Stagnant Investment Poses a Significant Challenge; Reviving Growth Requires Radical Changes
Stagnant Economic Engine: Identified Absent Key Stimulator of Growth
The slowdown in government spending on capital expenditure post-pandemic was unavoidable. While the immediate reason for the deceleration was to curb the fiscal deficit, it also highlighted the limitations of public capital expenditure as a long-term growth driver. In order to keep economic growth momentum, the overall investment rate, largely influenced by household savings, private sector investment, and net capital inflows, must show improvement.
Private consumption, accounting for the largest expenditure component of India's GDP, might struggle to maintain strength without a robust backbone from gross fixed capital formation (GFCF). In FY25, GFCF as a percentage of GDP slumped to 29.9%, marking a three-year low. This pales in comparison to the peak of 34.3% achieved in FY12 or the levels seen during the high-growth years of FY06-FY08.
Even in FY22, the economy's pump-priming year, the GFCF remained at 33.4%. On the other hand, China has managed to sustain a GFCF ratio of 40% and above, even in recent years, though it has dropped from the 45% peak in 2013[4]. Interestingly, the percentage of productive assets like machinery in India's GFCF has gone down, while that of dwellings has increased, diminishing the multiplier effect on the economy.
Chief Economic Advisor, V Anantha Nageswaran, expressed optimism about the economy’s growth in FY26, predicting a growth rate between 6.3% and 6.8%, supported by private consumption, a rural rebound, and resilient services exports. Despite this, the broad-range forecast comes with the possibility of further slowdown from the moderate 6.5% growth registered in FY25[2]. Mr. Nageswaran emphasized the need for continued measures to encourage Foreign Direct Investment (FDI) and increase in private capital investment to achieve the upper end of the projected growth band.
A sluggish economy's productivity can be discerned from the high incremental capital output ratio (ICOR). In contrast to a healthy level of 3.6-3.9 seen during FY06-FY08, the ICOR recently has been around 5[5]. Household savings, despite a slight improvement in FY25, continue to be low. Moreover, India's financialization of household assets shows promise, as it could potentially increase household savings. However, FDI inflows in recent years have fallen short of expectations, accompanied by a significant increase in outbound investments in FY25[4].
While India strategizes to navigate the challenges posed by the collapse of the rule-based multilateral trade order by concluding a series of bilateral trade pacts with developed nations[1], consolidating the benefits from foreign trade necessitates the thriving of the manufacturing sectors. Implementing productivity-boosting reforms like tax overhauls aimed at creating the "output effect" can't be delayed anymore[5].
Investment in India has traditionally been what economists term "hot money," flowing in and out with intraday changes[1]. Given this, it becomes crucial to shift focus towards long-term, sustainable investments. Capital accumulation, infrastructure development, job creation, and economic diversification are all current concerns, owing to lagging investment rates.
Household SavingsProductivity-Enhancing ReformsForeign Direct Investment (FDI)Manufacturing IndustriesIncremental Capital Output Ratio (ICOR)GDPChina's Growth Strategy
[1] Channel News Asia: Indian Govt introducing Production-Linked Incentive (PLI) schemes to boost manufacturing[2] Business Standard: Economic growth in FY26 to be between 6.3% and 6.8%, says CEA V Anantha Nageswaran[3] India Today: India's new growth story: The manufacturing sector's role[4] Livemint: India's investment-to-GDP ratio at 33.4% in FY22[5] Livemint: Incremental capital output ratio (ICOR) for Indian economy at 5: KPMG boss[6] ADB Working Paper: China's changing financial structure: Implications for the global economy
- To boost economic growth, it's crucial to encourage foreign direct investment (FDI) and increase private capital investment, as suggested by the Chief Economic Advisor, V Anantha Nageswaran.
- Productivity-enhancing reforms like tax overhauls aimed at creating the "output effect" can't be delayed anymore, as they are essential for the thriving of manufacturing industries, which consolidating the benefits from foreign trade necessitates.
- The shift from traditional "hot money" investments in India toward long-term, sustainable investments is imperative, considering the current concerns of capital accumulation, infrastructure development, job creation, and economic diversification, all of which are owing to lagging investment rates.
