Financing economic growth: India must rise to the challenge

Apart from human capital, which we have in abundance, the country will also need to ensure that it has the required financial capital needed to grow at a real rate of 7%-7.5% per annum to reach this goal.

Many sectors of the economy will require high levels of capital during this period. The investment requirements of the National Infrastructure Pipeline (NIP) alone are estimated to be $1.3 trillion.

The Economic Survey estimates that our energy transition journey will need $250 billion annually till 2047. MSMEs will require $1.5 trillion to scale up and achieve a digital transformation, of which only a fraction is available from the formal sector.

The chief economic advisor estimates that India’s gross fixed capital formation needs to go up from the current 28% of GDP to at least 35% on a sustained basis.

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Much of the recent years’ economic growth has been powered by increased capital expenditure by both the Union and state governments; combined, it has risen from 3.6% of GDP in 2019-20 to 5.6% in 2023-24. Much of this capital spending has been on infrastructure—budgetary support accounts for 40-45% of total infrastructure spending.

However, given the need for fiscal consolidation of government finances, there is limited room for expanding public investment at such a large scale. The private sector will need to play a bigger role in the future.

Raise the share of private investments: Public-private partnerships (PPPs), divestments and policy nudges that incentivize private investment, especially in manufacturing, can lead to significant benefits. Indian corporates have strong balance sheets.

Their debt-equity ratio has reduced from 1.2% to 0.9%, while equity fund raising has risen. Equity funds raised via initial public offers (IPOs), qualified institutional placements (QIPs) and rights issues surpassed the ₹3 trillion mark in 2024, a 64% jump from ₹1.88 trillion in 2021.

While corporate India is well positioned for the next capex cycle and there are also signs of capital expenditure picking up, the question is whether this pool of capital available is enough, or would it need to be supplemented?

We need foreign capital plus domestic investments: India’s growth over the last 30 years has largely been funded by domestic savings, the bulk of which comes from what households save. However, overall household savings have declined from pre-pandemic levels of some 20% of GDP to about 18% of GDP.

People are investing more in physical assets and taking on more debt. With a large part of savings being used to fund fiscal deficits, there is less available for private investments.

Thus far, overseas financing has had a limited role. Foreign direct investment (FDI) in India has been stagnant at around $70-85 billion. Similarly, private equity (PE) and venture capital (VC) investments have stayed at around $50-55 billion.

Given the strong interest among foreign investors in the India story, much can be done to turn intent into action. Measures such as further improvement in the ease of doing business, better contract enforcement, better-targeted marketing of opportunities in the country and greater clarity on long-term import tariffs can attract higher FDI.

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Deepen India’s corporate bond market: Debt funding is another avenue that can play a larger role in meeting India’s capital requirements.

The market for corporate bonds—at present largely driven by commercial banks and non-bank finance companies that fund only a handful of companies—has been growing, but is far below the level in advanced economies.

In India, this market represents about 16% of GDP against the global average of over 40%.

A deeper corporate bond market could help finance both private infrastructure development and capital-intensive manufacturing. Its potential can be unleashed by making available high credit-quality paper on the demand side and a larger pool of investors on the supply side.

Review norms for insurance and pension funds: Greater participation by global funds like insurance and pension players can help scale up India’s bond market. However, attracting them would require a review of investment norms.

In the US, pension funds typically invest 40-50% of their corpus in equity markets, 20-30% in bonds, 10-15% in PE and the balance in VCs, real estate, etc. In contrast, life insurance funds in India are required to invest a minimum of 50% of their corpus in Union and state government securities.

Under the National Pension System, people above the age of 55 need to have 75% of their allocation in government securities. Insurance and pension funds in India could be allowed to deploy greater capital in other assets, especially corporate bonds that offer consistent long-term returns.

Higher allocation to public markets and to PE or VC funds could draw greater capital to different types of financing and deliver better returns to investors.

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Historically, Indian policymaking has kept a prudent watch on the level of foreign debt capital flowing in. The country’s foreign exchange reserve position is comfortable and its current account deficit is in structural decline, thanks to rising remittances and service exports.

This gives us the confidence that India’s capacity to absorb foreign capital would be higher in the future.

A long-term capex cycle is needed to keep India’s economic growth in the fast lane. It is therefore crucial to implement policy measures that facilitate more private investments, FDI inflows and a better developed corporate bond market with insurance and pension funds as participants.

The author is chairman and CEO, EY India