Investment conundrum

Economic uncertainty may delay private investment

The government has been pushing capital expenditure for quite some time to support the economy, more so after the pandemic severely affected activity. At a time when the overall economic activity appears weak, it makes sense for the government to push capital expenditure, which can not only help revive demand and create jobs but also build productive capacity to increase potential growth over the medium to long term. The government has been doing exactly this and hoping to crowd in private investment to sustain demand. However, the private-sector investment story has not panned out as desired and is a risk for durable economic recovery. Chief Economic Advisor V Anantha Nageswaran raised some important points in this context last week, which should be debated for better policy outcomes.

There is no doubt that the government needs to push capital expenditure, but as Dr Nageswaran noted it might not be healthy to keep expanding at the same pace. At some point, the public sector would have to decide whether to continue at the same pace or allow the private sector to take over. It is worth noting here the government is running a higher deficit, and sustained higher borrowing may crowd out private investment at a time when interest rates in the economy are going up. The Union government’s allocation to capital expenditure has increased significantly in recent years. According to an analysis published in this newspaper, after a long gap the allocation crossed the 2 per cent of gross domestic product (GDP) mark in 2020-21. Further, the allocation increased to over 2.2 times in the current year compared to 2019-20 to reach 2.9 per cent of GDP.

While there has been significant investment in areas like roads and railways, it has not helped encourage private investment at the level desired. There could be various reasons for the lack of enthusiasm in the private sector. To be sure, the economic outlook remains uncertain. Although the Indian economy is expected to grow between 6.5 and 7 per cent, it’s partly because of the weak base of last year. Given the tightening of financial conditions, the global economy is expected to slow further in 2023, which would affect exports. Although capacity utilisation in the industrial sector has improved to over 70 per cent, the expansion might wait for a durable recovery and greater clarity on the international situation.

There could be additional reasons as well. A 2020 paper by the International Monetary Fund (IMF), which analysed about half a million firms in 49 countries, for example, noted that the impact of public investment on private investment depends on the level of leverage and financial constraints. The effect of public investment is weaker for firms that are constrained financially. It took time to repair both corporate and bank balance sheets in India after the global financial crisis. They are in much better shape and would help revive investment. In terms of pushing capital expenditure, as the IMF’S October 2020 edition of Fiscal Monitor highlighted, a fast increase in public investment may lead to inefficiencies. Limited state capacity, for instance, could affect implementation, resulting in delays and cost overruns — which is fairly common in India. Overall, while there is a need to push public investment, it should be in line with broader fiscal objectives. Sustained higher Budget deficits can have unintended consequences and create imbalances.