Whether nominal or real, India's investment rate needs to increase by 3 to 4 percentage points of GDP to support 8 per cent real growth, recommends Nikhil Gupta.
India's (nominal) investment was about 33 per cent of gross domestic product (GDP) in the past two years and is likely to be at similar levels in 2024-2025 (FY25) as well (it was 33.8 per cent of GDP in H1FY25, the same as in H1FY24), better than the 31 per cent of GDP in the pre-pandemic years.
More importantly, India's current account deficit (CAD) was only 0.7 per cent of GDP in FY24 and likely at 1.6 per cent of GDP in H1FY25, compared to 1.2 per cent in H1FY24.
With the CAD at around 1 per cent of GDP in FY25, India's savings would be 32 per cent of GDP during the year, similar to its pre-pandemic average.
India's real GDP growth stood at 8.2 per cent in FY24 and averaged 8.3 per cent in the past three years.
Why, then, do I keep worrying about savings and investment?
Well, since the CAD is the difference between investment and gross domestic savings (GDS), it is interesting to analyse the share of each domestic participant in India's external deficit (or the CAD).
There are three participants in an economy -- the corporate sector (including private and public financial and non-financial companies), the government (the Centre and the states), and the household sector (the residual, everything else).
The CAD, thus, can be effectively analysed as the difference between the investment and savings of each of these three domestic participants.
India's corporate sector turned from a very large net borrower to only a small deficit (to surplus) sector recently.
It essentially means that corporate investment has been almost equal to or only marginally higher than the sector's savings in the past many years (FY17-24), compared to net borrowing of as high as 6 to 8 per cent of GDP between FY06 and FY11.
This is because while corporate savings (the sum of retained earnings and depreciation) were at an all-time high of 13 to 14 per cent of GDP in the past decade (which possibly picked up further in FY24), corporate investment continued to hover at around 14 per cent of GDP during the corresponding years, compared to above 17 per cent of GDP in many years up to FY16.
At the same time, fiscal net borrowing is higher than in pre-pandemic years (though it has come down substantially since FY21), and the household net surplus (ie net financial savings, NFS) declined dramatically in recent years.
According to the official data, household NFS were at a four-decade low of 5.3 per cent of GDP in FY23, which we estimate to have improved marginally in FY24.
Overall, this suggests that India's CAD is contained because of the highly cautious corporate sector.
This composition will likely change in the future. If corporate investment recovers, as is widely expected or hoped, corporate net borrowing (or deficit) will widen.
Assuming that it leads to an increase in investment in the economy, such an increase in the corporate deficit would either lead to a higher CAD or will be offset (at least partially) by higher GDS, led by a lower fiscal deficit and/or higher household NFS. This is where the conundrum lies.
The government sector has been very clear about reaching its fiscal deficit of 4.5 per cent of GDP by FY26, after which it is not clear if fiscal consolidation will continue and at what pace.
The government has indicated that it will shift its focus to the debt-to-GDP ratio, which may be a better idea; however, it has also hinted that fiscal consolidation will likely happen at a much gradual pace in the future.
Simultaneously, considering the subdued growth in personal disposable income during the past decade, a pickup in household NFS would mean a moderation in household spending growth, pulling down real GDP growth.
This could potentially create a vicious cycle of weak demand, making it difficult for corporate investment to pick up substantially.
In any case, it is very likely that if the investment-to-GDP ratio picks up, it will be funded by some recovery in GDS and widening in the CAD.
This is exactly what has been borne out by the historical data as well.
During all the past episodes of a surge in India's investment rate (in the mid-1980s, mid-2000s, and early 2010s), India's GDS picked up but fell short and, thus, the CAD also widened during all the episodes.
Assuming that the investment ratio needs to rise by 3 to 4 percentage points of GDP to 36-37 per cent of GDP in order to achieve 8 per cent real growth, we do not have too much space to fund higher investment through external borrowing (or the CAD).
At most, we can widen the CAD by 1.0 to 1.2 percentage points of GDP, which means that at least two-thirds of the rise in investment has to be funded by the rise in GDS.
This seems like a tall task at this time, considering the lack of clarity on further fiscal consolidation post-FY26 and consumer spending.
But shouldn't we look at real investment? When we analyse the incremental capital-output ratio (ICOR), it is prudent to consider the real net fixed investment ratio rather than nominal gross investment.
Compared to the nominal gross investment-to-GDP ratio of 33 per cent, India's real net fixed investment ratio was 23.5 per cent of GDP in the past three years (FY22-24E), similar to what it was in the pre-pandemic decade (FY11-20).
At an ICOR of 3.5 (the average of the 2000s decade, excluding the worst [FY09] and the best [FY04] years), real net fixed investment must rise to 28 per cent of GDP to support 8 per cent real GDP growth.
Therefore, whether nominal or real, India's investment rate needs to increase by 3 to 4 percentage points of GDP to support 8 per cent real growth.
In order to be sustainable, it must be financed by higher GDS, which, to my mind, presents the biggest conundrum to higher growth at this time.
Nikhil Gupta is chief economist, Motilal Oswal Financial Services, and the author of The Eight Per Cent Solution. This article is based on the author's recent presentation at a seminar organised by the Centre for Social and Economic Progress.
Feature Presentation: Aslam Hunani/Rediff.com
