Time to revive the animal spirits as private investment stays weak

There have been three disconcerting features of private corporate investment in India. First, a quantitative test suggests that a structural break occurred in 2011-12, highlighting a regime shift in the way private investment has behaved in the economy. Private gross fixed capital formation growth decelerated sharply to 10.3 per cent during 2012-24, from 40.7 per cent during 2003-08 and 25.2 per cent in 2003-12.  

 

The year 2011-12 was when the uncertainty index was at its peak due to weak macroeconomic fundamentals — high inflation, an unsustainable current account deficit, large capital outflows, and pressure on the exchange rate. India was described as one of the five most fragile emerging economies in 2013. 

 

 Second, the accelerator effect (a rise in private investment in response to a rise in economic activity) has weakened sharply post-2011-12. A one per cent increase in gross domestic product (GDP) growth now translates into an approximately 1.5 per cent increase in private capex, compared with about 3 per cent growth during 2003-12. This suggests that GDP growth no longer amplifies private investment as much as it did before 2011-12. 

 

Third, public capital spending hardly “crowds in” private investment, with the correlation between public investment and one-year-forward private investment collapsing to 0.13  post-2012-13, from 0.54 during 2003-12.

 

The slowdown in private investment has been particularly acute in the sectors where it hurts the most — investment-heavy and employment-generating ones such as manufacturing, trade and hotels, construction, and electricity — which together constitute about 40 per cent of gross fixed capital formation. Private corporate investment has also been impacted by net foreign direct investment (FDI) flows, constituting 0.01 per cent of GDP in 2024-25, the lowest in 25 years, despite record gross inflows. 

 

Weak demand drags private investment: The slowdown in private capex has been driven by weak demand, both domestic and external. This is reflected in weak capacity utilisation, hovering at 70-75 per cent, significantly below the 80 per cent threshold level typically required to trigger new investments.  Capacity utilisation has been particularly weak in steel, cement, and passenger vehicles. 

 

Real private final consumption expenditure (PFCE) growth during 2012-24 was a tad higher at 6.1 per cent, compared with 6 per cent during 2002-12. However, in nominal terms, PFCE growth was much weaker at 11.6 per cent vis-à-vis 13.5 per cent. Both the wholesale price index (WPI) and consumer price index (CPI) inflation rates, which are used to deflate the nominal values of the constituents of GDP, were significantly lower after 2012-13, pushing up real PFCE. That is, real private final consumption has not been as strong as reflected in the numbers because of the inappropriate use of deflators. The government, therefore, would do well to expedite the use of the producer price index and apply double deflators (separately for inputs and outputs) to deflate nominal values and obtain an accurate picture of economic activity and its key constituents.

 

Multiple factors have contributed to weak private consumption in the country, such as the slowdown in wages — both in the informal and formal sectors —high goods and services tax (GST) rates until recently, and rising financial liabilities of the household sector. 

The slowdown of external demand has also  weighed heavily on our non-oil exports, which grew at an annual average rate of 8.1 per cent in nominal terms during 2012-24, vis-à-vis 19.9 per cent during 2003-12. Reflecting the overall capex slowdown, imports of capital goods have also slowed down.

 

To be fair, private investment has slowed down in all emerging market and developing economies (EMDEs) following the North Atlantic Financial Crisis in 2008, weakened, among other factors, by sluggish global trade and declining FDI inflows. However, the sharp slowdown in private investment in India is far more concerning for at least three reasons. 

 

First, India does not rely on external demand as much as other EMDEs. Second, even with recent relentless fiscal consolidation, the general government was able to push capital expenditure. Therefore, public capital spending in India did not slow as much as in other EMDEs. Three, business environment in the country has remained far more conducive relative to many other EMDEs with easy access to finance, the initiation of key structural reforms and political stability. 

 

The improving outlook : It has now been over a decade since the growth rate of private investment has remained weak. However, many recent developments bode well for its revival. Since the root cause of the slowdown in private capex has been weak demand, the government has done well to boost private consumption — first by providing direct tax relief in the last Union Budget and  later by rationalising GST rates. 

 

Companies have deleveraged and banks have cleansed their balance sheets. Interest rates have declined significantly, and the banking system is flush with liquidity. Resource mobilisation from the primary capital market has improved markedly since 2019-20. The share of capital goods imports in total imports has risen in recent years. Global macroeconomic and geopolitical uncertainty is the only major factor of concern from an investment standpoint.

 

To conclude, the revival of the private capex cycle is contingent upon sustained demand growth and a favourable business environment. Therefore, the recent rationalisation of GST rates is one of the most significant steps taken by the government, as it could help spur private consumption. It should now be followed up with free trade agreement with the US and the European Union on mutually beneficial terms, and to identify areas where structural reforms could be initiated to boost productivity and unleash the “animal spirits” of corporate India.

 

The authors are, respectively, senior fellow and  research associate at the Centre for Social and Economic Progress. The views are personal.