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Is India Inc ready to boost capex?
Tue, 15 Sep Pre-Open

Prime Minister Narendra Modi, on Tuesday last week, had asked India Inc to take risks and pump up investments. However, if history is any indicator, the Indian stock markets view the matter altogether differently.

Fathom this. As per an article in Business Standard, Indian markets, over the past ten years, have ignored companies that have gone in for higher capital expenditure (capex). In turn, markets have favored those that have remained asset-light.

Indeed, as per data, 14 companies contributed to half of the incremental growth in India Inc's capital expenditure between FY05 and FY15. These companies, however, accounted for only 20% of the incremental rise in the BSE 500 companies' market cap during the period. To demonstrate clearly, Reliance Industries, the biggest investor during the period, accounted for 8.7% of the incremental capex. However, its contribution to the incremental market cap stood at mere 3.7%. Whereas asset light companies from sectors such as FMCG, IT and pharma in particular have seen their market cap rising faster.

In recent times, companies themselves have been cautious before committing to invest in capex. And the main reason for this has been the overall economic slowdown and the wide gap between demand and supply. This has been seen from the return on asset (RoA) ratios which have been declining. Further, asset utilization has also dropped. Subpar demand levels have led to inventory pileup.

Thus, a widening gap is being seen between the capex heavy companies and their market cap due to factors such as:

  • The global commodity downturn leading to high inventory levels
  • High cost associated with capex leading to lower profitability
  • Investments being stuck due to leveraged positions of large corporates
  • Some domestic companies being in financial stress

Typically cyclical industries tend to be asset heavy. And so in a downturn, when the capacity utilization is low, there is no incentive to invest in more capex. So the key here is revival in demand. Once that happens and the economy begins to recover, the gap between demand and supply will automatically narrow down. This is nothing new and is the inherent nature of cyclical sectors.

However, from a longer term view, if the government wants India Inc to step up investments, it needs to do a lot in terms of improving the business climate in the country and ramping up infrastructure. Only then will not only Indian companies invest in the country, but foreign direct investments (FDI) will be more forthcoming too.

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