The scenario of double-digit investment growth and GDP growth reaching 8% over the next decade would push investments from around 30% of GDP in FY17 to ~35% of GDP in FY27, still lower than the historical level of 39% of GDP achieved in FY12. In aggregate terms, even as nominal GDP could rise from $2.2 trillion in FY17 to $6.8 trillion in FY27, gross capital formation could increase from $0.7 trillion annually to ~$2.4 trillion. According to our estimates, the private corporate sector would remain the largest source of investments rising from $272 billion to $905 billion over next 10 years, while households (including small enterprises) will be a close second, rising from $228 billion to $834 billion from FY17 to FY27. Finally, public investments could rise from $157 billion to $563 billion in the same period.
The financing of these investments is projected to come largely from domestic savings, particularly the households sector contributing around $1.5 trillion in FY27 vs $0.4 trillion in FY17, followed by private corporate sector rising to $0.7 trillion in FY27 from $0.3 trillion currently. The overall domestic savings could amount to around $2.3 trillion by FY27, leaving a savings investment gap of around $82 billion. Keeping with the savings investment gap identity, the current account deficit could rise to $82 billion (~1.2% of GDP) in FY27 from $15 billion in FY17.
If these investment trends are to materialise, then cumulative investment over the next 10 years is estimated to be $14.3 trillion, of which, the largest share will be private corporate investments at $5.4 trillion, followed by household investments of $5 trillion. Public sector investment of $3.3 trillion, predominantly in infra could also be significant over the next 10 years. In terms of financing the investments, the household savings could amount to $8.8 trillion (with gross financial savings at $5.2 trillion over the next decade vs $2 trillion in the previous decade) while the private corporate savings could amount to $4 trillion in next decade vs $1.7 trillion in the previous decade.
Given that private investment remains the largest component of overall capital formation, the recovery in private investment remains a prerequisite for investment growth to rebound to double digits. Six catalysts that could help investment recovery are:
Easing of corporate leverage
The Economic Survey for 2016-17 noted that around 40% of India’s corporate debt was held by corporates with an interest coverage ratio of less than one which suggests an acute stress in the corporate sector. As discussed in the survey, some of this can be attributed to an over-leveraging in the past boom cycle especially in the infrastructure sector (power, steel, telecom), and a course correction may be warranted (aided by regulatory and legislative measures). Furthermore, with asset sales by leveraged firms and fresh capital raising the corporate leverage could ease up. However, with India’s private sector debt-to-GDP at less than 60% of GDP, considerably below the emerging market (EM) average of 137% of GDP and advanced economy (AE) average of 160% of GDP, we believe there is large scope for India Inc to take up good debt even while the bad debt problem clears up. Roughly, even a 16% annual rise in private debt would lever up private debt to close to 80% of GDP, still a favourable condition among the rest of the EM pack.
The enactment of the new Insolvency and Bankruptcy Code (IBC) process and the bank-recapitalisation plan of `2.11 trillion ($32.8bn) has accelerated the recognition and resolution of banking sector NPAs, enabling the PSBs to restart the lending cycle. The bank credit growth that dipped to close to 5% YoY has begun to rebound and has now reached 10% YoY, though it remains considerably below the 24% growth during FY04-11. Even a 16% growth in credit over the next 10 years could keep overall debt within 80% of GDP, significantly lower than the EM average.
External demand recovery
Export growth, which averaged 18% between 2002 and 2008, has fallen to 3% during 2012-16. A higher share of exports would not only increase investment opportunities in India but also improve productivity. While it may be early to say, there are signs of a rebound in the elasticity of trade with the WTO estimating the ratio at 1.3 in 2017, which is also reflected in India’s strong exports growth after five years of flat to negative growth. With global growth broadening and deepening across economies and sectors, the outlook for trade could become even more buoyant. This could be India’s opportunity to explore the “Make in India” model of export-led growth which could kick-start the next leg of the investment cycle.
One of the proximate causes for the decline in investments from FY12 onwards has been the accentuation of macro instability as reflected in high inflation, high interest rates, higher deficits, and a depreciating currency. This issue has been addressed through a formal adoption of a flexible inflation targeting framework by India’s central bank with attendant benefits for inflation and interest rates, as well as on the real exchange rate front. The consumer price inflation that ranged between 3.8% and 12.3% and averaged 7.1% during the period FY04-FY11 is likely to stay lower and stable within the 4%+/-2% range and consequently inflation expectations could stay anchored. The lower and stable inflation regime is likely to allow nominal rates and real rates to drift lower over the longer term and become a tailwind for investment growth. We note that India’s real rates are one of the highest among the world at around 200 basis points (bps) compared to the global average of 15 bps, so clearly there is space for real rates to come down.
Revival of animal spirits
An essential pre-condition for animal spirits to revive among private investors will be the return of profitability. Low corporate earnings growth in the last 10 years, especially after the Great Financial Crisis, has been a drag on private capital expenditure recovery. Corporate profitability as seen from BSE 500 company earnings growth is showing some signs of recovery in 2016 and 2017 to 7-7.5% (quarterly trends in 2018 earnings are headed even higher), however, it still remains low compared to pre-financial crisis levels. Among other catalysts, the tax rate in India has room to come down. It is worrying that during FY14-FY16, India’s effective corporate tax rates have mostly gone up despite tax rate cuts for smaller firms.
The effective tax rate which Indian firms with taxable income exceeding Rs 100 mn ($1.5mn) pay is around 28% (statutory corporate tax rate of 35% is among the highest), and is comparable to EM peers such as Mexico and Brazil but higher than most other countries, including China. Any other competitive corporate tax rate cuts post the new US regime, could also necessitate a need to adjust India’s corporate tax rate cuts. In terms of composition, the corporate tax has room to become more progressive (smaller firms tend to have higher taxation), and currently favours capital-intensive industries. The direct tax reforms committee constituted in December 2017 is likely to take a considered view on this matter and suggest a move towards lower tax rates while reducing the plethora of exemptions to have a more streamlined tax system.
Reforms, productivity & investment
The government thrust on structural reforms and improving productivity parameters could help a revival in private investments. Reform-driven capital investments by a firm could by itself enhance productivity and offer scale benefits, leading to a further increase in investments. Clearly, the virtuous cycle could be set in motion with a relentless pursuit for globally competitive and high productivity enterprises.
Author is Chief economist (India), Citigroup
(Second of a three-part series)
Edited excerpts from Citi GPS’s report, Securing India’s Growth Over the Next Decade