Better numbers in private investment projects

Business Standard, 29 May 2023

Private investment is the most important component of Indian growth. For a long time now, private investment has fared poorly. The long decline bottomed out in 2021 and recent evidence shows gains. This is an important beginning, but we don't yet know if it will play out into a big growth episode.

While the Indian state dominates the airwaves, it is a small part of the economy. Almost all output and jobs are made in the private sector. Everything that happens by way of state action should be seen as modifying incentives for private people to invest. In this fundamental sense, public policy is not a game of muscular action in the economy. It is the game of establishing conditions in which the private sector will engage in muscular action in the economy. Similarly, the financial system should best be seen as creating conditions for the non-financial firms to build the economy. Policy, and finance, are the means to an end: to achieve vibrant growth of output and employment by the non-financial firms.

Hard evidence from firm data

Small firms in India are not observed, but large firms are. One good measure of investment activity is the year-on-year growth of net fixed assets of the large non-financial firms. This is hard data about the annual flow of investment by large firms. This time-series has a simple story of two episodes of torrid growth, one in the mid-1990s and another in the late 2000s. NFA growth has declined steadily from about 25% real in 2007-08 to about 0% real in 2021-22.

Leading indicator from projects data

A good leading indicator of investment is found using the CMIE Capex database, which tracks all large investment projects. The methods for the database have been consistently in place from 1995 onwards and it is thus a good record of investment activity in India. When a firm retools within an existing facility, without a formal announcement of an investment project, these investment expenditures do not show up in the database. What is measured in the database are all clear projects with a distinct name, which show up in various disclosures by the firm and by the state. We restrict ourselves to the projects that are classified as `under implementation' by CMIE.

Interpreting the value of projects outstanding as seen at a point in time requires care. The flow of annual expenditures associated with a project of value Rs.100 varies with the number of years over which the project is implemented. The flow of annual expenses associated with a project valued at Rs.100 is lower for a long-gestation infrastructure project vs. the typical two to three years for a manufacturing or construction project.

Let us look at the stock of value of private projects under implementation, expressed in real terms. This has been a great source of anxiety for observers of India, with a long decline from 2011-12 onwards. Things have now changed: it bottomed out in 2020 at a value of about Rs.47 trillion (in today's money). There was a slow recovery from 2020, and a sharp gain in early 2023. The latest value, at Rs.55 trillion (in today's money), is 17% real above the bottom. The long decline has reversed. This is an important positive change in Indian economic conditions. While the present value of the stock of private investment is far behind the peak value of 2011, some of that sustained decline has now been reversed: we are back to the levels last seen in 2018.

From a blip in projects to a torrid growth episode

The well known intuition of macroeconomics is that a demand impulse generates a multiplier effect. A spending shock -- such as increased private investment flows -- courses through the economy. Increased purchases and employment generate greater demand. Each person that sees friends and family getting jobs will interpret this as an improvement in economic conditions. This triggers off many good responses, such as greater borrowing, greater purchases of durables, greater investments in business plans, and non-workers transitioning into unemployed.

So far, we have examined aggregates for the economy. Beneath these totals lies a great churning, of some firms faring well and some firms collapsing. The drama of the recent decade has scarred many firms and business leaders. The limitations of firm resolution in India have led to the excessive survival of impaired organisations. The rising tide of recent quarters may not, as yet, lift all boats. Perhaps there is a set of firms that have landed on their feet, are seeing opportunities, and back to investing. Could we then first get a cautious growth episode, led by a small set of firms, which sets the stage for a bigger growth episode where the rising tide lifts all boats? Could the present optimism morph into something bigger, akin to the great growth episodes of the mid 1990s and the late 2000s?

The big three questions

There are three links in the chain that lead up to the happy outcome:

  1. Will this upsurge in private projects under implementation show up as an upsurge in investment as seen in the net fixed assets data (which is hard flows of investment expenses), and when?
  2. Will such a hoped-for upsurge in the flow of investment expenses trigger off a significant scale of the `multiplier effect' gains in demand and employment?
  3. Will a modest macroeconomic recovery kick off broad-based investment and torrid growth as was seen twice before?

If your view on these three questions is in the affirmative, then we are headed for the third torrid growth episode! These three questions are at the heart of Indian macroeconomics, but the research literature on Indian macroeconomics does not know the magnitudes and time-horizons of these relationships. We should watch three things in coming months: the NFA growth in the firm annual report data for 2022-23 and 2023-24, the number of persons working, persons jumping from non-working to unemployed, and the fraction of firms that are back to investing.

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