This article is partially in response to a recent ThePrint report on private sector investment in India, although the topic is of deep interest in itself. The nature of the arguments in the said article appears somewhat simplistic. It suggests an inadequate appreciation of the complexities underlying the causal factors determining private sector investment decisions and dynamics.
To begin with, the author himself notes that in nominal terms, “private investment hit an ‘all-time high’ of Rs 10.5 lakh crore in the January-March 2023 quarter”. In addition, our research, using the declared results of around 3,000 listed companies, showed that private sector investment during April-September (FY23) had been Rs 3.3 lakh crore, jumping from Rs 2.6 lakh crore in the first half (H1) of FY22 and higher than the pre-pandemic level of Rs 2.8 lakh crore in the H1 FY20. Note that even after allowing for possible differences between the two underlying databases, the trend suggests a significant acceleration in the momentum of private sector investment between H1 and last quarter (Q4) of FY23. The author’s number suggests that averaging the two quarters of H1, private sector investment in Q3 had been broadly 2.5 times that of Q1.
The analysis that private investment as a share of GDP has fallen from a “peak of 27.5 per cent” in 2007-08 is correct. The ratio of total investment, Gross Fixed Capital Formation (GFCF), to nominal GDP has fallen from 34.3 per cent in FY12 to 29.2 per cent in FY23. Total private sector investment, including corporations, financial intermediaries and households, has fallen from 27.0 per cent in FY12 to 21.8 per cent in FY22. However, this trend has reversed since FY21, with total investment rising from a low of 27.3 per cent of GDP to 29.2 per cent in FY23 (the decomposition into private and public investment is only available till FY22).
The substantive reasons for this drop and the underlying dynamics are as follows.
Corporate debt
Fall in the private investment to GDP ratio can be attributed largely to an unwinding of an unsustainable level of corporate debt built up over the previous decade. The 2022-23 Economic Survey (ES23) has extensively analysed the “unfolding of the private capital investment cycle”. Bank of International Settlements (BIS) data shows that core debt of the private non-financial sector had risen to over 110 per cent of GDP from FY10 to FY12, with a deterioration in corporate financial metrics like debt/equity, interest cover and other ratios.
Recall that investor perceptions of the resulting stress in a substantial segment of the corporate sector had been one of the reasons for the severe financial sector volatility during the “taper tantrum” in mid-2013. Despite multiple corrective measures, the problems related to the financial sector’s overexposure to corporate debt persisted, for instance, in the Non-Banking Financial Companies (NBFC) crisis of 2018. Remember that one of the lessons of the past financial crises in Asia and Latin America was that a significant amount of capital destruction is required before a new investment cycle can begin. In fact, in India, the adverse effects have been more limited.
The progressive amelioration of India’s “twin balance sheet problem” is well documented. Private non-financial corporate balance sheets and profit and loss metrics have improved significantly. The ES23 noted that private sector leverage significantly improved from 113.0 per cent of GDP in December 2010 to 83.8 per cent in December 2018. The share of debt in the total of the weakest corporates—those with an Interest Cover (IC) ratio less than one or Debt to Equity greater than 2—has reduced as of FY22.
The obverse side of this improvement is the increased robustness of the health of financial intermediaries—banks, NBFCs, and others—which are now considered to be amongst the best-capitalised and least risky in the world. The conditions required for the next cycle of private investment and capital expenditure (capex) are increasingly in place, ready for leveraging. But the bottom line is that the risk appetite for financing large projects, which had been seriously depleted, takes a long time to rejuvenate.
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Tech push, better investment efficiency
The share of “services” (including construction) has increased from 58.6 per cent of nominal GDP in FY12 to 60.6 per cent in FY23. Services are widely presumed to be less capital-intensive than manufacturing. Yet, many service segments are higher paid than manufacturing, contributing to growth in private consumption, which will result in increased demand. Manufacturing Capacity Utilisation at the end of 2022 had risen to 74.3 per cent, which, is lower than pre-2008 levels but is within reach of the thresholds at which fresh capex is likely to come into play.
Investment efficiency has also increased. Improvements in technology have enabled a drop in the Incremental Capital Output Ratio (ICOR). Inflation-adjusted (real) ICORs have fallen to an average of 5.22 during FY14 to FY23 (excluding FY21) compared to 5.68 over FY02 to FY13. A key component of this is the technological advances which require less land for large plants in sectors like cement, steel and power, reducing the quantum of required project costs.
As a corollary, small and micro businesses contribute a larger share of new investments. One of the changes during the pandemic was the marked increase in excess financial savings of the household sector in FY21, which then translated into an equally sharp increase in physical investments since FY22. A majority of the segment classified as “households” include these enterprises which dominate—in terms of number—the granular economic landscape of India: farmers, businessmen, traders, professionals and self-employed persons, proprietorships and partnership concerns, etc. Investments by households in “Plant and Machinery” in aggregate have been increasing since FY17, although the individual capex ticket sizes are smaller. This is also reflected in the increase in bank credit to micro and small segments of industry and services.
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Reduced inflation cost
The role of inflation in increasing project costs has been reduced. Moderation in inflation pressures—leaving aside the present supply shocks— has emerged as among the significant structural transformations over the past decade, particularly since the introduction of an inflation-targeting monetary policy approach. The GDP deflator, the broadest measure of inflation, has averaged 3.6 per cent year on year from FY14 to the pre-pandemic year FY20. This compares with an average of 8.0 per cent over FY05-06 to FY13.
ThePrint analysis attributes a “lack of confidence in how the economy is being managed” as the proximate cause for the lower investment / GDP ratio. In fact, the article is sub-titled “A vote of no confidence”. This is quite a remarkable stretch in identifying the causal factor. “Confidence” is intangible and must be inferred indirectly from various metrics. For one, recent trends in various RBI surveys show business confidence at high levels. The Industrial Outlook Survey’s Business Expectations Index reported net response index is at 126.4 for June 2024 just lower than the pre-global financial crisis peak of 127.5 in Q1 FY08. The Infra Sector Outlook Expectations index for H2 FY24 is close to the peak in Q1 FY16.
Foreign long-term investors are certainly yet to be reticent in their confidence. Despite a sharp global slowdown, tightening of financial conditions and significant losses for investors across all asset classes, India still received Foreign Direct Investment (FDI) of $44.5 billion over April to February FY23 (compared to the $ 55.5 billion in the corresponding months of FY22 when the world was awash in central banks infused liquidity). Notably, reinvested earnings from prior FDI were higher during this period than in the previous year.
This does not suggest that the stakeholders, including the government, should become complacent. Other than the focus on capital expenditure, over almost a decade, the government has undertaken deep reforms across multiple domains – regulatory, institutional, legal, process, etc. – to enhance India’s competitiveness in the global ecosystem progressively. In particular, the focus on fiscal discipline and consolidation has helped boost investor confidence. Recently, Finance Minister Nirmala Sitharaman reiterated a commitment to continue with the reform agenda to create a stronger and more dynamic economy. This effort is beginning to show results as India progressively integrates into global supply chains, and the momentum will only increase.
The author is Executive Vice President and Chief Economist, Axis Bank. Views are personal.
(Edited by Ratan Priya)