Despite the robust investment numbers for the September quarter, the drying up of external funding has already started to take a toll on domestic investment. It’s true that India has, in the past few years, seen an impressive improvement in its savings rate and rate of capital formation. The gross savings rate rose from 23.5% of gross domestic product (GDP) at market prices in FY02 to 36.2% in FY08. Similarly, gross capital formation went up from 22.8% of GDP at market prices in FY02 to 37.4% in FY08.
In July, the Prime Minister’s economic advisory council had said that the domestic savings rate would decline to 34.5% in FY09 because of increased subsidies which would erode government savings and on account of lower corporate profits that would slow corporate savings. The investment rate, however, was expected to remain at a high 37.5%, the shortfall resulting in a higher current account deficit.
But with the appearance of the credit crunch in India, analysts are taking a relook at these estimates. They point out that much of the rise in capital formation was the result of the surge in capital inflows that was the direct result of the global credit bubble.
Also See Foreign Funding (Graphic)
A recent Citigroup Inc. report says that net inflows in the capital account were equal to 24.6% of gross capital formation in FY08. Citi analysts write: “What does all this mean? Simplistically, large capital inflows have meaningfully supplemented domestic savings and effectively bumped up India’s investment and growth momentum. We believe such capital inflows, if reduced or negative, would have implications for investment-driven growth.”
Merrill Lynch and Co., Inc. analysts have estimated that the gap between corporate savings and investment was 7% of GDP in FY08. Of this gap, 3.7% was contributed by bank credit, the rest coming from external commercial borrowings and the capital market. The drying up of other sources of funds will hurt corporate investment.
But will the savings and investment rate go back to where they were in the early 2000s? FY08 was rather exceptional, because of very strong net capital inflows. In FY07, for instance, foreign capital inflows were 13.8% of gross domestic capital formation and in FY06 they amounted to 9.1%. That’s almost the same as in FY2000, when capital inflows were 8.7% of gross domestic capital formation.
So what is the likely extent of the slowdown? A note by Centrum Broking says: “Following a prolonged expansionary phase, spreading over 2003-2008, we expect the investment rate (gross domestic capital formation or GDCF/GDP, both in nominal terms) to realign with the falling savings rate (nominal savings/GDP). We now expect savings rate to fall marginally below 30% by FY10 from 38% in FY08 (estimated). The realignment of investment rate will be stronger due to lack of external capital flows. Hence, we now expect investment rate to gradually decline to 33% from our earlier estimate of 35% (39% actual in FY08).”
Note, however, that’s still well above the rates of growth of capital formation during the last downturn.
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