Context

The Finance Minister, Nirmala Sitharaman, said recently that India’s long-term growth prospects are embedded in public capital expenditure programmes. She added that an increase in public investment would crowd in (or pull in) private investment, thus reviving the economy.

Significance of public investment-led economic growth

• Public investment-led economic growth forms a credible strand of explanation for India’s post-Independence economic growth. 
• Revival after Asian financial crisis: When it was faced with a slow-down after the Asian financial crisis of 1997, the  government initiated public road building projects.
• In the form of the Golden Quadrilateral and the Pradhan Mantri Gram Sadak Yojana, these initiatives sowed the seeds of economic revival, culminating in an investment and export-led boom in the 2000s; GDP grew at 8%-9% annually.
• In comparison, the investment record during the 2010s has been dismal.
• However, a recent uptick is evident in the real gross fixed capital formation (GFCF) rate — the fixed investment to GDP ratio (net of inflation).
• The ratio recovered to 32.5% in 2019-20 from a low of 30.7% in 2015-16.

Analysing the Investment distribution

• As in the June edition of the Ministry of Finance’s Monthly Economic Review, the fixed investment to GDP ratio was 32% in 2021-22.
• However, there is need for caution in reading the most recent data, as they are subject to revision.
• Moreover, the budgetary definition of investment refers to financial investments (which include purchase of existing financial assets, or loans offered to States) and not just capital formation representing an expansion of the productive potential.
• The National Accounts Statistics provides disaggregation of gross capital formation (GCF) by sectors, type of assets and modes of financing; over 90% of GCF consists of fixed investments.
• No change in investment distribution: The investment distribution has hardly changed over the last decade, with the public sector’s share remaining 20%.
• Fall in share of agriculture and industry: Between 2014-15 and 2019-20, the shares of agriculture and industry in fixed capital formation/GDP fell from 7.7% and 33.7% to 6.4% and 32.5%, respectively.
• Services’ share rose to 52.3% in 2019-20 compared to 49% in 2014-15.
• The rise in the services sector is almost entirely on transport and communications.
• The share of transport has doubled from 6.1% to 12.9% during the same period.
• Within transportation, it is mostly roads.
• Decline in the share of investment: Its share in the investment ratio (column 2.1) fell from 19.2% in 2011-12 to 16.5% in 2019-20.
• This indicates that ‘Make in India’ failed to take off, import dependence went up, and India became deindustrialised.
• Import dependence on China is alarming for critical materials such as fertilizers, bulk drugs (active pharmaceutical ingredients or APIs) and capital goods.
• Instead of boosting investment and domestic technological capabilities, the ‘Make in India’ campaign frittered away time and resources to raise India’s rank in the World Bank’s Ease of Doing Business Index.
• Decline in foreign capital in GFC: The contribution of foreign capital to financing GCF fell to 2.5% in 2019-20 from 3.8% in 2014-15 (or 11.1% in 2011-12).
• With declining investment share, industrial output growth rate fell from 13.1% in 2015-16 to a negative 2.4% in 2019-20, as per the National Accounts Statistics.

Way forward

• Need for balance: As roads and communications are classic public goods, investment in them is welcome.
• However, for healthy domestic output growth, there is a need for balance between “directly productive investments” (in farms and factories) and infrastructure investments.
• And this balance was missed.
• The recent upturn in the aggregate fixed capital formation to GDP ratio is positive, though the rate is still lower than its mark in the early 2010s.

Conclusion

The claim that the investment revival is public sector driven is not borne out by facts. The budgetary figures refer to financial investment, not estimates of capital formation, indicating expansion of the economy’s productive capacity.

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Back2Basics: Gross fixes capital formation

• Gross fixed capital formation (GFCF), also called “investment”, is defined as the acquisition of produced assets (including purchases of second-hand assets), including the production of such assets by producers for their own use, minus disposals.
• The relevant assets relate to assets that are intended for use in the production of other goods and services for a period of more than a year.
• The term “produced assets” means that only those assets that come into existence as a result of a production process are included.
• It therefore does not include, for example, the purchase of land and natural resources.
• This indicator is available in different measures: GFCF at current prices and current PPPs in US dollars, and annual growth rates of GFCF at constant prices, as well as quarterly data for percentage change over previous period and percentage change over same period last year.
• The indicator at current prices and current PPPs is less suited for comparisons over time, as developments are not only caused by real growth, but also by changes in prices and PPPs.

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