Why have Private Investments dropped?

Context: Discussions regarding the upcoming Union Budget 2025 highlights the perceived underperformance of the private sector and slowdown of private investments in India.

Relevance of the Topic: Prelims: Private Sector Investments: Key Trends;  Gross Fixed Capital Formation. 

Historical Context: Public and Private Sector Investments

• Period of Public Sector Dominance:
  • During Second and Third Five-Year Plans (1956-1966), India had massive public sector investments.
  • Tax increases under TT Krishnamachari’s Budget (1958) financed these investments successfully.
• Shift in the 1980s: 
  • From independence to economic liberalisation, private investment largely remained either slightly below or above 10% of the GDP.
  • By the mid-1980s, public sector investments stagnated, and the government turned to the private sector.
  • Pro-growth reforms like tax cuts in 1985 and the LPG reforms of 1991, spurred private investments, despite challenges like low consumption and high interest rates.
• Post-liberalisation Era:
  • Post-liberalisation, private investment took the leading role in fixed capital formation.
  • Growth in private investment lasted until the global financial crisis of 2007-08. It rose from around 10% of GDP in the 1980s to around 27% in 2007-08. 
  • From 2011-12 onwards, private investment began to drop and hit a low of 19.6% of the GDP in 2020-21.
• Recent Trends:
  • Corporate tax rate reduction in 2019 (to 22%) was aimed at attracting private investment, but failed to yield desired results.
  • Even with a 15-year high profit-to-GDP ratio of 5% in 2024, private sector investments in India remain sluggish.

Why have private investments dropped?

• Structural issues (like policy uncertainty, issues in ease of doing business, delays in land acquisition, lengthy dispute resolution) have led to significant fall in private investment as a percentage of GDP. 
• High levels of NPAs in the banking sector have constrained credit availability for the private sector. 
• Crowding out of private investment due to expansionary fiscal policies and increased borrowings of the government. 
• Narrow corporate bond market due to illiquid secondary market, narrow investor base, lack of diversity of instruments and crowding out by large public issuance impacted corporate investment.
• Low private consumption expenditure can also be a reason for reducing demand-driven investment opportunities. 

Associated Challenges

• Low Private Investment: Declining private investment has been impacting the Gross Fixed Capital Formation (GFCF) in India. Private investment in India declined from 27% of GDP in 2007-08 to 19.6% of the GDP in 2020-21. As per NSO, GFCF in India declined from 34% in 2009-10 to 26% in 2021-22.
  • GFCF refers to the growth in the size of fixed capital in an economy.
    • Fixed capital refers to things such as land improvements, buildings, plants, machinery etc. which require investment to be created. 
    • GFCF excludes financial assets such as bonds, stocks, and other financial instruments. 
  • Private GFCF can serve as a rough indicator of how much the private sector in an economy is willing to invest.
• Preference to overseas investments:
  • Despite benefiting from government initiatives like Make in India (shielding domestic industries), private entities prefer international investments or overseas expansion. 
• Labour Exploitation Concerns:
  • Suggestions by industry leaders for employees to work 72-90 hours per week raise ethical and practical questions about workforce sustainability.

Policy Recommendations

• Rebalancing Tax Rates:
  • Government could consider revising the tax rates:
    • Increasing corporate tax 
    • Reducing personal income tax 
  • This could increase disposable income and stimulate demand and consumption.
• Focus on structural reforms like policy consistency, labour reforms, improving the ease of doing business, ease of land acquisition, early dispute resolution, etc. 
• Encouraging domestic investment: Introduce incentives for businesses investing in India, such as sector-specific subsidies or reduced compliance burdens for targeted industries.
• Strengthen corporate bond markets and diversify financial instruments to ensure adequate capital for private investments.  
• Strengthening Public-Private Partnerships (PPPs): Foster collaboration in long term projects (like infrastructure) and manufacturing to share risks and benefits equitably.

The biggest cost of low private investment would be slower economic growth as a larger fixed capital base is crucial to boost economic output.