In a meeting held with the country’s corporate leaders on September 15, Finance Minister Nirmala Sitharaman drew attention to an important aspect of the economy today. She rightly flagged concerns about sluggish corporate investment, despite the government’s business-friendly stance, including a reduction in the corporate tax. The reduction, effected in 2019, lowered the rate for existing companies to 22% from 30% and for new manufacturing companies to 15% from 25%. However, the corporate investment rate, i.e., investment as a share of the national income, has barely budged. Ms. Sitharaman challenged corporate leaders to invest, asking rhetorically whether, like Hanuman in the Ramayana, they needed to be reminded of their inborn strength. The analogy is mismatched, though. For, while Hanuman was so devoted to Lord Rama that he was ready to risk his life serving him, private firms are driven by profit expectations. Managers are averse to risk, and unlikely to rush to invest based on exhortation from a Minister if they do not anticipate enough profits. Private investment accounts for close to 75% of total capital formation in the economy; its revival therefore is essential for sustained growth of the economy.
Decline of private capital formation
The Narendra Modi government’s first pronouncements in 2014 had conveyed that it desired a shift away from a state-driven model of economic development. This much was apparent in its slogan ‘minimum government’. If this was to be, the private sector would take the lead in driving the economy. Mr. Modi had a reputation as a business-friendly Chief Minister of Gujarat. Upon reaching Delhi, he emphasised that his government would improve the ease of doing business in India. This by itself is a worthy objective, as anyone familiar with the working of the regulatory apparatus in India would agree.
As private capital formation last peaked in 2011–12, its decline is something that the present government inherited. However, it has had no success in turning it around. Though it has not allowed public investment to slip, that has not been enough under the circumstances. Either ideological predilection regarding the size of the government or the straitjacket imposed by the Fiscal Responsibility and Budget Management Act have held back the government from expanding it. We can see with hindsight that the government misread the situation prevailing when it came to power, and thus failed to recognise its own role at that moment.
So, what was the state of the economy then? The boom had ended by 2008, and the economy was held up only by former Finance Minister Pranab Mukherjee’s stimulus. When Mr. Modi arrived at the Centre, the upsurge in public investment had long since ended and agricultural growth had become erratic. In fact, in the first two years of his prime ministership, agriculture did not grow at all. Finally, with the global financial crisis and the slowing of the world economy, export growth declined. These added up to a slowing of the exogenous drivers of demand, and private investors could not but have seen that the situation was not likely to turn positive soon. Also, they would not necessarily have been enthused by the possibility that the ideology of ‘minimum government’ could end up putting public investment on hold, failing to expand aggregate demand when it was needed. So, based on the situation in 2014, India’s investors would have been fully rational in anticipating a not-so-rosy future for the economy unless some exogenous factors were to turn favourable, or the government were to act decisively to energise the situation through public investment. They would have seen that demonetisation, with the attendant digitisation, and the roll out of the GST could not have done much for the growth of demand.
Stepping up public investment
The one lever that the government could have pulled as it watched private investment decline was to step up public investment. It refused to do this for its first six years in office. Only ideological blinkers combined with the hubris that there is nothing to be learned from history can explain this inaction. Since 1947, every turning point of growth in India was preceded by a significant shift upward of the public investment rate. This includes the growth accelerations of the 1950s, the late 1970s, and the early 2000s and the downturns of the mid-1960s as well as the one that followed the 2008 global financial crisis. It suggests that crowding in, rather than crowding out, characterises the relationship between public and private capital formation in India.
While the Modi government has for long nursed an aversion to the government playing a role in capital formation, the experience during the pandemic seems to have brought about a change of mind. The Union Budget of 2022 was defined by a historic increase in the allocation for capital spending. This could have a positive effect on private investment, but past experience suggests that it could take time to play out. So, the expansion in public investment may have to be sustained for sufficiently long. Even the fiscally conservative International Monetary Fund has suggested that public investment can play the role of an engine of growth for the developing economies. The sustained growth needed to kindle private investment may require that the current public investment thrust be sustained for at least half a decade. However, two aspects would remain crucial even if the government were to find the will to maintain its current pace. One, it is important to choose the right projects. The investment must be focused on productivity-enhancing infrastructure. Here, some tied transfer of funds to the States would be desirable, as they are better placed to identify such investment. Two, inflation can derail a high public investment programme due to the disaffection it generates. Its control would require a step-up in the growth of agricultural produce other than the superior cereals. In fact, this should be seen as an opportunity to end India’s import dependence on edible oils and the persisting shortfall in the supply of vegetables. It is by now clear that the Reserve Bank of India does not have what it takes to control inflation, and only a supply-side thrust can permanently end food inflation.
Though this government may have inherited the sluggish private investment, it must reflect upon whether its own actions may have adversely affected the investment climate. Could the significant step-up in raids by the Enforcement Directorate and the Income Tax Department have had a chilling effect? Could the unreasonable stringency that governs the financial transactions of even not-for-profit organisations have stifled the legitimate economic activity that they give rise to? Could it be that the economy’s goose is being cooked by a surveillance state?
