India's Investment Cycle Might Just Be Recovering

Despite some ongoing economic recovery in India, getting the investment cycle back on track is turning out to be a rather slow process. The contribution of capital formation to the economy has been declining steadily over the past few years: In 2011-12, the numbers stood at 36% and are now down to 31.5% up to the first half of 2015-16. 

This loss of share, is also corroborated by the pace of credit creation in the economy, which has averaged a growth of an anaemic sub-10% rate for much of the past year. Industry, which forms the largest component of credit, has shown the slowest growth of 5% in November 2015 among all sectors. Foreign borrowings by corporate India have been weak in the past year, too. 

Disappointing as this is, it is however, only half the picture. 

A number of factors at work can mean better days ahead for the India investment story. For one, long-term foreign investments are impressive. For the period up to September 2015, India's FDI inflows are north of $24 billion, a trend, which continued for the year will result in the highest ever FDI inflows into the economy in a single year. 

The government at the centre has also front loaded its capital spends, possibly in a bid to improve overall investments in the economy. And the central bank on its part, has cut policy repo rate by 1.25 percentage points the past year, which could boost domestic credit creation.

Further, growth in production of capital goods  has picked up as per numbers from the monthly Index of Industrial Production (IIP) to 9.4% in the April-October 2015 period, compared to 5.3% in the same period in 2014.

Also, even though the contribution of capital formation to gross value added has slowed down over the years, the latest growth number gives room for hope. Capital formation in the second quarter of 2015-16 grew at its fastest pace in three quarters at 6.8%, a rate faster than consumption spending. If this growth rate pickup continues continues, then the share of investments in the economy could start rising in the coming quarters.

Not everyone buys this, though. According to Madan Sabnavis, Chief Economist, Care Ratings, capital formation as a ratio of the GDP in current prices is still a better indicator to look at, which is slowing down. Also, industrial capacity utilisation needs to pick up before companies can start further capacity creation. Banking sector NPAs can also make banks extra cautious while lending now.

All in all, though, chances of some return in investment growth is quite likely in the next quarters, even if it is cautious and even uneven across sectors and over time.

The article was first published in Business World online