Declining Private Investment and its Impact on Gross Fixed Capital Formation and Economic Growth

Context

The Indian economy has faced significant challenges due to a lack of acceleration in private investment.

Stagnant Gross Fixed Capital Formation (GFCF) and Decline in Private Investment in India

Stagnant Growth of GFCF: This is indicated by the stagnant growth of private Gross Fixed Capital Formation (GFCF) as a percentage of gross domestic product (GDP) at current prices.

Decline in Private Investment: Private investment in India has steadily declined since 2011-12. In 2019, the government reduced corporate taxes from 30% to 22% to encourage private investment.

Significance of Private Investment: Private investors are often regarded as more efficient capital allocators than public officials as it avoid wasteful spending. 

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What is Gross Fixed Capital Formation (GFCF)?

Gross Fixed Capital Formation (GFCF) refers to the growth in the size of fixed capital in an economy. Fixed capital refers to assets like buildings and machinery that require investment to be created. 

• Government GFCF includes capital formation as a result of government investment.

Significance of Gross Fixed Capital Formation (GFCF):

• Boost Economic Growth: GFCF matters because fixed capital helps to boost economic growth and improve living standards by helping workers produce a greater amount of goods and services each year. 
• Driving Economic Output and Consumer Purchasing Power: Fixed capital determines the overall output of an economy and, hence what consumers can actually purchase in the market. 

Trend of Private Investment in India

Trend of Private Investment: In India, private investment began to increase after the economic reforms of the late-1980s and the, early-1990s that improved private sector confidence. 

• From independence to economic liberalisation, private investment largely remained either slightly below or above 10% of the GDP. 

Trend of Public investment: Public investment as a percentage of GDP increased steadily from less than 3% of GDP in 1950-51 to overtake private investment as a percentage of GDP in the early 1980s. 

• However, post-liberalization, there was a decline in public investment with private investment assuming a leading role in fixed capital formation.

Pre and Post-Global Financial Crisis: The increase in private investment persisted until the global financial crisis of 2007-08, surging from approximately 10% of GDP in the 1980s to around 27% by 2007-08. 

• However, starting from 2011-12, private investment started to decline, reaching a low point of 19.6% of GDP in 2020-21.

Reasons for Decline in Private Investment in India

Low Private Consumption Expenditure: The failure of private investment to pick up over the last decade has been attributed to low private consumption expenditure. 

Structural Issues: Unfavourable government policy and policy uncertainty may likely be the  reason behind fall in private investment as a percentage of GDP over the last decade or so. 

• It may be the consequence of a slowdown in the pace of reforms in the last two decades.
• Moreover, the policy uncertainty can discourage private investment as investors expect stability to carry out risky long-term projects.

Relationship between Consumption and Investment

Inverse Relationship: Historically, there has been no direct correlation between an increase in private consumption and a rise in private investment in India. In fact, a decrease in consumption spending has often boosted private investment rather than suppressing it.

• Private final consumption expenditure (PFCE) dropped steadily from nearly 90% of GDP in 1950-51 to hit a low of 54.7% of GDP in 2010-11, which was a year preceding the peak of private investment and began its long decline. 
• And since 2011-12, private consumption has risen while private investment witnessed a decline as a percentage of GDP. 

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Reasons for Inverse Relationship: It may be likely because the money that is allocated towards savings and investment, either by the government or by private businesses, comes at the cost of lower consumption expenditure.

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