India’s capital expenditure (capex) boom is widely recognized, but with capex-linked equities soaring over the past three years, the focus is shifting to potential risks. Bernstein’s latest report takes a closer look at three critical areas of focus: financing, policy and implementation risks.
As India’s capex capabilities continue to grow, the importance of financing grows. Two major risks are emerging: the transition of capital investments from the government to the private sector, and increased scrutiny by regulators under the Reserve Bank of India’s (RBI) draft provisioning norms.
Bernstein recognizes that after more than a decade of limited private sector investment, private enterprise is poised to play a more critical role in driving capital investment, thereby fueling the shift away from government that has occurred in recent years the main driving force has been to start playing. The change in the focus of capital investments from the transportation to the energy and industrial sectors necessitates this shift. Fortunately, the private sector is now in a better financial position, with strong free cash flow providing a cushion. While scrutiny of projects is stricter than in the past so that only viable projects are financed, RBI’s draft provisions could increase borrowing costs slightly by 40 to 45 basis points. However, Bernstein believes these costs can be mitigated by small price adjustments and do not pose a significant risk.
With the election results approaching, there is speculation about how a change in government could affect investment policy. The current government has prioritized infrastructure and shifted focus from subsidies, which have grown at 4% per year over the past eleven years, to capex, which has grown at a compound annual growth rate (CAGR) of 18%. If a new government comes to power – a scenario with little likelihood – it could rely more on the private sector for capital investments, while reallocating public funds to social schemes. This could lead to a short adjustment period followed by a strong upward cycle, potentially impacting asset quality. Continuity in government policy would ensure a smoother and more sustainable investment cycle.
As India moves from simpler projects like transportation to more advanced projects like electric vehicle cells (EV) and renewable energy, new challenges arise. These include dependence on imported components, rare elements and advanced technologies – areas where China dominates with 80% of cell production capacity and 80-98% of solar panel components. Geopolitical tensions and trade policies towards China could disrupt project implementation. The Indian government is addressing these challenges through programs such as Production Linked Incentives (PLI). Furthermore, there is a shift from large-scale projects to smaller, more varied projects, which could reduce policy focus and introduce new risks.
Despite the highlighted risks, Bernstein sees a smoother investment cycle this time, marked by a shift from transportation to energy and industrial projects, and from government-led to private sector-led initiatives. While valuations for capex-related stocks are high, Bernstein favors stocks related to the energy cycle, including the generation, transmission and financing sectors.
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