Wake up & smell the capex cycle uptick

The Reserve Bank of India‘s (RBI) latest monthly ‘state of the economy’ report is optimistic about an upturn in the capital expenditure cycle in the near term. This is supportive for economic recovery at a time when the external environment is tenuous. Waning input cost pressures, buoyant corporate sales and a turn-up in fixed assets are seen as drivers for capex revival. A related paper by RBI lauds GoI for prioritising capex to drive recovery that will help crowd in private investment. GoI’s expenditure quality, measured by revenue expenditure to capital outlay (RECO), improved significantly in the first two quarters of this fiscal. However, capex of states has remained weak, leading to a deterioration in their expenditure quality. States must pick up the slack. Both states and Centre need to boldly policy-induce stepped-up capex to boost demand.

Data shows a pick-up in domestic demand. However, a full-fledged capex revival requires demand to be lasting. Weakening global demand will dent exports. Recovery has not been broad-based either. There are also worries in some quarters that fiscal constraints would limit GoI’s ability to spend, and that private investment is unlikely to pick up the slack due to uncertain growth prospects.

RBI acknowledges that financial conditions, especially borrowing costs, are biting into discretionary consumer spending and housing demand, and stalling investment in new capacity creation. So, it should resist steep hikes in the policy rates to fight inflation. There should be no cause for worry if the government’s expenditure leads to asset creation that also generates sufficient revenues to pay for the borrowings. Tax collections have been buoyant and lowering GST rates will help spur demand.