Private investment conundrum: Policy intervention to improve prospects

The Union government has increased capital expenditure after the pandemic-induced disruption. Aside from supporting demand during the recovery phase, the implicit assumption was that, at some point, the investment baton would be passed on to the private sector, which will sustain growth. The Union government’s capital expenditure increased from 1.67 per cent of gross domestic product (GDP) in 2019-20 to 3.4 per cent in 2024-25. Although the recovery from the pandemic was sharp — partly driven by statistical effects — revival in private investment has remained tepid. It is worth noting that the weakness in private investment goes back to pre-Covid days. The state of investment in the pre-pandemic years can be partly explained by what was termed the “twin balance sheet problem”. Both corporate and bank balance sheets came under significant stress in the years after the global financial crisis. The problem has since been fully resolved and the balance sheets of both corporations and banks are in good shape. However, the private sector is still unwilling to invest in a big way.

 

India’s gross fixed capital formation at constant prices is expected to be at 33.4 per cent of GDP this financial year. This will need to be pushed up to attain sustained higher growth. Prime Minister Narendra Modi, in this respect, this week asked Indian companies not to be mere spectators. He argued they should seek global opportunities and accept challenges. The issue of private investment also came up frequently in Manthan, the annual thought leadership summit hosted by this newspaper last week. Union Finance Minister Nirmala Sitharaman noted that the private sector should talk about what was stopping them from speeding up investment. Besides higher expenditure on improving infrastructure, the government is doing several things to facilitate investment. It has, for instance, removed over 42,000 compliances since 2014. Over 3,700 legal provisions have also been decriminalised, and the government is continuing to move in this direction. The prospects of a Deregulation Commission are being discussed. Since investment on the ground takes place in states, the commission, depending on its terms, will need to collaborate with states. High growth in the 2000s was, in a way, made possible by reforms in the 1990s.

 

Although some of the proposed measures can be classified as continuing efforts to improve the ease of doing business and will show results over time, there could be a variety of reasons why Indian firms are not investing in a big way. The data collected by the Reserve Bank of India shows capacity utilisation in manufacturing is at about 75 per cent, marginally higher than the longer-term average. It is typically the level at which firms start contemplating fresh investment to augment capacity. However, they may be reluctant because of at least two important reasons. First, the global economic environment has been uncertain for quite some time. The uncertainty only increased after the return of Donald Trump as American President. Second, there is significant overcapacity in China, which limits the prospects of increasing exports.

 

India’s high-growth years in the 2000s, with increased investment, were also a period of high growth in exports. The share of exports in GDP, according to the data maintained by the World Bank, increased from about 15 per cent in 2003 to over 25 per cent in 2013. It fell to about 18.7 per cent in 2019. Although the share has recovered since, it remains significantly below the peak. The weakness in investment and overall growth can partly be explained by export performance. While the government is easing duties on this front, a lot more will need to be done.