Higher capacity utilization indicates investment revival

Highlighting the company’s fresh investment prospects, capacity utilization in the manufacturing sector in the last three quarters rose to 75.3 percent as of March-end compared to the long-term average of 73.7 percent.

Higher capacity utilization is seen as a sign of a return to growth momentum, which has provided headroom for the Reserve Bank of India to bring forward the rate hike on Friday. But going forward, tighter monetary policy conditions and uncertain demand conditions – both global and domestic – could affect investment sentiment, experts said.

Across the sector, the signals are mixed. Auto and consumer goods have lagged in capacity utilization, despite witnessing a rise in steel and cement prices. Capacity utilization is the ratio of potential output to the actual output that can be produced under normal conditions. High capacity utilization, along with growing order books, 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 to create additional capacity,” RBI Governor Shaktikanta Das said in his monetary policy statement.

According to RBI’s survey, manufacturing firms expect a sustained improvement in production volumes and new orders in July-September 2022, which is likely to sustain through January-March 2023. Capacity utilization increased from 68.3 per cent in the second quarter of 2021-22 , 72.4 percent in Q3, and 75.3 percent in Q4, according to the RBI’s Order Books, Inventory and Capacity Utilization Survey, a quarterly quantitative survey that collects data on product-wise utilized manufacturing capacity at the firm level to obtain an aggregate. level capacity utilization.

The Indian economy, however, is expected to face headwinds from global forces – lingering geopolitical tensions, growing global financial market volatility, tightening global financial conditions, and the risk of a global recession, the central bank said. Uncertain global demand conditions and a subdued industrial recovery so far add to concerns of an uneven recovery ahead, with demand for high-end products largely unaffected and low-end products likely to be severely impacted.

Even with the increase in capacity utilization, the growth in new order book fell to 5.6 per cent quarter on quarter (Jan-Mar 2022) from 10.5 per cent in Q3 (Oct-Dec, 2021). According to analysts, capacity utilization of 75-80 per cent needs to be sustained for 3-4 quarters to translate into an expansionary drive for the industry.

“Inflation expectations are high, which implies that people will postpone their purchase decisions and push demand for later as people try to protect their savings now. An increase in the cost of funds through a rate hike will reduce demand. As long as inflation expectations moderate and global uncertainty increases, including recent tensions in the China-Taiwan region, further rate hikes are expected this fiscal with another 25-50 basis points hike,” said Devendra Kumar Pant, Chief Economist, India Ratings.

Concerns arising from China-Taiwan tensions could also hurt global demand prospects even as global crude oil prices moderated, translating into additional caution from the RBI. “Today’s policy decision was more encouraging than we expected, and we believe the RBI is effectively being cautious in its policy approach, especially ahead of the winter cycle, when energy prices can be volatile. This is evident in its inflation forecast, which has maintained an average level of 6.7 percent over the past six weeks despite a material decline in global commodity prices, including oil prices. This caution is underscored by the risks noted for the central bank’s current account deficit, which we expect to widen materially,” said Rahul Bajoria, Chief India Economist at Barclays.

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While the RBI has retained the real GDP growth estimate for 2022-23 at 7.2 per cent, experts say overall investment will improve, with the economy not seeing the level of investment-led growth seen in the earlier 2003-2009 period. “Then, both internal and external demand contribute to growth. But right now, the demand side is unlikely to increase in real terms amid high inflation rates. With nominal wages growing at just 3-4 per cent and inflation hovering around 7 per cent levels, demand in rural areas is likely to hit harder,” Pant said.

RBI’s OBICUS also showed that backlog orders grew at 4.7 percent quarter-on-quarter to 4.7 percent from 3.5 percent in October-December 2021 (3, 2021-22), while pending orders grew at 4.6 percent in Q4. Against 7.8 percent in Q3. Average new order book for 207 companies stood at Rs 222.4 crore in January-March this year as against Rs 224.4 crore in October-December 2021 for 205 companies.

Capacity utilization reflects demand conditions in an economy where the production process responds to changing demand and fluctuates accordingly. Rising demand may translate into upward pressure on the general price level and hence higher capacity utilization may be accompanied by an increase in inflation.

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