Indian Economy: A Deep Dive on Investments

Anindya Sengupta

The budget session of the parliament is going to start in a few days and the budget for FY 22-23 is going to be presented on 1st February, 2022. Let us examine what are the major impending issues faced by the Indian economy and what are the challenges, the budget needs to address. We will focus on various issues in front of the economy in a series of articles in the run up to the budget.

The Government of India released the advanced estimates of National Income 2021-22 recently. The GDP growth of the current financial year when compared to the pre pandemic period stands at 1.26%. Gross Fixed Capital Formation (Investment) is the second biggest component of GDP. As per the report on advanced estimates, the investments have seen a 2.56% increase in FY 21-22 when compared against the pre pandemic period (FY 19-20). The share of investment in total GDP went up from 32.5% in FY 19-20 to 32.9% in FY 21-22.

One needs to keep in mind here that investment demand has been shrinking in the pre pandemic period itself. The share of investment to GDP which was more than 40% during third quarter of FY 11-12 went down to 32.5% in the pre pandemic period itself.

Source: https://www.ceicdata.com/en/indicator/india/investment–nominal-gdp

As has been in the proportion of investment to GDP data, there has been a steady decline in share of investment to GDP for the last ten years even before the pre pandemic period. Now what does this decline means. If the share of investment reduces, it means that private players are investing in lesser proportion. This leads to lesser work opportunities in the private sector as more investment brings more employability. This leads to increase in unemployment and also reduces the ability of people to spend more as with lesser employability there will be lesser income and hence lesser the spend. With lesser demand ( due to lesser spend) in the economy, the investors don’t find it lucrative to invest more and hence proportion of investment reduces further. This is a vicious circle.

Now how to break this cycle. Government has tried the most common way of boosting investment demand, i.e. reduction of corporate tax in the pre pandemic period itself. As we can see in the above data it did not generate the desired outcome of increasing the investment at a substantial level.

Now why does the tax reduction did not bring a substantial increase in proportion of investment. There can be two possible reasons for this. One is that there is a lack of trust in the minds of the investors. During the pre pandemic period itself there has been a slow down in consumption demand. Even the recent advanced estimate suggest that the consumption demand in FY 21-22 is 2.9% lesser than what is was in the pre pandemic period of 2019-20. So investors will not invest in a economy where there is lack of demand as that means there investments will not be profitable.

The other possible reason is that sometimes the tax reduction has a lagged impact on the investments, i.e., tax reduction today impact the investment the day after. But in the run up of the corporate tax reduction period, the economy was impacted by the pandemic and hence the true impact of the tax reduction on investment did not materialize. In reality both the factors are at play. There is definitely a lack of demand impacting the investors trust in the system. Also the pandemic has played its part.

Given this backdrop, what are the alternatives in front of the government now to bring back the investments and arrest this steady decline in proportion of investment. One argument can be further reduction of the taxes. However firstly that might not be a right decision specially when the economy is coming out of a pandemic and more government spending is required. Second, the impact of tax reduction has not been effective even in the pre pandemic period as discussed above.

The focus of the budget should be to bring back the trust of the investors. This can be in form of government induced investments specifically in infrastructure sector. This can help in two ways. One given the government is investing more, the investors gets a trust that they can also invest. The other and most important is government induced investment leads to more income in hands of people and hence more spending and solves the problem of lack of demand. Hence investors gains the trust. Now one issue on this can be the fiscal challenge and government can investment only a certain amount. The other focus area can be more public private partnerships for different projects where the same outcome is generated and trust of investors is restored back.

Whatever steps the government takes in this regard, this is a long term battle. The proportion of investment to GDP will not go back to the glorious level of 40% in one go. A sustained effort in this regard needs to be there with long term plan. But the vision of that long term plan is expected in this budget.

In the next article of this series we will focus on social sector scenario with specific focus on education and health.

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