India Inc is not investing the money it has raised from markets, and that should worry you

Bull run in a china shop

The simple question is this: If companies do not want to invest in India, why are they raising money from the equity markets?

Pranav Haldea, Managing Director of PRIME Database, has an explanation for low capital investments by India Inc in the economy despite record fund-raising from the markets. "If you look at the breakup of Rs 1.6 lakh crore raised from the markets in 2017, you will see approximately 45% of the money was raised through Initial Public Offers, of which 80% was Offer For Sale (where promoters or PE/VC funds sold their stake) and just 20% was raised as fresh capital," he points out.

The bull run in the stock markets was achieved on the back of retail investors who are investing in the markets with the help of institutional investors.

More than 9 lakh systematic investment plans (SIP) accounts were added on average every month in 2017. SIP funds shot up to Rs 5,893 crore from Rs 3,973 crore just a year ago.

What the break-up of fund raising by Indian corporates suggests is that a large number of promoters, as well as other company investors like Private equity and venture capitalists, were raising money to reduce their own exposure in Indian companies.

It also suggests that the promoters of Indian companies are not hopeful about India's economic prospects in the near future and want to make the best use of the bull run in the stock markets by reducing their stakes.

Paying for past capacities

The high price/earnings or P/E ratio of BSE listed companies is an indication that those purchasing stock of Indian companies are doing so despite weak growth in their revenues and profits. India is one of the most expensive markets in the world with S&P's BSE Sensex having a P/E ratio of 23.66 as on 8 January, 2018, for the 2017-18 fiscal.

Net sales growth for a majority of BSE listed companies in the second quarter of fiscal 2017-18 was reported in single digit. While many believe that the third quarter earnings would be better, one does not expect a growth that justifies the high valuations of these companies.

Ravi Srivastava, a professor of economics at Jawaharlal Nehru Universtity says, “Indian companies had over-invested in capacity creation between 2003 and 2008 period. Those capacities are still not utilised because of lack of demand. Unless and until those capacities becomes fully functional we can't expect the companies to make big investments in future projects.”

Does that mean that a large number of people investing in stock markets today are paying for the capacity created by companies in the last decade? That is a difficult question to answer. However, one thing is sure: There's an asset bubble in the Indian equity markets. Whether it will burst or not will depend on how soon the earnings of Indian companies improve, and how soon the Indian companies begin to increase capital expenditure to create new capacities.

DK Joshi, chief economist at Crisil Ratings says, “It will take 4.5 quarters of sustainable growth before Indian companies begin to invest in India”. Srivastava, on the hand, adds a caveat to this time period, saying, “There should not be any new shock to the Indian economy in the next one year (external or internal) for the private sector investment to be back.”

But what if the bull run stops in this period? That is a thought that investors are hoping they will not have to deal with. After all, what else can they do now that they've purchased some of the most expensive stocks in the world?