Political/Monetary Developments Weigh In On Infrastructure Outlook

BMI View: We have turned slightly more bearish towards the near-term outlook of India's construction and infrastructure markets and have revised down our forecasts for both sectors accordingly. This downward revision is because some of the factors that are already dampening construction and infrastructure activity - namely non-conducive monetary conditions, lacklustre infrastructure activity and political risk - have grown in prominence in recent months.

As expected, India's construction industry value experienced a rebound in Q2 2013/14 (July-September). Latest estimates from India's Ministry of Statistics and Programme Implementation (MOSPI) show that real growth for the construction sector was 4.3% year-on-year (y-o-y) in Q2 2013/14 (July-September). This growth rate was higher than the previous quarter (2.8% y-o-y in Q1 2013/14) and the same quarter in the preceding year (3.1% y-o-y in Q2 2012/13).

This rebound in construction activity can be primarily attributed to a rebound in infrastructure output in Q2 2013/14, which we highlighted in our November 2013 analysis of the sectors ( see 'Construction Outlook To Darken Before The Dawn', November 12 2013). At the same time, we had stated our belief that the rebound would not be sustainable and our expectation for construction and infrastructure activity in India to remain weak for the rest of FY2013/14 in this November analysis.

In Decline
India - Estimates On Monthly Infrastructure Sector Output, % chg y-o-y (LHS); Quarterly Construction Industry Value Real Growth, By Date Of Release, % chg y-o-y (RHS)

Political/Monetary Developments Weigh In On Infrastructure Outlook

BMI View: We have turned slightly more bearish towards the near-term outlook of India's construction and infrastructure markets and have revised down our forecasts for both sectors accordingly. This downward revision is because some of the factors that are already dampening construction and infrastructure activity - namely non-conducive monetary conditions, lacklustre infrastructure activity and political risk - have grown in prominence in recent months.

As expected, India's construction industry value experienced a rebound in Q2 2013/14 (July-September). Latest estimates from India's Ministry of Statistics and Programme Implementation (MOSPI) show that real growth for the construction sector was 4.3% year-on-year (y-o-y) in Q2 2013/14 (July-September). This growth rate was higher than the previous quarter (2.8% y-o-y in Q1 2013/14) and the same quarter in the preceding year (3.1% y-o-y in Q2 2012/13).

In Decline
India - Estimates On Monthly Infrastructure Sector Output, % chg y-o-y (LHS); Quarterly Construction Industry Value Real Growth, By Date Of Release, % chg y-o-y (RHS)

This rebound in construction activity can be primarily attributed to a rebound in infrastructure output in Q2 2013/14, which we highlighted in our November 2013 analysis of the sectors ( see 'Construction Outlook To Darken Before The Dawn', November 12 2013). At the same time, we had stated our belief that the rebound would not be sustainable and our expectation for construction and infrastructure activity in India to remain weak for the rest of FY2013/14 in this November analysis.

This view has started to unfold in Q3 2013/14. Latest data show that India's monthly infrastructure output fall from an average of 4.9% y-o-y in Q2 2013/14 to 1.1% y-o-y in Q3 2013/14 (infrastructure output is based on production levels from eight industries, namely crude oil, natural gas, petroleum refinery products, coal, electricity, cement, fertiliser and finished steel).

Looking ahead, we have turned slightly more bearish towards the near-term outlook of India's construction and infrastructure markets and have revised down our forecasts for both sectors accordingly. We now expect the construction sector to grow by 5.1% in FY2014/15 (previously 5.6%) and 7.3% in FY2015/16 (7.6%), and infrastructure to grow by 4.7% in FY2014/15 (5.2%) and 6.5% in FY2015/16 (6.8%).

Weaker Recovery
India - Construction And Infrastructure Industry Value Forecasts

This downward revision is because some of the factors that are already dampening construction and infrastructure activity - namely non-conducive monetary conditions, lacklustre infrastructure activity and political risk - have grown in prominence in recent months.

Non-Conducive Monetary Conditions: Monetary conditions in India have continued to be increasingly adverse for construction investment, with the cost of capital in India at a relatively high level. On January 28 2014, the Reserve Bank of India (RBI) hiked the benchmark interest rate by 25 basis points (bps) to 8.00%, a 12-month high. This rate hike was contrary to market expectations as inflationary pressures had eased in December 2013. In our opinion, this suggests that the new governor of the RBI, Raghuram Rajan, is more concerned with inflation and currency stability than economic growth ( see 'New CPI Focus Will Not Negate Eventual Growth Concerns', January 29 2014). Combined with the lagged impact of monetary tightening, this means that the negative implications to credit uptake could persist over the whole of FY2014/15 and deter construction companies from taking on new construction and infrastructure projects.

Not Yet Conducive
India - Policy Rate, % & Headline WPI, % y-o-y (RHS)

In addition, the Indian rupee remains very weak. Even though its recent depreciatory trajectory has halted, the currency remains close to record-weakness and is trading at around INR62.00/US$ at the time of writing. This weakness in the Indian rupee is also likely to dampen infrastructure activity as it would make it more costly for Indian infrastructure companies to purchase overseas equipment and raw materials as well as repay their overseas debt borrowings. Foreign construction companies could also be dissuaded from taking on projects in India due to concerns over the final value of repatriated returns from their investments. To be sure, foreign direct investment into India has remained largely stagnant in recent months, despite the introduction of several measures to further liberalise India's foreign investment regime in mid-July 2013 ( see 'FDI Liberalisation Encouraging, But Stumbling Blocks', July 18 2013).

Near-Record Weakness
India - Exchange Rate, INR/US$

Lacklustre Infrastructure Activity: Besides monetary issues, the poor economic conditions in 2012-13 and the structural problems within the various infrastructure sub-sectors (namely transport and utilities infrastructure) have also deterred investors from taking on new projects and financers from providing funding. This is highlighted by the sharp decline in the value of new projects launched in India. According to data from Centre for Monitoring Indian Economy (CMIE), the number of new projects approved in recent quarters is at its lowest since 2004, and this dampens the potential for infrastructure activity in FY2013/14 and FY2014/15.

A key example is the roads sector. In January 2014, India's highways ministry announced that it plans to reduce its project award target for FY2013/14 from 7,300km to 3,300km. This is because the ministry has only been able to award 1,600km of highways.

Back At Previous Lows
India - New Projects, By Quarter, INRbn

We do not envisage a significant improvement in new projects approvals for the remainder of FY2013/14 and Q1 2014/15. Although the unwinding of India's external imbalances appears nearly resolved ( see 'Rebalancing Complete, Recovery Awaits', December 6 2013), other macroeconomic conditions are still dampening construction and infrastructure activity over the near-term. India economic performance remains mixed, with businesses still remaining cautious with their spending ( see 'Economic Divergence To Persist Until May Elections', February 7 2014). This negatively affects the demand for construction and infrastructure in India. India's public finances also remain in a precarious position, meaning that fiscal consolidation will have to be addressed in 2014 to stave off the threat of a ratings downgrade. This negatively affects the level of public spending on construction and infrastructure.

Furthermore, India is slated to hold general elections in May 2014. This is likely to prompt the government to focus on vote-winning policies (such as additional subsidies) and put on hold key decisions for infrastructure projects (such as project awards and approvals) until the latter half of FY2014/15. In the past few months, we have seen the central and state governments increase subsidies for several necessities such as food, energy and water ( see 'The Curious Case Of Indian Inflation', November 28 2013, and 'Economic Divergence To Persist Until May Elections', February 7 2014). Meanwhile, data from CMIE shows that new project approvals are typically at a cyclical-low during the quarters in which elections are held.

Greater Potential For Policy Paralysis: Infrastructure investors from taking on new projects as the elections nears until there is greater political clarity in India. At present, there is still a high degree of uncertainty towards the outcome of the elections, but our Country Risk team is leaning towards a victory for the main opposition, the Bharatiya Janata Party (BJP, see 'Election Scenarios: The Good, The Bad, And The Ugly', December 4 2013). The ruling United Progressive Alliance coalition, which is led by the Indian National Congress (INC), has lost significant political support to the BJP and regional parties, with the crushing defeat at the Delhi state legislative assembly elections held in December 2013 a potential sign of things to come ( see 'AAP's Rise Heightens Election Risks', January 23 2014).

Crushing Defeat
India - Delhi Legislative Assembly Election Results In 2008 & 2013, Number Of Seats

Even though the BJP is seen as a progressive, pro-development and business-friendly political party, this does mean an immediate increase in construction and infrastructure activity as a change of government often leads to a review of infrastructure projects approved by the previous incumbent. This typically results in new feasibility studies and schemes being conducted and crafted respectively, which could lead to project delays, revisions, or, at worse, cancellations.

Fragmented Polity
India - 15th Lok Sabha (Lower House), # of Seats

Even without a change in government, greater parliamentary representation from regional parties could lead to greater policy paralysis as they may pursue interests that are not aligned with the central government. To be sure, the lack of sufficient parliamentary representation has already proven to be the key reason for the INC's failure to push forward its proposed reforms as scheduled and this problem could continue to persist even after the elections. A recent example of such hamstrung governance is the delays to the privatisation process of six airports in India. The privatisation process was proposed in the middle of 2013, but has stalled repeatedly (the latest dateline is mid-February) due to opposition from Airports Authority of India employees, trade unions, airlines and some political parties such as the Janata Dal (United) party, a political party with political presence mainly in Bihar and Jharkhand.

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