Capacity utilization hovering at decade-low levels in key sectors
Investor sentiment may be great, but that doesn't necessarily mean that capex of Indian firms is going to increase in a hurry
Investor sentiment may be great, risk appetite high enough, but that doesn’t necessarily mean that capital expenditure (capex) of Indian companies is going to increase in a hurry. According to data compiled by Bank of America-Merrill Lynch Research, the average capacity utilization level in several industries, including cement, automobiles and steel, is at a decade’s low.
In some sectors such as commercial vehicles and passenger vehicles, the capacity utilization is as low as 52% and 65%, respectively. The expected recovery in the economy should see demand increase in these sectors, but it may take a while for the gap with supply to close.
This isn’t entirely surprising; many Indian companies raised capital in the pre-financial crisis days and were spurred on, thanks to the government’s stimulus soon after the crisis. With the economy expanding at a more sedate pace in the past few years, though, capacity utilization levels have fallen.
The other major problem is the high amount of debt on the books of many Indian companies. Jitendra Sriram, India strategist at HSBC Securities and Capital Markets India Ltd, says: “We do not see capacity utilization level improving for the next one to two years, until corporates repair their balance sheets." Of course, as analysts at Merrill Lynch point out, the buoyancy in the capital markets can help some companies raise capital and clean up their books to some extent. Even so, given the uncertainty surrounding coal procurement—the Supreme Court recently cancelled over 200 allotments of coal mines, citing irregularities in the process—capital formation in some sectors may take longer than others.
On the bright side, there could be investments in sectors such as logistics and infrastructure such as railways, roads and ports, where capacity is already constrained and projects have received necessary clearances. As a recent report by Morgan Stanley Research points out, while the capital goods sector has traditionally been very cyclical in nature and linked to industrial capex, there have been efforts by companies to reduce cyclicality by diversifying. Companies such as Larsen and Toubro Ltd have ventured into new markets and product lines and others are now emulating them.
That said, and even with the situation not being as bad as it was in previous downturns, capex cannot be expected to come back in a hurry. As Sriram points out, industrial capex will still take at least two years to return.
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