BS decodes the investment cycle

WHILE HEADLINE gross domestic product (GDP) grew by a healthy 7 per cent in Q3FY17, investment activity continues to be moribund. As Chart 1 shows, gross fixed capital formation as a percentage of GDP has been consistently falling. In fact, as seen in Chart 2, even in the new index of industrial production (IIP) series, capital goods, a proxy for investment demand, grew at a mere 1.9 per cent in FY17.

With the private sector unwilling or unable to invest, the burden of reviving investments has fallen on the public sector. While public sector capex has grown at a much faster pace, this has not been enough to compensate for the decline in private sector investments, Chart 3 shows.

The twin balance sheet problem continues to fester. Debt-laden companies simply don’t have the capacity to invest and banks burdened with mounting nonperforming assets, as shown in Chart 4, are unable to lend. As a consequence, bank credit growth has plunged well below its long-term average, Chart 5 shows.

A study by HSBC Global Research shows, in previous such episodes, bank credit tended to recover earlier than growth (Chart 6). In a sense, it was a leading indicator of economic growth. But, this doesn’t seem to be the case now. The experience of other countries shows, in credit-less recoveries, investment activity takes roughly six years to recover after the growth bottoms out (Chart 7). Based on this, HSBC estimates that investment growth, which bottomed out in 2016, is likely to recover gradually, hitting a 7 per cent growth rate only around 2020. The uptick is likely to be led by the housing sector, which should spur construction and support investment demand.