Have the Capacity Utilisation Rates Bottomed Out?

Mon, 23 May Pre-Open

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The extent to which the productive capacity of a plant or a firm has been utilized is measured by the Capacity Utilisation levels. It is a key indicator of the current level of productivity and potential for future investments. This indicates the company's ability to actually utilize its present total installed capacity. The trends in movement of capacity utilisation generally gives us an idea of the investment climate. An improvement in this metric could be a sign of increased demand and hence is a lead indicator for any fresh investments to be made to expand capacity.

The Reserve Bank of India on a quarterly basis provides a macro report on the capacity utilisation levels of manufacturing companies. It also provides key information such as inventory levels, finished goods levels, etc. It threw some interesting insights.

Over the past five years, the utilisation levels are on a decline, peaking in 2010-11 at 79.9%. However, since then there has been a steady drop in the numbers. The present levels recorded for Q3FY16 stood at 72.5%.

According to a report published by CARE ratings, one third of the variation in capacity utilisation is explained by the changes in manufacturing rate. i.e. the Index for Industrial Production (IIP) growth rates. Thus there is a strong relationship between both of them.

Interestingly, the utilisation levels were highest in 2010-11 when the interest rates were low with the RBI resorting to repo rate hike in the latter half of that year. The Index for Industrial Production (IIP) growth rate was also relatively high at 8-9%. The IIP numbers began to moderate from FY12 onwards, due to the increase in interest rates and a slowdown in the demand adversely affected the capacity utilisation rates.

The trend in the Index for Industrial Production can thus be one of the reliable indicators for a sign of revival in the utilisation numbers.

With over 50% of the incremental capital expenditure done in the 2013-14 period, some sectors saw overcapacity resulting in a hit to the utilization levels. Weakness in the overall demand made matters worse for the companies.

We believe that there is good news on the anvil. Higher demand for commercial vehicles particularly trucks are an early signs of a reviving economy. We can already see a small but visible recovery in demand from the improvement of utilization levels from the lowest levels of 70%.

The key metric to watch out for would be the growth in IIP numbers as it would drive utilisation rates higher. This, in turn, would kick off the capex cycle and revive growth in the Indian economy.

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