Rekindling corporate investment

To achieve the levels seen in 2008, it is essential to increase corporate productivity

Like farmers gazing at the horizon waiting and praying for the monsoon to arrive, everyone is eagerly waiting for the revival of the corporate capex cycle to accelerate India’s economic growth, which has been in a slowdown mode since 2012. Corporate investment (as a percentage of gross domestic product, or GDP) was 11 per cent in 2022, which is 6 percentage points lower than its peak of 17 per cent achieved in 2008.

What is most baffling is that it has been hovering in this 11-13 per cent range for the last decade or so, despite significant improvements in almost all enabling factors — profitability, non-performing assets (NPA) of the banking system, and corporate indebtedness — over the last five years, making the time ripe for corporations to start investing again. For example, corporate profitability increased to 7 per cent in 2022, compared to an average of 3 per cent between 2015 and 2020. Likewise, NPAs of the banking system were at 4 per cent in March 2023, compared to 11 per cent a couple of years ago. So, what explains the low corporate investment?

A core part of the answer lies in the scale of the corporate sector in India’s national economy. We argue in our paper, “India’s New Growth Recipe: Globally Competitive Large Firms”, that corporate investment (as a percentage of GDP) is a function of two independent factors — how much corporations invest as a share of their sales, and how big corporate sales are as a share of the national economy. The first one is cyclical in nature, while the latter is structural. It is noteworthy that both these factors contributed significantly to the rising corporate investment share between 2004 and 2012.

Analysing the national accounts data for investment over the last 25 years, we find that on an average corporations invest about 15 per cent of their overall sales, and this ratio was 14 per cent for 2022. Thus, as a share of their own sales, companies are not significantly holding back on investments. This probably explains why capacity utilisation is not shooting through the roof and has averaged at 73 percent between 2014 and 2020, despite the usual qualm of corporations not investing. Consequently, one key reason why corporate investment is still significantly lower than its peak must be because corporations are a much smaller share of the national economy today —  corporate sales account for a 12 per cent smaller share of India’s GDP today, compared to its peak of 88 per cent around a decade ago.

Bringing corporate investment back to its peak level on a steady basis, thus, necessitates increasing its share in the economy. The share is essentially driven by how productive corporations are in the domestic economy and the global arena. Let’s analyse these one at a time.

In terms of labour productivity, Indian corporations are seven to eight times more productive than their MSME counterparts in industry and around four times more productive in services. And this has remained at these relative levels since 1991. Given this significant edge in productivity, when corporations were allowed a level playing field at the beginning of 1991 through delicensing, de-reservation and trade liberalisation, their share increased from 52 per cent in 1995 to 82 per cent by 2012. For example, the metal industry was de-reserved between 2002 and 2006, which led to the share of large corporations in the industry increasing from 40 per cent to 52 per cent. It then remained constant until about 2012 and has declined since then to 40 per cent in 2020. This broad pattern remains the same for a couple of other industries that we looked at, such as the automotive sector. The decline in corporate share over the last 5-10 years is the result of a number of large firms that have gone bankrupt resulting in NPAs. As NPAs have bottomed out, we may see corporate output rising a bit to regain its lost share.   

On the export side also, something similar has happened. Corporations account for 55 to 60 per cent of India’s overall exports, and hence, their competitiveness is key to how much India is able to export to the world markets. One way to gauge the competitiveness of our exports is by looking at our export-multiple, i.e. the growth rate of India’s exports over the growth rate of world exports. Before the 1991 reforms, this ratio was almost unity. It jumped to 2 following the 1991 reforms. As a result, our share in global trade went up from 0.5 per cent in 1991 to 2.1 per cent in 2020. However, this export-multiple has remained static at 2 for the last couple of decades, indicating that while we are more competitive globally than we were before the reforms, that competitiveness has not increased over time, resulting in a rather tepid increase in India’s share of global trade.   

By inferring that low corporate investment is singularly attributable to corporations not investing, the debate has completely overlooked the structural component of the size of corporations in India’s economy, and its impact on their investment. As the Indian economy emerges from the NPA challenge, we expect to see some organic improvement in corporations’ share in GDP over time. However, it may not be enough to take corporate investment back to the level observed around 2008. Regaining that peak requires reforms that improve the competitiveness of India’s corporations and make them globally competitive, so that they become a bigger part of the economy.

This improved competitiveness will also incentivise corporations to invest a larger share of their revenues so that they can tap into the external markets far more than what they have managed so far, thus moving up the business cycle component as well.

The writers are, respectively, COO and senior fellow, and research associate at the Centre for Social and Economic Progress. The views are personal