Higher capacity utilisation signals investment revival

While illuminating the prospects for new investments by companies, capacity utilization in the manufacturing sector rose over the past three quarters to 75.3 percent by the end of March compared to the long-term average of 73.7 percent.

The use of higher capacity is seen as a sign of the return of growth momentum, which somehow provided space for the Reserve Bank of India to withstand the amount of Friday’s rate hike. But going forward, tighter monetary policy conditions and uncertain demand conditions – global and domestic – could affect investment sentiment, experts said.

Across sectors, the signals are mixed. While steel and cement are on the rise, capacity utilization in the automotive and consumer goods industries continues to slow. Capacity utilization is the ratio of the actual output to the potential output that could be produced under normal conditions. Higher capacity usage, combined with a growth in the order book, indicates strong demand conditions in the economy.

“Capacity utilization in the manufacturing sector is now above its long-term average, indicating the need for new investment activity in creating additional capacity,” Reserve Bank of India Governor Shaktikanta Das said in the monetary policy statement.

According to an RBI survey, manufacturers expect a sustained improvement in production volumes and new orders in the July-September 2022 period, which is likely to continue through January-March 2023., to 72.4 percent in the third quarter, and 75.3 percent in the quarter The fourth, according to order books, inventory, and capacity utilization survey, a quarterly quantitative survey, collects information on production capacity used in terms of product at the company level to derive the aggregation level of capacity utilization.

However, the Indian economy is expected to face headwinds from global forces – protracted geopolitical tensions, heightened global financial market volatility, tightening global financial conditions and risks of a global recession, according to the central bank. Uncertain global demand conditions and a weak industrial recovery so far add to fears of an uneven recovery, with demand for high-quality products not affected much, and a severe impact on lower-quality products likely.

Even with increased capacity usage, new order book growth slowed to 5.6 percent qoq in Q4 (January-March 2022) from 10.5 percent in Q3 (October-December, 2021). According to analysts, capacity utilization needs to continue at 75-80 percent over 3-4 quarters for it to translate into an expansion drive by the industry.

“Inflationary expectations are high, which means that people will postpone their buying decisions and lead to pent-up demand for later because people will try to protect their savings for now. Increasing the cost of money by raising interest rates will weaken demand. Until inflationary expectations are curbed and with global uncertainty in place Looming including the recent tension in the China and Taiwan region, a rate hike is expected with another 25-50 basis point increase likely in this fiscal year,” Devendra Kumar Pant, chief economist, Rating India said.

Emerging fears of tensions between China and Taiwan may also hurt the global demand outlook even as global crude oil prices decline, which translates into more caution from the Reserve Bank of India. “Today’s policy decision was more hawkish than we expected, and we believe the Reserve Bank of India is effectively being cautious in its policy approach, especially ahead of the winter cycle, when energy prices are volatile. This is evident in the inflation expectations, which maintained an average level of 6.7 in cent, despite the decline in global commodity prices, including oil prices, substantially during the past six weeks.This caution is underlined by the risks noted by the central bank to the current account deficit, which Rahul Bagoria, chief economist for India, Barclays, said. We expect it to expand materially.

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Although the Reserve Bank of India has kept its real GDP growth forecast for 2022-23 at 7.2 per cent, experts said that while aggregate investment will improve, the economy is not experiencing the levels of investment-led growth seen during Previous stage 2003-2009. Then domestic and external demand contributed to the growth. But at the moment, the demand portion is unlikely to grow in real terms amid the high rate of inflation. With nominal wages growing only 3-4 per cent while inflation is near 7 per cent levels, rural areas are likely to see an even bigger hit to demand, Pant said.

RBI’s OBICUS also showed that backlog growth was 4.7 percent qoq in the fourth quarter versus 3.5 percent in October-December 2021 (third quarter, 2021-22), while pending order growth was seen at 4.6% in the fourth quarter compared to 7.8% in the third quarter. The average new order books for 207 companies in January-March this year were Rs 222.4 crore compared to Rs 224.4 crore in October-December 2021 for 205 companies.

Capacity utilization reflects the demand conditions in an economy where production processes respond to changing demand and fluctuate accordingly. Increased demand may translate into upward pressure on the general price level, so higher capacity use can be associated with higher inflation.

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