A comprehensive explanation of why the private investment pipeline continues to run dry has to look beyond the usual suspects, like low capacity utilisation and weak demand. The fact that investors are holding back because they have spare capacity is an empty tautology. What we need to figure out is why this capacity is spare.
It’s best to get a couple of things out of the way at this stage. The claim that demand is somehow ‘saturated’ for a number of products is misleading. Take cars and trucks, the segment worst hit by the current slowdown. A cross-country analysis of vehicle ownership done by HDFC Bank shows that even at its current per-capita income levels, India’s vehicle ownership falls below the curve.
So, even if India’s growth were to slow to zero, vehicle ownership should, at least in theory, increase. To put this in context, Brazil and China are over-penetrated. For them, saturation is a problem.
The second caveat relates to identifying the cost and availability of funds as a constraint for investments. For one thing, reams of studies have shown that investment demand in India is relatively insensitive to interest rates.
Besides, while average costs of borrowing continue to be high — AAA bonds spread over 10-year government securities up by a third of a percentage point, while that for AA bonds rose by a full percentage point since December 2018 — the average masks the flight to safety in the loan market.
In a financial system flush with liquidity, both banks and bond investors have no option but to chase ‘quality’ manufacturers and service companies, and offer them low rates. For these companies, the decision to hold back on capacity expansion has little to do with price or supply of loans.
So why, then, this investment pessimism? First, consumer behaviour and preferences are showing a marked shift. One of the critical impacts of these changes for durable products like white goods or cars is a shrinking product cycle. In short, the shelf life of a new product has shortened considerably.
Caring is Sharing
This is fundamentally alternating the investment math for companies. Afew years ago, a car manufacturer could launch a new brand and give the investment a good six or seven years to pay for itself. Today, they need to recoup their investments in just three, if they are lucky. The tack in a highly price-sensitive market like India is to think of ways to reduce costs to increase returns. This is easier said than done.
An interesting phenomenon in the car market are quasi-mergers and cost-sharing models. Toyota and Suzuki, for instance, have formed an alliance to share supply-chain costs and develop new vehicle technologies together. Ford Motors is partnering with Mahindra & Mahindra, and the two will co-develop and strategically manufacture vehicles for each other.
The other significant change in behaviour patterns relates to the Indian consumer’s demand for easy access to products. One of the factors driving this change could be the rapid penetration of ecommerce. If news reports of Amazon delivering products to over 99% of postcodes is correct, then ecommerce is no longer an exclusively big city phenomenon. So, companies that planned to rely on offline selling simply because their target markets were outside the big city catchments have to rework their plans.
More generally, companies are realising that Indian consumers even in deep rural markets now want easy access to goods and services. Thus, the ‘hub’ model — where customers from, say, adjoining villages would visit their district town for their purchases — is breaking down. The ability to attract customers depends on being as close to them as possible. So, companies need to think of alternative distribution models with small stripped-down retail points, rather than a big showroom in a central hub.
For service providers like banks, an effective strategy could be to ramp up branch expansion and have the tiniest of tiny branches, but at as many locations as possible. Among FMCG companies, Patanjali and Dharampal Satyapal Group (DS Group) with its ‘Pulse’ candy could be taken as successful examples of those who used this ‘small retailing’ model to ramp up sales quickly.
Thus, the investment decision for companies is no longer a simple call based on capacity-utilisation and cost of funds. For starters, they have to look over their shoulders to see how technological change and automation are affecting their business.
A Battery of Options
A car manufacturer investing in capacity for electric cars needs to be sure that by the time his car hits the market, battery technology has not changed radically. A service company that has significant back-office operations will have to think of how much of the latter to automate, what technology to choose, and ways to negotiate the risk of quick obsolescence.
Much has been written about the challenges of technological disruption.
Companies, too, are facing significant disruption in their business models in core areas like sales and distribution. This disruption is riding on the back of a new consumer profile as the stereotype of the Indian consumer of being ‘like that only’ is getting busted. So, it may be much more difficult to kick-start the investment engine this time around.
The writer is chief economist, HDFC Bank. Views are personal