India Can Revive Investment by Learning from Itself

IMF Blog, June 6, 2012

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India’s investment was the main driver of economic growth in the mid-2000s when the country was growing in excess of 9 percent a year.
For the past five years (to June 6, 2012), investment has been sluggish while private consumption is growing at a rate comparable to pre-crisis levels.
Corporate investment’s share in GDP has fallen to about 10 percent—4 percentage points lower than that in 2007/08.
RBI Governor Subbarao: India’s “non-inflationary rate of growth is about 7 percent,” down from 8.5 percent before the global financial crisis.
Global reference: Global financial crisis of 2008-2009 is part of the backdrop to these developments.

Analysis period highlighted: comparison between 2006/07 and 2010/11.
Inflation and its volatility contributed five times more than global economic conditions to the decline in corporate investment between 2006/07 and 2010/11.
Lower domestic growth had a small impact on the investment decline.
Real interest rates actually helped investment because they were lower in 2010/11 than in 2006/07.
Macro variables alone cannot fully explain recent weakness in investment, implying structural factors affecting the business environment were also important.

Firm-level sample: over 1,000 companies across 12 cities.
Corporate capital expenditure depends on profitability, leverage, and liquidity.
Cash holdings matter, indicating room to improve access to credit.
Corporates’ liquidity position has not deteriorated substantially over the past few years.
Financial sector reforms have advanced (examples cited: interest rates fully liberalized; measures to help develop the corporate bond market and fund infrastructure).
Corporate profitability has worsened appreciably and has not returned to levels recorded before the global financial crisis.
Profitability is affected by business costs such as the cost of starting a business, registering property, enforcing contracts, and the cost of exporting—pointing to infrastructure and procedural costs as important determinants of profitability and investment.

World Economic Forum ranking: India was 56th in the global competitiveness index in 2011, down from 49th in 2009, reflecting weakening institutions and relatively slow pace of infrastructure development.
Authorities’ recognition: Finance Minister Pranab Mukherjee and Deputy Chairman Montek Singh Ahluwalia have highlighted deterioration in the domestic investment environment and stressed the need to revive the investment climate.
Large variations in the business environment exist across Indian cities:
- Example: For registering property (in percent of property value), the best city has a cost which is a fifth of the most expensive city.
Estimated impact of reducing business costs:
- Reducing the average of each cost of doing business to the lowest among Indian cities could boost aggregate corporate investment by as much as 10 percent.
- The direct demand impact of such improvement could yield up to 1.5 percent of GDP (not counting positive spillover effects).

Focus on domestic, structural reforms to lower business costs and improve infrastructure (power, coal, land, transport-related costs affecting exports).
Leverage intra-national best practices: poorly performing cities and states could emulate better-performing peers to reduce costs of doing business.
Improve access to credit and strengthen corporate profitability through measures that reduce business procedural costs and enhance infrastructure.
Prioritize reforms that address transparency of government decision making and speed of project approvals and clearances to restore corporate profitability and investment.

India Can Revive Investment by Learning from Itself — Laura Papi; June 6, 2012