Context:
The narrative thus far revolves around the persistent challenge of sluggish private investment, measured by the proportion of private Gross Fixed Capital Formation (GFCF) to gross domestic product (GDP) at current prices, which has hindered the progress of the Indian economy. Private investment has steadily declined since 2011-12, prompting the government to pin hopes on major Indian corporations to step up their investment efforts. In a bid to stimulate private investment, the government slashed corporate taxes from 30% to 22% in 2019.
Relevance:
GS3-
- Mobilization of Resources
- Growth
- Development
- Inclusive Growth and issues arising from it
Mains Question:
What is meant by the private Gross Fixed Capital Formation? Also discuss that how do government policies affect private capital formation. (10 Marks, 150 Words).
Gross Fixed Capital Formation:
- GFCF, or Gross Fixed Capital Formation, signifies the expansion of fixed capital within an economy. Fixed capital encompasses assets like buildings and machinery that require investment for their creation.
- Therefore, private GFCF serves as a rough gauge of the private sector’s willingness to invest. Additionally, overall GFCF includes capital formation resulting from government investment.
- The significance of GFCF lies in the fact that fixed capital enables workers to produce a greater quantity of goods and services annually, thereby fostering economic growth and enhancing living standards.
- Essentially, fixed capital largely determines an economy’s overall output and consequently influences what consumers can afford to purchase in the market.
- Developed economies like the U.S. typically boast higher levels of fixed capital per capita compared to developing economies like India.
Trajectory of Private Investment in India:
- Following the economic reforms of the late 1980s and early 1990s, which bolstered private sector confidence, private investment in India witnessed significant growth.
- Prior to economic liberalization, spanning from independence to the initiation of reforms, private investment hovered around or slightly above 10% of the GDP.
- In contrast, public investment as a share of GDP steadily increased over the decades, starting from less than 3% of GDP in 1950-51, eventually surpassing private investment as a percentage of GDP in the early 1980s.
- However, post-liberalization, public investment declined, while private investment assumed a leading role in fixed capital formation.
- The surge in private investment endured until the global financial crisis of 2007-08. During this period, it escalated from approximately 10% of GDP in the 1980s to around 27% in 2007-08.
- However, beginning from 2011-12, private investment experienced a downturn, reaching a nadir of 19.6% of GDP in 2020-21.
Factors that have Led to the Decline in Private Investment:
- Many economists in India attribute the primary cause to low private consumption expenditure, especially in the past decade, exacerbated by the onset of the pandemic.
- According to their analysis, robust consumer spending is crucial to instilling confidence among businesses that there will be adequate demand for their products once they invest in building fixed capital.
- Therefore, these economists advocate for increased government spending to stimulate consumption expenditure and, consequently, ignite private investment.
- However, historical trends in India suggest that an uptick in private consumption hasn’t necessarily translated into increased private investment.
- Surprisingly, a decrease in consumer spending has sometimes spurred private investment rather than hindering it.
- Over the years, private final consumption expenditure gradually declined from nearly 90% of GDP in 1950-51 to a low of 54.7% of GDP in 2010-11, which preceded a peak in private investment followed by a prolonged decline.
Private Investment vis-à-vis Private Consumption:
- Since 2011-12, private consumption has increased while private investment has experienced a concerning decline as a proportion of GDP.
- This inverse relationship between consumption and investment likely arises from the fact that funds allocated towards savings and investment, whether by the government or private entities, often come at the expense of reduced consumption expenditure.
- Another school of thought among economists posits that structural issues may underlie the significant drop in private investment as a percentage of GDP over the past decade or so.
- They point to unfavorable government policies and policy uncertainty as key factors affecting private investment. The upsurge in private investment during the 1990s and 2000s coincided with the initiation of economic reforms in 1991.
- Conversely, the downturn in private investment correlates with the deceleration in the pace of reforms over the past two decades under both the UPA (second term) and NDA governments.
- Moreover, policy uncertainty can deter private investment as investors seek stability to undertake risky long-term projects.
Conclusion:
Low Private Investment could lead to a deceleration in economic growth, as a robust fixed capital base is essential for enhancing economic output. Some view the government’s efforts to boost public investment as detrimental, arguing that it crowds out private investment. However, others argue that government investment serves as a necessary complement to offset the shortfall in private investment.
