Higher capacity utilization signals a recovery in investment

In what sheds light on the outlook for new investment by businesses, capacity utilization in the manufacturing sector has increased over the last three quarters to 75.3% at the end of March, against a long-term average of 73.7%. .

The higher capacity utilization is seen as a sign of a return to growth, which in a way gave the Reserve Bank of India the leeway it needed to anticipate the amount of the rate hike on Friday . But going forward, tighter monetary policy conditions and uncertain demand conditions — both global and domestic — could weigh on investment sentiment, experts said.

In all sectors, the signals are mixed. While steel and cement are up, capacity utilization in autos and consumer goods continues to lag. Capacity utilization is the ratio of actual output to the potential output that can be produced under normal conditions. Higher capacity utilization, accompanied by growth in the order book, signals robust demand conditions in the economy.

“Capacity utilization in the manufacturing sector is now above its long-term average, signaling the need for new investment activity in building additional capacity,” RBI Governor Shaktikanta Das said. in its monetary policy statement.

According to the RBI survey, manufacturing companies expect a sustained improvement in production volumes and new orders in July-September 2022, which is expected to continue through January-March 2023. is accelerating from 68.3% in the second quarter of 2021-22, to 72.4% in the third quarter and 75.3% in the fourth quarter, according to the RBI’s survey of order books, inventories and capacity utilization, a quarterly quantitative survey, which collects information on the production capacity used by product at company level to derive the aggregate level of capacity utilization.

India’s economy, however, is expected to face headwinds from global forces – prolonged geopolitical tensions, growing volatility in global financial markets, tightening global financial conditions and risks of a global recession, the central bank said. Uncertain global demand conditions and subdued industrial recovery so far add to fears of an uneven recovery going forward, with demand not much affected for high-end products and a likely large impact for low-end products.

Even though capacity utilization increased, new order book growth slowed to 5.6% QoQ in the fourth quarter (January-March 2022), from 10.5% in the third quarter (October-December 2021 ). According to analysts, a capacity utilization of 75-80% must be maintained for 3-4 quarters for it to translate into an expansion momentum for the industry.

“Inflationary expectations are high which will mean people are postponing buying decisions and lead to pent up demand for later as people try to protect their savings now. The rising cost of funds by rising Until inflationary expectations are subdued and with global uncertainties looming, including the recent tension in the China-Taiwan region, further rate hikes are expected with another 25% hike. to 50 basis points likely during this financial year,” Devendra Kumar Pant, Chief Economist, India Ratings said.

Emerging concerns over tensions between China and Taiwan could also hurt the outlook for global demand, even as global crude oil prices have moderated, translating into heightened caution from the RBI. “Today’s policy decision was more hawkish than expected, and we believe the RBI is indeed cautious in its policy approach, particularly ahead of the winter cycle when energy prices could be volatile. This is evident. in its inflation forecast, which has remained at an average level of 6.7%, despite the significant drop in global commodity prices, including oil prices, over the past six weeks. underscored by the risks the central bank has noted to the current account deficit, which we expect to widen significantly,” said Rahul Bajoria, chief economist for India, Barclays.

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Although the RBI has retained the real GDP growth projection for 2022-23 at 7.2%, experts said that while overall investment will improve, the economy is not experiencing the levels of l investment observed during the previous phase 2003-2009. “Secondly, domestic and external demand contributed to growth. But at present, the demand share is unlikely to increase in real terms in a context of high inflation. With nominal wages growing by only 3-4% while inflation is close to 7%, rural areas are expected to experience a greater impact on demand,” Pant said.

RBI’s OBICUS also showed backlog growth was 4.7% quarter-over-quarter in the fourth quarter, compared to 3.5% in October-December 2021 (Q3, 2021- 22), while backlog growth was 4.6%. in Q4 versus 7.8 percent in Q3. The average amount of new order books for 207 companies in January-March this year stood at Rs 222.4 crore compared to Rs 224.4 crore in October-December 2021 for 205 companies.

Capacity utilization reflects demand conditions in an economy where production processes respond to changing demand and fluctuate accordingly. Increased demand may result in upward pressure on the general price level and therefore higher capacity utilization may be accompanied by higher inflation.

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