Higher capacity utilisation signals investment revival

The higher capacity utilisation is being seen as a sign of return of growth impetus, which in some way has provided the headroom for the Reserve Bank of India to frontload the quantum of rate hike on Friday. But going forward, tighter monetary policy conditions and uncertain demand conditions – both global and domestic – may weigh on the investment sentiment, said experts.

Across sectors, the signals are mixed. While steel and cement are witnessing an uptick, capacity utilisation in auto and consumer goods continue to lag. Capacity utilisation is the ratio of actual output to the potential output that can be produced under normal conditions. Higher capacity utilisation, accompanied by order book growth, signals robust demand conditions in the economy.

“Capacity utilisation in the manufacturing sector is now above its long-run average, signalling the need for fresh investment activity in additional capacity creation,” RBI Governor Shaktikanta Das said in his monetary policy statement.

According to RBI’s survey, manufacturing firms expect sustained improvement in production volumes and new orders in July-September 2022, which is likely to sustain through January-March 2023. The capacity utilisation has picked up pace from 68.3 per cent in Q2, 2021-22, to 72.4 per cent in Q3, and 75.3 per cent in Q4, as per the RBI’s Order Books, Inventories and Capacity Utilisation Survey, a quarterly quantitative survey, which collects information on product-wise utilised production capacity at the firm level to derive aggregate level capacity utilisation.

The Indian economy, however, is expected to face headwinds from global forces – protracted geopolitical tensions, rising global financial market volatility, tightening global financial conditions, and global recession risks, the central bank said. The uncertain global demand conditions and subdued industrial recovery so far add to concerns of an uneven recovery going ahead, with demand not getting impacted much for higher-end products, and a likely steep impact for lower-end products.

Even as capacity utilisation increased, new order book growth eased to 5.6 per cent quarter-on-quarter in Q4 (January-March 2022) from 10.5 per cent in Q3 (October-December, 2021). As per analysts, capacity utilisation of 75-80 per cent needs to be sustained over 3-4 quarters for it to translate into an expansionary drive by the industry.

“Inflationary expectations are high, which will imply people deferring their purchase decisions and lead to pent up demand for a later time since people will try to protect their savings as of now. Increasing the cost of funds through the rate hike will dampen demand. Till the inflationary expectations are curbed and with global uncertainties looming over including the recent tension in China-Taiwan region, more rate increases are expected with another 25-50 basis points hike likely in this fiscal,” Devendra Kumar Pant, Chief Economist, India Ratings said.

Emerging concerns from the China-Taiwan tensions could also hurt global demand prospects even as global crude oil prices have moderated, translating into extra caution from the RBI. “Today’s policy decision was more hawkish than we expected, and we believe the RBI is effectively being cautious in its policy approach, especially ahead of the winter cycle, when energy prices could be volatile. This is evident in its inflation forecasts, which have maintained an average level of 6.7 per cent, despite global commodity prices, including oil prices, declining materially over the past six weeks. This cautiousness is underscored by the risks the central bank noted to the current account deficit, which we expect to widen materially,” Rahul Bajoria, Chief India Economist, Barclays said.

Though the RBI has retained real GDP growth projection for 2022-23 at 7.2 per cent, experts said while the overall investment will improve, the economy is not witnessing levels of investment-led growth seen during the earlier 2003-2009 phase. “Then, both domestic and external demand contributed to growth. But right now, the demand portion is unlikely to grow in real terms amid high inflation rate. With nominal wages growing at just 3-4 per cent while inflation is close to 7 per cent levels, rural areas are likely to see a greater hit on the demand,” Pant said.

RBI’s OBICUS also showed that the growth in backlog orders stood at 4.7 per cent quarter-on-quarter in Q4 as against 3.5 per cent in October-December 2021 (Q3, 2021-22), while pending orders growth was seen at 4.6 per cent in Q4 as against 7.8 per cent in Q3. The average amount of new order books for 207 companies in January-March this year stood at Rs 222.4 crore compared Rs 224.4 crore in October-December 2021 for 205 companies.

The capacity utilisation reflects demand conditions in an economy where production processes respond to changing demand and it fluctuates accordingly. Rising demand may translate into upward pressure on the general price level and so higher capacity utilisation can be accompanied by a rise in inflation.