Will the bet on private investment pay off?
3 min read . Updated: 27 Feb 2023, 11:59 PM IST
PremiumThe 2023-24 Union Budget increased capital expenditure in the hope that public investment would crowd in private corporate investment
The 2023-24 Union Budget increased capital expenditure in the hope that public investment would crowd in private corporate investment. The reason: consumption is the mainstay of the Indian economy, but it is investment that can push it into a higher growth trajectory.
Each period of strong economic growth in India’s post-1991 story has been backed by a surge in corporate investment. At its peak, private corporate investment reached 17.3% of GDP in 2007-08; by 2019-20, it had dropped to 11%. Corporate investment projects are typically characterized by large initial capital outlays and uncertain future returns. Such an investment opportunity can be viewed as a call option, with the company having the right but not an obligation to invest (Dixit and Pindyk, 1994). This “option" has a holding value, because as time passes, more information about the future is available, which reduces uncertainty around the timing and magnitude of returns. Thus it is valuable to wait when the investing climate is uncertain, and exercise the option to invest only when expected returns are higher than the value of waiting.
That explains why private fixed investment dries up during uncertain times, such as the 2008 financial crisis or the 2020 pandemic. Currently, an uptick in domestic growth indicators has generated cautious optimism. If inflation comes under control in 2023-24 as forecast by the Reserve Bank of India (RBI), then the option to invest in corporate capital projects could soon be in the money! The big “if", of course, is the uncertainty surrounding both inflation and growth in the year ahead.
A Matter of Credit
Bank credit grew at an average year-on-year rate of 14% during April-December 2022. By itself, this augurs well for investment. But it assumes greater importance in the light of two developments: significant corporate deleveraging and a reduction in banks’ non-performing assets (NPAs).
During 2015-19, India faced a “twin balance sheet problem", which originated from the credit-funded investment boom between 2004-07. Unfortunately, the global financial crisis in 2008, followed by a period of high commodity prices and rising interest rates, made it difficult for corporates to repay their debt.As bad loans went up, banks were reluctant to lend though there was plenty of credit slack in the system. At the same time, debt-heavy corporates could neither borrow nor invest. Subsequent efforts to clean up bank and corporate balance sheets have paid off. The resulting credit ecosystem is more suitable for borrowing and lending for investment projects.
Productivity Boost?
The government sector (excluding public sector enterprises) contributed only 10-12% of the annual gross fixed investment in the last decade. Yet government capex plays an outsized role in stimulating investment for many reasons.
First, infra spending improves investment productivity across sectors. Second, it is considered to be of higher quality than, say, cash transfers, as it creates sustainable livelihoods, and therefore improves consumer and business confidence. Finally, it directly boosts incomes by opening up jobs in the labour-intensive construction sector and allied industries.
The decision to opt for higher capex over higher welfare spending sends a clear signal to the private sector to invest. The jury is still out on the impact: the RBI’s latest bank lending survey shows a mixed trend in expected loan demand over the ongoing March quarter. Infra credit is expected to rise, but other sectors may not see much pick-up in loan demand.
Growth Factor
The multiplier impact of capex has been widely discussed after the Budget. The theory is that a rupee increase in government capex should result in a more than proportionate increase in GDP, mainly by crowding in private investment. With this, one would think, India is all set to welcome corporate investment: infrastructure budgeted for, bank lending robust, and inflation managed by RBI.
But no matter how conducive other conditions are, the cinching factor for private investment is always economic growth. India’s investment cycles have been closely linked to domestic and global growth rates in the past. A revival in private investment will not occur without growth, and some certainty of growth. Until then, government capex will merely serve as a buffer for the desired corporate investment.
Deepa Vasudevan is an independent writer in economics and finance.