The answer lies in the many kinds of political uncertainty, low and declining Gross Fixed Capital Formation, and the many quirks of Indian policymaking.
(1) Glass half full or empty? You call the recent rise 5% point rise in the investment ratio "an uptick." One might just as well have called it "a promising rebound," depending on mood and ideological inclination.
(2) You emphasize factors like regulation and policy uncertainty that (while important over the long haul) may not have changed much between the last government and this one, and which therefore cannot explain the fluctuation in investment. Attributing macro-cyclical fluctuations to slow-moving structural factors seems to be a typical category error in "Washington Consensus" type thinking. To the extent the Vodaphone incident caused an exceptional spike in uncertainty, that was, as you say, the work of the previous government.
(3) You mention but do not make enough of the horrible state of the financial sector at the end of the last government. Cleaning up the mass of bad debts took time and seems to have set off a severe credit squeeze. That is the sort of macro-cyclical shock that would provide a plausible explanation for the cycle in investment.
If rule of law is the big problem in India, why is the gross capital formation higher in bangladesh? We have worse rule of law on all possible metrics. Due to the energy crisis of 2021 the central bank banned PRIVATE banks from buying new cars. You Indians can't us when it comes to madness.
I think it's unrealistic for India to achieve rules based capitalism. It's better to go down the deals based capitalism route which was how the rest of Asia industrialised. Although I agree with you that you need radically decentralise power to introduce fiscal constraints and a more competitive deal making environment.
If rule of law is the big problem in India, why is the gross capital formation higher in bangladesh? We have worse rule of law on all possible metrics. Due to the energy crisis of 2021 the central bank banned PRIVATE banks from buying new cars. You Indians can't us when it comes to madness.
I think it's unrealistic for India to achieve rules based capitalism. It's better to go down the deals based capitalism route which was how the rest of Asia industrialised. Although I agree with you that you need radically decentralise power to introduce fiscal constraints and a more competitive deal making environment.
Hi Shruti, The Finance Minister Nirmala Sitharaman recently posted on Twitter about how Capital expenditure was increased manifold during the Modi tenure. Can you please go through it and highlight to us how those numbers seem positive and in complete contrast to your analysis? It would be really helpful for laymen like us to make sense of the numbers and also understand the narrative around them.
Echoing Milan's third point above, do you not buy (did not see it mentioned much) the general narrative that a huge part of the slowdown in investment is due to the "twin balance sheet problem" caused by toxic assets on bank and corporate balance sheets (due to over optimistic or fraudulent lending for projects pre-GFC) which has been taking time to unwind even after the new bankruptcy code was passed?
I have seen some argument that some of the uptick we are seeing now is the code having had some successes for some of those toxic assets and NPLs but that it has not been as successful as hoped in completely solving the issue.
To both you and Milan above, if the economy was sound in principle and the issue was just NPA clean up causing the crunch, then foreign capital should have increased. It's only natural that if investment opportunities exist and there is a domestic credit crunch, foreign investors rush in because they can make great returns. But FDI didn't pick up or rush in. Even when other economies were slowing down during Covid and post covid slow recovery in Western Europe we don't see the uptick in India. More recently it has decreased.
Second, a lot of NPAs was infrastructure. And that should have been the part that slowed down because of the NPA clean up. Not growth of small firms and factories etc. But government financed infrastructure seems to have boomed based on government partnerships and contracts and uncertainty reduced because it is a single party government likely to win another term.
Thanks. This is helpful for clarifying. But an additional two questions then.
The FDI argument I feel only considers bank balance sheets and appetite for lending. But if I recall on the twin balance sheet story the issue is also that corporate balance sheets are stressed and so they are unwilling to invest in new projects. I think there is some evidence showing that corporates over the last decades have been deleveraging, so wouldn't that also explain why FDI would not want to come in? (Unless they were allowed to come in on their own).
You noted that gfcf for Bangladesh has been increasing. But looking at FDI, FDI is larger in India than Bangladesh today and in the boom. Eye balling the figures for India say on WDI, it seems like aside from 2008 which seems like a quirk, the issue is that FDI never really took off in India even in the boom years (at least the level in East and Southeast Asia). So completely agree with you that there is a serious structural issue on India's lackluster performance on FDI but I'm not sure I see it as connected to the slowdown in overall investment.
Can't the slowdown in small firms and factories be explained by the credit crunch at banks? NPAs are in infra but impact on bank lending would affect all sectors if banks have to clean up their books no?
I wish you write more about the connections between the rule of law, public trust in institutions and economic progress over the long term. Your article implies that arbitrary policies erode public trust leading to an adverse impact on GFCF. However, arbitrary policies are a result of poor state of the justice system, lack of independence of institutions, and lack of transparency. These lead to a lack of trust in the rule of law and a just system, eventually impacting economic progress.
I’ll write more about that rule of law connections. But this is not about public trust. My argument is simple, when there is a lot of policy uncertainty individuals will hesitate to invest.
Whatever cautious optimism you showed, one thing is clear , india is not seeing any structural transformation in any way ... & nobody has given any full explanation of that ...
Indian economy is likely to be driven by crony capitalism and premiumisation / gentrification of consumer economy ....and "eliminating" poverty-well on paper.
Indian illiberal political class will deploy tiny transactional micro-schematic personalised welfarism & Lockean-Hayaek-type "policy-liberals" will profess "growth above equity" rebuking Picketty ( never mind, Premabular Values of egalitarianism & myth of trickle down in gentrified economy) ....till , situation becomes combustible with the frustration of lower class with extra-parlimentary uprising...
Till then , Both of this illiberal political class & "policy-liberals" would remain in equilibrium trap...
A few points.
(1) Glass half full or empty? You call the recent rise 5% point rise in the investment ratio "an uptick." One might just as well have called it "a promising rebound," depending on mood and ideological inclination.
(2) You emphasize factors like regulation and policy uncertainty that (while important over the long haul) may not have changed much between the last government and this one, and which therefore cannot explain the fluctuation in investment. Attributing macro-cyclical fluctuations to slow-moving structural factors seems to be a typical category error in "Washington Consensus" type thinking. To the extent the Vodaphone incident caused an exceptional spike in uncertainty, that was, as you say, the work of the previous government.
(3) You mention but do not make enough of the horrible state of the financial sector at the end of the last government. Cleaning up the mass of bad debts took time and seems to have set off a severe credit squeeze. That is the sort of macro-cyclical shock that would provide a plausible explanation for the cycle in investment.
If rule of law is the big problem in India, why is the gross capital formation higher in bangladesh? We have worse rule of law on all possible metrics. Due to the energy crisis of 2021 the central bank banned PRIVATE banks from buying new cars. You Indians can't us when it comes to madness.
I think it's unrealistic for India to achieve rules based capitalism. It's better to go down the deals based capitalism route which was how the rest of Asia industrialised. Although I agree with you that you need radically decentralise power to introduce fiscal constraints and a more competitive deal making environment.
If rule of law is the big problem in India, why is the gross capital formation higher in bangladesh? We have worse rule of law on all possible metrics. Due to the energy crisis of 2021 the central bank banned PRIVATE banks from buying new cars. You Indians can't us when it comes to madness.
I think it's unrealistic for India to achieve rules based capitalism. It's better to go down the deals based capitalism route which was how the rest of Asia industrialised. Although I agree with you that you need radically decentralise power to introduce fiscal constraints and a more competitive deal making environment.
Hi Shruti, The Finance Minister Nirmala Sitharaman recently posted on Twitter about how Capital expenditure was increased manifold during the Modi tenure. Can you please go through it and highlight to us how those numbers seem positive and in complete contrast to your analysis? It would be really helpful for laymen like us to make sense of the numbers and also understand the narrative around them.
Echoing Milan's third point above, do you not buy (did not see it mentioned much) the general narrative that a huge part of the slowdown in investment is due to the "twin balance sheet problem" caused by toxic assets on bank and corporate balance sheets (due to over optimistic or fraudulent lending for projects pre-GFC) which has been taking time to unwind even after the new bankruptcy code was passed?
I have seen some argument that some of the uptick we are seeing now is the code having had some successes for some of those toxic assets and NPLs but that it has not been as successful as hoped in completely solving the issue.
To both you and Milan above, if the economy was sound in principle and the issue was just NPA clean up causing the crunch, then foreign capital should have increased. It's only natural that if investment opportunities exist and there is a domestic credit crunch, foreign investors rush in because they can make great returns. But FDI didn't pick up or rush in. Even when other economies were slowing down during Covid and post covid slow recovery in Western Europe we don't see the uptick in India. More recently it has decreased.
Second, a lot of NPAs was infrastructure. And that should have been the part that slowed down because of the NPA clean up. Not growth of small firms and factories etc. But government financed infrastructure seems to have boomed based on government partnerships and contracts and uncertainty reduced because it is a single party government likely to win another term.
Thanks. This is helpful for clarifying. But an additional two questions then.
The FDI argument I feel only considers bank balance sheets and appetite for lending. But if I recall on the twin balance sheet story the issue is also that corporate balance sheets are stressed and so they are unwilling to invest in new projects. I think there is some evidence showing that corporates over the last decades have been deleveraging, so wouldn't that also explain why FDI would not want to come in? (Unless they were allowed to come in on their own).
You noted that gfcf for Bangladesh has been increasing. But looking at FDI, FDI is larger in India than Bangladesh today and in the boom. Eye balling the figures for India say on WDI, it seems like aside from 2008 which seems like a quirk, the issue is that FDI never really took off in India even in the boom years (at least the level in East and Southeast Asia). So completely agree with you that there is a serious structural issue on India's lackluster performance on FDI but I'm not sure I see it as connected to the slowdown in overall investment.
Can't the slowdown in small firms and factories be explained by the credit crunch at banks? NPAs are in infra but impact on bank lending would affect all sectors if banks have to clean up their books no?
I wish you write more about the connections between the rule of law, public trust in institutions and economic progress over the long term. Your article implies that arbitrary policies erode public trust leading to an adverse impact on GFCF. However, arbitrary policies are a result of poor state of the justice system, lack of independence of institutions, and lack of transparency. These lead to a lack of trust in the rule of law and a just system, eventually impacting economic progress.
I’ll write more about that rule of law connections. But this is not about public trust. My argument is simple, when there is a lot of policy uncertainty individuals will hesitate to invest.
Whatever cautious optimism you showed, one thing is clear , india is not seeing any structural transformation in any way ... & nobody has given any full explanation of that ...
Indian economy is likely to be driven by crony capitalism and premiumisation / gentrification of consumer economy ....and "eliminating" poverty-well on paper.
Indian illiberal political class will deploy tiny transactional micro-schematic personalised welfarism & Lockean-Hayaek-type "policy-liberals" will profess "growth above equity" rebuking Picketty ( never mind, Premabular Values of egalitarianism & myth of trickle down in gentrified economy) ....till , situation becomes combustible with the frustration of lower class with extra-parlimentary uprising...
Till then , Both of this illiberal political class & "policy-liberals" would remain in equilibrium trap...