India's falling investments: An exploration

India reported another set of dismal GDP number today, with Q4 2012-13 growth at 4.8% and the year's cumulative growth at 5%. While there is evident weakness across categories of GDP, in this post we look at one specific category of the GDP that has been a source of concern for sometime - investments. In this post, a version of which appeared first on IndiaSpend, Orbis Economics' Manika Premsingh takes a deeper look at Indian investments. (Note: the article was written before the Q4 GDP release, so those numbers are not included in this analysis). 

While India was seen as part of the new haloed ‘BRIC’ group at the turn of the century; a key emerging economy for the future, voices of how it might, a decade later, be a lost story have got louder over the recent past. Is the pessimism justified? We cannot say for sure, for the verdict itself is still out there. But, what we can do is try and understand what has led India to its current predicament.

One look at India’s recent economic performance and it is clear that India’s growth has fallen way below average. Growth in the Indian economy, as measured by the gross domestic product (GDP)   for the last quarter fell to a decade low, coming in at 4.5%, in stark comparison with the average growth of 8% over the past decade. The economy’s GDP release shows two categories – GDP by economic activity and GDP by expenditure, which are essentially reflections of each other.

GDP by economic activity comprises of three sectors – agriculture, industry and services. GDP by expenditure is essentially the usage of incomes generated in the economy. It comprises the private final consumption expenditure (PFCE), which is nothing but spending on various goods and services by the consumer; government final consumption expenditure (GFCE), which is government spending on various goods and services in the economy; gross capital formation (GCF), which is essentially the domestic investments and net exports, which is exports less imports.

Tumbling domestic investments

A close look at the expenditure components of India’s national income reveals that one of the major drags on GDP growth in the recent past have been domestic investments or GCF. Investments have been the most unimpressive aspect of India’s economic growth or in other words minimal growth in investments has significantly contributed to slowing down in India’s growth in the recent times.

Why is the investments component so important for India’s growth? First, the contribution of investments (which are defined as the sum of gross fixed capital formation, change in stocks and valuables) to overall GDP for the third quarter of 2012-13 is at a falling 34% on account of very little growth in the component over the recent past.

As per the Central Statistical Organisation’s (CSO’s) advance estimates, GCF or investments are expected  to have grown only at 3.9% in 2012-13, despite having been a no show in 2011-12 as well (growing by a negligible 0.5%). This is in stark contrast with the two prior years when investments grew in double digits (see chart). Not only does this hit overall GDP growth, it is also a reflection of how investments in the economy have come tumbling down. The combination of slowing global economic activity, its impact on domestic economic activity and high inflation are some of the reasons for slowing down in investments.

Gross capital formation (2004-05 prices, market prices)
Year	Growth
2005-06	16.2
2006-07	13.4
2007-08	18.1
2008-09	-5.2
2009-10	17.3
2010-11	15.2
2011-12	0.5
2012-13*	3.9
* CSO projections
Source: CSO

Recession and inflation impact Indian investments

During buoyant economic times, investments trends to be robust as well, since business sentiment is upbeat and preparing for future opportunity requires investment today. The reverse happens during recessions, when risk-taking ability declines as does the optimism for the future. The lack of perceived future demand further reinforces challenging economic times, making it a chicken and egg situation. Further, during years when growth is expected to slow down or has already slowed down, incomes in the private sector become stagnant or grow slowly. This leads to either lower absolute real incomes or lower growth in real incomes, where real income is measured as income adjusted for the effects of inflation. So, rise in prices or inflation remaining the same, if incomes have not grown over the year, effectively real income is less than what it was during the previous year. With prices rising and incomes remaining unchanged or growing slowly, consumers need to spend more and more to run their households. This, leads to less in the hands of the consumer to save and invest and gets reflected in overall investment slowdown overtime.   

Thus, it is not surprising, that in GCF, has grown at 1.4% over the April-December 2012-13 period in comparison with the corresponding period of the previous year. This is an even more disappointing number in light of the fact that in during 2011-12 it grew by 1.9% per cent, which was a low enough rate as it is. This growth also compares rather unfavourably to other components of the GDP like private final consumption expenditure and government final consumption expenditure at 2.9% and 5.7% respectively. (see table for more details).

GDP at market prices (2004-05), Rs crore, April-December
	% of GDP		% growth yoy
	2011-12	2012-13	2011-12	2012-13
Private Final Consumption Expenditure	61.1	60.7	7.4	2.9
Government Final Consumption Expenditure	11.2	11.4	9.0	5.7
Gross capital formation	40.7	38.1	1.9	1.4
Gross Fixed Capital Formation	34.1	33	5.0	0.1
Change in Stocks	2.3	3.4	-30.0	50.5
Valuables	2.4	1.7	3.5	-28.1
Exports	24.3	24.3	16.1	3.3
Less Imports	33.7	34.4	20.5	5.6
Discrepancies	-1.7	0	-62.1	-97.8
GDP at market prices	100	100	6.8	3.6
Sources: CSO, Orbis Economics Estimates

Added to this situation, is the fact that Indian inflation has been quite high in the recent times, at over 7% in 2012-13 and almost 9% in 2011-12 as measured by the Wholesale Price Index (WPI), India’s headline inflation index. At a recessionary time, this has led to the Indian consumer being squeezed on both sides – on the one hand incomes have not grown and on the other hand prices have risen quite fast. As a result, a savings and investment slowdown was only to be expected.

Is an investment pickup possible?

The current conditions in investments while worrisome, do not entirely call for a write off in the India story. Why? Because, it is a typical phenomenon seen during a recession and a recession is a fact of economic cycles. There are no booms without busts and vice versa! While policy impetus can soften the impact of a recessionary scenario, it cannot entirely do away with a recession. We have to wait for the cycle to turn, and that turn is already becoming visible to a small extent. Inflation, for one, has come off to acceptable levels, which can be a spur for savings and investments. India’s interest rates are being softened, which is also a plus and policy reforms have revived foreign interest in India. So a turnaround is quite possible even if it takes some time.

Read the article as it was published on IndiaSpend here