It is widely accepted that the economic slowdown in India is due significantly to the decline in investment activity. Consequently, any prospects of recovery must also depend on the willingness and, more importantly, ability of companies to invest. So, are Indian companies in a position to invest in capacity expansion or new businesses should the overall investment climate improve? Analysis by the Business Standard Research Bureau, which was reported on in this newspaper earlier this week, raises serious concerns about the ability of large Indian companies to put any more money to work. For companies to mobilise funds to invest, their financial condition needs to be visibly healthy - and the most tangible indicator of this is their net worth, or the difference between the market value of their shares and what they owe in the form of debt.
The study shows that, of the 406 companies in the BSE 500 that are neither in banking nor in finance, as many as 143 have a market capitalisation (based on July valuations) that is less than 1.5 times their debt (as of March 31, 2013). Many of these, therefore, could be in financial trouble, with market valuation lying below debt. Significantly, these companies account for about two-thirds of all projects under implementation by the top 500 companies. With valuations like these, their ability to continue to raise funds to keep the investments going is unquestionably doubtful. The low valuations reflect the market's scepticism about the viability of many of these projects and the returns that they can expect.
This combination of factors is what raises the key concern. If companies that are investing are being devalued by investors, what incentive do they - or, for that matter, anyone else - have to make investments? And if the micro-level situation appears so tenuous, how are the aggregate numbers going to add up to an investment recovery? What is particularly worrying is that many of these companies are in the process of implementing critical infrastructure projects, on whose successful completion rest hopes of a growth acceleration over the next few years.
But their financial condition increases the risk that many of these projects will run aground because their promoters hit financial constraints. In effect, the public-private partnership (PPP) model for infrastructure seems to have reached its limits. Overall economic and financial conditions are obviously partly responsible, but there are, equally obviously, constraints in specific sectors - clearances, pricing, fuel linkages and so on - that are also at play.
With economic policy now primarily focusing on short-term macroeconomic stability, these risks to investment may not get the attention they deserve. One could argue that the adverse valuations are, at worst, a cyclical phenomenon and that neither investors nor companies will allow them to deter financing and capital allocation decisions taken with a long-term perspective. But this could well be false optimism and persistent financial pressure on large companies could deter investment activity for some time to come, even after some macroeconomic stability has been achieved.
If an investment revival is to be engineered, therefore, the burden now seems to fall on the public sector, which, given the state of public finances, hardly appears to be in a position to take it on. Expanding the public sector's capacity to invest must now become a policy priority as well.