Capacity Utilisation Challenges Investments — Mahesh Vyas
The government has raised capital spending at over 20% for three years in succession but the private sector remains unimpressed.
Prime Minister Narendra Modi appealed to the private sector on March 7 to increase their investments just like the government so that the country benefits. The appeal is pertinent because a strong pick-up in private sector investments is perhaps the greatest need of the Indian economy today.
At the same time, the appeal also reveals the somewhat desperate situation on the investments front. Umpteen green shoots have been cited in the past but none could mushroom into the coveted animal spirits-driven investments frenzy. The central government has raised its capital spending at over 20% for three years in succession and has hoped that these would "crowd-in’’ the private sector, but the private sector remains unimpressed.
Low capacity utilisation is one of the reasons for the poor interest of the private sector. Capacities already created are still underutilised and therefore, the economic reason to create additional capacities is limited. There is merit in this argument.
We consider four capital intensive industries in which the private sector is a substantial investor. These are conventional power generation, petroleum refining, steel and cement. These four industries accounted for nearly 30% of the total net fixed assets of all non-finance companies in CMIE’s Prowess database. This is a fairly representative sample that yields financial statements of about 25,000 companies per year.
Conventional power generation accounts for nearly 11% of total net fixed assets of the non-finance companies. This is the largest industry by asset size. The total conventional power generation capacity in 2011-12 (when India’s investment cycle peaked out) was 175.4 GW and the plant load factor (or PLF, which is a measure of capacity utilisation in the power generation industry) was 73.5%. By 2021-22, the capacity had scaled up to 289.6 GW but the PLF was down to 58.9%. The PLF had dropped to an all-time low of 54.6% in 2020-21 and has risen back very slowly since then.
Conventional power generation now competes with renewable energy sources that have seen substantial investments in recent times. Nearly 30% of the total installed capacity is from renewable energy sources. Low PLF levels and high competition from renewables implies that investments into conventional power generation (the largest industry by asset size) will remain sluggish for a long time.
The next largest industry by asset size is petroleum refining. It accounts for a little over 10% of total net fixed assets of non-finance companies. Its capacity has increased from 183 million tonnes in 2011-12 to 249 million tonnes by 2021-22. But, capacity utilisation has dropped from 111% to 97% in the same time. Refineries usually report over 100% capacity utilisation. So, a fall to 97% is significant. It was worse at 89% in 2020-21.
Crude steel capacity has risen from 91 million tonnes in 2011-12 to 154 million tonnes by 2021-22. But again, capacity utilisation is down—from 81.8% to 77.8%. The story gets as bad, if not worse, in the case of cement where the data is also a bit sketchy. Capacity has increased from 228 million tonnes in 2010-11 to 593 million tonnes in 2020-21 and capacity utilisation has fallen from 70.34% to 64.5%.
There is no compelling reason for private sector entrepreneurs in any of these large capital intensive industries to consider making big investments at this stage. They have adequate slack capacity to ride the growth associated with the infrastructure investments push of the government. Steel and cement industries, in particular, are direct beneficiaries of the government’s aggressive investments plans. However, to expect these industries to continue to invest aggressively may be unreasonable.
CMIE’s CapEx database informs that there is no dearth of investment projects on hand. In steel, there are 347 projects that aim to set up 239 million tonnes of additional capacity. This is more than 1.5 times the current outstanding capacity. Of these 39 projects, involving nearly 71.3 million tonnes of capacity, are overdue for completion but the promoters seem to be in no hurry to commission the projects. Upon completion, these alone could raise the steel capacity by almost 50%.
Similarly, there are 182 cement projects on hand envisaging setting up 425 million tonnes of additional capacity over the current about 600 million. Projects to set up 79 million tonnes of cement capacity are overdue for completion. Delayed petroleum refining projects could raise the refining capacity by 58%, from the current 249 million tonnes to 394 million tonnes per annum. And, just the delayed power projects could add over 155 GW of capacity over the current 290 GW of conventional energy capacity.
There are adequate new projects in the pipeline; and new ones keep getting proposed as enthusiastic governments try to attract investments to their states. The problem is in the implementation of these projects. Governments, in general, have not been blamed by entrepreneurs for delays in clearances. At least till before the recent rate hikes, the availability and cost of finance were not impediments. Enterprises seem to be going slow in implementation of projects because of the low capacity utilisation described earlier.
Companies see a free ride to growth for some time when demand picks up further. They don’t feel the pressure to build capacities in preparation for a boom in demand.
Surveys by the Reserve Bank of India throw some interesting light on the possible desired levels of capacity utilisation required to spur investments. A mere increase in the utilisation rate is apparently not adequate.
According to the RBI’s OBICUS, capacity utilisation through all of 2022 was well over 70%. It peaked at 75% in March. This is higher than levels seen in most surveys since 2013. But, this increase was not adequate to spur investments. In March 2011, when the investment cycle was at its peak, OBICUS reported a capacity utilisation level of 83%.
Given this availability of slack capacity, it is unlikely that the private sector will heed the Prime Minister’s advice that they should significantly increase investments.
Mahesh Vyas is managing director and CEO of the Centre for Monitoring Indian Economy.
The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.