Private investment, the holy grail for India’s recovering economy

India has seen the longest period of weak investment activity in several decades. Economists at the Reserve Bank of India (RBI) showed in a 2018 paper that the typical Indian investment cycle lasts 12 quarters – followed by five quarters of investment slowdown with seven quarters of rising investment rates (India’s Investment Cycle: An Empirical ) Investigated by Janak Raj, Satyanand Sahu and Shiv Shankar, Reserve Bank of India Working Paper). The magnitude of the decline in Indian investment after the 1991 reforms has been lengthened, but the current one is clearly evident. It is now close to a decade when private sector investment has declined drastically. A fall in the investment rate impairs potential growth, or the rate at which the Indian economy can expand without burning the flames of inflation.

The private sector investment cycle in India is sensitive to many other economic variables, among them capacity utilization, corporate leverage, real interest rates, household financial savings, global growth and government policy. What do each of these variables look like as the pandemic’s second year ends? Economic recovery has been led by profits instead of wages and large firms instead of small enterprises.

Companies will build new capacity only if they are confident that the recovery in existing demand is sustainable. Data from RBI shows that Indian companies still had substantial spare capacity in the first quarter of the current fiscal, and capacity utilization was still down around 15 percentage points which is generally considered a trigger for higher capital expenditure by companies. goes. However, it is quite likely that capacity utilization has improved since then. Companies are also in a better financial position to invest in new capacity. Delivering over the past four years makes it more likely that cash flows will be used to purchase machines rather than pay off additional debt.

Financial conditions are also easing, although it is likely they will tighten next year as central banks withdraw some monetary stimulus. The October meeting of the Monetary Policy Committee was surprisingly focused on real interest rates. Ashima Goyal and Jayant Verma argued in their remarks that the Indian central bank should keep nominal interest rates below inflation for some more time, while Mridul Sagar said that negative real interest rates have to be corrected for savers. .

An extended period of negative real interest rates could impact the financial savings of Indian households, which have returned to normal after the first Covid lockdown in mid-2020 following a sharp increase in forced and precautionary savings. This could happen at a time when international capital flows may be sluggish as global central banks grapple with resurgent inflation. Much of the focus has been on the weak growth in bank credit, although this is no longer a concern as nearly half of the funding for large companies comes from the money market, bond market, stock market and private equity allocation. In addition, bank credit can sometimes be a laggard rather than a leading indicator of economic growth.

Preconditions exist for a revival in the private capital expenditure cycle, although the risks of further disruptions from the pandemic or intensifying global financial conditions cannot be overlooked. As far as investment activity is concerned, the government is mostly doing the heavy lifting, and this will need to continue for another six to eight quarters before private sector capital spending picks up enough momentum. There is also a significant difference between a cyclical recovery and a secular shift in investment spending. The investment rate as a ratio of gross domestic product (GDP) is down six percentage points from its 2007 peak.

Much of the discussion about the private sector investment cycle focuses on the current capacity utilization situation by existing companies. However, the next decade may also see new investments due to the structural shift towards a digital and carbonless economy.

History shows that new ways of doing things emerge after major external shocks. So, for example, will the new wave of investment come from traditional car companies making vehicles that run on fossil fuels or from new firms producing electric vehicles? Or some combination of both? The same question can be asked about their supply chains and many other parts of the economy.

Let’s call them the Keynesian investment cycle based on the production gap versus the Schumpeterian investment cycle based on creative destruction. This is an issue to which this column will return in the coming weeks.

Niranjan Rajadhyaksha is a member of the Academic Board of Meghnad Desai Academy of Economics