Investing for growth

Private-sector investment revival is crucial

The Government of India has been pushing capital expenditure to enable higher economic growth in the post-pandemic period. The idea is higher government capital expenditure will not only build the much-needed infrastructure in the country but also increase economic activity, which will encourage the private sector to invest. However, as this newspaper reported on Wednesday, several states are lagging and have reached only about a quarter of their capex target for the financial year. The role of investment in pushing economic growth has once again been underscored in a comprehensive study by the World Bank, published in the latest Global Economic Prospects report. Like the rest of the world, investment in India suffered significantly after the global financial crisis. India faced a twin balance-sheet problem where both corporate and bank balance sheets were stressed. It has now fully recovered from that phase and there are tentative signs of revival in private-sector investment, though their sustainability remains to be seen.
 

The World Bank study examined 104 economies, which included 35 developed and 69 emerging market and developing economies (EMDEs), between 1950 and 2022. As the study notes, during the periods of investment acceleration, output growth in EMDEs increased to 5.9 per cent per year, which was 1.9 percentage points higher than in other years. Empirical analysis in general and case studies highlighted in the report present three key observations related to the role of policy in enhancing the rate of investment that are worth discussing here. First, policy interventions that improve macroeconomic stability, such as efforts to reduce the fiscal deficit and the adoption of inflation targeting, along with structural reforms, including interventions to ease international trade and capital flows, have been seen to be helpful in increasing investment. Second, specific policy interventions play a role, but a comprehensive package of policy interventions that enables greater macroeconomic stability and focus on structural issues tends to significantly improve the possibility of accelerating investment growth. Third, the role of institutions, such as a well-functioning and independent legal system, is crucial. This is understandable because a well-functioning judicial system inspires confidence among investors and entrepreneurs because it makes enforcing contracts easier.
 

In this context, it is worth noting that India has a fairly high degree of macroeconomic stability. Nonetheless, it needs to improve its fiscal position. However, a higher level of fiscal deficit, to an extent, is being driven by higher government capital expenditure to induce private investment. A difficult policy question the government perhaps will soon need to address is: At what point should it start withdrawing to create space for the private sector? On the external front, while India has a fairly high degree of capital mobility, there have been some reversals on the trade side owing to tariff increases in recent years, which some economists believe will affect long-term growth.
 

Further, while India has an independent judiciary, its ability to enforce contracts is not at the level desired, which was also reflected in the (now suspended) ease of doing business rankings of the World Bank. The study also highlighted how a series of reforms that India initiated in the 1990s increased investment and growth in that decade. Given that the global economy is expected to grow at a slower pace in the foreseeable future and instances of investment acceleration have declined globally in recent years, Indian policymakers may have to go the extra mile to facilitate investment and growth in the medium term.