The queer thing about publ-ic investment is that it can as readily go to waste as go tow-ards building useful assets and, on the odd occasion, first rate assets too. That is so, since what drives choice of projects, location and configuration have little to with efficiency, but everything to do with pat-ronage, hobby horses and pol-itical deal-making. The private sector is driven by profit considerations and hence is spar-ed the pain of doing patently stupid things and is restricted to making the occasional error of judgement. There are good investments and poor ones; and the growth outcome of the choice that is made is widely different. Given the motivati-onal dynamic, the public sect-or is prone to make poorer ch- oices than is the private sector.
The chart plots the annual growth rate of fixed investment through the 1990s and up to 2002-03. Fixed investment by the private corporate, public and household sectors are plotted along with the rate of growth in overall fixed in-vestment. The public sector includes administration, dep-artmental enterprises, PSUs and quasi-government bodies (like ports). The household sector includes unincorporated businesses.
Growth of investment, in both private corporate and household sectors, shows cyc-lical behaviour, the amplitude being larger in corporates. Looking back to the late 1970s, we see that private corporate sector investment has been characterised by strong cyclical behaviour in investments, with an interval of three to four years, up to the end of the 1980s. Household investment growth also fluctuated, but mostly out of phase with priv-ate corporate investment beh-aviour. We would also see that public sector investment gro-wth in the 1970s and 1980s had very small year-to-year va-riation. These outcomes are as expected. Private investment, whether corporate or small bu-siness, is determined by economic conditions and reflect changes in these variables. Public sector investment, driven on a different track, is insulated from changes in economic conditions, varying more with decision-making in government.
But the composition of investment did change, even if the level did not overmuch. In the closing years of the 1970s, the ratio of fixed investment to GDP was 17%. This increased to 22% a decade later. In the mid-1990s, it rose further to 23% and in recent years fell back to a little over 22%. Public sector investment, which was nearly 8% of GDP in the late 1970s, rose to over 10% in the late 1980s, but fell to 7% by the mid-1990s and to under 6% now. Conversely, private corporate investment soared from a mere 1.3% in the late 1970s, to 3.3% in the mid-1980s, reaching over 8% in the 1996-98 period and is currently at about 5%. Household sector investment remained relativ-ely unchanged at around 8% between the 1970s and mid-1990s, but has risen to over 11% in recent years, indicating heightened activity in unincorporated businesses. The late 1970s and 1980s were also the period when India emerged from the Hindu rate of growth of 3.3% and broke the sound barrier of 5%. That this attended not on an elevation of the overall rate, but on a radical change in the institutional composition of investment in favour of the private sector, is intuitively explanatory.
The slump in the rate of growth of private corporate in-vestment after the peak in the 1996-98 period, with a recovery in 2001-02, is unusually protracted by the standards of the previous decades. The downward part of the cycle clearly coincided with the East Asian crisis and the collapse of commodity prices. In an environment of trade openness, Indian corporates were forced to adjust which they did in an unprecedented wave of restructuring, sell-offs and acquisitions. In an environm-ent where the cost of capital mattered in a way that it never had done in the past, Indian corporates invested managerial and technical resources in working their capital assets to the utmost that is, they raised productivity.
But from 2002 (see chart), all three components are moving upwards. In the private corporate sector, investment up-ticks tend to be in powerful surges and indications are that the investment cycle is poised for a significant upward move. This in-phase expansion of private corporate, small business and public investment has the potential of setting in a strong upswing in the growth cycle over the next few years. The catch is that it has to be fin-anced. With consolidated governments deficit, which is la- rgely revenue in nature, running at 10% of GDP, there is an obvious likelihood that financing can become a constraint both in the short and medium-term. It is in this context that the likelihood that political co-mpulsions can introduce additional budgetary drag or tra- nsfer resources from the private to the public sector (whi-ch is what higher taxes do) causes particular concern.
The author is economic adviser, ICRA, New Delhi