Amid the more popular concerns about high inflation and deteriorating public finances, one important question has been relatively neglected in recent months: Is India stumbling towards an investment drought?
New data on economic output in the fourth quarter of the previous fiscal year adds to the fears that have been voiced in recent months. Monthly data on machinery production over the past 12 months seemed to provide some advance warnings that investment activity was weak. However, the data was so volatile that some economists saw it as an indication of bad statistics rather than an actual problem on the ground. The capital goods component of the index of industrial production in FY11 had a standard deviation that was seven times greater than the same measure of volatility in the overall index. It is difficult to read an underlying trend when the data is bouncing around with such abandon.
The new GDP numbers released on Tuesday show that investment activity grew at a feeble 0.4% in the fourth quarter compared with the same period in the previous fiscal. Even though there are glimmers of hope from seasonally adjusted data, there are now even stronger reasons to believe that investment growth continues to weaken in an economy that could soon face capacity constraints. In fact, the economy is being held up by growth in consumption and net exports.
The correct response to this is not a less-tight monetary policy in Mumbai, but more policy reforms in New Delhi. Corporate investment is being held back because of a clouding of the investment climate as well as the inability of the Manmohan Singh government to move on important policy issues such as tax reform and access to land for new factories. The Reserve Bank of India has a big fight against inflation on its hands, and it would be best that it is not distracted from that fight. Getting investments back on track should be the concern of the government right now.
Measured as a percentage of GDP, investments have not clawed back to the highs we saw in the quarters before the financial crisis of 2008. Such weak investment activity carries two risks. The immediate risk is that supply rigidities at a time of strong consumer demand will lead to more inflation. The longer-term risk is that the lack of fresh capacity will hurt our growth trajectory in the coming years. Citi economist Rohini Malkani estimates that GDP growth in FY12 could slow to 7.2% in case we do not see an investment recovery in the second half of this fiscal.
In short, India needs far more robust investment action at this stage of its business cycle.
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