Govt Capital Spending Makes Up For Sluggish Private Investment, FDI Inflows, But For How Long?

The investment gap has been made worse by a secular stagnation in post-pandemic household savings. Consequently, the revival of domestic private savings and investments, as well as attracting new foreign direct investments (FDI), are of paramount importance to power India’s dream to become a US$7-trillion economy by 2030.

Though India's GDP grew 8.4 per cent in the October-December quarter of 2023-24, growth in private investment has been falling. According to data cited in the Finance Ministry’s Economic Review in January 2024, capital spending by private non-financial Companies expanded at slower pace of 23 per cent in FY 2022-23 compared to 28 per cent in FY2021-22. In the first half of the current fiscal year, it was up 10 per cent year on year. 

Private investment usually propels total investment in the economy, and investment growth is historically fuelled by domestic savings in India, particularly household savings. Traditionally, whenever there is a shortfall between investment and domestic savings, attempts are made to bridge the gap through FDI. In earlier years, the Indian economy had seen an infusion of substantial FDI. Lately this flow has tapered off.

How does then India fare in this scenario? The Secretariat dives deep into the anatomy of Indian investment growth.

India’s Investment Growth Remained Weak In Last Five Years

Even before the pandemic, India’s investment growth—measured by the year-on-year quarterly change in Gross Fixed Capital Formation (GFCF)—was negative for the last three quarters of 2019-20. Year-on-year growth rates were on the higher side during 2021-22, primarily due to a low base effect, as they were compared to a year when capital formation shrank.

Since then growth rates remained moderate in single digits for most of the quarters, before reaching another high of 11.6 per cent in the July-September quarter of 2023-24. However, the rate decreased once again to 10.6 per cent in the October-December quarter, according to the recently released GDP estimates.

A quick comparison of India’s GFCF as a percentage of GDP with China, Vietnam, Indonesia, and Bangladesh reveals some startling facts. In 2022, investments in India and Indonesia were tied at 29 per cent of GDP. Whereas, China, as expected, fared much better at 42 per cent of GDP, despite falling from the 45 per cent mark in 2013.

Vietnam and Bangladesh performed better in capital formation in 2022, at a comfortable 32 per cent of GDP. Interestingly, both the countries were performing far worse when compared to India, in earlier decades. In 2013, these countries reported a GFCF of 28 per cent, while India’s GFCF stood at 31 per cent.

Indian Household Savings Stagnated After Pandemic Surge 

This bumpy low-level investment growth in India has been accompanied by a drop in household financial savings in the last three years. Household savings in India have been historically around 60 per cent of total domestic savings. Any drop in this brings down total domestic savings.

According to the December 2023 RBI Financial Stability Report, gross household financial savings had surged to 15.4 per cent of GDP (at constant prices) at the peak of the pandemic in 2020-21, as families were forced to save in the face of adversity.

However, this household savings rate fell to 11.1 per cent in 2021-22 and then to 10.9 per cent in 2022-23 as families went on a revenge shopping and tourism spree. Analysts said the push that household savings could have given to capital investment went awry in the face of global consumption trends.

Government Capital Expenditures Filled The Gap

However, what kept the economy ticking despite weak domestic investment growth?

The answer lies in the steady growth in capital expenditure by both the central and state governments. Since FY19, central and state capital expenditures have started buffering public investment, to make up for the low appetite for private investments in an era when industrialists were unsure whether the global economy buffeted by a pandemic and subsequent wars would support production growth. 

The government’s intervention in public investment was and is based on the assumption that it will eventually “crowd in” private investment—a hope yet to be fulfilled.

Post-Pandemic FDI Growth In India Yet To Recover 

Has FDI growth managed to overcome the weak private investment link and the growing savings-investment gap in India? Insignificant growth in the last three quarters of pre-pandemic 2019-20 was followed by two volatile pandemic years.

One may argue that unprecedented circumstances of lockdowns and economic disruptions resulted in volatility in FDI growth in those two pandemic years. However, the fact remains that the post-pandemic two years witnessed consecutive six quarters of negative FDI growth in the Indian economy. The negative streak was reversed in the October-December quarter of 2023-24 when year-on-year quarterly FDI growth went up to 12.4 per cent.

India’s export rivals, Vietnam and Indonesia, surpassed the country in net FDI inflows in 2022, at 4.4 per cent and 1.6 per cent of GDP respectively. Net FDI inflows into India were just 1.5 per cent of GDP in 2022.

China, on the other hand, had a mixed performance. The re-ordering of the global supply chain after the Covid pandemic, to reduce the risk of over-depending on Chinese manufacturing to supply the world economy, seemed to favour the two South East Asian economies of Vietnam and Indonesia with their higher productivity and easier business norms.

Vietnam, which attracted net FDI inflows to the tune of 5.0 per cent of GDP in pre-pandemic years of 2017 and 2018, was the clear leader of the pack.

In comparison, net inflows of FDI into China fell from 3.0 per cent of GDP in 2013 to 1 per cent in 2022. Changes in the global supply chain accentuated by a trade war with the US, as well as strict lockdowns due to frequent outbreaks of COVID-19, were seen as the primary reasons for China’s weaker FDI story.

However, the Chinese GDP according to World Bank data, stood at US$ 17.96 trillion in 2022, second only to the USA’s GDP of  US$ 25.44 trillion. 

India’s ambition to touch the US$ 5 trillion mark of GDP in the next financial year has been reiterated by different ministers of the central government. The country also aspires to cross the US$ 7 trillion GDP threshold in 2030.

However, with a persistent savings-investment gap and weak private investment growth, the probability of achieving these goals appears thinner. As the FDI inflow consistently fails to compensate for the lack of domestic investment growth, the chances of reaching these officially stated economic goals look even more remote.

Unless private investment gets its mojo back and the FDI growth shows a big uptick, the Indian economy may be "Waiting For Godot".