Difficult to gauge if it will survive the recent demand shock, The severity of the demand fall has depressed sentiments.
India’s preoccupation with reviving investment goes back to over five years now. Since 2014, much fiscal-monetary ammunition, structural and other efforts have been expended to breathe some life into it. Yet, the share of gross fixed assets creation that sank 1.5 percentage points in FY13 to 32.6% of GDP (new series) is yet to get restored to even that lowered level. Last year, it reached 32.3%, inching 1.6 points in four years, from a 30.7% trough in FY16; this, too, mostly reflects public capex stimulus. When will private investment spring back? Why has all the hard work failed to achieve the intended objective?
In 2013, when aggregate investment sank –3.7%, it represented swelling uncertainty, besides deteriorated, unstable macroeconomic settings. Inter alia, sudden regulatory changes, retrospective tax legislation, a dysfunctional government delaying or jamming projects, other governance issues, and supply bottlenecks were major sources.
Business confidence steadily fell after FY11. News coverage turned extensively negative, reporting these developments. Disentangling India’s investment slowdown, the IMF employed a Policy Uncertainty index based on news coverage, inflation, and budget deficit, finding that heightened uncertainty about the future course of broader economic policies and deteriorating business confidence played a significant role. Uncertainty, thus, mattered for investment.
Post-2014, inflation lowered, budget deficits restrained—at least officially (the CAG’s revelation of significant build-up of hidden, off-budget liabilities came only last year)—and macro conditions stabilised. Stalled projects were cleared; hidden NPAs recognised with lagged resolution and recapitalisation; structural reforms like inflation targeting, GST, IBC, and RERA happened; business conduct was eased, along with other initiatives. These advancements were universally welcomed and endorsed. News coverage has been positive. Put differently, an update to the Policy Uncertainty index would show it much lowered.
Then, why has investment not reacted to the improvement, the reduced uncertainty? Why does it remain unmoved in committing fresh capital? Why have structural reforms not worked?
One reason is the damaged balance sheets of banks and corporates, dating back to pre-2014 days; these are yet to mend, regain vigour. Meanwhile, the pace of resolution has infected other balance sheets, i.e., initial delay in addressing bad loans was compounded by asymmetric recognition and recapitalisation, wherein inadequate capital support slowed recovery of banks, who, in turn, restrained lending. Substitution through scaled-up lending by healthier non-banks to replace the bank credit deficit proved costly: Balance sheets here stretched too far, too quickly in taking on the banks’ role. Non-banks raised outsized short-term funds to finance long duration loans, ending with asset-liability mismatches. Contagion has enhanced risk-aversion, credit deficit, and costs in other parts of the financial system, and for more participants.
Debt stress has also engulfed newer borrowers, viz. agriculture, small-medium businesses, and households that are burdened by falling incomes, and increased liabilities contracted at high real interest rates. Demonetisation, and a poorly designed and implemented GST, aggravated this situation. Borrowings-financed public capex spilled outside the budget, crowding out investment, and invalidating both fiscal and monetary stimulation; joined with low inflation, debt burden increased.
When responding agents are not in good shape, they are unlikely to react to supportive policy cues, and fresh openings from relative price changes induced by structural reforms. Reports of ICICI’s closure of its project finance division earlier this month betrays the persisting risk-aversion to enduring exposure, and a possible demand deficit for long-term investments.
Other than balance sheet weaknesses, there are intangible or soft reasons for investor anxiety. Despite positive news coverage and macroeconomic betterment, there are layers of uncertainty, originating from perceptions of private businesses, about structural changes, disappointments over unmet expectations, lack of clarity and unease about the direction of economic policies.
In the financial sector, capital support for public banks has been universally assessed to be deficient to cover provisioning and growth. Hidden bad loans and unethical lending uncovered at private Indian banks exposed governance problems akin to public sector banks, perpetuating mistrust. Banking reforms, too, have either fallen short or are reverse of expectations, e.g., consolidation instead of privatisation; no indications on the future role/direction of public banking; procyclical regulatory changes antithetical to recovery and repair, sometimes amended or even withdrawn, contribute a layer of uncertainty in the financial sector. The NBFC crisis, its persistence, and continuing defaults add another coat of uncertainty. These have hardly imparted confidence to the private sector about how to proceed.
The IBC is considered a huge positive step. But, it seems to raise uncertainty due to unanticipated and long-drawn legal tangles, constant amendments to refine the law, delayed timelines, and doubted outcomes. Unresolved problems in the power sector, fresh troubles and insolvencies in aviation and telecom, and fragilities in real estate, housing and infrastructure are another stratum of hidden, unspoken uncertainty. Tax terrorism is another layer. Uncertainty about the future course of policies towards public and private sectors also seems to have gained ground with more centralisation, the favouring and prioritisation of public over private sector.
Key structural reforms missed out on—land, labour market, etc—dejected private ardour, too. Changes in rules, norms, regulation without adequate feedback or studying ripple effects added another film of uncertainty, as in the automobile segment.
Last, but crucial, is uncertainty about demand conditions. This is not merely statistical, the large gap in robust growth portrayed by new GDP data and high-frequency volume indicators, or the contested unemployment-consumption estimates. Conflicting signs from multiple sources have created confusion amongst private agents about actual demand. For any firm planning production or capacity addition, future demand, especially consumption, is a crucial input for volume, revenue and cost projections.
The inability to anticipate policies with precision or clarity sows doubts in business’s mind, which is then likely to question a bet on committing money. The private sector perceives uncertainty as it sees collective policies and preferences in a longer timeframe.
Possibly, the plunge in business confidence in RBI’s April-June survey may reflect these intangibles, besides the June budget shock that alone could not have triggered a drop comparable to the global financial crisis (2009) and the dotcom (2001) shocks.
The policy environment has turned since then. Unpleasant tax proposals were reversed, and replaced by supportive fiscal actions, notably business tax cuts. Further reforms, e.g., relaxing labour regulations, have happened; more are likely to come. Fresh expectations of investment revival are in the air. The uncertainty about demand conditions has evaporated—most information sources, including GDP, lead indicators, and corporate performance are converging to show universally steep declines in economic activity. Should we, then, expect investment to finally get restored?
Ironically, the disappearance of demand uncertainty or the sureness about demand, its all-round confirmation and the severity of its fall, has widely depressed sentiments and confidence in matching proportion. For now, the demand outlook is assessed to be grim. Importantly, there are doubts about what lies ahead: No one is sure if growth will further decelerate, recover to 7%, or languish at low levels. This scenario suggests that fresh changes, reforms must wait to yield results as agents await clarity. Very steep demand declines often require a substantial uplift to restore beliefs about future economic prospects, to which is linked the mood to invest. India would be fortunate if this comes about.
The author is New Delhi based macroeconomist
Views are personal