Investments must stand before they can run

Key flank of India's growth gambit runs into the knock-on effects of the Russia-Ukraine war

India’s economic recovery next fiscal was pinning its hopes on a jump-start in investments. But the Russia-Ukraine conflict has messed with this plan.

The third Covid-19 wave had barely subsided, when the war erupted. That has spooked crude and commodity prices globally and brought in tow a host of new uncertainties for all. 

India is now looking at possibly lower growth, higher inflation, reduced leverage with fiscal and monetary policy, and lower opportunities for trade. 

A protracted conflict will spell a prolonged impact, and there’s no predicting how disruptive. 

While we retain our gross domestic product (GDP) growth forecast at 7.8 per cent for fiscal 2023 for now —on the premise that any potential upside of an early end to the mild third wave will be offset by the effects of the war — the risks to growth are firmly tilted to the downside.

Further, underneath this headline projection, the calculus is shifting.

Private consumption, the biggest demand-side driver of India’s GDP growth, remains subdued. 

Its growth trailed overall GDP growth this fiscal and its share in GDP (in real terms) marginally declined to 56.6 per cent from the pre-pandemic share of 56.9 per cent (that was already falling).

With trade looking iffy and consumption muted, recovery next fiscal critically hinges on investment revival. 

That, in turn, mainly implies government investment support, as private investment recovery is falling behind. 

Illustration by Binay Sinha

But rising crude and commodity prices are bound to bloat the subsidy bill of the government. This could result in cost overruns for infrastructure projects in the coming fiscal, for which these are crucial inputs.

To be sure, private sector investment could get a leg up from the production-linked incentive (PLI) scheme and the deleveraged balance sheets of corporates. But rising uncertainty and slack in the economy will hold back the animal spirits. 

And even if government capex goes according to plans, does it have the heft to turn around the investment cycle? 

The government sector (Centre and states combined) comprises one of the smallest investment components in the economy (see chart). Only in the past few years have government investments marginally exceeded that of the public sector enterprises. 

Despite it throwing its weight behind capex (4.2 per cent of GDP in fiscal 2021 from 3.5 per cent annually, on an average, in the preceding decade), overall investments in the economy still fell (to 26.6 per cent from 28.6 per cent in fiscal 2020). 

This goes to show that government investments alone cannot move the needle. 

There are two more reasons to be only cautiously optimistic.

The government’s capex push is premised on an ambitious Rs 111 trillion National Infrastructure Pipeline (NIP) programme over fiscal years 2020 to 2025. This is supposed to be split between the Centre, states and private sector in the ratio 39 per cent, 39 per cent and 22 per cent, respectively. 

This means, the governments (Centre and states) must spend Rs 87 trillion by fiscal 2025. 

In about three fiscal years, that is between April 2019 and January 2022, government (Centre and states combined) capex totalled Rs 25 trillion. 

Even if all of that is assumed to be spent on infrastructure creation, it will have to be stepped up significantly in the remaining time period (that is, Rs 62 trillion till fiscal 2025). 

This is a tall order, given the high lead times associated with infrastructure creation. Previously, it took the government 12 years (fiscal 2008-19) to spend Rs 55 trillion on infrastructure creation.

Moreover, state governments, which typically undertake two-thirds of the government capex, have been undershooting their budgeted capex targets in the last few years. 

Sticking to the committed spending on investments is further complicated next fiscal, now with the Russia-Ukraine conflict possibly forcing the government to reshuffle expenditure in favour of revenue spending due to the rising subsidy bill. 

Even if the government manages to pull that off, a decisive lift in the investment cycle will ultimately depend on how quickly investments by the private corporate sector and households rebound —both of which had significantly slowed in fiscal 2021. 

The current war has only accentuated the risks to private capex, already existent as pointed out by the Reserve Bank of India (RBI) in its outlook on private corporate investment (September 2021).

The PLI scheme has the potential to add some momentum in pockets, but it remains to be seen how much manifests on the ground.

The household sector (the largest investor in the economy) includes the unorganised sector, which has arguably been the hardest hit by the pandemic. Therefore, its potential to push investments, too, appears constrained. With two key drivers of investments dragging, we cannot not expect miracles on this front.   

There is one last potential risk worth monitoring with regard to financing of investments. In the national accounting framework, gross investments (or gross capital formation) is financed by domestic gross savings and net capital flow from the rest of the world (RoW). Not only have savings declined, there has also been a net outflow of capital in fiscal 2021, leading to a double whammy for investments. With consumption demand slowly trickling back, savings are likely to remain sticky. At the same time, withdrawal of easy monetary policies in key advanced economies and the geopolitical tensions could mean capital inflow from RoW will also remain subdued.

Net-net, investment revival is cornered on many sides and government heavy-lifting remains the only real chance for a breakout in 2022-23.  

 The writers are with CRISIL. The views are personal