Is the sharp increase in shelved projects, up from R46,145 crore in March 2011 to R1,55,366 crore in March 2012, according to CMIE data, a result of higher interest rates or is it due to the famed ‘policy paralysis’? That, in a nutshell, is the question the Reserve Bank of India (RBI) is asking as it prepares for its credit policy review later today — if a rate cut is not going to stimulate investment, but has the potential to stimulate inflation, why do it?
Perceptions differ widely. CMIE MD and CEO Mahesh Vyas argues neither interest rates nor policy paralysis are as important as made out to be in the context of investments. “In the capex cycle,” he says, “as more and more investments get announced, promoters reassess their projects in the light of increased competition and the relatively weaker ones get shelved.” The current shelving of projects, Vyas points out, accounts for just 3.5% of outstanding investments and have been shelved predominantly on account of land buys and environment-related issues — “their case for land acquisition or their lack of environmental clearance was weak and they therefore merited being shelved”, says Vyas.
It is this bullishness — completed projects are rising steadily and the ratio of projects under implementation to outstanding projects is up from 44.5% in FY06 to 54.8% in FY12 — that has ensured, apart from the government’s Economic Survey, CMIE has the highest GDP growth forecast (7.3%) for FY13. CMIE has put together a list of R2,86,115 crore of projects that have been shelved in 2011-12, none due to high interest rates (see table).
If Posco’s project hasn’t taken off, or the numerous SEZs, according to this line of thinking, it is because they didn’t get land or environmental clearances. If Qualcomm’s broadband wireless access network hasn’t taken off for almost two years, it’s because of ‘policy paralysis’ that held up the licence.
Ditto for telecom investment, where the government’s stance reversal has meant most 3G networks that have been rolled out may now be illegal. The lack of coal linkages that has nearly 50,000 MW of power projects in the balance, similarly, has little to do with interest rates. The list goes on.
While all of this is true, Saugata Bhattacharya, Axis Bank’s senior vice-president in charge of business and economic research, points out that given bank credit to the commercial sector is roughly Rs 40 lakh crore, a 3-percentage point hike in interest costs adds up to an additional interest cost of Rs 1.2 lakh crore – add the interest costs from non-bank sources, and this goes up to around Rs 2 lakh crore. As for new projects, Bhattacharya says, project internal rates of return (IRRs) also get affected. “Approximate calculations indicate that for long-gestation projects (for example, road and other infrastructure concessions), a 3-percentage point increase in costs is likely to reduce project IRRs by 2 percentage points”. In other words, projects that had IRRs of 14-15% when they were bid are largely unviable today with higher rates of interest. While there is no data on how many projects got shelved due to higher rates of interest, Bhattacharya thinks the number is significant.
Oxus Investment chairman Surjit Bhalla’s model, based on data from 1993 to 2007, shows that a 1-percentage point rise in real interest rates results in the share of investments in GDP falling by around 1 percentage point and GDP growth by around 0.5 percentage point. So Bhalla says the 5-percentage point rise in real interest rates over the past few years – a 200-basis point fall in inflation and 300 bps rise in nominal interest rates – has led to GDP growth falling 3 percentage points (from 8-9% to 5-6%) and to the investment-to-GDP rate falling around 2.5 percentage points.