The investment puzzle

Sustainable demand revival will need policy certainty

Demand destruction caused by the pandemic and associated restrictions seemed to have moderated over the past year, with the resumption of mobility and trade. This had led to hopes that private investment in the economy would revive, putting a growth recovery on firmer footing. The Indian economy in recent times — indeed, for years even prior to the pandemic — had suffered from the unwillingness of private capital to increase investment. As a proportion of gross domestic product (GDP), gross fixed capital formation has never reached the sustained high levels observed in the high-growth years of the 2000s. But there appeared to be a clear uptick in the trend, with its share of real GDP improving to 34.7 per cent in the first quarter of 2022-23 as compared to 32.8 in the equivalent quarter of the previous year. Some had hoped this uptick was driven by a similar increase in the share of private demand — private final consumption expenditure as a share of real GDP was over 3 percentage points higher in the first quarter than it was in the equivalent pre-pandemic quarter. Yet another explanation might simply be that both shares are responding to a fall in government expenditure as a fraction of GDP.

The dynamics of private demand are crucial because unless companies see demand returning to the economy they are unlikely to make major investment efforts. Alongside uncertainty about the actual path of domestic demand, there is increasing clarity that various headwinds are likely to operate on global growth as well. Inventories built up during the pandemic as a consequence of traders responding to supply interruptions will have to be run down first. Many large trading blocs are still not reaching the import levels displayed prior to the pandemic. Alongside cuts in growth expectations and galloping inflation, there is a reasonable chance that global demand will not recover on the timeline and to the levels that Indian exporters would prefer. Prices will likely respond to this lower than expected demand, reducing global earnings and therefore negatively affecting companies’ incentives to invest.

The government recognises the centrality of private investment to the growth recovery, and also that it cannot forever push up growth through its own current spending and investment. Union Finance Minister Nirmala Sitharaman recently asked industrialists why, given reductions and rationalisations in corporate taxes and the launch of various incentive schemes such as production-linked incentives, or PLIs, private sector investment was still below par. Part of the answer is no doubt the uncertainty discussed above. However, capital utilisation within the manufacturing sector is now hitting levels it has not seen for a while, crossing 75 per cent in the last quarter of 2021-22, which offers hope. Bank and corporate balance sheets that were seen as major constraints have also improved considerably over the past several quarters. The pieces are in place for a recovery in private investment over the medium to long term — if both debt levels and capacity utilisation continue this trend over the next quarters. The expected level of sustainable growth in both the domestic and global economy would now be the most important factor. On its part, the government should aim to provide policy certainty.