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Domestic capex needs a fillip

Posted by : Ravindran on | Mar 04,2015

Domestic capex needs a fillip

Many companies are sitting on under-utilized capacities and are unlikely to increase capex soon.

The year 2014 has been a good year for financial assets. However, investors are more than a little concerned that, going into the new year, markets are showing signs of volatility. The slipping and sliding in the front-line indices have shrunk year-to-date returns to around 30%. Before the correction, it was a good 36%. (Source: BSE India)

Nevertheless, going by the past average of around 18% per annum, the present returns are still good. As we head into the New Year, long- and short-term investors alike should evaluate market conditions and then attempt to pitch investments for a decent shot at improving run rates. Here are a few points that could prove useful to spruce up your investment portfolio next year.

India’s position

Global headwinds are likely to increase volatility and the effect will be felt throughout the world. First of all, we have been repeating for some time now that following the end the quantitative easing (QE) programme in the US, the international environment is changing. For the first time we are faced with the prospect of interest rates in the US inching up, probably towards late-2015. In this context, the inevitable strengthening of the dollar would affect global fund flows.

India, however, is better placed to withstand global choppiness. The Reserve Bank of India (RBI) has been factoring in the inevitability of QE coming to an end. Otherwise, we may have seen much lower interest rates today. This augurs well for India, as it can help tackle the tighter monetary policy, and a hike in rates in the West going into next year.

Another advantage we have now is that commodity prices are lower. Back in the market boom of 2002-07, commodity prices hit higher trajectories, creating problems for India later on. Now, oil has slipped below $60 a barrel and oil-guzzling countries, like ours, benefit through savings in foreign currency costs, along with helping contain inflation.

Other base commodities are also at lower levels, and that helps reduce input costs for companies. So, India has become one of the better macro-country going into 2015.

With softening international energy prices, better alignment of electricity prices with costs, moderating global commodity prices, and a stable rupee thanks to the Reserve Bank of India’s (RBI) remarkable efforts to keep policy rates at elevated levels, could reduce inflation in India.

Need for infrastructure spending

However, one hitch in our parade is the domestic capital expenditure (capex) cycle. The Indian economy only needs a little prod, which could begin with the government.

India has yet to see the kind of investment in infrastructure that could revive the capex cycle. Many companies are sitting on under-utilized capacities and, therefore, are unlikely to increase capex in the immediate future.

Hence, the onus to increase spending on infrastructure now lies with the government. I would be enthused if the government reduces the revenue deficit while letting the fiscal deficit remain a little loose, and in the process, opening its purse to spend on infrastructure. There is a need for the government to spearhead capex in the country, especially on infrastructure. Once the capex kicks in, the private sector will step in, turning it into a virtuous cycle.

Markets to provide opportunities

It may be difficult for the Indian market’s performance in 2014 to persist into 2015. From that standpoint, I would encourage investors to enter equity markets with a horizon of at least three years or more. It is my belief that next year, there may be ample opportunities to accumulate equity assets for three years and more.

Given the fundamentals of the economy, the macro-growth cycle has barely begun. In the past, it took four-six years for the growth cycle to take off. This time, with the added advantage of lower commodity prices, the Indian growth cycle has just started.

Therefore, use the opportunities thrown up by corrections in the market to accumulate good assets as well as to look for underpriced equity assets. With the run-up, many sectors are well-priced, but some names in the fast-moving consumer goods (FMCG) sector do not offer much comfort. Public sector divestments could offer good opportunities to accumulate some equity assets at good prices next year. Again, 2015 may see the power sector recover within the next three-five years; and it now looks inexpensive.

Over the shorter horizon of a year, the fixed income segment looks good, although upturn in debt had already begun in the past few months.

With inflation cooling, and oil prices down, there is room for the central bank to cut rates in the coming year. This could provide the requisite fillip to the debt market.

A fixed income boom has to occur before growth in the economy shifts to a higher gear. The interest rate cycle has to turn for the leveraging cycle to begin; this could, in turn, boost the equity cycle.

This article was published in Mint on 24th Dec 2014