Public spending is the first to pick up in any investment cycle and to give confidence to private companies to grow. The government announced the National Infrastructure Pipeline (NIP) which gives confidence in spending for the next 3 to 5 years with expected spending of Rs 111 lakh crore on FY20-25, i.e. twice the spending of Rs 56.5 lakh crore on FY13-19. We expect capital spending to increase in the energy sectors, especially renewables, roads, railways and water. The government is creating multiple sources of funding to finance this mega pipeline of infrastructure, either through increased borrowing or through funding from multilateral funding agencies such as the World Bank and a dedicated infrastructure financial institution.
We believe that increased government spending on infrastructure will lead to increased capacity utilization for cement, steel and other capital goods, leading to spending. Since new capacity additions could take 3-4 years to go live, we expect new factory orders to begin soon. Company announcements for new projects, industrial new orders, improved quarterly reviews, and capital goods imports (monthly) can be good indicators to guide the cycle’s progress.
Real estate sales are also expected to increase thanks to low interest rates, reduced stamp duties, reduced GST, etc. This could stimulate demand for building materials (cement, tiles, plywood, pipes, paints), consumer electricity, durable consumer goods. This cycle will also see new investment drivers, namely automation by industries, data centers and performance-linked incentive program (PLI) investments.
The Indian manufacturing sector has a unique opportunity to attract manufacturing companies looking to relocate their operations outside of China, i.e. the China + 1 strategy. For decades, companies have looked to China for their changing supply chain, and COVID-19 has accelerated that development. The Indian government is keen to take advantage of this opportunity and has implemented various policy measures such as imposing import bans, raising tariffs and performance-related incentive (PLI). The PLI started with the mobile segment, now has 13 sectors covered with a total investment of almost Rs 1.4 lakh crore.
Therefore, we believe India’s infrastructure / investment spending theme is making a comeback after ten years of subdued performance, led by the expected recovery in public and private spending. We expect engineering / manufacturing / infrastructure construction and related sectors to provide good thematic opportunities with a 3-5 year perspective. However, the representation of these sectors was reduced to 25% in September 2021 in Nifty 50 against 67% in 2007. In order to take advantage of this cyclical recovery in the Infrastructure / Industry sectors, individual investors can integrate thematic funds in their portfolio by allocating ~ 15% equity exposure for long-term investment and complement their existing core portfolio (after consultation with their financial advisors). Thematic funds are an effective way to gain exposure to and profit from the renewal of the infrastructure sector.
(Charanjit Singh is a fund manager at DSP Investment Managers. The opinions expressed are those of the author. Please consult your financial advisor before investing.)