Why corporate investment has not revived despite tax cuts and cheap credit

Source: The Hindu, Page 10, Text & Context
Published: 19 August 2026

Why in the News

Corporate investment as a share of Gross Domestic Product (GDP) has fallen to about 9 percent from a peak of 17.3 percent, and has not returned even to the low levels recorded during the Global Financial Crisis. A corporate tax cut from 30 percent to 22 percent and a sustained low interest rate regime failed to reverse the decline, which points to a constraint that cost side policy does not touch.

What does corporate investment as a share of GDP measure?

1. Definition: It measures the value of new fixed assets created by companies, such as plant, machinery and buildings, expressed as a proportion of the economy’s total output.
2. Why the ratio is used: Expressing investment as a share of output strips out inflation and growth in the size of the economy, so a fall in the ratio means investment is growing slower than output.
3. What it signals: Corporate investment builds the future productive capacity of the economy, so a sustained decline in the ratio caps the growth rate the economy can sustain later.
4. Data source used here: The trend is drawn from the Database on Indian Economy maintained by the Reserve Bank of India (RBI).

What are animal spirits?

1. Definition: Animal spirits, a term used by John Maynard Keynes, refers to the level of confidence with which firms hold their expectations about future profits.
2. How it acts: High confidence pushes the expected profitability schedule outward and raises investment at every level of cost, and pessimism about the future pulls it inward.

What is the principle of increasing risk?

1. Definition: The principle of increasing risk, proposed by Michal Kalecki, holds that the cost of borrowing rises as a firm takes on more loans in proportion to its own funds committed to a project.
2. Its consequence: The system is rigged against small capitalists even where small and large firms hold the same blueprint of a technology, because access to capital begets more capital.

What is the Prowess database?

1. Definition: Prowess is a firm level database of Indian companies compiled from their audited annual accounts, used for panel studies of corporate performance.
2. Use in this analysis: The study draws a balanced panel of listed manufacturing firms from Prowess to compare profitability and interest costs across firm sizes.

What is autonomous expenditure?

1. Definition: Autonomous expenditure is spending that does not depend on the current level of income or profit in the economy, so it can rise when private demand is falling.
2. Why it matters here: Government expenditure is the principal autonomous component, which is why it can create demand actively rather than merely responding to demand that already exists.

How has corporate investment moved since 2000?

1. The take off: Corporate investment took off in 2004, jumping almost four percentage points from 6.5 percent to 10.3 percent of GDP.
2. The peak: It rose further during the growth years to a peak of 17.3 percent.
3. The crisis fall: It fell during the Global Financial Crisis, then began a steady revival.
4. The break point: The revival ran until demonetisation hit the economy in 2016, after which the decline has been continuous.
5. Where it stands: The share is now about 9 percent, and has not returned even to the low levels recorded during the Global Financial Crisis.

Why is demonetisation treated differently from the other shocks?

1. Nature of the shock: The global economic crisis was an external shock beyond India’s control, and demonetisation was a self inflicted shock.
2. Depth of the fall: The post 2016 decline has taken the share below the crisis era floor, which the external shock itself never did.
3. Covid is not the explanation: Covid arrived in 2020-21 as another external shock, and the decline in investment had started a few years earlier.
4. Two channels of damage: Demonetisation pushed the expected profitability schedule inward both because immediate profitability declined and because the credibility of future policy steps became suspect.
5. The casualty at the margin: The fall was severe enough to push small firms below the cost of credit curve altogether, forcing many out of business, which is what happened to many micro, small and medium enterprises (MSMEs) in this period.

What three factors determine a firm’s investment decision?

1. Expected profitability: The profit a firm expects from selling the goods the new factory will produce, assessed over the whole life of the asset.
2. Confidence in that expectation: The certainty with which the firm can predict those profit rates over the factory’s lifetime, which sets the position of the profitability schedule.
3. Cost of credit: The price of borrowing, which matters once the planned investment exceeds the firm’s own available funds.
4. How profitability varies with size: Most industries have economies of scale, so larger equipment, factories and workspaces carry higher profit rates than smaller ones, and expected profitability rises with the size of the investment.
5. Where that stops: Each firm has an upper limit to how much it can sell, set by its share in the total market, and investment beyond that point leaves part of the factory idle.
6. Two channels for the interest rate: A firm that does not build can park its funds in an interest bearing asset, so expected profitability must exceed the market interest rate, and a firm that borrows faces a cost of credit that is flat up to its own capital and rises steadily thereafter.

Why does firm size change what constrains investment?

1. Small firms: With very low levels of own capital the cost of credit curve starts rising far sooner, and it cuts the upper portion of the profitability curve.
2. Their binding constraint: Investment by such firms is constrained by the availability of credit, and their interest costs are correspondingly high.
3. Large firms: Their own capital is high enough that the cost curve cuts the profitability curve on its vertical portion.
4. Their binding constraint: Such firms are limited by the market rather than by finance, and interest costs are not consequential for them.
5. The structural implication: The same technology blueprint yields different investment outcomes purely because of the firm’s existing access to capital.

What does the firm level data show?

1. The sample: A balanced panel of 1,224 listed manufacturing firms between 2000 and 2024, drawn from the Prowess dataset and grouped into three sizes.
2. Size definition: Median capital stock is Rs 14.5 crore for small firms, Rs 156.8 crore for medium firms and Rs 1,745.9 crore for large firms, all measured in 2011-12 prices.
3. The profitability gradient: Smaller firms have lower profitability than larger firms, with the median rate of profit rising across the three size classes.
4. The interest cost gradient: Smaller firms carry higher interest costs than larger firms, with median interest costs falling as size rises.
5. What it confirms: The asymmetry predicted by the theory, that small firms are credit constrained and large firms are demand constrained, holds by and large for the Indian manufacturing sector.

Why did a tax cut and cheap credit fail to revive investment?

1. The tax cut: The corporate tax rate was cut from 30 percent to 22 percent, alongside a low interest rate regime followed by the Reserve Bank of India.
2. No effect on small firms: A fall in the interest rate does not revive investment among smaller firms once their expected profitability has collapsed below the cost of credit.
3. No effect on large firms: A large firm is not constrained by credit in the first place, so cheaper credit has no impact on its investment decision.
4. The general result: Cost side policy interventions, including tax cuts, do not have much expansionary impact on investment, because neither group’s binding constraint is the cost of funds.
5. What the failure reveals: Both groups are ultimately held back by expected demand, and cheapening the supply of capital does nothing to create that demand.

What would shift expected profitability outward?

1. The required direction: What is needed is to push the profitability curve outward, which raises investment by both small and large firms simultaneously.
2. The only instrument that does it: This can be achieved only if government expenditure acts as an autonomous stimulus.
3. The mechanism: Such expenditure creates demand actively, and rising demand pushes the profitability curves outward for firms of every size.
4. The fiscal implication: It requires giving up on being a fiscal hawk, since the stimulus has to be sustained rather than symbolic.
5. The political signal being read: The same conclusion is drawn from the youth protesting on the streets asking for gainful employment.

Challenges to reviving corporate investment in India

1. Weak capacity utilisation: Firms do not add capacity while existing plants run below their rated output. e.g. manufacturing capacity utilisation tracked by the Reserve Bank of India has hovered around the mid seventies in percentage terms for extended periods.
2. Credit constraint on small firms: Formal lenders price small borrowers out or lend against collateral they lack. e.g. the credit gap for micro, small and medium enterprises runs into lakhs of crores against their assessed requirement.
3. Policy uncertainty: Abrupt changes damage the confidence component of investment decisions independently of the direct cost. e.g. the retrospective amendment to tax cross border share transfers after the Vodafone ruling deterred investors until it was withdrawn in 2021.
4. Weak household demand: Consumption growth caps the sales any firm can plan for. e.g. the collapse in employment generation under the rural employment guarantee programme in April to July 2026 cut rural purchasing power directly.
5. Land and clearance delays: Project timelines stretch well beyond the investment appraisal horizon. e.g. large steel and refinery projects in Odisha and Maharashtra have taken over a decade from announcement to commissioning.
6. Legacy stressed assets: Bank and corporate balance sheets recovering from earlier defaults limit fresh risk appetite. e.g. the twin balance sheet problem of the mid 2010s suppressed both credit supply and corporate borrowing for years.
7. Import competition in inputs: Cheaper imported inputs and finished goods reduce the return on domestic capacity creation. e.g. domestic solar module manufacturers competed against imported cells until duties and incentives were introduced.

Conclusion

Corporate investment has fallen to about 9 percent of GDP from a peak of 17.3 percent and remains below its Global Financial Crisis floor, with the decline dating from 2016 rather than from Covid. A corporate tax cut from 30 percent to 22 percent and a low interest rate regime failed because neither addresses the binding constraint, since small firms are held back by credit access and large firms by the size of the market. Pushing expected profitability outward requires government expenditure acting as an autonomous stimulus, which means abandoning fiscal hawkishness rather than repeating cost side concessions.

Foundational Context: What is Capital Formation?

1. About: Capital formation is the addition to the stock of physical assets in an economy in a given period, measured in the national accounts as Gross Fixed Capital Formation (GFCF).
2. Rationale: It exists as a distinct measure because current output can either be consumed or used to create productive capacity, and only the second raises future output.
3. Named typology, by the investing sector:
4. Public sector capital formation: Investment by the Central and State governments and by public sector enterprises, largely in infrastructure.
5. Private corporate sector capital formation: Investment by registered companies in plant, machinery and structures, which is the measure this item tracks.
6. Household sector capital formation: Investment by households and unincorporated enterprises, dominated by residential construction.
7. Related measure: The investment rate is Gross Fixed Capital Formation expressed as a share of Gross Domestic Product, and the incremental capital output ratio measures how much investment is needed to produce one additional unit of output.

Key Concerns Regarding Capital Formation in India

1. Private investment has not replaced public investment: Central capital expenditure has risen sharply while private corporate investment has stagnated, so the recovery rests on one leg.
2. Household investment is concentrated in real estate: A large share of household capital formation is residential construction, which adds less to productive capacity than plant and equipment.
3. Financing depth for small firms: The corporate bond market is accessible only to highly rated large issuers, leaving small firms dependent on bank credit at high spreads.
4. Crowding out concern: Sustained government borrowing to fund the stimulus can raise interest rates and reduce private investment, which is the standard counter argument to an expenditure led revival.
5. Measurement lag: Private corporate investment is estimated with a significant lag and revised substantially, which delays the recognition of a turning point in the cycle.

Statutory Framework Governing Fiscal Policy and Public Investment

1. Article 112: Requires the Annual Financial Statement of estimated receipts and expenditure to be laid before Parliament for every financial year.
2. Article 266: Establishes the Consolidated Fund of India and the Public Account, from which expenditure may be made only under authority of law.
3. Article 292: Empowers the Union to borrow upon the security of the Consolidated Fund of India within limits fixed by Parliament.
4. Article 293: Governs State borrowing and requires the consent of the Union where a State is indebted to it.
5. Article 280: Provides for the Finance Commission, whose recommendations determine the vertical and horizontal sharing of Union taxes.
6. Fiscal Responsibility and Budget Management Act, 2003: Sets statutory fiscal targets and requires the government to lay fiscal policy statements before Parliament.
7. Section 4: Prescribes the fiscal deficit and debt targets and the grounds on which they may be deviated from.
8. Section 7: Requires the Finance Minister to review and report on the trends in receipts and expenditure to Parliament.

Laws and Rules Governing Corporate Finance and Small Firm Credit

1. Companies Act, 2013: Governs incorporation, capital raising, disclosure and audit obligations of companies, which is the source of the accounts used in firm level databases.
2. Micro, Small and Medium Enterprises Development Act, 2006: Defines the three enterprise categories and provides for delayed payment remedies for small suppliers.
3. Section 15 and Section 16: Require payment to a micro or small enterprise within a specified period and provide for compound interest on delay.
4. Insolvency and Bankruptcy Code, 2016: Provides a time bound resolution process for corporate debtors, which determines how quickly stressed capital is redeployed.
5. Factoring Regulation Act, 2011, amended in 2021: Widened the set of lenders permitted to undertake factoring, easing receivables financing for small firms.
6. Reserve Bank of India Act, 1934: Provides the statutory basis for monetary policy, including the inflation targeting framework that governs the interest rate regime.
7. Fiscal Responsibility and Budget Management Rules, 2004: Prescribe the formats and the quarterly review obligations under the parent Act.

Back2Basics: Demonetisation of 2016

1. What it was: The withdrawal of legal tender status from the existing Rs 500 and Rs 1,000 currency notes, announced on 8 November 2016.
2. Legal basis: Effected through a notification under Section 26(2) of the Reserve Bank of India Act, 1934, on the recommendation of the Central Board of the Reserve Bank of India.
3. Stated objectives: Curbing unaccounted money, countering counterfeit currency and terror financing, and accelerating the shift to digital payments.
4. Replacement currency: New Rs 500 and Rs 2,000 notes were introduced, and the Rs 2,000 note was later withdrawn from circulation in 2023.
5. Return of notes: The Reserve Bank of India subsequently reported that the overwhelming majority of the demonetised currency was returned to the banking system.
6. Judicial position: A Constitution Bench of the Supreme Court upheld the decision by a 4 to 1 majority in January 2023, holding that the process followed did not suffer from a legal infirmity.
7. Economic effect recorded here: It marks the point after which corporate investment as a share of Gross Domestic Product began a continuous decline, and it pushed many micro, small and medium enterprises out of business.

Government Initiatives

1. Production Linked Incentive schemes: Pay incentives on incremental sales of goods manufactured in India across sectors including electronics, pharmaceuticals and automobiles, aimed at drawing private capital into manufacturing capacity.
2. National Infrastructure Pipeline and the National Monetisation Pipeline: Set out a project pipeline for public infrastructure investment and a route to recycle operating public assets into fresh capital expenditure.
3. PM Gati Shakti National Master Plan: Coordinates infrastructure planning across ministries to reduce logistics cost and project delay, both of which enter the investment appraisal of private firms.
4. Emergency Credit Line Guarantee Scheme: Provided fully guaranteed collateral free credit to micro, small and medium enterprises to keep credit constrained firms solvent.
5. Credit Guarantee Fund Trust for Micro and Small Enterprises: Guarantees collateral free bank lending to small firms, addressing the security requirement that keeps them off formal credit.
6. Trade Receivables Discounting System (TReDS): An electronic platform allowing small suppliers to discount invoices owed by large buyers, easing the working capital squeeze.
7. Corporate tax rate reduction: The concessional rate regime introduced for domestic companies, and a lower concessional rate for new manufacturing companies, intended to raise post tax returns on new capacity.

Key Facts about Investment in the Indian Economy

1. Peak investment rate: India’s overall gross fixed capital formation rate peaked in the years before the Global Financial Crisis, in step with the corporate investment peak of 17.3 percent recorded here.
2. Corporate tax rates: The headline domestic corporate tax rate was reduced from 30 percent to 22 percent, with a lower concessional rate offered to new manufacturing companies.
3. Monetary framework: India adopted flexible inflation targeting in 2016, with the target set at 4 percent and a tolerance band of plus or minus 2 percentage points.
4. Micro, small and medium enterprises: The sector accounts for roughly 30 percent of Gross Domestic Product and about 45 percent of exports.
5. Crowding out effect: The proposition that government borrowing raises interest rates and thereby reduces private investment, which is the standard objection to an expenditure led revival.
6. Data sources: The Database on Indian Economy of the Reserve Bank of India for macro aggregates, and firm level databases such as Prowess for company accounts.

Challenges in Reviving the Investment Cycle

1. Demand uncertainty: Firms will not commit to long lived assets without visibility on sales. e.g. consumer durables makers deferred capacity additions through successive years of weak rural demand.
2. Fiscal space for the stimulus: A sustained expenditure push runs against the statutory deficit path. e.g. the Fiscal Responsibility and Budget Management Act, 2003 targets constrain the size of a discretionary stimulus.
3. Transmission of rate cuts: Policy rate reductions reach small borrowers slowly and incompletely. e.g. lending rates for small firms have historically moved far less than the repo rate in the same period.
4. Skill and labour mismatch: New capacity requires skilled workers who are not available at scale. e.g. semiconductor and electronics assembly investments have flagged shortages of trained technicians.
5. Land acquisition cost and delay: Assembling contiguous land for large plants remains the slowest step. e.g. industrial projects across several States have stalled for years at the land acquisition stage.
6. Global trade uncertainty: Export oriented capacity decisions are hostage to tariff shifts abroad. e.g. punitive tariffs of 50 percent on Indian goods disrupted the export calculus for entire product lines.
7. Concentration of profitability: Profits accrue disproportionately to large firms, which are the very firms not constrained by finance. e.g. the firm level panel shows median profitability rising and interest costs falling as firm size increases.

Way Forward

1. Use expenditure as the lead instrument: Direct sustained public expenditure at demand creating heads so that expected profitability rises for firms of every size rather than only for the largest.
2. Target employment intensive spending: Prioritise programmes that put income directly in the hands of households, since that is what converts stimulus into the sales firms plan around.
3. Fix credit access rather than credit price: Expand guarantee backed and receivables based lending to small firms, whose constraint is availability rather than the interest rate.
4. Restore policy predictability: Avoid abrupt, economy wide interventions, since the confidence component of the investment decision recovers far slower than the immediate profitability component.
5. Complete the public capital expenditure pipeline: Convert announced infrastructure projects into commissioned assets on schedule, so that the demand impulse is actually delivered.
6. Report investment data faster: Shorten the lag and revision cycle in private corporate investment estimates so that a turning point is identified in time to act on it.

Matching Previous Year Question

“[2026] Which one of the following best describes the ‘Crowding Out Effect’ in the context of fiscal policy?
(a) A situation where private investment increases due to increased Government spending
(b) A situation where Government borrowing leads to higher interest rates, which reduces private investment
(c) A situation where an increase in taxes leads to increased private sector investment
(d) A situation where Government spending has no impact on aggregate demand
Answer: (b)”