Understanding the Investment Decline

What is the issue?

There is a decline in overall investment rate between 2011-12 and 2016-17 in India.
The household, and not corporate, sector is said to be responsible for the decline.

How important is investment?

Growth can occur with better utilisation of existing capacity or with new investment.
However, over the medium to long term, the key driver of growth is investment.
Without a high investment rate, it is difficult to sustain a high growth rate.

How has income growth been?

Over the last 4 years, the growth rate has been maintained at a reasonable level.

How has savings been?

The major source of funding investment is domestic savings.
The gross domestic savings rate has fallen in the last six years.
It has declined from around 34% of GDP in 2011-12 to around 30% in 2016-17.
The steepest decline in savings has been with respect to the household sector.
Within this, both financial savings and that in physical assets have declined sharply.
The private corporate sector savings have actually increased by almost 2.5 percentage points.
The savings rate of the public sector including general government shows no change.

How has the investment trend been?

Trend - The investment rate also registers a disturbing decline.
In 2011-12, the gross fixed capital formation rate was around 34% of GDP.
By 2016-17, it had come down to around 28%.
Understanding the behaviour of different components of fixed capital formation is crucial to address the declining trend.
Components - Investment (gross capital formation) includes three elements:

The most important component is gross fixed capital formation.
It refers to the capital expenditures on machinery and equipment and dwellings.
The gross fixed capital formation rate fell over the period from 2011-12 to 2016-17.
However, Gross fixed capital formation stayed at a little above 7% of GDP.
Public sector including general government showed no change.
Private corporate sector investment showed in fact a rise.
Hence, the only sector that appears to have been responsible for the decline in investment is households.
Household sector’s fixed capital formation rate has shown a steep decline.
It has declined from around 15% to nearly 9% over the six-year period.

Why is the trend a cause for concern?

Base Year - The base year for these indicators had been revised from 2004-05 to 2011-12.
Notably, the investment ratios according to the new series with base show a much higher rate as compared to the old series.
E.g. the gross fixed capital formation rate for 2011-12 was 31.8% according to the older series.
For the same year, it is 34.3% according to the new series.
But despite the new series, the investment rate has been declining since 2011-12.
Cause - The focus for the slowdown in growth has been on weak investment demand by the corporate sector.
There has been increased attention to the number of stalled projects.
This has been interpreted as a failure of the corporate sector to make investment.
But the decline in gross fixed capital formation rate has actually been caused by the household sector rather the corporate sector.

Why is the household sector a cause?

Household sector’s savings in physical assets, which is the same as investment, is normally in the form of housing.
But it is difficult to attribute the sharp decline only to the reduction in investment in housing.
Notably, the term ‘households’ includes not only individual households but also non-corporate business.
By definition what is not government and private corporate comes under the category of households.
Households' investment in machinery and equipment came down in 2012-13 to 2015-16 period.
Therefore, in part small businesses have suffered more and invested less.
Within the business sector, the non-corporate business seems to have borne a higher burden.
Thus, the fall in investment rate as an explanation for the slowdown in growth is reasonable.
But clearly, the corporate investment, as believed, is not the cause.

Source: The Hindu