India's capital expenditure (capex) boom is widely recognized, but as stocks tied to capex have surged over the past three years, the focus is shifting to potential risks. Bernstein's latest report delves into three critical areas of concern: Financing, Policy, and Execution risks.
As India's capex opportunities continue to expand, the significance of financing grows. Two main risks are emerging: the transition of capex drivers from government to private sector, and tighter regulatory scrutiny under the Reserve Bank of India’s (RBI) draft provisioning norms.
Bernstein acknowledges that after more than a decade of limited private sector investment, private enterprises are poised to play a more crucial role in driving capex, shifting from the government which has been the primary force in recent years. The change in capex focus from transport to power and industrial sectors necessitates this shift. Fortunately, the private sector is in a better financial position now, with strong free cash flow generation providing a buffer. Although project scrutiny is more stringent than in the past, ensuring only viable projects get funded, RBI’s draft provisioning norms might slightly raise funding costs by 40-45 basis points. However, Bernstein believes these costs can be mitigated by minor pricing adjustments and do not constitute a significant risk.
With election results around the corner, there's speculation on how a change in government could impact capex policies. The current administration has prioritized infrastructure, shifting focus from subsidies, which grew at 4% annually over the last 11 years, to capex, which has grown at an 18% compound annual growth rate (CAGR). If a new government comes into power—a low probability scenario—it might lean more on the private sector for capex while reallocating government funds towards social schemes. This could lead to a brief period of adjustment followed by a strong upcycle, potentially affecting asset quality. Continuity in government policy would provide a smoother, more sustainable capex cycle.
As India transitions from simpler projects like transportation to more sophisticated ones like electric vehicle (EV) cells and renewable energy, new challenges arise. These include dependency on imported components, rare elements, and advanced technologies—areas where China dominates with 80% of cell manufacturing capacity and 80-98% of solar panel components. Geopolitical tensions and trade policies towards China could disrupt project execution. The Indian government is addressing these challenges through schemes like Production Linked Incentives (PLI). Additionally, 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 capex cycle this time, marked by a shift from transportation to power and industrial projects, and from government-led to private sector-led initiatives. While valuations for capex-related stocks are high, Bernstein favors stocks linked to the power cycle, including generation, transmission, and financing sectors.
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