The influential council of economists advising the prime minister released its economic review of the current fiscal year on Wednesday. A close reading of the document suggests that the key reason for the loss of economic momentum in recent quarters is the clouding of the investment climate, and especially the cautious mood in corporate boardrooms.
“The entire slowing down of fixed capital formation in the post-crisis period has flowed from the private corporate sector, offset to an extent by investments made by households, including unincorporated businesses,” says the economists’ council that is headed by former Reserve Bank of India governor C. Rangarajan.
Take a look at the data. Gross domestic fixed capital formation peaked before the financial crisis, and has been falling since then. It is also worth remembering that previous economic booms --- in the mid-1990s and the mid-2000s --- were accompanied by strong investment activity by private sector companies.
Reviving investment activity is a complicated task, yet one that needs full policy attention because it is central to the goal of accelerating growth. Underlying the fall in investment activity is the decline in the domestic savings rate, led by the deterioration in the fiscal health of the government, and a sharp fall in the surpluses of public sector companies and the railways. In short, a large part of the blame for the fall in the national savings rate should be placed at the door of the government, even though the savings rate of the private sector has also fallen by 1.4 percentage points from its peak.
Getting savings back on track will require credible fiscal correction by the government, rather than just an ambitious target that nobody believes in. One clear option is a new fiscal responsibility law. It is almost sure now that the fiscal deficit target for the current year will be missed, perhaps by as much as one percentage of GDP. The mismanagement of the railways in recent years is also hurting.
Higher savings will not necessarily lead to higher investment in fixed assets unless concrete steps are taken to improve the investment climate, which means a fresh round of reforms as well as sorting out issues such as land acquisition and access to stable power supply to new factories.
None of this will be easy, especially for a government that has shown little commitment to economic reforms since 2004. The next 18 months are a window of opportunity before the political system moves into election mode ahead of the 2014 Lok Sabha campaign.
More procrastination will only increase the chances that the slowdown in economic activity becomes structural, an unfortunate result for a country that dreamt of double-digit growth not too long ago.
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