GS Paper: GS3-14.Investment models

Context

• In September, Finance Minister Nirmala Sitharaman was anguished that industry was holding back from investing in manufacturing despite a significant cut in corporate tax rates in 2019.

Analyzing the corporate Investment since the pandemic

• Less investment is not the result of losses: The slowdown in corporate investment did not happen because companies were making losses.
• More profit but less investments by corporates: In fact, private companies, boosted by considerable tax cuts, made windfall profits. A State Bank of India analysis shows that tax cuts contributed 19% to the top line of companies during the pandemic. But this did not result in increased investments.
• Dividends to shareholders: Before the pandemic, instead of investing in themselves, companies chose to reward shareholders with higher dividends.
• Investment in equity and debt instead of Infrastructure: During the pandemic, they did not use the profits for paying out dividends; they retained a big chunk of the profits. However, instead of investing in buildings, plants and machinery, they invested in equity shares and debt instruments.
• Corporate cited the slowdown in demand as reason for less investment: So, both before and after the outbreak, they shied away from capital investments. The hesitancy to invest can be explained by a slowdown in the demand side of the economy.
• Corporates didn’t invest in long term returns sectors: Consumer demand started to decline the year before the pandemic and worsened after the COVID19 outbreak. This forced companies to use the increased profits to decrease their debts, pay dividends and invest in financial instruments instead of increasing productivity by making capital investments.

What is The current consumer’s demand situation?

• Average Consumer sentiment index: Private companies invest when they are able to estimate profits, and that comes from demand. The Centre for Monitoring Indian Economy’s (CMIE) consumer sentiment index is still below pre-pandemic levels but is far higher than what was seen 12-18 months ago.
• Buoyant Aggregate demand: RBI’s Monetary policy report dated September 30 says, Data for Q2 (ended Sept) indicate that aggregate demand remained buoyant, supported by the ongoing recovery in private consumption and investment demand. It shows that seasonally adjusted capacity utilization rose to 74.3% in Q1 the highest in the last three years.
• High household savings: Along with household savings intentions remaining high, might hold the key to the investment cycle kicking in.

Statistic on demand and investment

• New investment projects: The new investment projects announced as a % of GDP, since FY18, the share has remained below the 5% mark, compared to over 9% between FY05 and FY22.
• Collection of corporate tax decreased: Corporate tax and income tax collected in India as a % of GDP after the cut in 2019, the share of corporate tax declined dramatically, while the share of income tax gradually increased.
• Double burden on tax payers: The shift in tax burden from the corporates to the people came at a time of job losses and reduced income levels. This pushed more people into poverty.
• Corporate profit increased after tax cut: Profit after tax earned by non-financial private companies in ₹ trillion after the tax cut, the profits of these companies rose to ₹4-5 trillion in the last two financial years from ₹1-2 trillion in many of the previous periods.
• Increase and decrease in dividend to shareholders: Dividends paid by non-financial private companies as a share of profits earned after tax, Payouts to shareholders surged in FY20, the year before the pandemic, but reduced in the following years.
• Profit retention increased: Retained profits as a % of profit after tax surged to 63% in FY22 the highest in a decade (limited companies were analyzed in FY22, so data are provisional).
• Profits are invested in equities: In FY21, the debt-to-equity ratio came down to 0.86 the lowest in at least three decades. In FY22 (provisional data), it came down further to 0.71.
• Year on year decline in capital investment: Year on year change in the investments of non-financial private companies in fixed assets such as buildings, plants, machinery, transport and infrastructure have declined in recent years. But the year on year change in investments in financial instruments such as equity, debt and mutual funds have surged.

Conclusion

• Corporates are holding their pockets in hope of demand rise in future. However, this affects the post-pandemic recovery of economy. IMF and RBI was right to revise their growth forecast this year. Unequal recovery of economy have certainly affected the income levels of middle class. Government has taken a lot of step on supply side (corporate side and banking reform) but no intervention in revival of demand.

Mains Question

Q. Analyze the corporate investment pattern before and after the pandemic? What are the reasons for decline in corporate investment in fixed assets in economy since the pandemic?

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Context

The government has announced an ambitious programme of asset monetisation. It hopes to earn ₹6 trillion in revenues over a four-year period.

About Asset monetisation

• Unlike in privatisation, no sale of government assets is involved.
• The government parts with its assets — such as roads, coal mines — for a specified period of time in exchange for a lump sum payment.
• Asset monetisation will happen mainly in three sectors: roads, railways and power.
• Other assets to be monetised include: airports, ports, telecom, stadiums and power transmission.
• Two important statements have been made about the asset monetisation programme.
• The focus will be on under-utilised assets.
• Monetisation will happen through public-private partnerships (PPP) and Investment Trusts.

Challenges

1) Investors would prefer property utilised assets over underutilised assets

• Suppose an asset is not being used adequately because it has not been properly developed or marketed well enough.
• A private party may judge that it can put the assets to better use.
• It will pay the government a price equal to the present value of cash flows at the current level of utilisation.
• This is a win-win situation for the government and the private player.
• The government gets a ‘fair’ value for its assets.
• The private player gets its return on investment.
• Increase in efficiency: The economy benefits from an increase in efficiency.
• Monetising under-utilised assets thus has much to commend it.
• However, in case of an asset that is being properly utilised, the private player has little incentive to invest and improve efficiency.
• It simply needs to operate the assets as they are.
• The private player may value the cash flows assuming a normal rate of growth.
•  The cost of capital for a private player is higher than for a public authority.
• The higher cost of capital for the private player could offset the benefit of any reduction in operating costs.
• The government earns badly needed revenues but these could be less than what it might earn if it continued to operate the assets itself.
• There is no improvement in efficiency.
• The benefits to the economy are likely to be greater where under-utilised assets are monetised.
• However, private players will prefer well-utilised assets to assets that are under-utilised.
• That is because, in the former, cash flows and returns are more certain.

2) Valuation challenges

• It is very difficult to get the valuation right over a long-term horizon, say, 30 years.
•  For a road or highway, growth in traffic would also depend on factors other than the growth of the economy.
• . If the rate of growth of traffic turns out to be higher than assessed by the government in valuing the asset, the private operator will reap windfall gains.
• Alternatively, if the winning bidder pays what turns out to be a steep price for the asset, it will raise the toll price steeply.
• The consumer ends up bearing the cost.
• It could be argued that a competitive auction process will address these issues and fetch the government the right price while yielding efficiency gains.
• But that assumes, among other things, that there will be a large number of bidders for the many assets that will be monetised.

3) Life of the returned asset may not be long

• There is no incentive for the private player to invest in the asset towards the end of the tenure of monetisation.
• The life of the asset, when it is returned to the government, may not be long.
• In that event, asset monetisation virtually amounts to sale.
• Monetisation through the PPP route is thus fraught with problems.

Way forward: InvIT route

• Infrastructure Investment Trusts (InvIT) are mutual fund-like vehicles in which investors can subscribe to units that give dividends.
•  Monetisable assets will be transferred to InvITs.
• The sponsor of the Trust is required to hold a minimum prescribed proportion of the total units issued.
• InvITs offer a portfolio of assets, so investors get the benefit of diversification.
• In the InvIT route to monetisation, the public authority continues to own the rights to a significant portion of the cash flows and to operate the assets.
• So, the issues that arise with transfer of assets to a private party — such as incorrect valuation or an increase in price to the consumer — are less of a problem.

Key takeaways

• Low cost of capital for public authority: In general, due to the low cost of capital for public authority, the economy is best served when public authorities develop infrastructure and monetise these.
• InvIT route: Monetisation through InvITs is likely to prove less of a problem than the PPP route.
• Monetise under utilised assets: We are better off monetising under-utilised assets than assets that are well utilised.
• Monitoring authority should be set up: To ensure proper execution, there is a case for independent monitoring of the process.
• The government may set up an Asset Monetisation Monitoring Authority staffed by competent professionals.

Consider the question “How asset monetisation is different from privatisation? What are the challenges in asset monetisation? Suggest the ways forward.”

Conclusion

Government must pay attention to the challenges in asset monetisation and use it in the proper way to increase the efficiency in the economy.

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