Interest rate policy is a prime indicator of the way the investment/capex cycle moves. Higher interest rates deter investments thereby impacting growth in the near term. On the other hand lower interest rates encourage investments in physical infrastructure. This not only increases consumption (through increased output) but also generates capital for future growth. Hence, a loose monetary policy is effectively required to boost investment and growth.
However, with inflation being above the comfort zone RBI has been raising rates a number of times (50 bps hike undertaken yesterday). As a result, the investment/capex cycle has virtually come to a standstill. However, consumption has been on a steady rise. Rising consumption in absence of investments (higher interest rates) has further stoked inflation. Rising inflation would mean interest rates will increase further. And higher interest rates prove to be a gross disincentive for future investments. As you can see this interest rate-investment cycle is quite vicious one.
So, apart from lowering rates (not a possibility in the near future), what exactly needs to be done to encourage investments in physical infrastructure?
We believe that one of the most important factors that influence's capex cycle is - policy roadmap. Recently, land acquisition issues and environmental concerns have impacted execution of various projects. And this in turn has delayed the capex cycle. Unless, these policy issues are addressed the investments would continue to suffer.
Another way to encourage investments is to award incentive packages. In the past, quite a few industries like IT (tax exemption for ITES services) and Textile (Technology Up-gradation Fund) have received such benefits. Providing subsidy in the form of lower interest rates or taxes to priority sectors is another option.
We believe that these options could well prove to be viable considering that inflationary environment ensures interest rates would remain high. However, we are well aware that reform process in India is quite lengthy. Even incentivizing a few sectors has to be done after keeping in mind the fiscal goals as subsidies are effectively borne by the government.
Hence, unless the rate cycle softens we do not think the capex cycle would take any meaningful turnaround in the near future.