By Charanjit Singh
India’s capex cycle has been muted for the last ten years as private capex was flat despite 1.7x rise in corporate profits. It was only the government capex that had supported infrastructure spending with 13% CAGR over FY10-20. The most pertinent question to answer right now is — what factors drove the capex supercycle of FY03-07 characterized by a high capex to GDP ratio and are we witnessing similar factors in the current environment?
We believe the investment cycle has bottomed out as investment contribution to GDP has reduced to 26.7% in FY21 from peak of 36% in FY07. We see all the building blocks of the new investment cycle in place like at the beginning of previous cycle namely reduction in NPAs in banks’ balance sheets, low cost of funds and low and globally competitive corporate tax rate at 15% for new manufacturing companies.
Reforms also played an important role in revival of capex cycle. Some of the reforms done in the past such as GST, RERA, IBC etc have started to show results. Incremental implementation of reforms like Corporate tax rate, Production Linked Scheme, Labour Reforms, Increase in FDI limit will further strengthen the capex cycle. In the last cycle, The Electricity Act (EA), 2003, brought key reforms in the power sector such as delicensing of power generation which led to increased capacity additions by the private sector. Multiple attempts over the years to reform the distribution sector have failed to yield results. Hence, Government is keen to pass Electricity Amendment Bill 2021 which proposes to delicense distribution, strengthen renewable portfolio obligations and make state electricity regulatory commissions more independent. As part of the solution, it will require investments in smart meters and smart grids. Also delicensing of power distribution will allow private sector participants to enter the sector which would yield positive results. India is aiming for 24X7 power for all and 450 GW of installed renewable capacity by 2030. Also, Government key initiatives of Make In India or Aatmanirbhar Bharat would require reasonably priced high quality power which will be possible by implementation of these reforms.
Government spending is the first to revive in any capital cycle and give confidence to the private companies to expand. The government has announced National Infrastructure Pipeline (NIP) which gives confidence on spending for next 3-5 yrs with expected spending of Rs 111 lakh crore over FY20-25 which is 2x of spending of Rs 56.5 lakh crore over FY13-19. We expect capex to scale up across power specifically renewables, roads, railways and water segments. Government is creating multiple sources of financing to fund this mega infrastructure pipeline either through increased borrowing, financing from multi-lateral funding agencies like World Bank and a dedicated infrastructure financial institution.
We believe rise in Government spending on infrastructure will lead to rise in capacity utilization for Cement, Steel and other capital equipment thereby driving the spending. As new capacity additions could take 3-4 years to come on stream, we expect new plant orders to start soon. Corporate announcements for new projects, industrial sector order inflows, improving quarterly commentary and capital goods imports (monthly) can be good indicators to guide progress of the cycle.
Real Estate sales too are likely to grow led by low interest rates, reduction in stamp duty, GST concession, etc. This could drive demand for building material (cement, tiles, plywood, pipes, paints), consumer electrical, consumer durables. This cycle will also see new capex drivers namely automation by industries, data centres and capex linked to performance-linked incentive (PLI) scheme.
Indian manufacturing sector is getting once in a lifetime opportunity to attract manufacturing firms looking to relocate operations out of China, i.e. the China+1 strategy. For decades, companies have looked at China for their supply chain, which is changing and COVID-19 has accelerated this move. Indian government is keen to benefit from this opportunity and has implemented various policy measures such as imposition of import bans, tariff hike and Performance Linked Incentive (PLI). The PLI started with the mobile segment, now has 13 sectors covered with a total investment of close to Rs 1.4 lakh crore.
Hence, we believe India’s infrastructure/capital spending theme is making a comeback after ten years of muted performance, led by expected pickup in government and private spending. We expect engineering / manufacturing / infrastructure construction and related sectors to offer good thematic opportunities from a 3-5 years’ perspective. However, representation of these sectors has reduced to 25% in Sep 2021 in Nifty 50 from 67% in 2007. In order to benefit from this cyclical recovery in Infrastructure/ Manufacturing sectors, retail investors can integrate thematic funds in their portfolio by allocating ~ 15% of equity exposure for long-term investment and complement their existing core portfolio (after consulting with their financial advisors). Thematic funds provide are an effective way to get exposure to Infrastructure sector revival and benefit from it.
(Charanjit Singh is a Fund Manager at DSP Investment Managers. Views expressed are the author’s own. Please consult your financial advisor before investing.)