Issues related to Economic growth

[op-ed snap] Two engines of the economy need to fire

Note4students

Mains Paper 3: Economy | Growth

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Sluggsh investments in economy especially from private sectors and ways to revive them


Context

Investments picking up slowly

  1. The recovery in investments will continue in fiscal 2019, led by government efforts to build roads and houses
  2. Capacity utilization, which is a pre-condition to the revival in private sector investments, should also keep improving
  3. The crowding-in impact of public investments is expected to kick in later
  4. Yet a broad-based and decisive pick-up in the investment cycle will take time

Investment rate in India

  1. The share of gross fixed capital formation—fresh investments in the form of plant and machinery, dwellings and other buildings—in the gross domestic product (GDP), is called the investment rate
  2. India’s investment rate averaged 31% in fiscals 2015-2018, compared with 33.6% in fiscals 2010-2014
  3. It touched a decadal low of 30.3% in fiscal 2016

The decline in private investment

Data suggests weakness on two fronts as the reason for the decline in investments

One, the sticky share of private corporate sector investments in GDP

  • CSO data shows private non-financial corporate investments have remained subdued
  • Data from the Reserve Bank of India (RBI) also suggests that capital expenditure by the private sector declined for the sixth straight year in fiscal 2017

Two, a secular decline in household investments

  • The household sector was the biggest contributor to investments in fiscal 2012 (share of about 45%), but its share has declined consistently since then and was about 31% in fiscal 2017
  • Purchase of houses is generally the largest part (more than three-fourths) of household investments, so a slowdown on that score becomes a key reason for the decline

Reasons behind the decline

A broad-based pickup in private corporate investments was elusive for three reasons:

First is the capacity overhang

  • Data from the RBI suggests overall capacity utilization declined to 74% at the end of December 2017 from 81% at the end of March 2011
  • CRISIL Research analysis corroborates this trend

Second is the focus of corporates on improving their capital structure

  • High leverage has also been haunting the corporate sector and has been a deterrent for fresh investments in the economy
  • Companies are, therefore, focused on improving capital structure than investments
  • Consequently, debt/equity and interest coverage ratios have improved, not so much investments

Third was that the transitory shocks from demonetization and implementation glitches in the roll out of the goods and services tax (GST)

  • It added to the uncertainty, which further delayed investment decisions

Productivity of investment

  1. The productivity of investments is measured by the incremental capital-output ratio (ICOR)
  2. Lower the ICOR, higher is the productivity of capital because ICOR measures the capital required to produce an additional unit of output

Expectations on the pickup in investments

  1. A broad-based pickup in investments is unlikely this fiscal as capacity overhang persists and corporates continue to focus on reviving their capital structure
  2. Pre-election year uncertainty, too, discourages private sector investments
  3. This fiscal is expected to see a mild improvement in investments, given the government’s sharp focus on affordable housing, rural infrastructure and roads
  4. Beyond the current fiscal year, there is more optimism on a broad-based pick-up in investments
  5. The government has initiated a number of steps to ease the business environment:
  • big moves such as the GST and Insolvency and Bankruptcy Code (IBC)
  • introducing an online single-window model for providing clearances and filing compliances
  • fast-tracking foreign investments
  • surpassing the Foreign Investment Promotion Board

Way Forward

  1. Both investment and its productivity should pick up as the deleveraging phase gets over, crowding-in benefits of public investment kick in and efficiency-enhancing reforms start bearing fruit
  2. That will lead to faster economic growth
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