For decades, economists constantly lamented that we are spending too much on revenue expenditure and not enough on capital expenditure (capex). That complaint, at least, can be retired. In the past 11 years, the Narendra Modi government has spent close to Rs54 lakh crore on capex, about Rs38 lakh crore, after the pandemic. For three consecutive years, public investment has exceeded Rs11 lakh crore annually, poured into roads, railways, defence, water and other infrastructure. In FY24-25, capital outlays accounted for 23% of total government spending—the highest in two decades.
Surely, this would have got us big dividends, economic and non-economic: faster connectivity, lower or stable infrastructure costs, leading to higher productivity and output and competitiveness. The non-economic benefits would be cheaper and faster travel, better civic infrastructure, water and power connections. The government spending would trickle down quickly and benefit the masses with more jobs and higher wages. Above all, the State’s heavy spending was expected to awaken a long-dormant animal spirit: private capital expenditure.
No Dearth of Efforts
That spirit, however, remains stubbornly asleep. Successive policy rounds have tried to rouse it—each with the same disappointing result. The government’s first diagnosis was that private investment was held back by India’s festering bad-loan problem. Public sector banks (PSBs), burdened with dud assets from the previous Congress-led years, were too crippled to lend. The response was sweeping: bad loans were written off, a bankruptcy code was enacted and the system was purged of its rot—though few culprits were punished. But nobody asked businessmen whether it was a lack of money or poor demand that was holding them back from investing. Private capex remained weak.
Next came tax cuts. In September 2019, amid flagging exports, a consumption slowdown and a shadow-banking crisis, corporate income-tax rates were slashed dramatically. The logic was textbook: lower taxes would fatten profits and spur reinvestment.
Again, nobody asked the obvious question—whether companies were held back by high taxes or by tepid demand. The result was the same: private capex remained weak.
In round three, the government went further. Still believing in the private sector to be the main engine for growth, it launched a State spending initiative, the production-linked incentive (PLI), designed to directly boost private capex.
Finally, the State itself took up the mantle of boosting growth and employment through government capex, especially after the COVID-19 pandemic. Indeed, government capex has been the primary engine of investment growth since FY21-22. One assumption was that now that the government has stepped forward with unprecedented largesse, private capex will follow. It did not. Stripped of PLI giveaway (806 applications and investments of Rs1.76 lakh crore), private capex remained subdued.
Overall, government capex averaged 4.1% of the GDP over FY22–25, up from 2.8% pre-COVID, while private capex's share remained at around 2% of the GDP. It may be higher this year but no one expects it to sustain, given the trade troubles. Private participation in total gross fixed capital formation (GCFC) fell to a low of 34.4% in FY23-24, from peaks above 40% pre-2016. To be sure, those earlier peaks were inflated by crony lending and scandal-ridden projects. Even so, after four major interventions—bank clean-ups, tax cuts, subsidies and state-led investment—private investment remains underwhelming.
In FY24-25, capex will account for 23% of total government spending, reaching levels last seen in FY03-04. Back then, India experienced one of its strongest private investment cycles. How did that happen and why are things so subdued this time?
For the past 15 years or more, I have watched economists at major brokerage houses wistfully predicting another private capex boom like 2004-07. They would have been right only if the same causal factors were present—which is an unprecedented global and local boom. In those years, both the main engines of global growth–US and Europe–were firing together. Pent-up demand, after years of recession caused by the dotcom crash and 9/11 attacks on the US, was supported by low-cost exports at a massive scale from China and a tidal wave of global savings mainly from Asia.
It is the Asian tigers who made the most of that demand boom, being highly export competitive. Apart from its own share of exports, India benefited from the massive inflow of capital from foreign investors pumping money not only into stock markets, but for the first time, into real estate. The 2004-07 capex and consumption boom was not due to some deft policy-making, nor due to entrepreneurship. It was a happy accident of global excess. When the global financial crisis struck in 2008, the tide went out. India never had genuine, large and productive private capex.
How To Fix It?
Policy-makers continue to treat private investment as a supply-side puzzle, to be solved with cheaper capital, fiscal sops, or government-led crowding in. The real constraint, however, lies on the demand side. Entrepreneurs invest when they see customers. India’s domestic demand remains weak because consumption is weak, since the real wages of the vast majority of people are not increasing. External demand offers no relief either: exports are uncompetitive and the global trade winds unfavourable.
Luck, alas, is no policy. India’s investment problem will not be solved until policy turns its gaze from the balance sheets of corporations to the income of its citizens.
(This article first appeared in Business Standard newspaper)
1. Does the quality of assets built matter? Yes, the government has been funding capex - but the quality is shoddy, and there is a high likelihood of government spending flowing back into party coffers through electoral bonds, routine corruption, and so on. So even with so much capex, we can't really expect the economic and non-economic benefits to accrue.
2. Yes, real wages are stagnating. But what about the cash transfers from governments? Why is that not triggering private consumption?
Tepid demand is a fact - but something doesn't add up as far as explaining it goes.
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1. Does the quality of assets built matter? Yes, the government has been funding capex - but the quality is shoddy, and there is a high likelihood of government spending flowing back into party coffers through electoral bonds, routine corruption, and so on. So even with so much capex, we can't really expect the economic and non-economic benefits to accrue.
2. Yes, real wages are stagnating. But what about the cash transfers from governments? Why is that not triggering private consumption?
Tepid demand is a fact - but something doesn't add up as far as explaining it goes.