Weighing in on India’s investment-led recovery


Prospects for a sustained recovery in investment are expected to harden with the depreciation of the rupee and rising inflation

Prospects for a sustained recovery in investment are expected to harden with the depreciation of the rupee and rising inflation

Finance Minister Nirmala Sitaraman said recently that India’s long-term growth prospects are being built into public capital expenditure plans. She added that an increase in public investment would attract (or attract) private investment, thereby reviving the economy. The minister was speaking at the Third Meeting of Finance Ministers and Central Bank Governors (FMCBG) of the G20 hosted by Indonesia in Bali.

Delay in investment

Economic growth driven by public investment has a respectable academic pedigree and is a credible explanation for India’s post-independence economic growth. Here is an illustration. When faced with a downturn after the 1997 Asian financial crisis, the Atal Bihari Vajpayee government led by the National Democratic Alliance launched public road construction projects. In the form of the Golden Quadrilateral (to connect metropolitan cities with a high-quality road network) and the Pradhan Mantri Gram Sadak Yojana (to “provide good all-weather road connectivity to unconnected dwellings”), these initiatives sowed the seeds of economic revival, culminating in an investment and export boom in the 2000s; GDP grew by 8% to 9% per year.

By comparison, the record of investment during the 2010s has been dismal. However, a slight rise is evident in the real rate of gross fixed capital formation (GFCF) – the ratio of fixed investment to GDP (net of inflation). The ratio fell to 32.5% in 2019-2020 from a low of 30.7% in 2015-16 (figure).

Ms. Sitaraman claimed that the government has maintained the pace of investment even during the novel coronavirus pandemic (2020-21 and 2021-22). As in the June edition of the Ministry of Finance’s Monthly Economic Review, the fixed investment-to-GDP ratio was 32% in 2021-22. However, care should be taken when reading the most recent data, as it is subject to revision. Moreover, the budgetary definition of investment refers to financial investments (which include the purchase of existing financial assets, or loans offered to states) and not just capital formation representing an expansion of productive potential.

On gross capital formation

National accounts statistics provide a disaggregation of gross capital formation (GCF) by sector, type of asset and mode of financing; more than 90% of the GCF is made up of fixed investments. The rise in the investment rate is welcome, although its productive potential depends on its composition. Contrary to Ms. Sitaraman’s claims, the distribution of investment has changed little over the past decade, with the public sector share remaining at 20%.

The table shows the distribution of the GCF by agriculture, industry and services (columns 1 to 3); in service transport (column 3.1) and in transport, roads (the largest item of expenditure; column 3.1.1).

Between 2014-15 and 2019-20, the shares of agriculture and industry in fixed capital formation/GDP fell from 7.7% and 33.7% to 6.4% and 32.5% , respectively. The share of services increased to 52.3% in 2019-2020 from 49% in 2014-15. The rise in the services sector is almost entirely on transport and communications. The share of transport doubled from 6.1% to 12.9% during the same period. In transport, it is mainly roads.

Since roads and communications are classic public goods, investments in these goods are welcome. But overemphasizing this can be unbalanced. For healthy growth of domestic production, it is necessary to find a balance between “directly productive investments” (in farms and factories) and investments in infrastructure. And this balance has been missed. In addition, the share of agriculture and industry declined even as the rate of gross capital formation in the economy tended to decline (see figure).

Import dependency has increased

The case of manufacturing is distressing. Its share in the investment rate (column 2.1) fell from 19.2% in 2011-12 to 16.5% in 2019-20. Not surprisingly, ‘Make in India’ has failed to take off, import dependency has increased and India has deindustrialized. Import dependence on China is alarming for critical materials such as fertilizers, bulk drugs (active pharmaceutical ingredients or APIs) and capital goods. This worsened during the COVID-19 pandemic when China imposed export restrictions, prompting the prime minister to announce the “Atmanirbhar Bharat” campaign.

Instead of boosting investment and domestic technology capabilities, the “Make in India” campaign wasted time and resources to raise India’s ranking in the (debatable and disputed) ease of doing business index. of the World Bank. India’s position rose from 142 in 2014 to 63 in 2019, but it failed to boost industrial investment, let alone foreign investment.

The contribution of foreign capital to GCF financing fell to 2.5% in 2019-20 from 3.8% in 2014-15 (or 11.1% in 2011-12). With the decline in the investment share, the growth rate of industrial production fell from 13.1 percent in 2015-2016 to 2.4 percent in 2019-2020, according to national accounts statistics.

Public investment

The Minister of Finance affirmed that public investment is the backbone of the ongoing investment-led economic recovery. The recent upturn in the aggregate fixed capital formation-to-GDP ratio is positive, although the rate remains below its level of the early 2010s. not confirmed by the facts. The jury could still be out on the suggested increase in public investment during the COVID-19 pandemic. Budget figures refer to financial investment, not capital formation estimates, indicating an expansion of the economy’s productive capacity.

During the 2010s, the investment shares of agriculture and industry declined but rose sharply in services. The percentage share of roads has doubled. The expansion of roads and communications is certainly welcome. Given such a skewed investment priority, the “Make in India” strategy failed to take off, deepening India’s dependence on imports, especially from China, leading to deindustrialization.

Lack of domestic capacity for essential industrial raw materials and capital goods could prove costly. This will likely test India’s ability to withstand external economic challenges. With a depreciating currency and rising (imported) inflation, the prospects for a sustained recovery in investment may become more complicated. The balance of payments deficit is already well above policymakers’ comfort level of 2.5% of GDP.

R. Nagaraj works at the Center for Development Studies in Thiruvananthapuram. Opinions expressed are personal


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