India’s economic engine has been logging growth rates of over 7 per cent in the last three years. This has been partly driven by a focus on infrastructure creation, with government capital expenditure (capex) in construction and public administration growing by over 10 per cent on average during this period. At 3.4 per cent of GDP, government’s capex in this year’s Interim Budget doubled from 1.7 per cent in 2019-20. It is expected that the thrust on capex will continue in the upcoming Budget. Despite the significant increase in capex, private sector investments have remained subdued, posing a considerable challenge to sustaining high growth.
In emerging economies such as India, the complementarity between public and private investments is natural. Public investment leads to job creation, increases income, and creates necessary infrastructure. These enhance private investment’s profitability that lead to higher investment and kick-starts a virtuous cycle. Has this cycle been broken?
The higher growth in the 2000s was a testament to the power of this cycle. As the government embarked on ambitious infrastructure projects, this catalysed private investments. Between 2000-01 and 2004-05, Central Government capex grew by 19 per cent annually (CAGR), expanding from 2.2 per cent to 3.6 per cent of GDP, while private capex grew by 20 per cent annually (CAGR), increasing from 2.9 per cent to 4.7 per cent of GDP in the same period. While Central government capex is gleaned from Budget documents, we measure private investment (as the total cash flow towards the purchase of fixed assets for over 40,000 non-financial companies) from CMIE.
However, the lag between government outlays and the actual construction of infrastructure means that the impact of government capex on private investment has a delayed effect. So, while government capex ( per cent of GDP) peaked in 2003-04 (3.9 per cent), private investment peaked in 2007-08 (8.6 per cent), just before the onset of the financial crisis.
The 2010s witnessed a gradual slowdown in investments and economic growth. The deceleration in government capex to 8 per cent annually between 2010-11 and 2018-19 corresponded with a commensurate decline in private investments growth of 4 per cent annually, highlighting the indispensability of the former in creating an enabling environment for the latter to thrive.
The twin-balance sheet crisis was another major impediment to private investment in the 2010s. The decline in global demand and commodity prices in the early years of the 2010s led to a worsening of the profitability of corporates and banks accumulated large amounts of non-performing assets (https://shorturl.at/bjtM4), which constrained the credit supply to corporates, leading to a significant slowdown in investment activity.
Reigniting the cycle
There was a visible decline in the growth rate before Covid-19. Public capex plays a crucial role in the virtuous cycle by releasing the constraint on demand and profitability. The government made a big push towards infrastructure creation to support growth by stimulating demand to increase private investment. Further, the government cut corporate tax. The lower tax rates were expected to incentivise higher investment as a larger fraction of the profit was made available to corporates.
The government increased its capex share in GDP from 1.7 per cent in 2019-20 to 2.7 per cent in 2022-23, growing by over 21 per cent annually, but, we don’t see any green shoots in private investments — the complementarity between public and private capex seems to be broken which is surprising.
Concerted efforts to clean the banking system and surge in commodity prices in recent years have improved the banking sector’s health. Gross NPAs fell to an all-time low of 3 per cent by December 2023 suggesting that loan supply has not deterred private investment.
Moreover, higher commodity prices and inflation have led to a record surge in corporate profitability. Hence, the unavailability of cash flow and equity contributions by corporations cannot be cited as a reason for lower private investments.
One potential factor behind the sluggish private capex is the trajectory of future consumption in the economy. Private final consumption grew by a moderate 4 per cent in 2023-24, the lowest in over a decade (excluding Covid). The erosion of household balance sheets, amplified by factors such as inflationary pressures and income stagnation, has dampened consumer confidence and affected spending.
Net household financial savings in 2022-23 have fallen to 5.1 per cent (of GDP) relative to its long-term average of 7-7.5 per cent, driven by a rise in financial liabilities from 3.8 per cent (of GDP) in 2021-22 to 5.8 per cent (of GDP) in 2022-23. Even this lower consumption growth is supported by debt which is not a good indicator of sustained demand going forward. In this climate of uncertainty, corporates are opting for a cautious approach until signs of sustained demand emerge.
The government, despite its best efforts to drive growth and private investment through increased capital expenditure, cannot sustainably prop up private investment in times of worsening household balance sheets. The revenue buffers this year will allow the government to maintain its fiscal deficit target below 5.1 per cent for 2024-25. However, there is a need to implement policies to improve household balance sheets. A balanced approach that integrates public and private investments with strong household financial health is essential for sustained economic growth.
Abhishek is Non-Resident Associate Fellow and Divya is Research Associate, Centre for Social and Economic Progress. Views are personal