Will private sector investment in India see sustained recovery?
The asset turnover ratio of Indian firms has fallen to a 17-year low, suggesting that new investments may not be on the horizon yet
Mumbai: The recently released data on India’s quarterly gross domestic product (GDP) showed that growth in the quarter-ended December was driven largely by a recovery in investments, raising hopes that the long-subdued capex cycle in India may be springing back to life. But a Mint analysis of corporate balance sheet data suggests that a sustained recovery in private sector investments may not be on the horizon yet.
The analysis shows that the asset turnover ratio—or the ability of firms to generate revenues from their fixed assets—has declined to its lowest levels since the turn of the century. The analysis is based on a constant sample of 1,510 non-financial companies, for which consistent data is available for the past two decades.
The firms under consideration had an averaged fixed asset turnover ratio of 2.94 in the 10 years from 2006-07 to 2015-16. This ratio has declined to 1.95 in fiscal 2017. This means that while firms were able to generate nearly Rs300 in net sales for every Rs100 worth of fixed assets, now they are able to generate only Rs195 in sales for every Rs100 worth of fixed assets.
A decline in the fixed asset turnover ratio indicates over-capacity in plants or manufacturing units. In other words, this means that companies have put too much money into assets that are generating little by way of sales, indicating that corporations are facing weak demand, and hence weak pricing power. Net sales have barely kept pace with new investments over the past half a decade, as the chart below shows.
During the past investment booms, growth in net sales tended to outpace growth in fixed assets, leading to a rising asset turnover ratio before—and during—an investment boom. As the first chart shows, the asset turnover ratio for the firms under consideration began rising even before the investment cycle picked up in earnest during the boom phase of 2004-2008. In stark contrast, the asset turnover ratio has been declining steadily over the past few years. As companies struggle with over-capacity and weak sales growth, it is unlikely that they will raise investment levels in a big way.
Data from the Reserve Bank of India’s Order Books, Inventories and Capacity Utilisation Survey (OBICUS) shows that capacity utilization levels have been low in recent quarters. Data on 756 manufacturing firms covered by the survey in the September 2017 quarter showed that capacity utilization is at a lowly 71.8%. The capacity utilization rate was close to 80% five years ago.
The latest numbers from the capex-tracking database of the Centre for Monitoring Indian Economy (CMIE) also suggest that an investment revival is unlikely to happen soon. The data shows that new project announcements fell to its lowest levels in the December-ended quarter, even as the stalling rate in private sector projects continued to rise.
The slowdown in investments has structural roots. The banking crisis in the country has made bankers wary of lending even as leveraged balance sheets have made companies cautious about fresh investments. The resulting slowdown in aggregate demand hasn’t helped matters.
The inability to generate revenues from fixed assets seems to have made firms wary of making new investments or acquiring new assets. The growth in fixed assets—of the firms considered for this analysis —declined to its lowest levels in a decade in the past fiscal year.
While the coming months might witness a cyclical recovery in the investment cycle, a sustained recovery may not be on the cards yet.
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