Thursday , February 27 2020
Home / india / Why aren't investments improving? And no, demand saturation is not a reason

Why aren't investments improving? And no, demand saturation is not a reason

By Abheek Barua

A comprehensive explanation of why the private investment pipeline continues to dry needs to look beyond usual suspects such as low capacity utilization and weak demand. The fact that investors are being late for having available capacity is an empty tautology. What we need to find out is why this capability is available.

It is better to solve some things at this stage. The claim that demand is somehow "saturated" for various products is misleading. Take cars and trucks, the segment most affected by the current slowdown. A cross-country analysis of vehicle ownership by HDFC Bank shows that even at current per capita income levels, India's vehicle ownership is below the curve.

So even if India's growth slows to zero, vehicle ownership should, at least in theory, increase. To put this in context, Brazil and China are over-penetrated. For them, saturation is a problem.

The second caveat concerns the identification of the cost and availability of funds as a constraint for investments. On the one hand, reams of studies have shown that the demand for investment in India is relatively insensitive to interest rates.

In addition, while average borrowing costs remain high – AAA bonds spread over ten-year government bonds by one-third of a percentage point, while AA bonds have increased by a full percentage point since December 2018 – the average masks the safety flight. in the lending market.

In a liquidity-rich financial system, banks and bond investors have no choice but to pursue "quality" manufacturers and service companies and offer low rates. For these companies, the decision to withhold capacity expansion has little to do with the price or supply of loans.

So why, then, this investment pessimism? First, consumer behavior and preferences are showing a marked change. One of the critical impacts of these changes to durable products, such as white goods or cars, is a shrinking product cycle. In short, the shelf life of a new product has shortened considerably.

Caring is Sharing
This is fundamentally alternating the math of investing for companies. A few years ago, a car manufacturer could launch a new brand and give the investment a good six or seven years to pay off. Today, they need to recoup their investments in just three if they are lucky. The trend in a highly price sensitive market like India is to think of ways to cut costs and increase returns. This is easier said than done.

An interesting phenomenon in the auto market is near-mergers and cost-sharing models. Toyota and Suzuki, for example, have formed an alliance to share supply chain costs and develop new vehicle technologies together. Ford Motors is partnering with Mahindra & Mahindra, and the two will strategically co-develop and manufacture vehicles for themselves.

The other significant change in behavior patterns is related to the Indian consumer demand for easy access to products. One of the factors driving this change may be the rapid penetration of e-commerce. If news from Amazon delivering products to over 99% of zip codes is correct, e-commerce will no longer be a big city phenomenon. Therefore, companies that planned to rely on offline sales simply because their target markets were outside major cities have to redo their plans.

More generally, companies are realizing that Indian consumers, even in the deepest rural markets, now want easy access to goods and services. Therefore, the hub model – where customers from, say, neighboring villages would visit the district city for shopping – is deteriorating. The ability to attract customers depends on being as close to them as possible. Therefore, companies need to think of alternative distribution models with small reduced retail points rather than a large showroom in a central hub.

For service providers like banks, an effective strategy could be to increase branch expansion and be as small as possible, but in as many locations as possible. Among FMCG companies, Patanjali and Dharampal Satyapal Group (DS Group) with their sweet & # 39; Pulse & # 39; can be taken as successful examples of those who used this 'small retail' model to quickly increase sales.

Thus, the investment decision for companies is no longer a simple call based on capacity utilization and the cost of funds. To get started, they need to look over their shoulders to see how technology changes and automation are affecting their business.

A battery of options
An automaker that invests in electric car capacity needs to make sure that when the car hits the market, battery technology will not change dramatically. A service company that has significant back office operations will have to think about how much of the latter will automate, what technology to choose, and ways to negotiate the risk of rapid obsolescence.

Much has been written about the challenges of technological disruption.

Companies are also facing significant disruption to their business models in core areas such as sales and distribution. This disruption underpins a new consumer profile as the Indian consumer stereotype of being "just that" is being broken. Therefore, it may be much more difficult to start the investment engine this time.

The writer is chief economist, HDFC Bank. Views are personal

Source link