Investment revival: Why reliance on govt spending alone is unsustainable

Among the four drivers of the economy — private consumption, investment, government spending, and exports — government spending, particularly through capital expenditure, has been the predominant force behind India’s growth in recent years. In the ongoing year, the Union government’s capital-expenditure allocation, for instance, stands at 3.4 per cent of gross domestic product. However, reliance on government spending to drive economic growth is not sustainable in the long run because of fiscal constraints at both the Union and state levels. As the fiscal space tightens, it will be important for private investment to pick up to sustain economic growth over the medium to long term.

In this regard, the recent data from the Reserve Bank of India (RBI) showed a rising capacity utilisation rate in manufacturing. As of the fourth quarter of 2023-24, capacity utilisation reached a decadal high, consistently hovering around 75 per cent since the third quarter of 2021-22. Higher capacity utilisation typically encourages businesses to expand their production capabilities, thereby driving new investment. However, the ratio of inventories to sales remains significantly elevated compared to pre-pandemic levels. Although it has decreased from its peak of 113.8 per cent in the first quarter of 2020-21 to 65.4 per cent in the fourth quarter of 2023-24, this persistent elevation reflects uncertainty and weakness in consumer demand. This disparity between rising capacity utilisation and persistent inventory levels perhaps indicates that consumption revival at scale is slower than expected, which may not encourage corporations to immediately start investing in a big way. As reported by this newspaper on Wednesday, for example, India’s largest carmaker, Maruti Suzuki India, is “adjusting” its production to ease inventories with dealers.

Besides, as an analytical chapter in the latest RBI monthly bulletin shows, India’s manufacturing sector has a high level of spare capacity compared to other major economies, such as Brazil and those in the European Union. Spare capacity refers to the additional output that can be achieved under current conditions if demand were to increase. The spare capacity in India’s manufacturing is also higher than that of the services sector, further underscoring the existing room for expansion in production if demand recovers. However, on the positive side, both the corporate and bank balance sheets are in a healthy position, and that should aid private-investment revival. According to Moody’s Ratings, Indian companies are projected to invest $45-50 billion annually over the next one-two years as they expand capacity. This spending will be driven by efforts to increase vertical integration, achieve net-zero targets, and enhance self-sufficiency. Moody’s also estimates consolidated earnings for rated companies in India to grow by 5 per cent annually over the next two years, supported by broadbased growth across various sectors.

The data on bank credit also indicates improvement in investment. However, it may still be too early to say a broadbased private-sector investment revival is underway. Capacity utilisation has increased, but industry also has higher inventories. Thus, a lot will depend on how private consumption demand moves in the coming quarters. A good monsoon and revival in rural demand could help. But investment will be driven also by global factors. Increased geopolitical tensions, trade disruption, and a possibility of demand slowdown in advanced economies will affect export demand and investment. Significant excess capacity in China will also have a bearing on investment in India, particularly in the exporting segments.