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Context

• Private investment, as measured by private Gross Fixed Capital Formation (GFCF) as a percentage of GDP, has been declining since 2011-12.

• Government initiatives, such as corporate tax cuts in 2019, aimed to encourage private investment.

GFCF and its Significance:

Gross fixed capital formation (GFCF) comprises fixed asset acquisitions minus disposals by resident producers.

Fixed assets are tangible or intangible assets from production processes that are used repeatedly and continuously in other production processes for at least one year.

• GFCF reflects the growth in fixed capital, including buildings and machinery.
• It indicates the private sector's willingness to invest and impacts economic growth and living standards.
• Developed economies have more fixed capital per capita than developing economies like India.

Trend in Private Investment:

• Private investment picked up significantly after economic reforms in the late-1980s and early-1990s.
• Public investment exceeded private investment in the early 1980s but dropped post-liberalization.
• Private investment peaked at around 27% of GDP in 2007-08 but dropped to 19.6% in 2020-21.

Reasons for the Decline:

• Some economists attribute the decline to low private consumption expenditure, suggesting that boosting consumption could stimulate investment.
• However, historical data shows that an increase in private consumption has not always led to higher private investment in India.

Possible Causes for the Decline:

• Structural problems and policy uncertainty may be core reasons for the decline.
• Economic reforms correlated with a rise in private investment, while a slowdown in reforms correlated with a decline. 

Impact of Low Private Investment:

• Slower economic growth due to a smaller fixed capital base.
• Concerns that government investment, while compensatory, could crowd out private investment.
• Private investors are considered better allocators of capital, helping to avoid wasteful spending.
• Taxes imposed to fund public spending can be a drag on the economy.

Achieving Sustainable GDP Growth in India

Investment Rate Requirement

Private Investment Revival:

• Revive private investment to over 25-30% of GDP.
• Encourage large Indian corporations to ramp up investment. 

Public Investment:

• Increase public investment to around 14-15% of GDP.
• Total investment rate target of over 40-45% of GDP for the next twenty years.

Drivers of Private Investment

1. Public Investment Impact:
• Critical for building public capital.
• Acts as a catalyst for attracting private investment.
2. Real Exchange Rate:
• Competitive level crucial for investment.
• A 10% real depreciation could add almost 0.3% points to GDP growth.
3. Credit Availability:
• Growth in credit to private sector must rise above 10% of GDP.
• Large fiscal deficits crowd out credit; NPL problems in banking system constrain credit growth.

Role of Public Investment

Increase and Allocation:

• Increase public investment by around 5% of GDP.
• Focus on investment by state and central governments, not just public sector undertakings.

Credit to Private Sector

Growth Requirement:

• Growth in credit to private sector must rise above 10% of GDP.
• NPL problems in banking system must be addressed to facilitate credit growth.

Impact on Growth:

• India's growth rate could increase by around 1.7% of GDP with 10% credit growth and by almost 2.2% points with 15% credit growth.

Policy Recommendations

Comprehensive Approach:

• Increase public investment to 14-15% of GDP.
• Depreciate real exchange rate by at least 10%.
• Increase growth of credit to over 10% of GDP.

Emulating Success Stories:

• Follow the policy package of fast-growing countries like China over a 20-30 year period.
• Focus on sustained investment, competitive exchange rates, and credit growth.

Conclusion

• In conclusion, the decline in private investment in India is a complex issue with multiple underlying factors.
• Addressing this challenge requires a combination of measures to stimulate private consumption, reduce policy uncertainty, and tackle structural issues within the economy.
• A conducive policy environment that fosters private sector confidence and investment is essential for promoting sustainable economic growth and development in India.

Gross Fixed Capital Formation (GFCF) Gross Fixed Capital Formation (GFCF) is a crucial component of a country's expenditure on Gross Domestic Product (GDP). It represents the portion of the new value added in an economy that is invested rather than consumed. GFCF measures the value of acquisitions of new or existing fixed assets by the business sector, governments, and households (excluding their unincorporated enterprises), minus disposals of fixed assets.GFCF is termed "gross" because it does not deduct the consumption of fixed capital (depreciation of fixed assets) from investment figures. It is essential for analyzing the development of the productive capital stock, as it measures the value of acquisitions less disposals of fixed assets beyond replacement for obsolescence due to wear and tear. "Net fixed investment," which includes depreciation, is called net fixed capital formation. However, GFCF does not encompass total investment, as it only measures the value of net additions to fixed assets, excluding financial assets and stocks of inventories. Land sales and purchases are also excluded, as the total amount of land does not increase with sales. The measure applies to the resident enterprises of a national territory, ensuring that any new fixed investment associated with enterprises resident in the territory is included. GFCF is a flow value measured by the total value of acquisitions, less disposals of fixed assets, during an accounting period. Fixed assets are acquired through various means, including purchases, barter trade, and financial leases. Disposals of fixed assets exclude consumption of fixed capital and exceptional losses. In summary, GFCF is a critical measure in national accounts, reflecting investment in fixed assets by enterprises, government, and households. Understanding GFCF is crucial for analyzing economic growth, investment patterns, and business activity.

SOURCE: THE HINDU

PRACTICE QUESTION Q. Discuss the significance of private investment in India for achieving sustained economic growth. What are the key factors influencing private investment, and how can policy measures be designed to stimulate private investment in the country?